On March 8, 2018, Judge Block of the EDNY issued a decision in Illinois Union Ins. Co. v. US Bus Charter & Limo Inc., Case No. 1:16-cv-06602-FB-RLM, holding that indemnification rights under a liability policy survived a class action settlement in which the insured consented to a $50 million judgment against it, subject to a covenant not to execute the judgment against the insured’s assets. The insured in Illinois Union had sought defense and indemnity coverage under a liability policy for a putative class action in which it was accused of sending unsolicited text messages advertising bus charters. After the liability carrier denied coverage, the insured proceeded to settle the claim, consenting to the entry of a $50 million judgment against it, subject to a covenant that the judgment could not be “executed on any assets or property” of the insured. Instead, the insured assigned its indemnification rights under the policy to the plaintiff class, leaving it to the plaintiff to litigate the coverage issue and attempt to satisfy the judgment through the insured’s policy.
Seeking to sidestep liability for the judgment, the insurer brought a declaratory judgment action, arguing, inter alia, that the plaintiff’s covenant not to execute the judgment against the insured’s assets vitiated any indemnification rights under the policy, since the insured was no longer “legally obligated to pay” the judgment. (Under a standard policy provision, coverage was limited to amounts the insured is “legally obligated to pay as Damages and Claim Expenses.”) Judge Block disagreed, and granted partial summary judgment to the insured on the issue of coverage, explaining:
The New York Court of Appeals has not addressed whether an insured’s legal obligation to pay survives an assignment to a third party in exchange for a covenant not to execute against the insured. This Court therefore must predict how the New York Court of Appeals would rule by considering the rulings of other state courts and those of intermediate New York courts. . . .
As another judge in this court recently observed, intermediate New York courts have held that an insured remains “legally obligated to pay” despite an assignment of indemnification rights and a covenant not to execute a judgment, so long as the settlement agreement does not include a release of liability. See Intelligent Digital Sys., LLC v. Beazley Ins. Co., Inc., 207 F. Supp. 3d 242, 246 (E.D.N.Y. 2016) (citing Home Depot U.S.A., Inc. v. Nat’l Fire & Marine Ins. Co., 866 N.Y.S.2d 255, 258 (2d Dep’t 2008); Westchester Fire Ins. Co. v. Utica First Ins. Co., 839 N.Y.S.2d 91, 94 (2d Dep’t 2007)). Illinois Union cites no contrary New York state court authority.
Moreover, a majority of courts in other jurisdictions holds that coverage exists in such a scenario. See Intelligent Digital Sys., 207 F. Supp. 3d at 246 (collecting cases) (“New York courts and a majority of courts in other jurisdictions have held that an insurance company remains ‘legally obligated’ to pay a claim under a policy even where, as here, the claim was assigned to a third party, and the third party agreed not to execute a judgment against the insured’s personal assets.”); see also Justin A. Harris, Judicial Approaches to Stipulated Judgments, Assignments of Rights, and Covenants Not to Execute in Insurance Litigation Approaches to Stipulated Judgments, Assignments of Rights, and Covenants Not to Execute in Insurance Litigation, 47 Drake L. Rev. 853, 857-58 & n.22 (1999) (acknowledging majority rule). Given that New York intermediate courts are in agreement with the majority rule, the Court concludes that the New York Court of Appeals would find that an insured remains “legally obligated to pay” despite an assignment of indemnification rights to a third party and the third party’s covenant not to execute against the insured.
This decision illustrates one risk an insurance carrier takes in disclaiming its duty to defend – it loses control of the defense, and can find itself on the hook for a settlement to which it might not have consented had it been at the settlement table. The insurer can mitigate that risk somewhat by bringing a preemptive declaratory judgment action early on, so that the issue of defense coverage is resolved at an early stage of the underlying litigation. But that course of action has another downside for the insurer – fee-shifting. Ordinarily, an insured that prevails in a declaratory judgment action is not entitled to recover legal fees incurred in the lawsuit against the insurance carrier; rather, each side bears its own costs. However, the New York Court of Appeals has recognized an exception to the so-called “American Rule” on fee-shifting, permitting an insured to recover attorneys’ fees when it prevails in a declaratory judgment action commenced by the insurer. See Mighty Midgets v. Centennial Ins. Co., 47 N.Y.2d 12, 21 (1979).