Jason L. Shaw ()
The New York Court of Appeals in its February 2014 session issued within several days of each other two significant insurance coverage decisions, K2 Investment Group v. American Guarantee & Liability Ins. (K2 II) (Feb. 18, 2014) and Executive Plaza v. Peerless Ins. (Feb. 13, 2014). K2 II allows liability carriers to breathe a sigh of relief. Executive Plaza takes a small bite out of the contractual two-year lawsuit limitations period in New York fire insurance policies.
K2 II was the more extraordinary of the two decisions. However, this was not because of its holding. The K2 II holding reinstated old law and eliminated a judicial economy rule the court had created only eight months earlier in K2 Inv. Group v. Am. Guar. & Liab. Ins., 21 NY3d 384 (2013) (K2 I). The extraordinary part of K2 II was that the court granted a motion for reargument of K2 I, decided it had been wrong in K2 I, and vacated K2 I. According to those knowledgeable of the court’s practice, over the last decades the court has granted motions for reargument about the same number of times as there are fingers remaining on the right hand of an old saw mill worker.
K2 I, decided in June 2013, had the insurance liability carriers in New York in a tizzy. The case held that a liability insurer, in K2 I, a professional liability insurer, who wrongly breaches its duty to defend its insured, “may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.”
K2 I built on a well-known principle of insurance that the duty to defend is broader than the duty to indemnify. Automobile Ins. Co. of Hartford v. Cook, 7 NY3d 131, 137 (2006). Thus, even if a liability insurer might ultimately rely upon a policy exclusion to escape paying a judgment against the insured, it must still provide a defense to its insured if the four corners of the complaint could arguably be alleging a covered occurrence for which the insured could be liable.
K2 I raised the stakes for an insurer if it disclaims all coverage shortly after it receives notice of the claim. The insurer had one bite at the apple, so it better be right about the disclaimer. Coverage attorneys were advising insurance company clients to defend under a reservation of rights listing the potential coverage exclusions or to immediately commence a declaratory judgment action naming as defendants the insured and the plaintiff in the underlying action, making everyone a party in a lawsuit to determine coverage.
K2 I promoted judicial economy. An insurer would be wise to attempt to resolve a coverage issue immediately. Moreover, the resolution of coverage would doubtless drive the behavior of the plaintiff in the underlying liability case. Unless the plaintiff in the underlying liability case knew the insured has deep pockets, an early judicial determination of no insurance coverage for the alleged injury would force the plaintiff to decide whether to accept a nominal sum in settlement or to pursue the case, potentially driving the defendant-insured into bankruptcy. If the case had been taken on a contingency basis, as a practical matter the lack of coverage would lessen the plaintiff’s attorney’s interest in pursuing the case. Finally, an early determination of coverage would make the insurer more likely to evaluate the underlying case for possible early settlement.
K2 II, written by Judge Robert Smith, was driven by the court’s perception that its decision in K2 I had inadvertently overruled its prior decision of Servidone Construction Corp. v. Security Ins. Co. of Hartford, 64 N.Y.2d 419 (1985). The court had not even mentioned Servidone in K2 I. Servidone had held that an insurer’s breach of its duty to defend cannot create coverage, so when an insured settles with the plaintiff, neither the insured nor the original plaintiff is entitled to receive indemnification from the carrier unless there was a covered loss. In Servidone there was a policy exclusion for a loss arising from an obligation the defendant-insured had assumed pursuant to contract, and this exclusion could have arguably applied had the insurer not initially disclaimed coverage.
K2 1 relied on language in Lang v. Hanover Ins., 2 N.Y.3d 350 (2004), a decision written by Judge Victoria Graffeo. At the end of the Lang decision, the court advised insurers to seek from the outset a declaratory judgment about its duty to defend or indemnify. Lang warned that if an insurer simply declines to defend the underlying lawsuit, the injured party, armed with a judgment, could pursue the insurer directly under Insurance Law section 3420, and the liability carrier could litigate the validity of its disclaimer but could not challenge the liability or damage determinations in the underlying judgment.
In its motion for reargument to the court, the K2 1 defendant-insurer successfully argued that the court had overlooked Servidone and had misread Lang as preventing a carrier, not just from challenging the underlying judgment against its insured, but also from raising contractual exclusions that could have allowed the carrier to escape its obligation to indemnify. During oral argument on the reargument motion, the judges’ questions showed they were wrestling with whether the policy considerations supporting K2 1 outweighed the 29-year-old rule of Servidone. There was also concern that K2 1 would put New York in the minority among other state courts that had ruled on the same issue.
In the end, the court in K2 II decided it would not overrule Servidone and acknowledged that Lang, on which the court had relied in K2 I, had in fact only stated the established principle that the underlying judgment was not subject to collateral attack by the insurer. Lang did not extend to preclude a wrongfully disclaiming insurer from raising contractual exclusions to avoid payment of the judgment.
In her K2 II dissent, Judge Graffeo hit hard on the policy reasons for allowing K2 I to stand. She said that requiring an insurer to either assert its exclusions in a declaratory judgment action to determine its underlying duty to defend or indemnify or lose the right to assert exclusions later would bring all interested parties “together in a judicial forum” and would contribute to the “efficient resolution of factual issues for the benefit of the litigants without unduly burdening the ability of injured parties to obtain recovery for covered losses.” Graffeo pointed out that allowing a disclaiming insurer to reserve its exclusions and then assert them after the underlying litigation had been concluded would result in repetitive and prolonged litigation.
An important point raised by Graffeo, one glossed over by the majority, is the distinction between a policy exclusion and an actual absence of coverage. An exclusion applies where there would be coverage for a loss, but the policy states that a specified cause for the loss excludes the loss from coverage. Early on, a carrier must assert an exclusion as a possible defense to coverage or it will likely waive the exclusion. In contrast, a carrier’s failure to raise an absence of coverage can never create coverage. For example, a person who is not an insured cannot become an insured by the carrier’s failure to raise the lack of insured status.
Graffeo proposed that the Servidone holding survive, that a carrier be allowed to raise an absence of coverage for a loss after a wrongful disclaimer of coverage, but that the wrongful disclaimer would prevent the carrier from relying on the policy exclusions in a later lawsuit brought by the insured or the plaintiff in the underlying case.
K2 II eliminates any thought that Lang had changed the consequences of an improper disclaimer. A plaintiff seeking to collect a judgment from a disclaiming carrier and any insured seeking to force its insurer to provide coverage may be in for a long, and potentially expensive, battle with a carrier. After its extraordinary vacating of K2 I, there is no chance that the court will revisit this issue any time in the near future.
Executive Plaza v. Peerless Ins., 2014 Slip Op. 00898, granted relief to an insured caught in the conundrum of complying with two standard property and casualty policy clauses. One clause requires the insured to actually replace the loss before receiving a replacement cost payment. The other states that an insured must sue an insurer for a breach of the policy within two years of the date of the loss.
Executive Plaza came to the New York court on a question certified by the U.S. Court of Appeals for the Second Circuit, and the procedural history of Executive Plaza shows bad blood between Peerless and its insured. For myriad reasons, most pointless, animosity between an insured and a carrier can occur and results in extraordinarily expensive litigation that could have been avoided.
Executive Plaza’s building was in 2007 severely damaged by a fire, and it ultimately cost more than $1 million to restore the building to its previous condition. Peerless insured the building for over $1 million. As with most property and casualty policies, without doing anything to the building, Executive Plaza recovered the actual cash value of the building, which in this case was just over $750,000. Actual cash value is less than the full replacement cost. It is a depreciated value of a building based upon its age, condition, and other factors and is paid regardless of whether the building is replaced. Executive Plaza notified Peerless that it would be replacing the building and would be seeking the balance of the $1 million in coverage. Peerless’ response was that it wanted Executive Plaza to submit documentation verifying the repairs before payment would be made.
The problem was that Executive Plaza, now coming up on two years after the fire loss, had not completed replacing the building and Peerless had held back the replacement cost payment. Frequently in these situations, if the insurer sees that its insured had been moving forward with replacement, the insurer will either make incremental payments or extend beyond two years the time in which the insurer can bring a lawsuit, to allow the insured to preserve its rights. Apparently, either Executive Plaza made no such extension request or Peerless refused to grant it.
Before the two-year contract limitations period, but also before the building replacement was completed, Executive Plaza filed suit in state court to collect the replacement cost holdback. Peerless removed to federal court on diversity jurisdiction and promptly moved to dismiss the case because Executive Plaza had not completed replacing the building, a condition precedent to obtaining replacement cost. The district court granted the dismissal motion, finding the lawsuit was premature.
Executive Plaza then completed the replacement and again brought suit. By this time, however, the policy two-year limitations period had passed. Once again Executive Plaza commenced suit in state court; once again Peerless removed to federal court, and again moved to dismiss, this time because the lawsuit was untimely. The district court found the two-year limitations period reasonable, and again dismissed the suit. Charles Dickens could have used this case in a chapter of Bleak House.
Executive Plaza appealed to the Second Circuit. There were now two lawsuits and one appeal over a $242,187 replacement cost holdback amount. The Second Circuit certified to the New York Court of Appeals the question of whether an insured was covered for replacement cost and could still maintain an action to recover replacement cost if it could not reasonably complete the replacement within the two years. The Executive Plaza court answered the question in the affirmative.
In a decision also written by Judge Smith, the Executive Plaza court found the two-year contractual limitations period to be generally reasonable. But the court said the problem in Executive Plaza was not the two-year duration, but the “accrual date” of the two-year period. The court said that it was “neither fair nor reasonable to require a suit within two years from the date of the loss, while imposing a condition precedent to the suit—in this case, completion of the replacement of the property—that cannot be met within that two-year period.” It described a limitations period that expires before a suit can be brought as “not really a limitations period at all, but simply a nullification of the claim.”
The court pointed out that the insured had unsuccessfully commenced two actions to collect the replacement cost, one brought too soon and the other brought too late. In other words, the court said that in this particular case, where the building could not reasonably be replaced within the two-year limitations period, the limitations period would not bar the insured’s’ suit.
The plaintiffs’ bar in the insurance coverage world immediately cheered Executive Plaza. Any attorney involved with policy issues knows that the two-year limitations period, which runs from the date of the loss, a date which can be months before the loss claim is submitted, is always a concern.
The Executive Plaza holding is limited to cases where replacement cannot be completed within two years of the loss. Indeed, the Executive Plaza court said there was nothing inherently wrong with the two-year limitations period. Practically speaking, an insured’s attorney does not want a courtroom battle about whether a building could, in fact, have been replaced within two years of the loss so as to avoid the limitations period. If that possibility exists, the attorney or the insured’s adjuster should begin documenting the progress of the claim and construction as early as possible.
Jason L. Shaw is a partner of Whiteman Osterman & Hanna in Albany and a member of the Executive Committee of the New York State Bar Association Tort Insurance & Compensation Law Section.