by Christopher Graham and Joseph Kelly

Two recent decisions impose severe consequences upon insurers that breach a duty to defend. A New York case, K2 Investment Group, LLC, et al v. American Guarantee & Liability Ins. Co, 21 N.Y.3d 384 (2013), involved a legal malpractice insurance policy. A Missouri case, Columbia Casualty Company v. Hiar Holdings, LLC, No. SC93026 (Mo. Aug. 13, 2013), involved a CGL policy. But the decisions are important for all duty-to-defend insurers in those states, regardless of the policy-type.

Under the New York K2 decision, an insurer wrongfully disclaiming a duty to defend, must indemnify its insured for any resulting judgment even if policy exclusions otherwise negate coverage. Lenders had sued an entity and its owners to collect on a debt, but then also sued an attorney/owner for legal malpractice, alleging that, as lenders’ counsel, the attorney failed to record a mortgage securing the debt. The legal malpractice insurer refused to defend the attorney/owner, citing exclusions for a “Claim based upon or arising out of, in whole or in part . . . D. the Insured’s capacity or status as: 1. an officer, director, partner, trustee, shareholder, manager or employee of a business enterprise . . . E. the alleged acts or omissions by any Insured . . . for any business enterprise . . . in which any Insured has a Controlling Interest.” The insurer thereafter also refused to settle for $450,000, well under the $2 million policy limit. The trial court in the malpractice and collection case then entered a default judgment against the attorney on the malpractice claim, for over the $2 million policy limit.

Lenders, as the insured attorney’s assignee, sued the insurer for breach of contract and bad faith. The New York Court of Appeals affirmed a judgment holding the insurer liable for the entire default judgment. It explained that “by breaching its duty to defend [its insured, the insurer] lost its right to rely on these exclusions in litigation over its indemnity obligation.”

Under the Hiar Holdings decision from Missouri, an insurer that wrongfully refuses to defend its insured is liable for all damages flowing from the breach, even exceeding the policy limits. The CGL insurer refused to defend and then settle a class action against its insured alleging violations of the Telephone Consumer Protection Act involving junk faxes. The insured with court approval settled with the class for $5 million, well over the $2 million CGL policy limit. The class then sued the CGL insurer under a garnishment statute, with the insurer counterclaiming for a declaratory judgment. The Court affirmed a judgment against the insurer for the entire $5 million settlement, finding the insurer breached its duty to defend claims alleging both property damage and advertising injury under the policy.

The New York and Missouri decisions are somewhat similar to what Illinois courts have been doing for quite some time. In Illinois, an insurer that fails to defend under a reservation of rights or bring a declaratory action is estopped from raising coverage defenses to an indemnity obligation, where it has breached a duty to defend. Doe v. Illinois State Medical Inter-Insurance Exchange, 599 N.E.2d 983 (1st Dist. 1992).

The insurer in the New York decision is seeking further review. So stay tuned. But these decisions are a red-flag for any insurer that caution is in order when declining a defense obligation in New York, Missouri, and Illinois.

Tags: New York, Missouri, Illinois, legal malpractice insurance, professional liability insurance, duty to defend, estoppel