New York’s Highest Court Sends Clear Message to Liability Insurance Companies: Disclaim the Duty to Defend at Your Own Peril

This article was originally published in the Anderson Kill Policyholder Advisor Volume 22, Issue 4 (September/October 2013)

The New York Court of Appeals' June 11, 2013 opinion in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., 21 N.Y.3d 384, 993 N.E.2d 1249 (2013) reiterated a clear message to liability insurance companies: disclaim the duty to defend a policyholder at your own peril. If the insurance company is later found to have done so unjustifiably, K2 Investment Group confirms that the insurance company may not thereafter deny coverage and must instead indemnify its policyholder "even if policy exclusions would otherwise have negated coverage."

New York's Highest Court Reconfirms That Insurance Companies May Need "An Incentive to Defend"

K2 Investment Group arose from a business dispute in which the plaintiff loaned approximately $2.8 million to a corporation, secured by mortgages on property held by the corporation's two principals. The plaintiff, K2 Investment Group, soon discovered the mortgages were not recorded, which prejudiced its rights as a creditor when the corporation defaulted and entered bankruptcy. K2 sued the corporation and the principals. Among the claims asserted by K2 was a cause of action for legal malpractice against one of the principals, an attorney, who had also been responsible for drafting and recording K2's mortgages.

The attorney's legal malpractice carrier, American Guarantee, disclaimed its duty to defend on the grounds that the principal was acting as a businessman, not an attorney, when he neglected to record the mortgages. K2 obtained a default judgment and an assignment of rights from the principal, and it then sued American Guarantee for breach of contract. The trial court granted judgment in favor of K2; the Appellate Division affirmed in full. The Court of Appeals likewise upheld the result, and further clarified and confirmed a remedy espoused nine years earlier in Lang v. Hanover Ins. Co., 3 N.Y.3d 350, 820 N.E.2d 855 (2004):

[W]e now make clear that Lang . . . means what it says: an insurance company that has disclaimed its duty to defend "may litigate only the validity of its disclaimer . . . " If company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify. This rule will give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit...