K2 Investment Group, LLC, et al., Respondents-Appellants,v.American Guarantee & Liability Insurance Company, Appellant-Respondent.BriefN.Y.January 7, 20140 STATE OF NEW YORK Court of Appeals APL-2012-00055 K2 INVESTMENT GROUP, LLC and ATAS MANAGEMENT GROUP, LLC, Plaintiffs-Respondents-Appellants, vs. AMERICAN GUARANTEE & LIABILITY INSURANCE COMPANY, Defendant-Appellant-Respondent. New York County Index Number: 117902/09. AMICI CURIAE BRIEF ON BEHALF OF NEW YORK INSURANCE ASSOCIATION, INC., THE NATIONAL ASSOCIATION OF MUTUAL INSURANCE COMPANIES, PROPERTY CASUALTY INSURERS ASSOCIATION OF AMERICA and THE FEDERATION OF DEFENSE AND CORPORATE COUNSEL HURWITZ & FINE, P.C. Attorneys for New York Insurance Association, Inc. (“NYIA”), the National Association of Mutual Insurance Companies (“NAMIC”), Property Casualty Insurers Association of America (“PCI”) and the Federation of Defense and Corporate Counsel (“FDCC”) 1300 Liberty Building Buffalo, New York 14202 Telephone: (716) 849-8900 Facsimile: (716) 855-0874 DAN D. KOHANE, ESQ. Of Counsel Date of Completion: November 13, 2013. BATAVIA LEGAL PRINTING, INC.— Telephone (866) 768-2100 COURT OF APPEALS STATE OF NEW YORK K2 INVESTMENT GROUP, LLC and ATAS MANAGEMENT GROUP, LLC, Plaintiffs-Respondents-Appellants, vs. AMERICAN GUARANTEE & LIABILITY INSURANCE COMPANY, Defendant-Appellant-Respondent. Docket Number: APL-2012-00055 CORPORATE DISCLOSURE STATEMENT Pursuant to Rule§ 500.1(f) of the Rules ofthe Court of Appeals (22 NYCRR), the proposed amici make the following disclosures: 1. New York Insurance Association, Inc. ("NYIA") is a New York domestic not-for-profit corporation. It has no parents, subsidiaries, or affiliates. 2. National Association of Mutual Insurance Companies ("NAMIC") is a not-for-profit trade association incorporated in Indiana. NAMIC is considered by the Indiana Department of Insurance to be an Insurance Holding Company as to NAl\11C Insurance Company, Inc. (trade name NAMICO), a stock insurance company. Subsidiaries are NAMIC Services Corp., NAMIC PG, Inc., 1 and NAMIC Insurance Agency. Affiliated entities are Group Insurance Trust, Master Retirement Trust and Multiple Employer Plan. 3. Property Casualty Insurers of America ("PCI") is a 501(c)(6) corporation incorporated in Illinois. It has no affiliates and one for-profit wholly owned subsidiary, Independent Statistical Service. 4. Federation of Defense & Corporate Counsel is a not-for-profit corporation organized under Illinois law. It has no corporate parents, subsidiaries, or affiliates. The only other related legal entity is the Federation of Defense & Corporate Counsel Foundation. INTEREST OF AMICI CURIAE The New York Insurance Association, Inc. ("NYIA") is a state trade association that has represented the property and casualty insurance industry in New York for more than 130 years. NYIA's membership includes both national and regional carriers, domestics and non-domestics, collectively writing nearly $12 billion annually in New York premium. The association represents stock, mutual, and cooperative insurers writing in virtually every county of New York State. NYIA's mission is to promote an insurance market that is viable and strong in order to better serve the insuring public, to promote the economic, legislative and public standing of its members and the insurance industry, to provide a forum for discussion of policy issues of common concern to its members 2 and the insurance industry, and to serve the public interest through activities promoting the safety and security of persons and property. The National Association of Mutual Insurance Companies ("NAMIC") is the largest and most diverse property/casualty trade association in the country, with 1,400 national, regional and local mutual insurance member companies serving more than 135 million auto, home, and business policyholders. These companies write in excess of $196 billion in annual premiums, accounting for 50 percent of the automobile/homeowners market and 31 percent of the business insurance market. More than 200,000 people are employed by NAMIC member companies. Property Casualty Insurers Association of America ("PCI") promotes and protects the viability of a competitive private insurance market for the benefit of consumers and insurers. PCI is composed of more than 1,000 member companies, representing the broadest cross section of insurers of any national trade association. PCI members write more than $195 billion in annual premiums, 39 percent of the nation's property casualty insurance. Member companies write 46 percent of the U.S. automobile insurance market, 32 percent of the homeowners market, 3 7 percent of the commercial property and liability market, and 41 percent of the private workers' compensation market. In New York, PCI members write 3 50.5 percent of all personal lines coverage, 48.6 percent of commercial auto coverage and 38.8 percent of the commercial property market. The Federation of Defense & Corporate Counsel ("FDCC") was formed in 1936 and has an international membership of 1,400 defense and corporate counsel. FDCC members work in private practice, as general counsel, and as insurance claims executives. Membership is limited to attorneys and insurance professionals nominated by their peers for having achieved professional distinction and demonstrated leadership in their respective fields. The FDCC is committed to promoting knowledge and professionalism in its ranks and has organized itself to that end. Its members have established a strong legacy of representing the interests of civil defendants. DATED: Buffalo, New York November J3, 2013 Respectfully submitted, n D. Kohane, Esq. Attorneys for Proposed Amici Curiae New York Insurance Association, National Association of Mutual Insurance Companies, Property Casualty Insurers Association of America and Federation of Defense & Corporate Counsel 1300 Liberty Building Buffalo, New York 14202 (716) 849-8900 4 TABLE OF CONTENTS Table of Authorities ................................................................................................. iii PRELIMINARY STATEMENT ............................................................................... 1 POINT I AN INSURER THAT REJECTS A VALID REQUEST FOR DEFENSE IS BOUND BY FACTS NECESSARILY DECIDED IN THE UNDERLYING ACTION, BUT THE TERMS OF THE INSURANCE POLICY DETERMINE THE SCOPE OF COVERAGE ............................................................................................. 3 A. This Court's Undisturbed Precedent OfMore Than 30 Years Establishes That An Insurer Preserves Its Right To Litigate The Applicability Of Its Stated Coverage Defenses ............................. 4 B. This Court's Holding In K2 Fails To Acknowledge That A Breach Of The Duty To Defend May Not Necessarily Lead To An Obligation To Indemnify- The Policy Provisions Control. ......... 11 (1) There Are Situations Where The Facts Established By The Underlying Judgment Do, In Fact, Resolve The Coverage Questions .................................................................. 11 (a) The "Alleged" Driver ........................................................ 11 (b) The Negligent Tenant.. ...................................................... l2 (2) However, The Facts Established By The Underlying Judgment Do Not Always Resolve The Coverage Questions ................................................................................... 12 (a) The Business Pursuit ......................................................... 13 (b) The Taxicab Driver ........... : ............................................... 16 (c) The Builder ........................................................................ 17 (d) The Non-Permissive User ................................................. 18 (3) In Lang, This Court Held That An Insurer Is Precluded From Re-litigating The Underlying Facts ONLY If It Has Failed To Honor Its Defense Obligation. Courts Do Not Preclude An Insurer From Re-litigating Underlying Facts If That Insurer Has Provided A Defense .................................. 18 C. The Broad Language Of This Court's Decision In K2 Departs From Established Precedent And Might Be Read To Impose An Indemnity Obligation On An Insurer Even Where The Facts Pertaining To Coverage Were Neither Litigated Nor Necessarily Decided In The Underlying Action ........................................................................................ 21 POINT II NOT ONLY IS THE ENHANCED PENALTY IMPOSED BY THIS COURT IN ITS DECISION IN THIS MATTER INCONSISTENT WITH ITS PRIOR HOLDINGS, IT IS NOT COMMENSURATE WITH THE ALLEGED BREACH ...................... 22 CONCLUSION ........................................................................................................ 30 11 TABLE OF AUTHORITIES Cases A.B. C. Builders, Inc. v American Mut. Ins. Co., 661 A2d 1187 [1995] .................. 25 Afcan v Mutual Fire, Marine and Inland Ins. Co., 595 P2d 638 [Alaska 1979] ....................................................................................................... 25 Alabama Hasp. Ass 'n Trust v Mutual As sur. Soc. of Alabama, 538 So2d 1209 [Ala 1989] ................................................................................... 25 American States Ins. Co. v State Auto Ins. Co., 721 A2d 56 [Pa Super Ct 1998] ............................................................................................... 25 Arceneaux v Amstar Corp., 66 So3d 438 [La 2011]. ............................................... 25 Brown v State Auto. & Cas. Underwriters, 293 NW2d 822 [Minn 1980] .............. 25 Bucci v Essex Ins. Co., 323 F Supp2d 84 [D Me 2004] .......................................... 26 Bucci v Essex Ins. Co., 393 F3d 285 [1st Cir 2005] ................................................ 26 Burroughs Wellcome Co. v Commercial Union Ins. Co., 713 F. Supp. 694 [SDNY 1989] ........................................................................................................ 26 Capital Environmental Services, Inc. v North River Ins. Co., 536 F Supp2d 633 [ED Va 2008] ......................................................................... 26 Colon v Aetna Life and Cas. Ins. Co., 66 NY2d 6 [1985] ....................................... 18 Colonial Oil Industries Inc. v Underwriters Subscribing to Policy Nos., 491 SE2d 337 [1997] ............................................................................................ 25 Dreyer v New York Central Mutual Fire Insurance Company, 106 AD3d 685 [2nd Dept 2013]. .......................................................................... 19 Elliott v Hanover Ins. Co., 711 A2d 1310 [Me 1998] ............................................. 25 Emhart Industries, Inc. v Home Ins. Co., 515 F Supp2d 228 [D R12007] ............. 26 Employers Ins. of Wausau v Ehlco Liquidating Trust, 708 NE2d 1122 [ 1999] ...... 25 lll Enserch Cmp. v Shand Morahan & Co., Inc., 952 F2d 1485 [5th Cir 1992] [Texas law] ................................................................................... 26 Fireman's Fund Ins. Co. v Rairigh, 475 A2d 509 [1984] ....................................... 25 Flannery v Allstate Ins. Co., 49 F Supp2d 1223 [D Colo 1999] ............................. 26 Frontier Insulation Contractors, Inc. v Merchants Mut. Ins. Co., 91 NY2d 169 [1997] ............................................................................................... 6 George A. Fuller Co. v US. Fid. and Guar. Co., 200 AD2d 255 [1st Dept 1994] ............................................................................ 17 Gilmore v. Beach House, Inc., 174 P3d 439 [2008] ................................................ 25 Halloway v State Farm Ins. Companies, 23 AD3d 617 [2d Dept 2005] ................. 16 Hamlin Inc. v Hartford Ace. and Indem. Co., 86 F3d 93 [7th Cir. 1996] [Wisconsin law]. .......................................................................... 26 Hanover Ins. Co. v Cowan, 172 AD2d 490 [2d Dept 1991] ................................... 13 Hirst v St. Paul Fire & Marine Ins. Co., 683 P2d 440 [Ct App 1984]. ................... 25 Hogan v Midland National Ins. Co., 476 P2d 825 [1970] ....................................... 25 Johnson v Studyvin, 828 F. Supp. 877 [D Kan 1993] ............................................. 26 Johnson v Studyvin, 839 F Supp 1490 [D Kan 1993] .............................................. 26 K2Inv. Group, LLC v Am. Guar. & Liab.Ins. Co., 21 NY3d 384 [2013] ........ 14, 15 K2 Inv. Group, LLC v Am. Guar. & Liab. Ins. Co., 91 AD3d 401 [1st Dept 2012] ..................................................................................................... 21 Kaczmarekv Shoffitall, 119 AD2d 1001 [4th Dept 1986] ...................................... 20 Keller Industries, Inc. v Employers Mut. Liability Ins. Co. of Wisconsin, 429 So 2d 779 [Fla Dist Ct App, 3d Dist 1983] ................................................... 25 Lang v Hanover Ins. Co., 3 NY3d 350 [2004] ......................... 1, 2, 3, 4, 5, 6, 12, 15, ..................................................................................................... 16, 22, 24, 27,29 Linette v Hanover Ins. Co., 29 AD3d 338 [1st Dept 2006] ..................................... 21 IV Lombardi, Walsh, Wakeman, Harrison, Amodeo & Davenport, P.C. v Am. Guar. and Liab. Ins. Co., 85 AD3d 1291 [3rct Dept 2011] ..................................... 9 Mendoza v. Schlossman, 87 AD2d 606 [2d Dept 1982] .......................................... 14 Mighty Midgets, Inc. v. Centennial Ins. Co. 47NY2d 12 [1979] ........................... 28 Missionaries of Co. oflvlary, Inc. v Aetna Cas. & Sur. Co., 230 A2d 21 [1967] ............................................................................................... 25 Naddeo v Allstate Ins. Co., 533 SE2d 501 [2000] ................................................... 25 Northwest Pump & Equipment Co. v. American States Ins. Co., 925 P2d 1241 [1996] ............................................................................................ 26 Polaroid Corp. v Travelers Indem. Co., 610 NE2d 912 [1993] .............................. 25 Radke v Fireman's Fund Ins. Co., 577 NW2d 366 [Ct. App. 1998] ....................... 25 Rochester Woodcraft Shop v. General Ace. Fire & Life Assur. Corp., 35 AD2d 186 .......................................................................................................... 9 Royal Ins. Co. of America v Kirksville College of Osteopathic Medicine, Inc., 304 F3d 804 [8th Cir 2002] [Missouri law] ................................ 26 Sellie v North Dakota Ins. Guar. Ass'n, 494 NW2d 151 [ND 1992] ...................... 25 Servants of Paraclete, Inc. v Great American Ins. Co., 857 F Supp 822 [D NM 1994] ............................................................................. 26 Servants of Paraclete, Inc. v Great American Ins. Co., 866 F Supp 1560 [D NM 1994] ........................................................................... 26 Sen7idone Constr. Corp. v Security Ins. Co., 64 NY2d 419 [1985] .................................... 1, 2, 6, 7, 9, 11, 12, 16, 17, 22, 24,29 Servidone Constr. Corp. v Security Ins. Co. of Hartford, 102 AD2d 59 [3d Dept 1984] ............................................................................. 7, 8 Servidone Constr. Corp. v Security Ins. Co. of Hartford, 106 Misc2d 118 [ 1980] .......................................................................................... 7 Signature Development Companies, Inc. v Royal Ins. Co. of America, 230 F3d 1215 [1Oth Cir 2000] [Colorado law] .................................................... 26 v Spencer v. Assurance Co. of America, 39 F3d 1146 [lith Cir.1994] ..................... 26 St. Paul Ins. Co. v Bischoff, 389 NW2d443 [1986] ................................................ 25 State Farm Mut. Auto. Ins. Co. v Paynter, 593 P2d 948 [Ct App, Div 1 1979] ...................................................................... 25 Timberline Equipment Co., Inc. v St. Paul Fire & Marine Ins. Co., 576 P2d 1244 [1978] ............................................................................................ 26 Time Oil Co. v Cigna Property & Cas. Ins. Co., 743 F. Supp. 1400 [W.D. Wash. 1990] ................................................................ 26 Underwriters at Lloyds v Denali Seafoods, Inc., 927 F2d 459 [9th Cir 1991] [Washington law] .................................................... 26 Statutes Insurance Law§ 3420[a][2]. ................................................................................ 2, 14 Other Authorities Alan D. Windt, Insurance Claims and Disputes, Representation of Insurance Companies and Insureds § 4.37 [6th ed rev 2013] ................................................ 25 U.S. Tort Liability Index: 2008 Report, Pacific Research Institute, 2008 .............. 28 VI PRELIMINARY STATEMENT This Court has routinely placed insurers on notice that rejection of a request to defend an insured places the insurer at substantial risk. If it is later determined that the decision not to defend was mistaken, this Court in Lang v Hanover Ins. Co. (3 NY3d 350 [2004]) and Servidone Constr. Corp. v Security Ins. Co. (64 NY2d 419 [1985]) defined the penalties: facts necessarily decided in the underlying action cannot be re-litigated in subsequent coverage litigation, and the quantum of damages assessed against the insured, absent collusion, cannot be revisited. Amici do not ask this Court, on this submission, to rewrite these consequences, despite their severity. This brief is presented, instead, to respectfully suggest that this Court should refrain from expanding these previously articulated penalties to impose an obligation of indemnification, an outcome that enlarges the coverage beyond that for which the parties contracted. A strict and literal reading of the Court's earlier decision in this matter suggests that additional impact. This Court should stand by its prior precedent holding that an insurance carrier remains entitled to rely on the terms, conditions and exclusions contained in its policy where the facts upon which the denial of coverage is based were not litigated or necessarily decided in the underlying action. 1 This Court in Servidone and Lang made it clear, and the Court is respectfully requested to reaffirm on this reconsideration, that the consequences for a mistaken failure to defend do not alter the nature of the insurance contract or the extent of its coverage. Insurers and insureds alike have the right to rely upon policy terms, inclusions, exclusions and conditions. Contractual defenses and policy exclusions based upon facts not necessarily decided in the underlying action have long remained subject to separate determination, either through a declaratory judgment action or a direct action pursuant to Insurance Law § 3420(a)(2). A failure to defend is not- and should not be- a vehicle for resolving adversely to the insurer facts external to the issues decided in the underlying action and which were neither litigated nor necessarily determined in that proceeding. To the extent the Court's decision in this matter suggests otherwise, it is respectfully submitted that the decision should be withdrawn and that a ruling consistent with prior precedent should be issued. The ramifications of allowing the present ruling to stand unexplained and in contrast to this Court's prior rulings, as detailed below, are contrary to the interests of policyholders as well as insurers, and will impair the resolution of coverage disputes, adding to the cost and delay of attendant litigation. 2 POINT I AN INSURER THAT REJECTS A VALID REQUEST FOR DEFENSE IS BOUND BY FACTS NECESSARILY DECIDED IN THE UNDERLYING ACTION, BUT THE TERMS OF THE INSURANCE POLICY DETERMINE THE SCOPE OF COVERAGE In its landmark 2004 opinion in Lang v Hanover Ins. Co. (3 NY3d 350), this Court directly addressed the risks associated with an insurance company failing to honor its contractual duty to defend. The Court noted that failing to accept the defense of a claim potentially falling within the scope of coverage can, and normally does, result in the carrier's forfeiture of the ability to contest those facts decided in the underlying litigation bearing on the insured's liability to the aggrieved party. Failure to defend also results in an insurer's loss of its rights to object to and oppose the award of damages to an aggrieved party, absent collusion. In short, the facts establishing an insured's tort liability and determining the extent of the damages owed by the insured would be resolved and could not be re-litigated by the insurer. However, these factual determinations would not preclude an insurer from relying upon policy terms that circumscribe and define coverage. The duty to defend is broader than the duty to indemnify. Regardless of the outcome of underlying tort litigation, and despite a determination that an insurer has breached 3 its duty to defend, the insurer should be permitted to litigate the "validity of its disclaimer." The facts to be considered in the determination of the obligation to indemnify should include those necessarily decided through the underlying adjudication as well as those facts extraneous to that deteimination which have not been previously decided. Those facts - all the facts - should then be juxtaposed against policy provisions to determine if there is any obligation to indemnify. That obligation would then be determined by all the facts, including those not necessarily decided in the underlying litigation and with reference to the entire policy, and the result would provide the insured with the coverage purchased. A. This Court's Undisturbed Precedent Of More Than 30 Years Establishes That An Insurer Preserves Its Right To Litigate The Applicability Of Its Stated Coverage Defenses. This Court held in Lang v Hanover Ins. Co. (3 NY3d 350 [2004]), that an insurer that fails to honor its contractual obligation to defend, denying the insured the protection for which it has paid a premium, cannot re-litigate the underlying resolution. This Court also recognized, though, that the insurer who believes it does not owe an obligation to defend and/or to indemnify has an option available under the law: it can commence a declaratory judgment action seeking confirmation of its coverage position. 4 Indeed, the Court noted, the insurer would be "well-advised" to do so. (ld. at 356.) 1 The Court cautioned insurers that the risk of declining to defend and not seeking such a determination was that following a judgment against the insured "the insurance carrier may litigate only the validity of its disclaimer." (I d.) The risk defined by the Court in Lang is not that the carrier will be barred from reliance upon its contract and the limitations of its coverage set forth therein. Rather, the risk is that the carrier will be bound by the determination made in the underlying action as to liability and damages. The rationale behind that distinction is manifest: there are two separate obligations under the policy, the broad duty to defend and the narrower duty to indemnify. The difference in these contractual mandates has long been measured by different standards: As this Court has explained, "an insurer may be contractually bound to defend even though it may 1 There are several instances when an insurer may choose to seek that determination: Where the insurer believes that the allegations fail to assert a claim within coverage and therefore the duty to defend is not triggered, and the insurer seeks confirmation of that belief; Where the insurer is unsure whether the allegations will be considered to assert a claim within coverage and therefore seeks a determination of its obligations; Where the insurer acknowledges that the claims do, in fact, trigger a defense obligation, since the duty to defend is based on the allegations in the complaint, even if groundless false or fraudulent, but verily believes that the totality of the facts would absolve it from its obligation to indemnify and, therefore, its duty to defend. 5 not ultimately be bound to pay, either because its insured is not factually or legally liable or because the occurrence is later proven to be outside the policy's coverage" (citation omitted). While the duty to defend is measured against the possibility of a recovery, "the duty to pay is determined by the actual basis for the insured's liability to a third person" (Servidone Constr. Corp. v Security Ins. Co., 64 NY2d 419 [1985]). (Frontier Insulation Contractors, Inc. v Merchants Mut. Ins. Co., 91 NY2d 169, 178 [1997].) The Servidone decision set important precedent and Lang is in harmony. A close review of the procedural history of Servidone highlights the status of the law in this regard, undisturbed prior to the Court's decision in the present case. Servidone Construction Corporation ("Servidone"), was a third party defendant in a personal injury action brought by its employee against the United States Army Corps of Engineers ("Corps") arising out of a construction accident. The employee sued the Corps under the Federal Tort Claims Act, and the Corps impleaded Servidone, asserting causes of action in common law and contractual indemnification. Servidone asked Security Insurance Company ("Security"), its insurer, to provide a defense. Security concluded that, although covered under the policy, common law indemnification was not a viable cause of action and further, 6 that a policy exclusion vitiated its duty to defend the claim for contractual indemnification. Security undertook Servidone's defense as to both causes of action under a reservation of rights. Subsequently, Security notified Servidone that it would no longer provide it with a defense, citing as a reason the fact that the Corps had abandoned the common law indemnification cause of action. Servidone engaged its own counsel to defend the personal injury lawsuit and to commence a declaratory judgment action against Security. Concerned about the possibility of an adverse verdict in the personal injury action, Servidone thereafter settled the action, contributing $50,000. The court in the declaratory judgment action determined that Security breached its duty to defend and was responsible for all damages flowing from that breach. The trial court declared that the settlement was reasonable and that Security was obligated to indemnify Servidone for the payment. (Servidone Constr. Corp. v Security Ins. Co. of Hartford, 106 Misc2d 118 [1980].) The Third Department affirmed, concluding that the allegations in the pleadings imposed a defense obligation on the insurer in that Servidone always remained "exposed to damage based on common law indemnification, a theory for which policy coverage existed." (Servidone Constr. Corp. v Security Ins. Co. of Hartford, 102 AD2d 59,62 [3d Dept 1984].) 7 On the question of the indemnity obligation, the Third Department determined that the insurer was compelled to pay the $50,000 settlement as a consequence of the error of abandoning the defense. The court reasoned that it was not expanding coverage where none existed, but rather was imposing an obligation to indemnify for a reasonable settlement achieved after the insurer wrongfully declined to defend, because it was impossible to determine whether or not the plaintiff would have prevailed on a theory of liability covered under the policy. (Servidone Canst. Corp., 102 AD2d at 62-63.) Two justices agreed that the duty to defend was breached, but dissented as respects the responsibility to indemnify: [I]n cases of this nature, two separate and distinct issues are created which require the application of different legal principles. The duty to defend is much broader than the duty to indemnify. An insurer must defend no matter how unreasonable or frivolous the allegations might be. On the other hand, the contract of insurance does not create a duty to indemnify unless it is established that the insured's liability is within the coverage. (Servidone Canst. Corp., 102 AD2d at 66-67[emphasis added].) On appeal, this Court agreed with the dissent. The Court measured the duty to defend, appropriately, against the underlying allegations, and noted that the insurer could be relieved of that duty only if, as a matter of law, "there is no possible factual or legal basis on which [the insurer] might eventually be held to be 8 obligated to indemnify [the insured] under any provision of the insurance policy." (Servidone Canst. Corp. v Security Ins. Co. of Hartford, 64 NY2d 419, 424 [1985].) On the issue of indemnity, however, this Court held that the actual basis for the insured's liability had to be considered in light of the policy's breadth and depth: The duty to indemnify is, however, distinctly different. The duty to defend is measured against the allegations of the pleadings but the duty to pay is determined by the actual basis for the insured's liability to a third person (see, Rochester Woodcraft Shop v. General Ace. Fire & Life Assur. Corp., 35 AD2d 186, 187). (!d. at 624) Where there is no issue but that the loss was within the scope of the policy, the Court explained that an insurer could not escape liability for a reasonable settlement. However, the Court distinguished cases where there was neither a determination nor an agreement that the loss was within the ambit of the policy and directed further proceedings to determine whether the true facts established a covered loss, as "there can be no duty to indemnify unless there is first a covered loss. " (Servidone Canst. Corp., 64 NY2d at 423-26 [emphasis added]; see also, Lombardi, Walsh, Wakeman, Harrison, Amodeo & Davenport, P.C. v Am. Guar. and Liab. Ins. Co., 85 AD3d 1291 [3rd Dept 2011].) 9 Clearly, the holdings from these cases are instructive. In the grant of coverage, the insurer promises to defend the insured against claims that, as alleged, fall within the ambit of the policy, even if groundless, false or fraudulent. However, the duty to indemnify is governed by the entire insuring agreement and the actual facts, not by the allegations of a complaint. That independent duty is measured against the terms of the policy, with the carrier affording coverage for the risks it undertook, no more and no less. The teaching of this Court in Servidone and Lang is clear: a carrier that breaches its duty to defend will lose the right to contest a liability determination, the amount of a verdict, or the reasonableness of a settlement entered into by the insured. However, a carrier that declines a request for defense does not thereby expand its coverage so as to insure risks beyond the contract it made. Such a result would afford coverage to the insured for risks for which no premium was collected or paid. Rather, the determination as to whether a carrier must indemnify an insured for a loss will be determined by measuring the actual facts against the yardstick of the policy's coverage, even where it is determined that the insurer breached the duty to defend. As this Court noted in Servidone, if the facts which determine coverage were decided directly or necessarily in the underlying action, the carrier may not re-litigate those facts as to liability or damages. However, where the 10 obligation to indemnify depends on facts not decided in the underlying action, the carrier has a right to litigate those facts in a subsequent proceeding. To find otherwise would render meaningless the Court's holding in Lang, recognizing the right of the carrier to litigate the validity of its disclaimer, and the Court's direction for further proceedings in Servidone. B. This Court's Holding In K2 Fails To Acknowledge That A Breach Of The Duty To Defend May Not Necessarily Lead To An Obligation To Indemnify- The Policy Provisions Control. When an insurer declines to defend its insured, and it is determined that it was obligated to defend, this Court made it clear in Lang that the insurer loses its right to contest the underlying facts establishing tort liability. But, that does not, in all cases, end the inquiry. (1) There Are Situations Where The Facts Established By The Underlying Judgment Do, In Fact, Resolve The Coverage Questions. The following examples are illustrative. (a) The "Alleged" Driver Plaintiff alleges in a complaint that insured was driving his vehicle on a particular date and struck the plaintiff as he was walking across a street. The insured denies he was driving and his auto carrier refuses to defend him. A default judgment is entered against the insured, establishing that he was the driver and was negligent and awards a sum of money. Under Lang, liability is resolved and the insurer is obligated to pay the judgment. The issue of whether the insured was 11 driving cannot be relitigated. On these facts, unlike K2, the liability determination necessarily establishes the carrier's obligations. (b) The Negligent Tenant Customer asserts that she slipped on water on the floor in a store located in a shopping mall. The store owner, a tenant in the mall, is sued, with an allegation of negligence. The tenant's carrier refuses to defend the tenant, claiming that the floor was wet because of a broken pipe in the ceiling and that was the landlord's responsibility. If a judgment is entered against the tenant, establishing its negligence, the insurer's obligations are clear. If the applicable insurance policy required the insurer to indemnify the tenant for findings of negligence and there were no applicable exclusions within that policy that would remove coverage, the insurer would be obligated to pay the judgment up to the policy limits. (2) However, The Facts Established By The Underlying Judgment Do Not Always Resolve The Coverage Questions. This Court has never endorsed a penalty for the failure to defend that expands an insurance policy beyond its terms. The following hypothetical, but common, factual situations illustrate how the holdings of Servidone and Lang operate in harmony without expanding an insurance policy beyond its terms. 12 (a) The Business Pursuit The plaintiff alleges that she was injured while in the basement of the defendant-insured's home. It is claimed that she sustained an injury to her ear, and she sues the homeowner for the injury. The complaint does not allege how or why the plaintiff was there or how or why the injury occurred. The insurer conducts an investigation and determines that, in fact, the homeowner was operating a hair salon in her basement, for profit, and the homeowner's policy excluded coverage for business pursuits. Assume that, despite a timely disclaimer based on the business pursuits exclusion, the insurer is asked to defend the lawsuit against the insured and declines to do so. (see Hanover Ins. Co. v Cowan, 172 AD2d 490 [2d Dept 1991].) Assume that the insured retains her own defense counsel and is found to be negligent by a fact finder, or defaults and a judgment is entered on a negligence determination, or settles the underlying case and claims to have done so as a result of admitted negligence. Assume further that an award by a jury or judge or a settlement was for $50,000. If a declaratory judgment action (or a direct action under Insurance Law Section 3420[a][2Ji is commenced to secure the indemnity proceeds of the 2 By its terms, in a direct action brought by a judgment creditor against an insurance company to enforce a judgment against an insured, the Legislature has limited recovery to the contractual coverage and limits of the policy: A provision that in case judgment against the insured or the insured's personal representative in an action brought to recover damages for injury sustained or loss 13 homeowner's policy, and it is determined that the insurer should have defended based on the complaint's allegations, Lang instructs that the refusal to defend binds the insurer to the finding of negligence. In K2, a finding that the insurer had a defense obligation would likewise bind the insurer in that case to a finding of professional negligence. As this Court correctly held in its decision, a "default judgment on the issue of liability in a legal malpractice action disposes of the issue of the lawyer's negligence and the validity of the underlying claim." (K2 Inv. Group, LLC v Am. Guar. & Liab. Ins. Co., 21 NY3d 384, 390 [2013] citing Mendoza v. Schlossman, 87 AD2d 606, 607 [2d Dept 1982].) However, the factual findings supporting the conclusion of negligence, whether it be for the injured ear in the example above or malpractice by the attorney in K2, facts to which the insurer is now bound, still leave open the question as to whether there are unresolved facts that determine coverage under the policy purchased. As this Court held, in Lang: Finally, we note that an insurance company that disclaims in a situation where coverage may be or damage occasioned during the life of the policy or contract shall remain unsatisfied at the expiration of thirty days from the serving of notice of entry of judgment upon the attorney for the insured, or upon the insured, and upon the insurer, then an action may, except during a stay or limited stay of execution against the insured on such judgment, be maintained against the insurer under the terms of the policy or contract for the amount of such judgment not exceeding the amount of the applicable limit of coverage under such policy or contract (Emphasis added). (Insurance Law§ 3420[a][2].) 14 arguable is well advised to seek a declaratory judgment concerning the duty to defend or indemnify the purported insured. If it· disclaims and declines to defend in the underlying lawsuit without doing so, it takes the risk that the injured party will obtain a judgment against the purported insured and then seek payment pursuant to Insurance Law § 3420. Under those circumstances, having chosen not to participate in the underlying lawsuit, the insurance carrier may litigate only the validity of its disclaimer and cannot challenge the liability or damages determination underlying the judgment. (Lang v Hanover Ins. Co., 3 NY3d at 356 [emphasis added].) Accordingly, if the injured plaintiff-now-turned-judgment creditor brings a direct action against the insurer to enforce the judgment against the insured, or if the insured brings a declaratory judgment action, or if the judgment creditor decides to proceed by assignment (as it did in K2), the insurer may still litigate the validity of its disclaimer, i.e. whether the business pursuits exclusion applies to preclude coverage. Whether or not the insured was operating a business for profit was not determined in the underlying lawsuit, only that the plaintiffs ear was injured due to the negligence of the homeowner. In this and like circumstances, the elements necessary for a judgment on liability· in a tort action are separate and distinct from those necessary for a coverage determination. In order to recover in negligence, it is not necessary for a plaintiff to establish the facts necessary for a determination of insurance coverage. 15 Therefore, in recognizing the right of a carrier that had wrongfully declined to defend to contest coverage after a liability judgment against the insured, this Court's decision in Servidone acknowledged that the carrier would be litigating issues that were, as yet, undecided. In a subsequent coverage action, the validity and enforceability of the exclusions and the coverage denial would be properly litigated. Additional examples illustrate this principle: (b) The Taxicab Driver Plaintiff, a passenger in defendant's car, is injured when the car strikes a tree. He sues the driver for negligence. The personal auto insurance carrier investigates and the insured owner/driver admits that she was using her car as a taxicab. Assume further that the insurer timely denies coverage based on the livery exclusion. (cf, Halloway v State Farm Ins. Companies, 23 AD3d 617 [2d Dept 2005].) When the passenger sues the driver, he merely alleges that he was injured in an auto accident and asserts the negligence of the driver in operating the vehicle. Again, assume that the insurer refuses to defend based on the undisputed, but unalleged, facts of livery operation. Whether judgment is obtained by default, verdict or otherwise, this Court in Lang made it clear that the validity of the disclaimer can still be litigated, although the verdict of negligence and the amount 16 of the verdict cannot. Once again, the finding of negligence did not require the adjudication of the facts necessary to invoke the livery exclusion. To hold otherwise would contradict this Court's holding in Servidone, as it would impose an obligation on an insurer to indemnify where the policy did not cover the loss. (c) The Builder A contractor is hired to construct an office building and does so, using defective materials and methods. The structure collapses and the property owner sues the contractor generally alleging property damage. The commercial general liability insurer timely disclaims and denies coverage based on the "workmanship exclusions" refusing to defend upon the ground that there was no "occurrence" and that the exclusions applied in any event. (see, George A. Fuller Co. v US. Fid. and Guar. Co., 200 AD2d 255 [1st Dept 1994], motion for leave to appeal, denied, 84 NY2d 806 [1994].) Whatever the outcome of the underlying lawsuit, the builder's policy should not be expanded to provide coverage beyond the terms. To impose an obligation on the part of the carrier to provide coverage for excluded claims would do violence to the sanctity of contract and provide the insured with a more expansive insurance policy than the one for which it has paid a premium. 17 (d) The Non-Permissive User This Court has visited this question before. In Colon v Aetna Life and Cas. Ins. Co. (66 NY2d 6 [1985]), Colon was operating a vehicle without the owner's permission. Both he and the vehicle owner acknowledged and admitted the non-permissive use. The complaint in a personal injury action against Colon alleged that he was operating the vehicle with the owner's permission, and Aetna, the owner's insurer, refused to defend. Colon hired a lawyer and, in fact, it was determined that he did not have permission to drive the car. The Court found that Aetna had to reimburse the driver for defense costs based on the allegations in the complaint. The insurer had wrongfully refused to defend. However, the Court of Appeals did not impose any obligation to pay the $80,000 judgment, which the jury had awarded against Colon in the underlying injury action. This would have afforded Colon coverage beyond what the contract provided as Colon, a non-permissive operator, would not qualify as an insured under the policy. (3) In Lang, This Court Held That An Insurer Is Precluded From Re-litigating The Underlying Facts ONLY If It Has Failed To Honor Its Defense Obligation. Courts Do Not Preclude An Insurer From Re-litigating Underlying Facts If That Insurer Has Provided A Defense. While an insurer who breaches its duty to defend is bound by the facts determined in the action against its insured, the rule is different where the insurer 18 provides the insured with counsel, while preserving its position that the policy does not afford coverage for the loss. In Dreyer v New York Central Mutual Fire Insurance Company (1 06 AD3d 685 [2nd Dept 2013]), the underlying personal injury action arose out of an incident in which a vehicle driven by Walter Dreyer ("Walter"), and owned by Patricia Dreyer ("Patricia"), was struck in the rear by a vehicle driven by Schwartz. After the collision, Schwartz exited his car. Walter then intentionally drove into him and then left the scene. Walter was charged with assault and leaving the scene of an accident and eventually pled guilty to disorderly conduct and leaving the scene. Schwartz then sued Walter and Patricia, asserting negligence and assault causes of action against Walter and Patricia, and asserting intentional tort causes of action against Walter alone. The Dreyers' insurer, NY Central, denied coverage for the intentional claims but agreed to provide a defense based on the allegations of the complaint. The Dreyers commenced an action for a judgment declaring that the insurer was bound to both defend and indemnify them in the underlying action. At the conclusion of the trial in the underlying action, only the negligence cause of action was submitted to the jury. The jury determined that Walter was negligent and awarded damages to Schwartz. 19 In the declaratory judgment action, the insureds argued that they were entitled to indemnification in that the insurance policy covered damages for bodily injury sustained in an automobile accident for which Walter became "legally responsible," and that the jury found Walter to have been negligent. However, the Court recognized that the insurer was not bound by the underlying verdict of negligence since it did not have its day in court on the issue of intentional conduct. While the insurer provided a defense, it was not a party to or in privity with a party to the tort action, and it was unable to offer proof of intentional conduct through defense counsel, whose obligation was to the insured and not to the insurer. Similarly, in Kaczmarek v Sho.ffstall (119 AD2d 1001, 1002 [4th Dept 1986]), the insured was sued for negligence and assault for allegedly pouring scalding water on the back of the plaintiff. State Farm provided its insured with a defense and then moved - with separate coverage counsel - to intervene in that action in order to establish that the conduct was, in fact, intentional and excluded. The Fourth Department recognized that defense counsel, in respecting the ethical obligation owed to his client, the insured, could not establish the facts that would move this case out of coverage. Although denying the request for intervention, relying on principles of res judicata the court ruled that an insurer that honors a defense obligation will not be bound by the underlying determination if it did not 20 have the opportunity to present proof on the issues that would define the indemnity obligation. The First Department agreed in Linette v Hanover Ins. Co. (29 AD3d 338 [1st Dept 2006]), holding that an insurer that was not a party to or in privity with a party to an underlying personal injury action, and thus did not have a full and fair opportunity to be heard, was not bound by the judgment. C. The Broad Language Of This Court's Decision In K2 Departs From Established Precedent And Might Be Read To Impose An Indemnity Obligation On An Insurer Even Where The Facts Pertaining To Coverage Were Neither Litigated Nor Necessarily Decided In The Underlying Action. In the underlying case, as the insured-Daniels defaulted, the determination of his professional negligence cannot be re-litigated by him or by his insurer, if it is determined that his insurer wrongfully refused to defend. Notably, however, it was the applicability of the policy exclusions that split the First Department. (K2 Inv. Group, LLC v Am. Guar. & Liab. Ins. Co., 91 AD3d 401 [1st Dept 2012].) The question before this Court was not whether legal malpractice was established below; surely it was by the insured's default. Rather, the parties debated the applicability of the policy exclusions. The facts which determine the applicability of those exclusions were not resolved by default on the professional 21 liability claims, much the same as a finding by default that a vehicle operator was negligent does not resolve the issue of whether the livery exclusion applied. If the exclusions in the professional liability policy issued to Daniels apply, the policy's indemnity obligation is not triggered. If the exclusions do not apply, the insurer will be obligated to pay the judgment, up to the policy limits, and is not permitted to question or revisit the finding of negligence or the amount of damages awarded. The facts that determine whether the policy exclusions upon which the carrier relied apply were not litigated in the underlying action. The teaching of Servidone and of Lang is that the validity of the disclaimer can still be litigated, regardless of whether or not the duty to defend was breached. However, in the absence of a breach of the duty of good faith and fair dealing, and each of the 12 judges and justices who reviewed this case concluded there was no such breach, the policy should not be expanded beyond its terms. POINT II NOT ONLY IS THE ENHANCED PENALTY IMPOSED BY THIS COURT IN ITS DECISION IN THIS MATTER INCONSISTENT WITH ITS PRIOR HOLDINGS, IT IS NOT COMMENSURATE WITH THE ALLEGED BREACH The consequences imposed upon an insurer that fails to defend its insured, where the pleadings cast coverage within the embrace of the policy, were clearly set forth by this Court in Servidone and reaffirmed in Lang: the insurer 22 cannot challenge the liability or damages determination made in the underlying action. There exists no basis for an expansion of that penalty, where, as was determined here, there was no bad faith conduct on the part of the insurer. Yet, in its June 2013 decision in this case, this Court imposed a penalty on the insurer that effectively altered the contract the parties themselves made. The decision expanded coverage beyond its intended scope, potentially placing the insured in a better position by reason of the insurer's failure to defend than the position the insured would have occupied had that duty been performed. The Court's decision to re-write the agreed policy terms, as a consequence of breach of a duty to defend, is contrary to the precedent discussed above and is disproportionate to the determined breach. Where an insurer breaches its duty to defend, the insured is made whole by requiring the insurer to reimburse defense costs to the insured. The insurer is further penalized by losing its opportunity to contest the factual findings, necessarily determined, in the underlying suit. While those results are arguably a logical consequence of the failure to defend, to amplify the outcome by depriving the insurer of any opportunity to prove previously undetermined facts that place the loss outside the coverage of the policy is disproportionate to the alleged breach, unnecessarily punitive and unwarranted. 23 In Servidone, as discussed above, this Court held that an insurer's breach of the duty to defend does not create coverage and that, even in cases of negotiated settlements, there can be no duty to indemnify unless there is first a covered loss. This basic precept of contract interpretation has remained the touchstone for evaluating an insurer's obligations, and it remains the appropriate standard. In Lang, this Court again made clear that a breach of the obligation to defend does not create coverage where none otherwise existed. Rather, the indemnity obligations under the policy define the coverage owed, and the failure to defend does not, and should not, modify the insurance contract to expand the agreed upon coverage beyond its accepted terms. To do so imposes extra- contractual liability upon an insurer where the insurer's conduct does not warrant such a penalty. Imposing extra-contractual liability upon an insurer who has engaged in no bad faith, but who has mistakenly analyzed the policy provisions, including the policy exclusions, and has determined that it will never be charged with a duty to indemnify, is inconsistent with this Court's holdings in Servidone and Lang. In addition to being a departure from the standing precedent in this State, adoption of such a rule would likewise be a departure from a majority of jurisdictions around 24 the County. (Alan D. Windt, Insurance Claims and Disputes, Representation of Insurance Companies and Insureds§ 4.37 [6th ed rev 2013].) Indeed, more than thirty (30) jurisdictions have previously addressed the appropriate penalties where, as here, a carrier violates its duty to provide a defense. Of those states, only a select few have adopted the rule that a breach of the duty to defend precludes all future policy defenses.3 On the other hand, more than twenty-five (25) jurisdictions have rejected arguments that lobby for estopping an insurer from relying upon otherwise valid policy defenses after a breach of the duty to defend has been determined. This includes appellate courts from eighteen ( 18) different states. 4 Moreover, an additional eight (8) 3 (Missionaries of Co. of Mary, Inc. v Aetna Cas. & Sur. Co., 155 Conn 104, 230 A2d 21, 26 [1967]; Employers Ins. of Wausau v Ehlco Liquidating Trust, 186 Il12d 127, 708 NE2d 1122, 1133 [1999]; Radke v Fireman's Fund Ins. Co., 217 Wis2d 39, 577 NW2d 366, 370-71 [Ct. App. 1998]; Naddeo v Allstate Ins. Co., 139 NC App. 311, 533 SE2d 501, 507 [2000].) 4 Alabama Hasp. Ass'n Trust v Mutual Assur. Soc. of Alabama, 538 So2d 1209, 1216 [Ala 1989]; Afcan v Mutual Fire, Marine and Inland Ins. Co., 595 P2d 638, 647 [Alaska 1979]; State Farm Mut. Auto. Ins. Co. v Paynter, 122 Ariz 198, 593 P2d 948, 953 [Ct App, Div 1 1979]; Hogan v Midland National Ins. Co., 3 Cal3d 553, 91 Cal Rptr 153, 476 P2d 825, 832 [1970]; Keller Industries, Inc. v Employers Mut. Liability Ins. Co. of Wisconsin, 429 So 2d 779, 780-81 [Fla Dist Ct App, 3d Dist 1983]; Colonial Oil Industries Inc. v Underwriters Subscribing to Policy Nos. T031504670 and T031504671, 268 Ga 561, 491 SE2d 337, 339 [1997]; Hirst v St. Paul Fire & Marine Ins. Co.,106 Idaho 792, 683 P2d 440, 447 [Ct App 1984]; Gilmore v. Beach House, Inc., 38 Kan App2d 949, 174 P3d 439, 444-45 [2008]; Arceneaux v Amstar Corp., 66 So3d 438, 452 [La 2011]; Fireman's Fund Ins. Co. v Rairigh, 59 Md App 305, 475 A2d 509, 515 [1984]; Elliott v Hanover Ins. Co., 1998 ME 138, 711 A2d 1310, 1313 [Me 1998]; Polaroid Corp. v Travelers Indem. Co., 414 Mass 747, 610 NE2d 912, 921, 36 Env't Rep Cas (BNA) 2045 [1993]; St. Paul Ins. Co. v Bischoff, 150 Mich App 609, 389 NW2d 443, 445 [1986]; Brown v State Auto. & Cas. Underwriters, 293 NW2d 822, 825-26 [Minn 1980]; Sellie v North Dakota Ins. Guar. Ass'n, 494 NW2d 151, 155-56 [ND 1992]; A.B. C. Builders, Inc. v American Mut. Ins. Co., 139 NH 745, 661 A2d 1187, 1191 [1995]; American States Ins. Co. v State Auto Ins. Co., 721 A2d 56, 64 [Pa Super Ct 1998]; Timberline Equipment Co., Inc. v St. Paul Fire & Marine 25 United States District Courts5, and seven (7) different United States Circuit Courts have also rejected the principle that the breach of a duty to defend results in the forfeiture of policy defenses. 6 It is respectfully submitted that this Court should not abandon its previous precedent for the imposition of a new rule which, as demonstrated above, has been rejected by an overwhelming majority of jurisdictions from around the Country. Surely, an insurer that chooses not to defend its insured, having in good faith assessed the risk as one that falls outside the scope of the policy, understands the outcome if that coverage position is ultimately determined to be Ins. Co., 281 Or 639, 576 P2d 1244, 1248 [1978]; Northwest Pump & Equipment Co. v. American States Ins. Co., 144 Or App 222, 925 P2d 1241, 1243 [1996].) 5 (Flannery v Allstate Ins. Co., 49 F Supp2d 1223, 1227 [D Colo 1999]; Capital Environmental Services, Inc. v North River Ins. Co., 536 F Supp2d 633, 645 [ED Va 2008]; Johnson v Studyvin, 828 F. Supp. 877, 886-87 [D Kan 1993]; Johnson v Studyvin, 839 F Supp 1490, 1497 [D Kan 1993]; Bucci v Essex Ins. Co., 323 F Supp2d 84, 91, [D Me 2004]; Servants ofParaclete, Inc. v Great American Ins. Co., 866 F Supp 1560, 1579-80 [D NM 1994]; Servants ofParaclete, Inc. v Great American Ins. Co., 857 F Supp 822, 833 [D NM 1994]; Emhart Industries, Inc. v Home Ins. Co., 515 F Supp2d 228,257-62 [D RI 2007]; Burroughs Wellcome Co. v Commercial Union Ins. Co., 713 F. Supp. 694, 697-99 [SDNY 1989]; Time Oil Co. v Cigna Property & Cas. Ins. Co., 743 F. Supp. 1400, 1421,31 Env't. Rep. Cas. (BNA) 1985 [W.D. Wash. 1990].) 6 (Bucci v Essex Ins. Co., 393 F3d 285, 292-95, [1st Cir 2005]; Enserch Corp. v Shand Morahan & Co., Inc., 952 F2d 1485, 1493 [5th Cir 1992][Texas law]; Hamlin Inc. v HartfordAcc. and Indem. Co., 86 F3d 93, 94-95 [7th Cir. 1996][Wisconsin law]; Royal Ins. Co. of America v Kirksville College of Osteopathic Medicine, Inc., 304 F3d 804, 806-807 [8th Cir 2002] [Missouri law]; Underwriters at Lloyds v Denali Seafoods, Inc., 927 F2d 459,464 [9th Cir 1991] [Washington law]; Signature Development Companies, Inc. v Royal Ins. Co. of America, 230 F3d 1215, 1222 [lOth Cir 2000][Colorado law]; Spencer v. Assurance Co. of America, 39 F3d 1146, 1149 [11th Cir.1994].) 26 erroneous - those issues determined in the underlying litigation are binding. However, the scope of the penalty to be imposed does not- and should not- extend so far as to preclude litigation of whether the policy, in fact, covered the loss. As this Court acknowledged in Lang, the insurance carrier who incorrectly declines to defend its insured may nonetheless litigate the validity of its disclaimer. Contrary to this Court's stated conclusion in K2, that this newly expanded obligation will provide insurers an incentive to defend the cases they are bound by law to defend and thus give insureds the full benefit of their bargain, the imposition of such an expanded penalty for failure to defend will instead promote unnecessary and costly litigation. Insurers will bring more declaratory judgment actions against insureds and will defend cases for which no indemnity obligation could ever have been established, thereby increasing their costs. Even in situations where there is no factual or legal basis on which the insurer may ultimately be obligated to indemnify their insured, the insurer will be duty bound to defend the insured, while retaining coverage counsel to prosecute a coverage action. Moreover, insureds and claimants alike will be faced with additional expense, as they will be required to hire counsel to defend them in the declaratory judgment actions commenced by the insurers. Each is a necessary party to such an action in order for them to be bound by the court's declaration as to the insurer's coverage obligations. If an insurer's coverage position is upheld, the insured will 27 not be entitled to recover its attorneys' fees in the declaratory judgment action. (Mighty Midgets, Inc. v. Centennial Ins. Co. 47 NY2d 12 [1979].) Additionally, the multiplicity of declaratory judgment actions, and the defense costs paid where they ultimately would not be owed, will without question adversely affect premiums for all policyholders. This is a particularly salient point in a State that has traditionally rated towards the bottom of rankings related to tort reform, costs of litigation, and costs of insurance. A recent study from 2006 revealed that New York's tort losses exceeded $16 billion annually, which placed the State second only to California for tort-related losses. (U.S. Tort Liability Index: 2008 Report, Pacific Research Institute, 2008, pg. 20.) When it comes to tort-related litigation risks, New York's status only improved one slot, to forty-eighth (48th). (U.S. Tort Liability Index: 2008 Report, Pacific Research Institute, 2008, pg. 16.) That same study noted that, with respect to direct monetary loss, New York again ranked forty-eighth (48th) for losses falling within a Commercial General Liability policy. (U.S. Tort Liability Index: 2008 Report, Pacific Research Institute, 2008, ppg. 18-19.) That number only slightly improved to twenty-seventh (27th) when ranking total monetary losses under a homeowners' policy. (U.S. Tort Liability Index: 2008 Report, Pacific Research Institute, 2008, ppg. 18-19.) 28 The above references are only a select few of a multitude of statistics which all point to the same inescapable conclusion. New York's tort system already exceeds its capacity. Despite its status as home of the commercial heart of the United States, the tort system in this State provides a remarkably difficult environment in which to do business. With insurance expenses, including premium rates, exceeding most areas of the Country, a further increase in risks attendant with liability insurance will further expand delays, inefficiencies and costs which already tax the system to its maximum capacity. Despite the many challenges facing insurers in New York, the rules espou·sed in this Court's decisions in Lang and Servidone have struck the appropriate balance between protecting the sanctity of the duty to defend and carrier autonomy in evaluating risks associated with each case. It is respectfully submitted that an insurer should remain entitled to rely upon valid policy exclusions when the facts necessary to determine the applicability of such exclusions were not litigated or necessarily decided in the underlying litigation. An erroneous coverage assessment has its consequences. Those consequences should not include re-writing the contract of insurance to provide coverage for a loss where such coverage was never contemplated by the parties or provided for in their bargain. 29 The appropriate remedy has already been established and there is no justification to expand it. CONCLUSION In its June 2013 decision in this case, this Court spoke expansively of the penalties to be imposed on an insurer in the event of a breach of the duty to defend. The result the Court announced is in contravention of its previously established precedent, which the Court neither cited nor over-ruled. The Court's decision appears to proceed from an assumption that the facts necessary to determine the applicability of the exclusions at issue were decided in the underlying action. To the extent that, in this case or others, the facts upon which coverage depends are not so decided, it is respectfully submitted that the Court should re-affirm its prior rulings and declare that an insurer's breach of its duty to defend does not automatically result in the imposition of an indemnity obligation, without any opportunity for the insurer to be heard. The insurance policy, purchased by the policyholder and issued by the insurer, is the defining instrument of the coverage purchased. It is respectfully submitted that expanding its terms by disallowing a determination of the depth and breadth of purchased coverage is contrary to well-established, carefully reasoned and sensible precedent. 30 The Court is respectfully urged to withdraw its earlier decision in this matter and issue a determination consistent with that precedent. DATED: Buffalo, New York November _!J_, 2013 Dan D. Kohane, Esq. Elizabeth A. Fitzpatrick, Esq. Steven E. Peiper, Esq. Diane F. Bosse, Esq. HURWITZ & FINE, P.C. Attorneys for Proposed Amici Curiae New York Insurance Association, National Association of Mutual Insurance Companies, Property Casualty Insurers Association of America and Federation of Defense & Corporate Counsel 1300 Liberty Building Buffalo, New York 14202 (716) 849-8900 31