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Insurers Reach the Summit: N.Y. Court of Appeals Reverses K2, Says Exclusions Not Lost in Breach of Duty to Defend


Insurers Reach the Summit: N.Y. Court of Appeals Reverses K2, Says Exclusions Not Lost in Breach of Duty to Defend

February 18, 2014

After granting reargument, the New York State Court of Appeals reversed its previous decision finding that the rule of stare decisis must govern and that the court erred by failing to take account of controlling precedent in Servidone Const. Corp. v. Sec. Ins. Co. of Hartford. In that previous decision, K2-I, the court arguably rewrote New York law by adopting a minority position that recognized the doctrine of coverage by estoppel ruling that where an insurer breaches its duty to defend, it has “lost its right” to rely on policy exclusions to deny coverage for indemnification. On reargument the court acknowledged that its K2-I holding and the holding in Servidone could not be reconciled.

The court narrowed the issue in K2, finding it to be the same issue that was addressed in Servidone, i.e., whether the insurer may rely on policy exclusions that do not depend on facts established in the underlying litigation after breaching its duty to defend the insured. The court acknowledged that the Servidone rule is a majority rule which must be followed, and does not impose a bar on an insurer’s reliance on policy exclusions despite a wrongful failure to defend its insured in an underlying action.

Finding that the plaintiffs in this matter did not present any indication that the Servidone rule is unworkable, or has caused significant injustice or hardship since it was adopted in 1985, the court stated that when it “decides 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 made it clear that the Lang v. Hanover Ins. Co. decision did not silently overrule Servidone, but cited to its statement that “an insurance company that disclaims in a situation where coverage may be arguable is well advised to seek a declaratory judgment concerning the duty to defend or indemnify the purported insured,” calling it “sound advice.”

The opinion drew a dissent by Judge Victoria Graffeo, who was joined by Judge Eugene Pigott in favor of implying the harsh remedy of forfeiture of policy exclusions where an insurer has breached its duty to defend the insured. The dissent urges the distinction between policy exclusions and the defense of “noncoverage,” advocating for “legal consequences” for insurers that breach the duty to timely defend and encouraging the use of declaratory judgment actions for efficient resolution of coverage issues without unduly burdening the insured or the injured parties. The dissent would apply a restriction to the Servidone rule “to clarify that an insurer’s breach of the duty to defend prohibits it from avoiding indemnification on the basis of policy exclusions, but not from demonstrating that there never was coverage for the loss in the first instance.”

After an arduous climb, the K2 era has finally come to end. The result adds clarity and puts an end to the speculation, allowing insurers to climb out of the space between the rock and the hard place that many found themselves in under the K2-I decision.

If you have questions about how this may impact your business, contact: