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Liability cover can be denied even when duty to defend breached: Court


A professional liability insurer can rely on exclusions to deny coverage even when it has breached its duty to defend, New York state's highest court has ruled in reversing its own earlier decision.

New York-based American Guarantee & Liability Insurance Co., a unit of Zurich American Insurance Co., provided professional liability insurance to attorney Jeffrey Daniels, whom it wrongly refused to defend in a legal malpractice case, according to Tuesday's ruling by the New York Court of Appeals in K2 Investment Group L.L.C. et al. v. American Guarantee & Liability Insurance Co.

According to court papers, the plaintiffs — limited liability companies South Jordan, Utah-based K2 and New York-based ATAS Management Group L.L.C. — made loans totaling $2.83 million to Goldan L.L.C. Mr. Daniels was one of two principals at Goldan, a Garden City, N.Y., real estate company.

The loans were to be secured by mortgages, but Goldan failed to repay the loans and the plaintiffs discovered that their mortgages had not been recorded. A bankruptcy petition was later filed against Goldan.

One claim in the ensuing litigation was for legal malpractice against Mr. Daniels, who is a lawyer. American Guarantee refused to provide either defense or indemnity coverage. A default judgment was entered against Mr. Daniels, and he assigned his American Guarantee rights to K2, which sued the insurer in seeking to recover the $2 million policy limit.

In a June 2013 ruling that attracted significant attention, the New York Court of Appeals held that “by breaching its duty to defend Daniels, American Guarantee lost its right to rely” on policy exclusions to deny coverage.


The court subsequently agreed to rehear the case based on American Guarantee's motion.

In its 4-2 ruling Tuesday, the court said its earlier decision was wrong. The New York Court of Appeals pointed to its 1985 ruling in a similar case, Servidone Construction Corp. v. Security Insurance Co. of Hartford, in which it held that an insurer could later rely on policy exclusions to escape its duty to indemnify an insured for a judgment against him, even if it has breached its duty to defend.

Courts in several states have ruled similarly, the court said.

“Under these circumstances, we see no justification for overruling Servidone,” the court said in its Tuesday ruling. “Plaintiffs have not presented any indication that the Servidone rule has proved unworkable, or caused significant injustice or hardship, since it was adopted in 1985.”

When deciding a question of insurance law, “insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the legislature decides otherwise,” the court ruled.

The court then turned to the question of whether exclusions in this case were applicable. The exclusions say the policy will not apply if the insured's capacity or status is as an “officer, director, partner, trustee, shareholder, manager or employee of a business enterprise” or if he had a controlling interest.

As principal of Goldan, “it is fair to infer that (Mr. Daniels) was at least a 'manager' at Goldan, and had controlling interest within the policy's meaning,” the court said in holding that the exclusions applied and vacating its earlier ruling.

“The reversal keeps New York in line with the predominant rule nationally regarding coverage exclusions,” the New York-based New York Insurance Association, which submitted an amicus brief on American Guarantee's behalf, said in a statement reacting to Tuesday's ruling.

“The original decision would have greatly increased litigation costs for the entire New York court system and led to inevitable delays for injured parties,” the association said.