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New York’s highest court has been asked to settle a split of authority on the awarding of attorney’s fees in cases where an insurance company loses a bid to disclaim coverage.

The U.S. Court of Appeals for the Second Circuit invited the New York Court of Appeals to determine when an insured can recover fees after defeating an insurance company which had sought a court’s ruling that it was not obligated to defend the case.

The case involved an exception to the rule that a prevailing party cannot recover attorney’s fees. It raises an “important, unsettled and determinative question of state law,” the circuit said in an opinion by Judge Guido Calabresi.

The issue in U.S. Underwriters Insurance Co. v. City Club Hotel, 03-7533, involved the injury of construction worker Marek Szpakowski in 2000 in a scaffold collapse. City Club Hotel, a tenant, and Shelby Realty, a property owner, were initially considered covered by U.S. Underwriters.

The decision will be published Tuesday.

U.S. Underwriters later disclaimed coverage, pointing to an employee exclusion clause in the policy.

Mr. Szpakowski, a City Club Hotel employee, became embroiled in litigation over workers’ compensation payments and his allegation of job-site safety violations. He sued Shelby Realty and two City Club Hotel partners in Manhattan Supreme Court for claims under state labor and industrial laws.

The insurance company in turn filed an action in the Southern District seeking a declaratory judgment that it had no duty to defend Shelby Realty or the partners, although it was doing so in the meantime.

The insurer lost on the issue of its liability, but the defendants were denied their request for attorney’s fees. U.S. Underwriters appealed to the Second Circuit on the issue of its liability, and the defendants appealed the denial of attorney’s fees.

Agreeing with the district court, the circuit first ruled that U.S. Underwriters had given “unexcusably late notice” of its intention to disclaim coverage.

Turning to the issue of attorney’s fees, Judge Calabresi noted that New York courts “have carved out a ‘narrow exception’ to the general American rule that a prevailing party cannot recover attorneys’ fees.

“Under this exception, an insured who prevails in a declaratory judgment action brought by an insurance company seeking to deny a duty to defend and indemnify is allowed to recover fees expended in defending against that action,” he said.

The standard, he said, announced in Mighty Midgets Inc., v. Centennial Ins. Co., 47 N.Y. 2d 12 (1979), is that an insured can be awarded fees “when he has been cast in a defensive posture by the legal steps an insurer takes in an effort to free itself from its policy obligations.”

Even though Mighty Midgets “states the exception in broad terms,” Judge Calabresi said, “lower federal and state courts have consistently disagreed about whether the exception applies in cases where the insurer, who sought disclaimer of liability and lost, had earlier discharged its duty to defend the insured in the underlying action” — an issue, he said, that was not discussed in Mighty Midgets.

Judge Calabresi said federal courts have, for the most part, been concerned that awarding fees in these circumstances would “create an incentive for the insurer to refuse to defend in the underlying suit, thereby leaving it up to the insured to bring a declaratory action seeking coverage.”

But “several Appellate Divisions and at least one federal court,” he said, believe that Mighty Midgets requires awarding fees whenever the disclaimer declaratory action has been brought by the insurer — that it does so, that is, even where an insurer does not breach its duty to defend in the underlying suit.”

This split of opinion, Judge Calabresi said, should be resolved by the New York Court of Appeals.

“This division in interpreting New York law between the majority of New York lower courts, and the majority of federal district courts . . . has created an unusual and undesirable degree of uncertainty in cases of this sort, cases like the one we have before us today,” he said.

If the Court of Appeals decides to resolve the issue, it will be the second case it has accepted from the Second Circuit this year.

Judges Amalya Kearse and Jon O. Newman joined in the opinion.

Steven Verveniotis and Jason B. Gurdus of Miranda & Sokoloff represented U.S. Underwriters. Mark J. Bunim and Alan Garten of Bryan Cave represented Shelby Realty.

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