On September 17, 2019, Judge Hurd of the NDNY issued a decision in Lohnes v. Liberty Mut. Ins. Co., Case No. 19-cv-00068, dismissing a claim for bad faith claims handling for failure to plead “specific conduct” by the insurer distinct from the underlying breach of the policy.

As previously discussed on this blog (see here, here, and here), New York law does not recognize a separate tort claim for bad faith claims handling.  However, the courts—beginning with a pair of Court of Appeals decisions, Bi-Economy Market, Inc. v. Harleysville Ins. Co. of N.Y., 10 N.Y.3d 187 (2008) and Panasia Estates, Inc. v. Hudson Ins. Co., 10 N.Y.3d 200 (2008)—have permitted insureds to recover consequential damages (above the policy limits) on a theory that the insurer’s bad faith conduct violates the implied covenant of good faith and fair dealing.  (An example would be a property insurer that stalls the claims handling process following a house fire, as a result of which the house collapses, compounding the insured’s damages.)

In Lohnes, the Court concluded that the complaint failed to plead such a claim, explaining:

Under New York law, there is a covenant of good faith and fair dealing implied in all contracts.  This covenant embraces a pledge that neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.  Generally, under New York law, parties to an express contract are bound by an implied duty of good faith, but breach of that duty is merely a breach of the underlying contract.  To successfully plead a breach of contract under a theory of breach of the implied covenant of good faith and fair dealing, a plaintiff must allege that defendant, in bad faith, engaged in behavior that effectually destroyed or injured the plaintiff’s right to receive the fruits of the contract.  Further, plaintiffs are required to plead specific factual allegations of a party’s bad faith, as conclusory allegations of a party’s failure to act in good faith are insufficient.

Because a breach of this duty is merely a breach of the underlying contract, New York law does not recognize a separate cause of action for breach of the implied covenant of good faith and fair dealing when a breach of contract claim, based upon the same facts, is also pled. A breaching party’s bad faith in connection with a breach of contract does not provide an independent basis for recovery.  Thus, a claim premised on a breach of the implied covenant should be dismissed as duplicative if it is based upon the same facts underpinning an express breach of contract claim.

Here, as Plaintiff represents in her memorandum of law, the facts underpinning the bad faith claim are the same as those underpinning her express breach of contract claim. Namely, that Liberty refused to defend and indemnify Mr. Terrance. While Plaintiff asserts that this refusal to comply with the terms of the Policy constituted breaches of Liberty’s duties under the contract and amounted to “bad faith insurance practices,” she has not plead specific conduct by Liberty that is different from that underpinning the breach of contract claim. Further, Plaintiff’s assessment in her memorandum of law that this conduct was deliberate and reckless, and amounted to a gross disregard for the interests of Mr. Terrance, does not make out a claim different from the breach of contract claim.  Accordingly, Liberty’s motion is granted to the extent it seeks to dismiss the bad faith claim asserted in the Amended Complaint.

(Citations omitted).

Pleading rules are a procedural matter, and thus may differ in certain respects in state and federal court.  Notably, however, the First Department ruled earlier this year (in a decision covered on this blog) that an insured need not satisfy a “heightened pleading standard” in alleging consequential damages arising from an insurer’s bad faith claims handling.

On August 27, 2019, Judge Pauley of the SDNY issued a decision in Gemini Ins. Co. v. Titan Construction Servs., Case No. 17-cv-8963, dismissing a declaratory judgment claim as premature because the lability insurer’s duty to indemnify would depend on facts to be developed in the underlying lawsuit against the insured.

Judge Pauley explained:

It has long been well-established that a liability insurer may bring an action for a declaratory judgment against the parties in an underlying lawsuit involving its insured without waiting for the underlying action to proceed to judgment. However, when the duty to indemnify necessarily depends on the resolution of one or more issues to be determined in the action, a declaratory judgment on that duty is premature.

What caused Mejia’s accident and who was responsible have not yet been established in the State Action. And without any such finding, this Court cannot declare whether Gemini will ultimately be obligated to indemnify Titan or Hudson View.

Accordingly, this Court dismisses all parties’ claims for declaratory judgments on the duty to indemnify as premature.

(Citations omitted).

The same principle applies to the duty to advance defense costs.  In a case previously discussed on this blog (in which I represented the insureds), Justice Sherwood of the New York County Commercial Division granted a preliminary injunction, directing three excess D&O insurers to advance defense costs for a criminal matter, and stayed discovery pending the resolution of the underlying prosecution.  Justice Sherwood held that a “declaratory judgment action cannot be used to conduct discovery regarding the very facts at issue in the EDNY Indictment and the SEC Complaint.” 

On August 29, 2019, the California Supreme Court issued a decision in Pitzer College v. Indian Harbor Ins. Co., Case No. S239510, ruling (in response to a certified question from the Ninth Circuit) that New York’s no-prejudice rule—under which a first-party insurer can avoid coverage based on delayed notice without showing prejudice—is contrary to a “fundamental public policy” of California.

Unlike the majority of states, New York common law does not require an insurer to demonstrate prejudice to disclaim coverage based on late notice by the insured.  As previously discussed on this blog, for liability policies “issued or delivered” in New York, after January 17, 2009, a statute (Insurance Law § 3420(a)(5)) imposes a “notice prejudice” rule.  However the common law no-prejudice rule still applies with regard to first-party insurance coverage.

Pitzer College involved an insurance policy issued to a California college, which had a New York choice of law provision.  As the policy was not “issued or delivered” in New York, the statutory “notice prejudice” rule did not apply.  The insured filed a declaratory judgment action for declaratory relief and breach of contract.  Following removal to federal court, the district court granted summary judgment to Indian Harbor on a late notice defense, ruling that the insured failed to establish that California’s notice prejudice rule was a “fundamental policy” that could override a contractual choice of law provision. 

Addressing a certified question from the Ninth Circuit, the California Supreme Court held that the district court was incorrect, explaining:   

[W]e conclude that California’s notice-prejudice rule is a fundamental public policy of California. The rule is based on the rationale that the essential part of the contract is insurance coverage, not the procedure for determining liability, and that the notice requirement serves to protect insurers from prejudice, not  to shield them from their contractual obligations through a technical escape-hatch.  Prejudice is a question of fact on which the insurer has the burden of proof.  The insured’s delay does not itself satisfy the burden of proof.  The insurer establishes actual and substantial prejudice by proving more than delayed or late notice. It must show a substantial likelihood that, with timely notice, and notwithstanding a denial of coverage or reservation of rights, it would have settled the claim for less or taken steps that would have reduced or eliminated the insured’s liability.  In the context of third party coverage, for example, the insurer must show that timely notice would have enabled it to achieve a better result in the underlying third party action.

(Citations omitted).

This decision underscores the importance of notice requirements under New York insurance law.  It goes without saying that you can’t get coverage if you don’t ask for it. Although a statutory notice-prejudice requirement now applies in some cases, delayed notice can still present traps for the unwary.    

On September 10, 2019, Judge Reiss of the WDNY issued a decision in Korn v. Federal Ins. Co., Case No. 1:17-cv-00188, ruling that an insurance carrier providing a defense to the insured in a criminal prosecution had no obligation to “monitor” the fees incurred by defense counsel to ensure that the coverage was not exhausted prior to trial.

In Korn, an insured brought breach of fiduciary duty and breach of contract claims against a liability insurer, alleging that the insurance company failed “to monitor his criminal defense attorneys, audit the legal fees they incurred, and replace counsel when Plaintiff made Defendant aware that the firm was wasting the finances available for coverage,” such that the policy limits were reached with an extensive amount of work left to be done to prepare for trial.

Judge Reiss granted summary judgment to the insurance company on the breach of fiduciary duty claim, explaining:

Generally speaking, a liability insurer may not be held vicariously liable for the lapses of retained counsel exercising independent judgment on behalf of the insured.”  The reasons for this exception are twofold:

First, the duty to defend an insured is by its very nature delegable, as all the parties must know from the outset, for in New York an insurance company is in fact prohibited from the practice of law (Judiciary Law § 495).  Accordingly, the insurer necessarily must rely on independent counsel to conduct the litigation. Second, the paramount interest independent counsel represents is that of the insured, not the insurer. The insurer is precluded from interference with counsel’s independent professional judgments in the conduct of the litigation on behalf of its client.  Vicarious liability thus produces an untenable situation here: on the one hand an insurer is prohibited from itself conducting the litigation or controlling the decisions of the insured’s lawyer, yet on the other hand it is charged with responsibility for the lawyer’s day-to-day independent professional judgments in the “nuts and bolts” of representing its client.

Despite the general rule that an insurer owes no fiduciary duty to the insured, there are instances where a fiduciary relationship springs into existence under circumstances where there is a special relationship of trust and confidence between the parties.  But those instances are the exception rather than the rule.  In general, a contract of insurance does not otherwise create a fiduciary relationship between the parties.  Such a relationship exists and a fiduciary duty is created [only] when the insurer undertakes the responsibility of representing the insured in the context of litigation.  The basis for the fiduciary obligation is quite clear in the litigation context, for the insurer is undertaking to represent the insured’s interests.

To the extent Plaintiff seeks to hold Defendant liable for the alleged shortcomings of his defense counsel in the Criminal Action or their day-to-day independent professional judgments, given the insurer’s inability to provide or control the legal services in issue, and the existence of a remedy for incompetence against counsel the imposition of vicarious liability in the circumstances is unwarranted.  Because it is undisputed that Defendant did not represent Plaintiff in the Criminal Action, there is neither a factual nor legal basis for concluding that Defendant assumed responsibility for Plaintiffs defense.  Even if Defendant brokered the attorney-client relationship as Plaintiff contends, this is not one of those rare cases in which a fiduciary duty may be found. Defendant’s motion for summary judgment on Plaintiffs claim for breach of fiduciary duty/vicarious liability is therefore GRANTED.

(Citations omitted).

The Court also rejected the insured’s breach of contract claim, finding that (1) the policy did not require the insurer “to ensure the Criminal Action reached a final resolution before the Policy limits were exhausted”; (2) the insurer had no duty to enforce its own billing guidelines for the benefit of the insured; and (3) the insurer did not add attorneys to the defense team without the insured’s knowledge and consent.

On August 30, 2019, Justice Masley of the New York County Commercial Division issued a decision in Otsuka Am., Inc. v. Crum & Forster Specialty Ins. Co., Index No. 650463/2019, ruling that coverage opinions prepared by outside counsel for an insurer are discoverable, explaining:  

In the context of insurance, the payment or rejection of claims is a part of the regular business of an insurance company.  Consequently, documents prepared in the ordinary course of an insurance company’s investigation to determine whether to accept or reject coverage and to evaluate the extent of a claimant’s loss are not privileged, and, therefore, discoverable.  Thus, these documents do not become privileged merely because the investigation was conducted by an attorney.  Where an attorney acts as a claims investigator, and not as an attorney, the communications are not privileged.  Additionally, reports prepared by insurance investigators, adjusters, or attorneys before the decision is made to pay or reject a claim are not privileged and discoverable, even when those reports are mixed/multi-purpose reports, motivated in part by the potential for litigation. 

The common thread [in the cases finding that documents prepared by an insurer’s attorneys are not privileged] is that the insurance companies retained counsel to provide a coverage opinion, i.e. an opinion as to whether the insurance companies should pay or deny the claims. Stated otherwise, counsel were primarily engaged in claims handling.

(Citations omitted).

On August 26, 2019, Judge Caproni of the SDNY issued a decision in Spandex House, Inc. v. Hartford Fire Ins. Co., Case No. 18-CV-8367 (VEC), enforcing an IP exclusion in a CGL policy that circumvented the “entire action” rule by precluding both defense and indemnity coverage for an otherwise-covered “advertising injury” claim if that claim was joined with any IP claim unconnected to advertising.

As Judge Caproni explains, under a duty to defend policy, “if a lawsuit contains a mix of allegations covered by an insurance policy and other allegations falling outside the scope of the policy,” New York law requires an insurer “to defend the policyholder against the entire lawsuit, including both the covered and the non-covered allegations.”  This well-established rule is variously known as the “entire action” rule, the “complete defense” rule, or the “in for one, in for all rule.”

The policy at issue in Spandex House effectively circumvented this rule.  The “advertising injury” coverage was subject to an IP Exclusion that barred coverage for “any injury or damage alleged in any claim or ‘suit’ that also alleges an infringement or violation of any intellectual property right . . . regardless of whether this insurance would otherwise apply.”  That exclusion was limited by an Advertising Exception, which provided that the IP Exclusion does not apply if “the only allegation in the ‘claim’ or suit is limited to” an IP infringement in the insured’s advertisement.

Spandex House argued that the IP Exclusion contravened the “entire action” rule, since it effectively allowed the insurer to avoid its duty to defend an action involving covered and non-covered claims.

Judge Caproni disagreed and granted summary judgment to the insurer, explaining: 

Spandex House argues that Hartford’s policy “aim[s] to circumvent” the entire-action rule.  In some sense, Spandex House is correct. The language of the Advertising Exception mirrors the policy’s definition of advertising injury (contained within the definition of “personal and advertising injury”).  Pursuant to the General Coverage Provision, advertising injury is, ordinarily, covered by Hartford’s policy. But when the IP Exclusion applies, advertising injury is covered only if it is “the only allegation” in a case.  Put differently, when the IP Exclusion applies, Hartford has no duty to defend otherwise-covered allegations of advertising injury if they are joined with allegations of other, unrelated sorts of injury.  This arrangement is unusual: ordinarily, insurers agree to defend against suits alleging a mix of covered and non-covered injuries, consistent with the entire-action rule. But, by expressly conditioning coverage on a particular injury being “the only allegation” in a lawsuit, Hartford has essentially contracted around the entire-action rule.

Second, the policy language is clear and unambiguous. While New York applies the entire-action rule, New York law also requires unambiguous insurance contracts to “be enforced as written.”  Because “[f]reedom of contract” is a “deeply rooted” tradition under New York law, this Court is not free to substitute Spandex House’s notions of fairness and propriety for the express provisions of the parties’ agreement; rather, “parties to an insurance arrangement may generally contract as they wish and the courts will enforce their agreements without passing on the substance of them.”  That Hartford’s policy may “aim to circumvent” traditional insurance arrangements affords no basis for this Court to strike or modify it.

Third, the IP Exclusion and Advertising Exception, although unusual, comport with the broad purposes underlying the entire-action rule. The rationale behind the rule is that an insurer can provide its insured with a meaningful defense only if it provides a complete defense. . . .  Put simply, the entire-action rule makes the duty to defend a binary proposition: either the insurer has a duty to defend, in which case it must defend the entire lawsuit, or the insurer has no duty to defend the lawsuit at all. What the insurer cannot do is provide a defense for some claims in a lawsuit but not others.

Hartford’s policy does not violate these principles, as nothing in the policy would require Hartford to provide Spandex House with this sort of partial defense. The IP Exclusion and the Advertising Exception determine when Hartford has an obligation to defend an action at all, not which claims within an action Hartford must defend. When the second paragraph of the IP Exclusion applies, Hartford has no duty to cover “[a]ny injury or damage” alleged in the applicable suit.  And in order for the Advertising Exception to apply, “the only allegation[s]” in the suit must be covered forms of “personal and advertising injury,” making Hartford indisputably obligated to defend the entire action. Id. (emphasis added). In short, Hartford’s policy does not alter the rule that if an insurer has a duty to defend, it must defend the entire action; instead, it simply narrows the range of cases in which the duty to defend exists in the first instance.

Fourth, and finally, the IP Exclusion and Advertising Exception are analogous to other insurance-policy provisions that have been upheld under New York law. Several courts have upheld provisions that exclude from coverage “damage caused by an excluded peril even when covered perils also contribute to the damage” (known as “anti-concurrent” clauses). . . .  Similar to the provisions at issue in these cases, Hartford’s policy excludes entire actions from coverage unless a particular injury is the only loss alleged in the case.

(Citations omitted).

This decision illustrates the importance of examining policy exclusions carefully.  The advertising injury coverage under this policy was quite narrow:  there was no coverage unless the only claims involved infringement in an advertisement; any allegations involving distribution, sales etc. of infringing products would preclude both indemnity and defense coverage, even for advertising-related claims.  By contrast, the policy at issue in another “advertising injury” case covered on this blog—High Point Design, LLC v. LM Ins. Corp. (2d Cir. 2019), Docket No. 16-1446-cv—had an exclusion for IP claims that did not bar coverage for otherwise-covered claims if those claims were joined with non-advertising related claims.

On July 25, 2019, Justice Crane of the New York County Supreme Court issued a decision in American Empire Surplus Lines Ins. Co. v. Burlington Ins. Co., 2019 NY Slip Op 32221(U), holding that a CGL carrier was required to provide a defense to an additional insured for a personal injury claim, but concluding that, absent a showing of prejudice to the insured, the insurer’s delay in issuing a reservation of rights letter was not a basis to impose a duty to defend.

Justice Crane’s decision provides a helpful overview of the role of an insurer’s reservation of rights letter under New York law:

New York permits an insurer to assume the defense of its insured subject to a reservation of rights, thus allowing the insurer the flexibility of fulfilling its obligation to provide its insured with a defense, while continuing to investigate the claim further.

Reservation of rights letters operate to prevent equitable estoppel and waiver from attaching before determination of the insured’s liability is determined.

By reserving its rights, the insurer is not imposing conditions on its defense. The defense remains unqualified; the insurer, by reserving its rights, is merely putting the insured on notice of what the insurer believes are its existing rights under the policy. Notwithstanding the foregoing, the insured has the right to reject the conditions the insurer is seeking to impose, by objecting or requesting separate counsel. To be sure, the insurer’s reservation affects only the insurer’s duty to indemnify, not its duty to defend, and, unlike some nonwaiver agreements, reservation of rights letters do not require that the insured make any concessions with regard to the insurer’s duty to indemnify.

(Citations omitted).

Although the Court found that the insurer (Burlington) had a duty to defend the additional insured under the applicable policy, Justice Crane explained that Burlington’s delay in issuing a reservation of rights letter was not a basis to impose any duty on the insurer, explaining:

In 206-208 Main St. Assoc., Inc. v Arch Ins. Co., 106 AD3d 403, 407-408 [1st Dept 2013]), the court held that the insured has the burden on a motion for summary judgment to present evidence showing that it was prejudiced by the insurer’s late reservation of rights as a matter of law. The court ruled that the posture of litigation is a relevant factor but determined that the insured had not been prejudiced here as the subject reservation of rights was issued when the underlying litigation was, by the insured’s own admission, still in its “early phase” (id. at 407). The court further held that the insured had also failed to establish prejudice on the basis that “plaintiff insurer had taken advantage of information defense counsel had communicated to it to form the basis for the eventual disclaimer” (id. at 408).

The court notes filed the underlying action on November 5, 2015 and that the parties were still engaged in discovery, on May 26, 2016, the time Burlington issued its reservation of rights letter. Thus, plaintiff has not established that the underlying litigation was in an advanced stage, nor did plaintiff present any evidence sufficient to demonstrate that it was prejudiced by Burlington’s alleged late reservation of rights. Thus, this Court will not impose a duty to defend on Burlington merely because of the timing of its reservation of rights letter.

Notably, the coverage issues in this case did not involve an exclusion to coverage.  However, where an insurer seeks to invoke a policy exclusion to deny liability coverage for a death or bodily injury claim, the New York Insurance Law requires the insurer to “give written notice as soon as is reasonably possible of such . . . denial of coverage.” N.Y. Ins. Law § 3420(d)(2).  Failure to do so can result in a waiver of the exclusion.  While the determination whether the insurer has provided notice “as soon as is reasonably possible” is fact specific and not subject to a strict bright-line rule, Courts have found delays of more than 30 days to be unreasonable.

On August 15, 2019, Justice Perry of the New York County Supreme Court issued a decision in Villas of Ocean Dunes Assn., Inc. v. First Specialty Ins. Corp., 2019 NY Slip Op 32435(U), denying an insured’s petition to compel an excess insurer to submit a disputed property damage claim to appraisal under an appraisal provision in the primary policy.

The insured in Villas of Ocean Dunes was a condominium in Florida that suffered damage during Hurricane Irma.  The condominium had two insurance policies covering property damage:  a primary policy issued by Westchester Surplus Lines Insurance Company, and an excess policy issued by First Specialty Insurance Corporation.  The primary policy contained a provision requiring the parties to submit disputes concerning the value of a claim to an appraisal proceeding.  In such an insurance appraisal, each side retains an appraiser to assess the value of the claim. If the parties’ appraisers are unable to reach agreement, they select a neutral umpire to resolve the dispute.  (As discussed in an earlier post on this blog, the scope of the appraisal is limited:  it cannot be used to resolve legal questions regarding the interpretation of the policy, but only to determine the amount of the covered loss.)

The excess policy “followed the form,” meaning that it generally incorporated the terms of the primary policy, except to the extent the excess policy had express terms that were “inconsistent” with the primary policy (in which case the excess policy’s terms would “supersede” those of the primary policy).  The excess policy was silent on this issue of appraisal, but contained a mandatory forum selection clause, stating that the parties “irrevocably” agreed that all disputes would be determined in the “exclusive” jurisdiction of the courts of the State of New York and that the “parties expressly waive all rights to challenge or otherwise limit such jurisdiction.” The insured reached an impasse with the excess insurer and filed a petition to compel an appraisal, pursuant to the appraisal provision in the primary policy. 

Justice Perry held that the New York forum selection clause in the excess policy superseded the appraisal provision in the primary policy, and dismissed the petition, explaining:

Petitioner’s attempt to avoid the unambiguous language of First Specialty’s forum selection clause in favor of the appraisal provision set forth in the Westchester primary policy is unavailing. Even abiding a liberal construction of the pleadings and giving petitioner every favorable inference, does not alter the plain language of the terms, conditions and endorsements set forth in First Specialty’s excess surplus lines policy.

This court has reviewed the language of the policies at issue and notes that the excess policy contains a forum selection clause that is clear and unambiguous. Notably, unlike the primary policy, the excess policy does not contain an appraisal provision. Moreover, the choice of law and forum selection clause is mandatory and unmistakable in its scope, providing that “[t]he laws of the State of New York, without regard to any conflict of laws rules that would cause the application of the laws of any other jurisdiction, shall govern the construction, effect, and interpretation of this insurance agreement.” Additionally, the forum selection clause provides that the parties “irrevocably” agreed that all disputes are to be determined in the “exclusive” jurisdiction of the courts of the State of New York and the “parties expressly waive all rights to challenge or otherwise limit such jurisdiction.”

Granting the relief sought in the Amended Petition, would be tantamount to this court rewriting the terms of the contract the parties negotiated and agreed to be bound by. The First Specialty excess contract expressly states that the “provisions, terms, conditions and exclusions . . . shall supersede, for the purposes of coverage under this Policy, any provisions of the Followed Policy that are inconsistent with this Policy. No endorsement . . . to the Followed Policy or to any primary, underlying or any other insurance shall alter the provisions . . . of this Policy, including without limitation, any Attached Endorsement.”  As such, First Specialty has demonstrated that the terms of its excess contract require that all disputes be resolved exclusively in New York courts and that the policy does not contain the appraisal provision on which petitioner relies in seeking to compel First Specialty to participate in an appraisal.

(Some citations omitted).

This decision illustrates the complications that can arise in construing a “follow the form” excess insurance policy. 

But was the forum selection clause in the excess policy “inconsistent” with the primary policy’s appraisal provision, as Justice Perry held? Notably, in the context of another ADR procedure (arbitration), the First Department held that a contract provision “vesting the courts of this State with exclusive jurisdiction in all actions and proceedings” did not negate an arbitration clause in the same agreement.  Rather, in light of New York’s “strong policy favoring arbitration,” the “exclusive jurisdiction provision” was interpreted as merely fixing “the required venue of applications to compel arbitration or confirm or reject arbitration awards.” Isaacs v. Westchester Wood Works, Inc., 278 A.D.2d 184, 185 (1st Dep’t 2000). At least arguably the same public policy applies with respect to insurance appraisal.         

On May 29, 2019, Justice Crane of the New York County Supreme Court issued a decision in Continental Cas. Co. v KB Ins. Co., Ltd., 2019 NY Slip Op 31513(U), holding that an exclusion for “Knowing Acts” did not excuse a CGL carrier’s duty to defend Lanham Act claims against the insured. 

In the underlying litigation, the insured, Value Wholesale, Inc. (Value), was sued by the patent holder for FreeStyle blood glucose test strips for allegedly selling imported test strips not authorized for sale in the United States and selling them in FreeStyle product boxes.  The action asserted claims for “trademark and trade dress infringement, fraud, racketeering, unfair competition, and other illegal and wrongful acts.”  One of Value’s CGL carriers (Continental) agreed to defend the case under the coverage for “personal and advertising injury.”  Continental then commenced a coverage action seeking contribution from another CGL carrier (KBIC), which had disclaimed defense coverage under an exclusion that applies if Value acted “with knowledge that the act would violate the rights of another,” or published material “with knowledge of its falsity.” 

Justice Crane held that the exclusion did not excuse KBIC’s duty to defend, explaining:   

KBIC has not satisfied its heavy burden. The underlying complaint alleges that all the defendants participated in a deliberate scheme to substitute unapproved test strips in place of the approved strips. However, Abbott can establish Value’s liability even without a finding that Value knew that its conduct would violate Abbott’s rights and inflict the advertising injury at issue. . . .

Neither the parties nor the court has found a controlling First Department case with parallel facts. However, the Fourth Department has addressed the issue. In Cosser v One Beacon Ins. Group (15 AD3d 871, 873 [4th Dept 2005]), the plaintiffs sought a declaration that the defendant insurer owed them a defense in a Lanham Act action. The Court concluded that a duty existed because the plaintiffs “may be liable … in the underlying action without a showing of intentional or knowing conduct on [their] part”.  A few decisions from justices in this county have utilized similar reasoning to rule that the insurer had a duty to defend (see, e.g., The Andy Warhol Found. For Visual Arts, Inc. v Phi/a. Indem. Ins. Co., 37 Misc 3d 1229 [A], 2012 NY Slip Op 52228 [U], *6 [Sup Ct, NY County 2012] [Sherwood, J.]; Sarin v CAN Fin. Corp., 21 Misc 3d 1101 [A], 2008 NY Slip Op 51909 [U] [Sup Ct, NY County 2008] [Fried, J.]).  The duty to defend exists whenever the complaint alleges any facts or grounds which bring the action within the protection purchased.

(Some citations omitted). 

This decision illustrates both the breadth of the duty to defend and the narrow construction courts apply to policy exclusions.

On April 25, 2019, Justice Sherwood of the New York County Commercial Division issued a decision in Westchester Fire Ins. Co. v. Schorsch, 2019 NY Slip Op 31188(U), holding that a D&O policy’s “insured versus insured” exclusion did not preclude coverage for claims against corporate officers by a Creditor Trust.

In Schorsch, corporate officers sought coverage under the corporation’s D&O policies for claims brought against them by a Creditor Trust set up in the corporation’s Chapter 11 bankruptcy proceedings.  Two of the excess insurers disclaimed coverage based on an “insured versus insured” exclusion that precludes coverage for losses in connection with any claim brought “by, on behalf of, or at the direction of the Company or Insured Person.”  Justice Sherwood disagreed, and granted summary judgment to the insureds, explaining:

. . . [T]he insured versus insured exclusion . . . is intended to prevent a company from recovering business losses that it was in a position to avoid by more carefully supervising its own officers and directors.  The exclusion has exceptions for a bankruptcy trustee or a similar authority, since the funds recovered will be used for the benefit of creditors, rather than the company, and are subject to supervision by the bankruptcy court or a regulatory authority. Plaintiff has asserted that the Creditor Trust is not a bankruptcy trustee, examiner, receiver, liquidator or a creditor committee. However, the Primary Policy uses the phrase “comparable authority” which phrase is not defined.  The phrase is ambiguous and therefore must be construed against the insurer, particularly since it is being invoked to exclude coverage.  Plaintiff and RSUI have not shown that the exclusion prevents defense and coverage under their respective policies.

(Citations omitted).

This decision underscores the well-established principle that coverage exclusions are narrowly construed, with any ambiguities resolved in favor of coverage.  Also of note: because the insurers initiated this coverage action (and lost), the insureds were entitled to fee shifting under the Court of Appeals’ decision in Mighty Midgets, Inc. v. Centennial Ins. Co., 47 N.Y.2d 12, 21 (1979).