What's So Special About 'K2'?

, New York Law Journal

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A recent New York Court of Appeals' decision is causing a groundswell of confusion among legal pundits and commentators in the liability insurance industry, many of whom rotely construe the New York Court of Appeals' less-than-perspicuous analysis in K2 Investment Group v. American Guarantee & Liability Insurance, 21 N.Y.3d 384, 993 N.E.2d 1249, 2013 NY Slip Op 04270 (June 11, 2013), to blanketly mean that whenever a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify (pay the loss on behalf of) the insured for a judgment against him, even if such exclusions would otherwise have negated the duty to indemnify under the policy.

However, such a drily logical interpretation gives short shrift to the actual facts upon a careful reading of the K2 decision, and would amount to an enormous leap of faith in effectively overruling a solid string of New York Court of Appeals' case precedent as to the subsisting right of a liability insurer to disclaim coverage—as long as it has neither waived and/or become estopped to assert the right to do so—notwithstanding its improper refusal to defend (See, e.g., Schiff Associates v. Flack, 51 N.Y.2d 692 (1980); Servidone Construction v. Security Ins., 64 N.Y.2d 419 (1985); See also, Colon v. Aetna Life & Cas., 66 N.Y.2d 6 (1985)).

In September, 2013, the New York Court of Appeals granted defendant American Guarantee leave to reargue its appeal in K2 ostensibly based on such insurer's claim that the court overlooked its prior decision in Servidone Construction v. Security Insurance, in having held that by breaching its duty to defend, American could not avoid its indemnity obligation under its policy. However, to recognize the substantive differences between K2 and Servidone is to realize that American Guarantee's position is fatally flawed. Although in K2 and Servidone each insurer breached its respective duty to defend, the court in Servidone allowed the insurer to rely on a policy exclusion in contesting its obligation to indemnify because the insured settled the underlying tort action before any adjudication of liability could be made, and thus it was unknown whether the loss compromised by the insured fell within the indemnity coverage of the insurer's policy. However, in K2, an adjudication of liability had already been made against the insured that was conclusive of American Guarantee's duty to indemnify under its policy, barring such insurer from asserting defenses to coverage which served to defeat the covered liability determination underlying the judgment against its insured.

This article seeks to explain and clarify that the Court of Appeals' holding in K2 has not overruled any of the court's prior rulings, and that a liability insurer's improper refusal to defend will not bar it from later asserting any valid defense to coverage which negates its duty to indemnify, unless such disclaimer would defeat its insured's right to coverage already established by a liability judgment or determination rendered against such insured in the underlying tort action.

Facts and Background

In K2, plaintiffs, two limited liability companies, made loans secured by mortgages totaling $2.83 million to Goldan, a real estate development company owned by Mark Goldman and Jeffrey Daniels. When Goldan failed to repay the loans, plaintiffs discovered their mortgages had not been recorded, and sued Goldan and its two principals, Goldman and Daniels, asserting, among other claims, a claim by each plaintiff for legal malpractice against Daniels, as their attorney.

Although plaintiffs alleged that Daniels was a member of Goldan, the basis of the legal malpractice action was that Daniels agreed to act as plaintiffs' attorney with respect to their loans to Goldan, and that his failure to record the mortgages was "a departure from good and accepted legal practice," causing financial injury to plaintiffs by rendering their loans unsecured, and thus uncollectible. The action was based exclusively on Daniels' obligation to plaintiffs, as their attorney. It was not alleged that Daniels was negligent in rendering legal services to his business enterprise, Goldan.

Daniels' malpractice carrier, American Guarantee, disclaimed coverage claiming, inter alia, that the allegations against Daniels "[were] not based on the rendering or failing to render legal services for others," and fell within two exclusions under American's professional liability policy. One exclusion, the "Insured's Status" exclusion, barred claims based upon or arising out of the insured's capacity or status as an officer, director, etc., of a business enterprise. The other exclusion, the "Business Enterprise" exclusion, barred any claim arising out of the alleged acts or omissions of the insured for any business enterprise in which he had a controlling interest.

Thereafter, plaintiffs K2 made a settlement demand on Daniels for $450,000—significantly less than the $2 million limit of American Guarantee's policy—which demand was transmitted by Daniels to American Guarantee, which rejected it for the same reasons earlier given for denying coverage.

After Daniels failed to appear in the malpractice action, a default judgment was entered against him in excess of the policy limit, and Daniels assigned to plaintiffs all of his rights against American Guarantee. Plaintiff-assignees, thereafter brought an action seeking to recover the $2 million policy limit against American Guarantee for breach of contract, among other grounds.

American sought summary judgment based on the above exclusions, arguing that the claim against Daniels arose out of his "capacity or status" as a member and owner of Goldan, and out of his "acts or omissions" on Goldan's behalf.

Plaintiffs K2 cross-moved for summary judgment. Supreme Court granted their motion as to the breach of contract claims, holding that American breached its duty to defend Daniels, and was therefore bound, up to the $2 million limit of its policy, to pay the resulting judgment against him.

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