On April 8, 2014, Justice Kornreich of the New York County Commercial Division issued a decision in Madison 96th Associates, LLC v. 17 East Owners Corp., 2014 NY Slip Op. 50569(U), ruling that an insurance policyholder that successfully brought a declaratory judgment action establishing its right to coverage was not entitled to recover its attorneys’ fees incurred in the declaratory judgment action even though it would have been so entitled had its insurer brought the action.
Under the well-known American Rule, each party to a litigation incurs its own legal fees, unless a statute, court rule or agreement provides otherwise. In Mighty Midgets v Centennial Ins. Co., 47 N.Y.2d 12, 21 (1979), the Court of Appeals recognized a limited exception in the insurance context, allowing an insured to recover fees when it “has been cast in a defensive posture by the legal steps an insurer takes in an effort to free itself from its policy obligations.” As Justice Kornreich explained:
In other words, when an insurance company brings a declaratory judgment action against its insured seeking to disclaim coverage, if the insured prevails, the insured is entitled to be reimbursed its legal fees spent defending the insurance company’s lawsuit. However, when an insured commences a declaratory judgment action against its insurer seeking coverage, the insured cannot recover its attorneys’ fees in such action, even if it prevails. The rationale for this distinction is that when an insurer casts an insured in a defensive posture the liability feature of the insurance is triggered and provides coverage for defense expenses incidental to the assertion of claims against the insured.
(Citations and internal quotation marks omitted) (emphasis added).
Recognizing the “perverse incentive” created by this rule (since fee-shifting is triggered only if the insurance company files suit, it is in the insurer’s interest to deny coverage and leave it to the insured to bring a coverage action), Justice Kornreich concluded that “public policy strongly militates in favor of forcing [the insurance company] to pay the [insured’s fees].” Nevertheless, the court concluded that it was “bound by the Mighty Midgets doctrine,” and accordingly, denied the insured’s claim for attorneys’ fee. Justice Kornreich took the unusual step of encouraging the plaintiff to appeal the decision. If the Court of Appeals were to revisit the Mighty Midgets rule, it could have a dramatic effect on insurance coverage litigation in New York.