Posted: November 23, 2020

Federal Court Stays Coverage Action Where Insurer’s Duty to Defend and Indemnify Is Contingent on Facts at Issue In Underlying State Court Action

Posted by Bradley J. Nash, Litigation Partner

On October 22, 2020, Judge Román of the SDNY issued a decision in U.S. Specialty Ins. Co. v. Village of Chester, Case No. 19-cv-467(NSR), staying an insurer’s declaratory judgment action pending the resolution of a parallel state court action that would determine the factual issues underlying the coverage dispute.

The Village of Chester sought liability coverage for a lawsuit by a developer who alleged that the City had improperly interfered with the planned construction of a multifamily residential development.  At issue in the underlying litigation was the enforceability of stipulations the village signed in earlier CPLR Article 78 proceedings to permit the development project to go forward.  The Village lost at trial, and a $3 million judgment was entered against it, but it appealed that ruling.

The insurer (U.S. Specialty) disclaimed coverage and filed a declaratory judgment action in federal court, arguing that (1) coverage was excluded under an “Assumption of Liability Exclusion” because the Village “assumed liability for a breach of contract” when it entered into the stipulations; and (2) the loss “is uninsurable under New York law because it arises from a breach of contract and of the implied covenant of good faith and fair dealing.”

The insured filed a motion to dismiss or stay the coverage action under the so-called Wilton/Brillhart Abstention doctrine because issues to be determined in the state court appeal – e.g., “whether the Village can legally contract away its legislative power via the Stipulations – would be determinative of the coverage issue.

Judge Román granted the insured’s motion and stayed the coverage action, explaining:

A court has the discretion to stay or dismiss actions seeking declaratory relief where the questions in controversy between the parties to the federal suit can be better settled in a proceeding pending in the state court.  This form of abstention is called “Wilton/Brillhart” abstention after two Supreme Court opinions.

Wilton/Brillhart abstention is routinely invoked in insurance coverage actions where the insurance company is also a party to the state lawsuit.  However, courts in this district have invoked abstention where the insurer is not a party to the underlying lawsuit in cases that “represent the atypical case where the duty to defend is contingent on a factual issue squarely raised in the state court proceeding.” In these cases where the ultimate factual issues are the same and the issues can be better settled in the state-court action, courts invoke Wilton/Brillhart abstention.  Brillhart v. Excess Ins. Co. of America, 316 U.S. 491 (1942); Wilton v. Seven Falls Co., 515 U.S. 277 (1995). . . .

Wilton/Brillhart abstention does not require all parties to the federal action to be parties to the state action. Instead, it merely requires that the legal and factual issues overlap significantly.

*          *          *

Defendants argue Wilton/Brillhart abstention warrants a stay or dismissal of Plaintiff’s claims. This argument is premised on Defendants’ assertion that this case and the Underlying Action address the same ultimate issues.  The Court agrees. . . .  This is the exact “atypical” situation . . . where the Court’s determination of a duty to defend or indemnify is contingent on factual findings made in the state case.

An analysis of the relevant factors further confirms that declaratory judgment is not appropriate at this time. While a declaratory judgment will settle Plaintiff’s liability, it will not finalize the underlying controversy. More importantly, a judgment would undoubtedly increase friction between sovereign legal systems and improperly encroach on the domain of a state court.  The factual issues the Court would need to resolve to provide the declaratory relief requested by the Plaintiff mirror those currently being considered by the state. Thus, to make such factual determinations would be duplicative. It would also produce a bizarre result if the Court made a factual finding that later conflicted with the findings in the state case. The scope of the pending state proceeding and the defenses available to Defendants are very similar. In both cases, the validity of the contract and a challenge to the loss sustained are key defenses. Finally, the pending state case also predates this action significantly, has included extensive discovery, and has gone to trial. Although, admittedly, there are some factors that weigh against abstention, such as the fact that Plaintiff is not party to the Underlying Action, the Court believes abstention is warranted.

(Some citations omitted).

Although this decision relied on a federal abstention doctrine, the New York state courts have likewise stayed or dismissed coverage actions that raise issues to be determined in the underlying litigation.  For example, in Freedom Specialty Ins. Co. v. Platinum Mgt. (NY), LLC, 2017 NY Slip Op 32728(U) (Sup. Ct. N.Y. Co. Dec. 21, 2017), a case covered on this blog where I represented the insured, Justice Sherwood of the New York County Commercial Division stayed discovery in a coverage action and ordered the insurers to advance defense costs, pending the resolution of an underlying criminal prosecution.  See also National Union First Ins. Co. v. Xerox Corp., 6 Misc. 3d 763, 776 (Sup. Ct. N.Y. Co. 2004) (dismissing insurer’s declaratory judgment action where facts relevant to coverage defenses “will likely be fully determined in the context of the various securities actions”); Nationwide Mutual Ins. Co. v. Dennis, 14 A.D.2d 188, 189 (3d Dep’t 1961) (“the policy in this State has been to deny the [insurer’s] declaratory judgment where the matter in dispute can be determined in the [underlying] action”).

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