On December 4, 2018, Justice Lebovits of the New York County Supreme Court issued a decision in Chelsea Piers, L.P. v. Colony Ins. Co., Index No. 150402/2017, holding that a purchase order signed by a contractor triggered coverage for the property owner under the additional insured endorsement to the contractor’s CGL policy.

The policy at issue in this case provided additional insured coverage for “any person or organization for whom you [i.e., the contractor] are performing operations when you and such person or organization have agreed in writing in a contract or agreement that such person or organization is an additional insured on your policy.”  (Emphasis added).  The only written agreement was a purchase order, executed by the contractor, which provided that the contractor would indemnify the property owner, and that the contractor’s “general liability insurance shall apply on a primary and non-contributory basis with respect to all protection provided to Chelsea Piers [i.e., the property owner].”

Chelsea Piers tendered the defense of an injury lawsuit by an employee of the contractor to the CGL carrier (Colony Insurance).  Colony denied coverage, arguing that (1) the purchase order was not a “written contract” because it was not signed by both parties; and (2) the purchase order fails to state expressly that the contractor is required to provide additional insured coverage to the property owner.  A coverage action followed.  Justice Lebovits granted summary judgment to Chelsea Piers on the issue of Colony’s duty to defend the lawsuit.

The Court held that the fact “that the Purchase Order is not signed by both parties is of no consequence, where, as here, [the] policy merely requires a written contract not a signed one.”  (Citations omitted).  Further, Justice Lebovits found that the purchase order satisfied the “written contract” requirement of the additional insured endorsement, explaining:

[T]he Purchase Order’s language does not lend itself to more than one interpretation, but unambiguously provides that Chelsea shall have coverage under the contractor’s general liability insurance. Colony argues that, while this appears to be the presumption, because the Purchase Order fails to “expressly and specifcally” state so, no additional insured coverage is available. (Trapani v J O Arial Way Assoc., 30 1 AD2d 644, 647 [2d Dept 2003] [stating that “‘(a] provision in a construction contract cannot be interpreted as requiring the procurement of additional insured coverage unless such a requirement is expressly and specifically stated”] .) It also argues that “contract language that merely requires the purchase of insurance will not be read as also requiring that a contracting party be named as an additional insured.” (Id. [denying additional insured coverage where contract merely required contractor to provide a certificate of insurance demonstrating that contractor had certain types of coverage]; accord Mangano v Am. n Stock Exch. , 234 AD2d 198, 198-199 (1st Dept 1996] [finding no contractual obligation to procure insurance coverage for fourth-party plaintiff, where contract required fourth-party defendant to obtain insurance without requiring it to name fourth-party plaintiff as an insured].)

But, here, the Purchase Order makes express reference to Chelsea and states that Chelsea is to be covered under the contractor’s general liability policy. To interpret it as merely requiring EPS to procure coverage for itself, would render meaningless large portions of the Purchase Agreement, namely:

“Lessee’s, contractors, vendors, etc. general liability insurance shall apply on a primary and non-contributory basis with respect to all protection provided to Chelsea Piers thereunder. In addition, the general liability insurance shall provide that no act or omission of lessee, contractor or vendor will in any way effect or reduce the insurance coverage available to Chelsea Piers thereunder.”

While Colony insists that the language is, at best, ambiguous, Colony fails to provide an alternate interpretation. Therefore, defendants fail to demonstrate the absence of the requisite written contract. (See Christ the King Regional High Sch. v Zurich Ins. Co. of N. Am. , 91 AD3d 806, 808 [2d Dept 2012] [finding that the insurance policy’s written agreement requirement for additional insured coverage was satisfied, where the named insured was contractually required to “to provide a ‘(c]ertificate of [i]nsurance freeing [the plaintiff] of all liability, because “the relevant contractual provision . . . refer[red] directly to the (plaintiff, [and could not] be interpreted as requiring only that [the named insured] obtain liability insurance for itself, as that would render the phrase ‘freeing [the plaintiff of all liability’ meaningless”.)

Determining who qualifies as an additional insured under a contractor’s CGL policy is a frequently disputed issue in construction-related insurance coverage matters.  (See our previous posts here.)  Property owners, project managers and general contractors are well-advised to review the additional insured endorsement in a subcontractor’s CGL policy before work commences to confirm that all the requirements for coverage are satisfied.

On December 6, 2018, the Second Circuit issued a decision in Patriarch Partners, LLC v. Axis Ins. Co., Case No. 17-3022, holding that a Warranty Statement executed in connection with the issuance of an Excess D&O policy barred coverage because the insured had knowledge prior to the issuance of the policy of “facts or circumstances that would reasonably be expected to result in a Claim.”

The coverage dispute in this case arose from an SEC investigation of Patriarch Partners, a private equity investment firm.  The investigation began as an “informal inquiry”, but on June 3, 2011, the SEC issued a formal Order of Investigation.  Although the Order of Investigation was not public, Patriarch admitted that its outside counsel “became aware” of the Order on June 13, 2011.  Further, on August 11, 2011, an SEC officer sent an email to Patriarch’s counsel requesting certain information and stating that the SEC “will follow this voluntary request with a subpoena.”

That same month, Patriarch added a third layer of excess coverage to its existing $20 million in D&O coverage.  The new excess insurer, Axis, conditioned issuance of the excess policy on a Warranty Statement signed by Patriarch’s sole director and officer (Lynn Tilton).  The Warranty stated that as of August 12, 2011, “neither the undersigned nor any other director or officer of Patriarch is aware of any facts or circumstances that would reasonably be expected to result in a Claim under the [Axis] policy.”  The Warranty further provided that the policy “does not provide coverage for Claims relating to facts and circumstances that, as of the date of this letter, Patriarch was aware of and would reasonably have expect to result in a Claim covered by” the excess policy.  Under the primary policy — and thus under the Axis policy, which followed the form — a claim was expressly defined to include an “order of investigation” by the SEC.

The SEC subsequently filed an administrative enforcement action against Patriarch.  The cost of defending that proceeding depleted the underlying $20 million in coverage, triggering the Axis policy.  Axis denied coverage, and a coverage action followed.  Axis argued, inter alia, that the Warranty Statement excused coverage.  After extensive discovery, Judge Caproni of the Southern District of New York granted summary judgment to Axis on another ground: that the claim was barred by a “pending or prior claim” exclusion.  (See our prior post about this policy provision here.)

The Second Circuit’s decision on appeal focused on the Warranty Statement.  Patriarch made two principal arguments:  (1) the Warranty only excluded claims relating to facts and circumstances of which Tilton (Patriarch’s sole officer and director) was personally aware; and (2) the Warranty referred only to Claims in excess of $20 million – i.e., those that would trigger liability under the Axis policy.  The Second Circuit rejected these arguments, explaining:

Patriarch’s position that the Warranty applies only to facts or circumstances subjectively known by Tilton is unsupported by the text of the Warranty, which explicitly refers to facts or circumstances that “Patriarch was aware of.” Moreover, under traditional principles of agency an attorney’s knowledge must be imputed to her client.  Thus, at a minimum, we consider that facts and circumstances that were known not only to Tilton, but to Patriarch’s outside counsel and Patriarch’s in-house counsel are facts and circumstances that “Patriarch was aware of” for purposes of analyzing the Warranty.

Patriarch’s position that the Warranty applies only to known facts or circumstances that Patriarch would reasonably have expected to result in a Claim with losses exceeding the $20 million in underlying policies is also not established by the text of the Warranty. The Warranty’s use of the capitalized term “Claim” indicates that it is a defined term and thus means “Claim” as defined in the CNA Policy. The CNA Policy definition of “Claim” is not limited in the manner Patriarch urges. It is true that the Warranty refers both to Claims “under” the Axis Policy—a term best understood to mean “defined by”—and to Claims “covered by” the Axis Policy. Patriarch insists that the Axis Policy “covers” only Claims whose losses exceed $20 million. Reading the Warranty as a whole, however, and taking into consideration its context and purpose, we are not persuaded by Patriarch’s interpretation.  Because the Axis Policy is a “follow-form” policy, the same Claims that are “covered by” the CNA Policy are also “covered by” the Axis Policy and other underlying excess policies. That Axis provides excess insurance does not change or limit the class of Claims that it provides coverage for; it changes only the circumstances under which Axis must pay for losses resulting from such Claims.  The only reasonable interpretation of the Warranty, in our view, is that it excludes claims arising from facts or circumstances of which Patriarch was aware as of August 12 and that Patriarch would reasonably have expected to result in a Claim as defined by the CNA Policy.

(Citations omitted).

Importantly, the facts that triggered the Warranty Statement in Patriarch Partners – the firm’s awareness of an SEC administrative order prior to issuance of the policy – were undisputed.  D&O insurers cannot rely on the government’s allegations against the insured (or other disputed facts) to avoid their coverage obligations (see our previous blog post on this issue here).

On November 26, 2018, Judge Feuerstein of the EDNY issued a decision in Merritt Environmental Consulting Corp. v. Great Divide Ins. Co., 17-CV-7495, holding that a policy exclusion for claims “arising out of” radioactive contamination did not require proximate causation, but rather “some causal relationship” between the contamination and the claim.

In Merritt Environmental, an environmental consulting business sought coverage under a professional liability policy for lawsuits by a client alleging that Merritt negligently failed to identify radioactive contamination in a property.  The insurer denied coverage based on an exclusion applicable to claims “arising from” radioactive contamination.  Merritt argued that the exclusion did not apply because the proximate cause of the claims was Merritt’s alleged professional negligence, not the underlying radioactive contamination.  Magistrate Judge Shields rejected this argument in a report and recommendation issued on October 10, 2018 (the “Report”), finding that the language of the exclusion only required that the contamination be a “but for” cause of the claim.  Judge Feuerstein overruled Merritt’s objections and upheld the Report, explaining:

In the context of an insurance policy exclusion, “[t]he New York Court of Appeals has held that the phrase ‘arising out of’ is ‘ordinarily understood to mean originating from, incident to, or having connection with[,]’” Federal Ins. Co. v. American Home Assur. Co., 639 F.3d 557, 568 (2d Cir. 2011) (quoting Maroney v. N.Y. Cent. Mut. Fire Ins. Co., 5 N.Y.3d 467, 472, 805 N.Y.S.2d 533, 839 N.E.2d 886 (2005) (internal quotations and citation omitted)), and “requires only that there be some causal relationship between the injury and the risk for which coverage is provided.” Id. (quoting Maroney, 5 N.Y.3d at 472, 805 N.Y.S.2d 533). Magistrate Judge Shields properly applied a “but for” test to determine, based upon the complaints in the underlying lawsuits and the language of the relevant provisions of the subject Policy, that the “arising out of exclusion” at issue, i.e., the radioactive matter exclusion in the subject Policy, applies and bars coverage for the underlying lawsuits. See Mount Vernon Fire Ins. Co. v. Creative Hous. Ltd., 88 N.Y.2d 347, 350, 645 N.Y.S.2d 433, 668 N.E.2d 404 (1996); Country-Wide Ins. Co. v. Excelsior Ins. Co., 147 A.D.3d 407, 409, 46 N.Y.S.2d 96 (N.Y. App. Div. 2017).

Insurance policies often employ terms of art that have accepted meanings.  Here, the phrase, “arising under”, as used in the exclusion connotes but-for causation.  By contrast, New York courts interpret the phrase, “caused in whole or in part by” to require proximate causation.  (See our previous posts here and here).

On December 4, 2018, the Second Circuit issued a decision in American Empire Surplus Ins. Lines v. Colony Ins. Co., Case No. 17‐3799, holding that a city agency’s CGL policy did not cover a claim for injuries sustained by employees of a contractor hired by the agency.

American Empire arose from a personal injury lawsuit filed against the New York City Housing Authority (NYCHA) by employees of a contractor (Technico) hired to remodel certain buildings owned by NYCHA. Technico’s insurance carrier (American Empire) defended NYCHA in the lawsuit and then filed a lawsuit seeking contribution from NYCHA’s liability carrier (Colony). NYCHA’s policy covered “bodily injury” caused by an “occurrence” arising from “Operations performed for [NYCHA] by the ‘contractor’.” (The defined term “contractor” meant Technico). However, an exclusion provided that there was no coverage for “bodily injury” sustained by “any contractor . . . or any of their ‘employees.’” American Empire argued that the undefined term “any contractor” used in the exclusion did not include Technico, the specific “contractor” identified in the policy. The Second Circuit rejected this argument, explaining:

As the district court concluded, the exclusion provides, in straightforward and unambiguous wording, that the policy does not provide coverage for bodily injury sustained by employees of “any contractor.” “Any contractor” must be read to have its plain meaning. The plain meaning of “any contractor” includes Technico, because Technico is defined in the policy as a “contractor” (in quotes). Technico does not lose its status as a contractor simply because it is also the defined “contractor” (in quotes). The presence of the word “any” before contractor supports the breadth of the exclusion. Because these lawsuits were filed by employees of a contractor, Technico, they are excluded under the plain terms of the policy.

Further, American Empire’s argument‐‐that “any contractor” does not include the defined “‘contractor’”‐‐is refuted by another contract provision. The “Other Insurance” clause provides: “[W]e will not seek contribution from any other insurance available to you [NYCHA] unless the other insurance isprovided by a contractor other than the designated ‘contractor’. . .” (emphasis added). The explicit exclusion of the designated “‘contractor’” (Technico) in this provision reinforces the conclusion that the phrase “any contractor” (in the exclusion) includes the designated “‘contractor’”. If the parties wanted to exclude Technico from the policy exclusion, they would have done so explicitly, as they did elsewhere in the contract.

(Record citations omitted).

This decision illustrates that, although exclusions are construed narrowly in favor of coverage, the plain meaning of the policy governs where it is unambiguous.

Schlam Stone & Dolan LLP is pleased to announce the launch of the Same-Day Justice Program, an arbitration service where participants can participate in an evidentiary hearing and receive a decision in their case that same day.

The Same-Day Justice Program is designed to give parties with disputes in the $50,000-$500,000 range an efficient and affordable solution for resolution of their commercial disputes. Parties who use the program will waive their right to go to court and agree instead to arbitrate their dispute before a private neutral arbitrator, who has binding authority to issue an award resolving the matter.

Each side pays a flat fee—for a half-day or full day—and the expert arbitrator will carefully consider each side’s evidence at the hearing and then render a decision. That award is enforceable in courts, just like a judgment obtained after years of litigation in the court system. The parties don’t need to use a lawyer, although they are free to do so.

The arbitration hearing takes place in person, unless the parties agree otherwise. The parties bring all their evidence (documents and witnesses) to the hearing for consideration by the arbitrator. Shortly before the hearing, the parties will exchange with each other the documents they intend to use at the hearing as well as a list of the witnesses they will call to testify. The parties may present their case in any manner they chose, whether by narrative or in question-and-answer format.

The arbitrator issues a decision on the day of the session.

* * *
The Same-Day Justice Program is administered by Schlam Stone & Dolan LLP partner Erik Groothuis, who has spent two decades practicing civil litigation—roughly half representing plaintiffs and half representing defendants.

For more information, visit www.same-dayjustice.com or contact Erik S. Groothuis at egroothuis@schlamstone.com.

On November 1, 2018, the Third Department issued a decision in Lafarge Bldg. Materials Inc. v Harleysville Ins. Co. of N.Y., 2018 NY Slip Op 07385, holding that a property owner was not entitled to additional insured coverage under a contractor’s CGL policy because it gave late notice of the claim.

The coverage dispute at issue in Lafarge arose from an injury sustained by a contractor’s employee in the course of a project at a cement plant owned by LaFarge Building Materials, Inc.  As required by the terms of the purchase order for the project, the contractor procure a general liability policy naming LaFarge as an additional insured. Lafarge did not notify the CGL carrier of the lawsuit until nine months after it was served with the complaint.  The insurer disclaimed defense and indemnity coverage for LaFarge for the injured employee’s claim “on the ground that plaintiff failed to provide it notice of the lawsuit ‘as soon as practicable’” – a condition to coverage under the policy.

The personal injury action ultimately settled for $1.425 million, and LaFarge commenced an action against the carrier for breach of the duty to defend and indemnify.  The Third Department affirmed the trial court’s decision granting summary judgment to the insurer, explaining:

Where, as here, a policy of liability insurance requires that notice of an occurrence or claim be given “as soon as practicable,” such notice must be accorded the carrier within a reasonable period of time. The insured’s failure to satisfy the notice requirement constitutes a failure to comply with a condition precedent which, as a matter of law, vitiates the contract.  Because the subject policy was issued prior to the amendment to Insurance Law § 3420, defendant was not required to show that it was prejudiced by plaintiff’s failure to give timely notice in order to successfully disclaim coverage.  Further, although there may be circumstances where the insured’s failure to give timely notice is excusable, the insured bears the burden of establishing the reasonableness of the proffered excuse.

Here, defendant made a prima facie showing of its entitlement to judgment as a matter of law based upon plaintiff’s nearly nine-month delay in notifying defendant of the underlying personal injury action.  Thus, the burden shifted to plaintiff to raise a question of fact as to the reasonableness of such delay.  Even construing all inferences in favor of plaintiff, we find that plaintiff failed to do so.

Plaintiff attributes the delay in notifying defendant of the underlying lawsuit to its purported lack of knowledge that it was covered under the applicable insurance policy and its claimed diligent efforts to ascertain coverage. It is undisputed, however, that, upon commencement of the underlying personal injury action, plaintiff possessed contemporaneous knowledge of the date and location of the incident, as well as the fact that it occurred in the course of O’Dell’s employment with AMS, one of plaintiff’s contractors. Plaintiff’s own submissions further establish that, promptly after service of the complaint in the underlying action, it found in its records the April 26, 2005 certificate of liability insurance in AMS’s name, which, notably, listed plaintiff as the holder and defendant as the insurance carrier for the project. While the certificate of insurance did not specifically list plaintiff as an additional insured on the policy, the uncontroverted evidence submitted on the motion established that all contractors performing work for plaintiff at the Ravena plant did so pursuant to a purchase order issued by plaintiff, and that all such purchase orders contained standard terms and conditions requiring the contractor to name plaintiff as an additional insured on the contractor’s general liability insurance policy before work would be approved. Thus, shortly after being served with the complaint in the underlying action, plaintiff (1) knew that an occurrence had taken place at its facility, (2) was aware that the incident involved an employee of one of its contractors, (3) had located the certificate of liability insurance listing it as the holder thereof and defendant as the insurer for the project, and (4) knew that the language contained in its standard purchase orders required contractors, such as AMS, to name it as an additional insured on their policy of liability insurance.

*       *       *

In light of the information possessed by plaintiff promptly after service of the complaint in the underlying action, plaintiff should have realized that there was a reasonable possibility of the subject policy’s involvement.  While we are mindful that the reasonableness of any delay and the sufficiency of the excuse offered ordinarily present questions of fact to be resolved at trial, here the proffered excuse for the delay in providing notice was unreasonable as a matter of law.  Accordingly, Supreme Court properly granted defendant’s motion for summary judgment and dismissed the complaint.

(Citations omitted).

You can’t get insurance coverage if you don’t ask for it.  And, as the additional insured learned here, a delay in giving notice to the carrier can compromise the coverage.  Under Section 3420(a)(5) of the New York insurance law (which did not apply in this case because the policy was issued before the law’s effective date), an insurer for a policy covering liability for “injury to person” must demonstrate prejudice to invalidate a claim for late notice.  Nevertheless, the best practice is to give notice as soon as possible.

On October 5, 2018, the Fourth Department issued a decision in Pioneer Cent. Sch. Dist. v. Preferred Mut. Ins. Co., 2018 NY Slip Op 06682, holding that a school district was not entitled to coverage under a cleaning company’s CGL policy – either as an additional insured or as the named insured’s contractual indemnitee – because the underlying injuries were not proximately caused by the named insured.

In Pioneer Central, a school sought coverage under a cleaning company’s CGL policy for a personal injury action by an employee of the cleaning company who was injured “when she slipped on snow or ice in the parking lot of Pioneer Middle School after completing her shift.”  The motion court granted summary judgment to the school, but the Fourth Department reversed, explaining:

We conclude that Pioneer is not an additional insured under the policy inasmuch as Ayers’s injuries were not proximately caused by Kleanerz. The policy’s additional insured endorsement provides that the injury must have been “caused, in whole or in part, by” Kleanerz’s conduct, and thus it requires that the insured must have been a proximate cause of the injury, not merely a “but for” cause.  Here, it is undisputed that Kleanerz was not responsible for clearing ice and snow from the parking lot and that Ayers’s fall resulted from her slipping on the ice or snow. Although Pioneer contends that Kleanerz caused the accident by instructing Ayers to exit Pioneer Middle School through a door located near the area where Ayers subsequently slipped, Kleanerz’s instructions to Ayers merely furnished the occasion for the injury by fortuitously placing Ayers in a location or position in which an alleged separate instance of negligence acted independently upon her to produce harm, and were not a cause of the accident triggering the additional insured clause of the policy.

We further conclude that the indemnification provision in the janitorial services contract did not create coverage under the insurance policy. The insurance policy covers liability assumed in an “insured contract” between Kleanerz and a third party. An “insured contract” is defined in the policy as “[t]hat part of any other contract or agreement pertaining to [Kleanerz’s] business . . . under which [Kleanerz] assume[s] the tort liability of another party to pay for bodily injury’ . . . to a third person or organization, provided the bodily injury’ . . . is caused, in whole or in part, by [Kleanerz] or by those acting on [Kleanerz’s] behalf.” Here, the injuries were not “caused, in whole or in part, by” Kleanerz’s acts, and thus the indemnification provision of the janitorial services contract does not fall within the “insured contract” coverage provided by the insurance policy.

(Citations omitted).

CGL policies sometimes provide coverage for parties other than the named insured.  One important example is the Additional Insured Endorsement, which has been the subject of numerous posts on this blog.  CGL policies also often provide coverage for “insured contracts” – i.e., indemnification agreements under which the named insured assumes the tort liability of a third party.  As always, the scope of this coverage is defined by the policy.  Here, coverage for “insured contracts” only extended to claims “caused, in whole or in part” by the named insured.  Thus, there was no coverage, given the Court’s conclusion that the named insured did not proximately cause the injury.

On September 20, 2018, the First Department issued a decision in J.P. Morgan Sec., Inc. v. Vigilant Ins. Co., 2018 NY Slip Op 06146, holding that a disgorgement payment made as part of the settlement of an SEC enforcement action was a “penalty” and therefore did not qualify as a covered “loss” under a CGL policy.

At issue in J.P. Morgan v. Vigilant was a settlement the SEC reached with Bear Stearns, resulting from allegations that “Bear Stearns violated securities laws between 1999 and September 2003 by knowingly facilitating ‘late trading’and deceptive ‘market timing’ for certain hedge fund customers, and affirmatively assisting those customers in evading detection, thereby enabling them to earn hundreds of millions of dollars in profits at the expense of mutual fund shareholders.”  A component of the settlement was a disgorgement payment that included $140 million “allegedly representing the improper profits acquired by third-party hedge fund customers.”  Bear Stearns’ CGL policy excluded “penalties imposed by law” from the definition of a covered loss.  The insurer disclaimed coverage for the disgorgement payment on the ground that it was a “penalty.”  The First Department agreed, explaining:

In Kokesh [v. Securities & Exchange Commission __ U.S. __, 137 S. Ct. 1635 (2017),] . . . the United States Supreme Court held that SEC disgorgement constitutes a penalty, and is therefore subject to the five year statute of limitations of 28 USC § 2462. In so ruling, the Supreme Court reasoned that SEC disgorgement (i) is imposed as a consequence for a wrong committed against the public, rather than a wrong against particular individuals; (ii) is meant to punish the violator and deter others from similar violations; and (iii) in many cases, does not compensate the victims of securities violations; rather, the wrongdoer pays disgorged profits to the district court, which has discretion to determine how and to whom to distribute the money.

The Supreme Court’s rationale as to the nature of disgorgement in Kokesh applies with equal force to the issue of whether the disgorgement paid by Bear Stearns, even if representing third-party gains, was a “Loss” within the meaning of the policy and whether public policy bars insurance companies from indemnifying insureds paying SEC disgorgement. In both instances disgorgement is a punitive sanction intended to deter. To allow a wrongdoer to pass on its loss emanating from the disgorgement payment to the insurer, thereby shielding the wrongdoer from the consequences of its deliberate malfeasance, undermines this goal and violates the fundamental principle that no one should be permitted to take advantage of his own wrong. Thus, as SEC disgorgement is a penalty, it does not fall within the definition of “Loss” and there is no coverage.

(Citations omitted).

As a general matter, New York public policy does not permit indemnity coverage for intentional wrongdoing.  Importantly, however, defendants accused of deliberate misconduct can look to their liability carriers for defense coverage.

On September 21, 2018, the Second Circuit issued a decision in SPARTA Ins. Co. v. Technology Ins. Co., Inc., Case No. 17‐3441, holding that a liability insurer that assumed the defense of a claim was estopped from disclaiming coverage based on a nine-month delay in asserting coverage defenses and resulting prejudice to the insured.

In SPARTA Ins. Co., a subcontractor’s liability carrier (SPARTA) assumed the defense of a property owner and general contractor in an injury lawsuit brought by the subcontractor’s employee, without a reservation of rights.  In later correspondence, SPARTA attempted to make a generic reservation of rights, invoking “the terms and conditions of the policy it issued” but did not “spell what terms and conditions might bear on its obligation.”   More than nine months later, SPARTA “argued that it was not required to indemnify the property owner because the property owner allegedly caused the worker’s injury through its negligence.”  The Second Circuit affirmed the District Court’s holding that SPARTA was estopped from asserting this coverage defense, explaining:

An insurer who undertakes the defense of an insured, may be estopped from asserting a defense to coverage, no matter how valid, if the insurer unreasonably delays in disclaiming coverage and the insured suffers prejudice as a result of that delay.  Prejudice may be presumed where an insurer, though in fact not obligated to provide coverage, without asserting policy defenses or reserving the privilege to do so, undertakes the defense of the case, in reliance on which the insured suffers the detriment of losing the right to control its own defense. In such cases, though coverage as such does not exist, the insurer will not be heard to say so.  These principles apply to coverage allocation disputes between insurers as well as to coverage disputes between insurers and insureds.

SPARTA undertook the defense and indemnification of the general contractor and property owner without asserting policy defenses or reserving the privilege to do so. . . .

SPARTA’s assertion of defenses to coverage for the defense and indemnification came after an unreasonable delay.  The reasonableness of any delay is judged from the time that the insurer is aware of sufficient facts to issue a disclaimer. As the district court observed, SPARTA’s arguments regarding its coverage obligations are based on the terms of SPARTA’s own policy issued to the subcontractor and the contract between the general contractor and subcontractor, facts known to SPARTA at the time it agreed to undertake the defense and indemnification. Yet SPARTA failed to assert that it had reserved its rights‐‐let alone reach its ultimate conclusion regarding the extent of its coverage‐‐until April 28, 2014, more than nine months later. . . . [A] nine‐month delay is plainly unreasonable under New York law.

Finally, allowing SPARTA to assert defenses to complete coverage would prejudice the general contractor and Technology. In reliance on SPARTA’s undertaking of the defense and indemnification, the general contractor chose to forgo filing a third‐party complaint against the subcontractor for indemnification in the underlying tort suit. Because that suit has been readied for trial during SPARTA’s control of the defense, the general contractor and Technology have lost the opportunity to pursue third‐party claims against the subcontractor. The general contractor and Technology would therefore face actual prejudice from SPARTA’s assertion of defenses to coverage after an unreasonable delay.

SPARTA is therefore estopped from seeking reimbursement of past and accruing defense costs in the underlying tort suit.

(Citations omitted).

This decision illustrates the importance of the insurer’s reservation of rights letter.  The failure to issue such a letter, or to invoke specific defenses in the letter, can impact the insurer’s ability to disclaim coverage down the road.

On September 18, 2018, Justice Hagler of the New York County Supreme Court issued a decision in Aspen Specialty Ins. Co. v. Zurich Am. Ins. Co., 2018 NY Slip Op 32328(U), holding that property owners and their construction manager were not entitled to defense coverage under a CGL policy based on a stop work order issued by the New York City Department of Buildings.

The standard CGL policy at issue in Aspen Specialty required the insurer to defend a “suit,” defined as “a civil proceeding in which damages because of . . . ‘property damage’ . . . to which this insurance applies [is] alleged.”  Under New York law, the duty to defend has been described as “exceedingly broad.”  The duty may be triggered before the filing of a formal lawsuit.  Thus, “New York law . . . permits a demand letter to serve as the functional equivalent of a ‘suit’ . . . where the claimant against an insured assumes a coercive adversarial posture and threatens the insured with probable and imminent financial consequences.”  Carpentier v. Hanover Ins. Co., 248 A.D.2d 579, 580-81 (2d Dep’t 1998).  Justice Hagler cited Second Circuit cases holding that an “insurer’s duty to defend may be triggered by an administrative agency’s demand letter that commences a formal proceeding against the insured, advising it that a public authority has assumed an adversarial posture toward it, and that disregard of the demands may result in the loss of substantial rights by the insured.”  Texaco A/S (Denmark) v. Commercial Ins. Co. of Newark, NJ, 160 F.3d 124, 130 (2d Cir. 1998) (quoting Avondale Indus., Inc. v. Travelers Indem. Co., 887 F.2d 1200, 1206 (2d Cir. 1989)).

However, the Court concluded that the stop work order in this case was “insufficiently ‘coercive’ or ‘adversarial’ to constitute the functional equivalent of a ‘suit,’’’ explaining:

. . . [A] stop work order is “an order by the Buildings Department to stop all work at the site, unless otherwise noted on the stop work order.” . . .  The blank form states that “you are hereby ordered to immediately stop all work at the above premises . . . FAILURE TO COMPLY WITH THIS STOP WORK ORDER MAY RESULT IN CRIMINAL CHARGES BEING FILED AGAINST YOU.”  Significantly, Ross [a witness for the DOB] stated that “the stop work order is really the violation itself,” and that “the violation is in itself[] the stop work order.”

The notice of violation issued in this case states that the “Violating Conditions Observed” included “failure to adequately support adjoining ground and/or structures during pile driving operations” and noted that there was “[e]xtensive thru-cracking observed running vertically on side and rear walls of 2-story extension of adjoining” building.  Under the heading “Remedy,” the notice of violation states “stop all work forthwith,” “reevaluate means and methods of installation so as to prevent damage to all property and structures,” and “submit all plans and monitoring reports to SEPEX for eng’g revision.”  The notice of violation indicates that it is designated a “hazardous,” “class l” violation, requiring an appearance before the New York City Environmental Control Board to determine the amount of civil fines and penalties. The purpose of the hearing was to determine the amount of any fines for violations, not to determine whether the stop work order should be lifted.

Notably, third-party plaintiffs were not directed to perform remediation work. Third-party plaintiffs were not advised that they were facing a lawsuit or imminent financial consequences for failure to comply (compare Kirchner v Fireman’s Fund Ins. Co., 1991 WL 177251, *5, 1991 US Dist LEXIS 12244 [SD NY 1991] [insurer was required to defend letter that required insured to conduct an investigation and warned that failure to comply would result in legal action seeking reimbursement for funds expended and penalties]). Third-party plaintiffs point out that the DOB directed that they take affirmative measures to “reevaluate means and methods of installation so as to prevent damage to adj. property and structures,” and to “submit all plans and monitoring reports” for review. However, in Ryan [v. Royal Ins. Co. of Am., 916 F.2d 731 (1st Cir. 1990)], the Court found language in letters requesting that the insured submit plans for approval to be insufficiently adversarial (Ryan, 916 F3d at 742).

Rather, the evidence indicates that the stop work order at issue was more like “an invitation to voluntary action” (Technicon [Elecs. Corp. v. Am. Home Assur. Co., 141 AD2d 124, 146]). Indeed, Rosstestified that “we [the DOB] would require a – request the contractor to do it. If he could not do it or failed to do it, we would have HPD step in and do the work.”  The DOB would “give the owner the option to either get it fixed, or we will fix it”: In the latter case, the DOB would seek to hold the owner financially responsible for the work. The HPD would place liens on the property to insure payment, and would go to court to seek an order of payment. Ross also testified that the purpose of a partial stop work rescind order was to “allow the site to do some work at the site after a stop work order is issued.” When a partial stop work rescind order is issued, the original stop work order is still in effect; “[i]t gives you an allowance under the stop work order.”  There is no evidence that the HPD ever threatened third-party plaintiffs with litigation in this case. “But the mere possibility of future litigation, indefinite and unfocused, cannot trigger the duty to defend under a CGL policy” (Ryan, 916 F3d at 743).

*          *          *

Consequently, Zurich is not obligated to defend the stop work order issued to third-party plaintiffs.

(Record citations omitted).

This decision shows that while the duty to defend is broadly construed, its scope is not limitless, particularly prior to the commencement of formal legal proceedings against the insured.