K2 Investment Group, LLC, et al., Respondents-Appellants,v.American Guarantee & Liability Insurance Company, Appellant-Respondent.BriefN.Y.January 7, 2014 APL-2012-00055 New York County Clerk’s Index No. 117902/09 Court of Appeals of the State of New York _________________________________ K2 INVESTMENT GROUP, LLC and ATAS MANAGEMENT GROUP, LLC, Plaintiffs-Respondents-Cross-Appellants, – against – AMERICAN GUARANTEE AND LIABILITY INSURANCE COMPANY, Defendant-Appellant-Cross-Respondent. BRIEF OF COLTEC INDUSTRIES INC. AND SPX CORPORATION AS AMICI CURIAE IN SUPPORT OF PLAINTIFFS-RESPONDENTS P. Benjamin Duke COVINGTON & BURLING LLP The New York Times Building 620 Eighth Avenue New York, NY 10018-1405 Tel: (212) 841-1000 Fax: (212) 841-1010 William F. Greaney Elliott Schulder Matthew Kudzin COVINGTON & BURLING LLP 1201 Pennsylvania Ave. NW Washington, DC 20004-2401 Tel: (202) 662-6000 Fax: (202) 662-6291 December 5, 2013 Counsel for Amici Curiae Coltec Industries Inc. and SPX Corporation i CORPORATE DISCLOSURE STATEMENTS The corporate disclosure statements of Coltec Industries Inc. and SPX Corporation are attached as an addendum at the end of this brief. ii TABLE OF CONTENTS CORPORATE DISCLOSURE STATEMENTS ....................................................... i TABLE OF AUTHORITIES ................................................................................... iv INTERESTS OF AMICI CURIAE ........................................................................... 1 QUESTION PRESENTED ON REARGUMENT ................................................... 3 STATEMENT ........................................................................................................... 3 A. The Underlying Action .............................................................. 4 B. The Proceedings Below ............................................................. 5 C. This Court’s Opinion ................................................................. 7 ARGUMENT ............................................................................................................ 8 I. The Duty to Defend Is a Critical Component of a Liability Policy .................................................................................................. 10 II. An Insurer That Breaches Its Duty to Defend Should Not Be Permitted to Rely on Policy Exclusions to Avoid Its Obligation to Pay an Adverse Judgment .............................................................. 14 A. This Court’s Ruling is Consistent With Basic Principles of Contract Law ....................................................................... 14 B. This Court’s Ruling Is Consistent With Existing Law Encouraging Insurers to Honor the Duty to Defend ................ 16 C. This Court’s Ruling Protects the Interests of Insurance Companies ................................................................................ 19 III. This Court’s Ruling Is Consistent With Mainstream Authority ........ 23 A. Many States Prohibit Insurers From Raising Policy Defenses When They Have Breached Their Duty to Defend ...................................................................................... 24 B. Other States Provide Incentives to Encourage Insurers to Honor Their Duty to Defend .................................................... 28 iii C. Leading Authorities Agree That Courts Should Fashion Rules That Encourage Insurers to Honor Their Duty to Defend ...................................................................................... 33 CONCLUSION ....................................................................................................... 35 ADDENDUM (CORPORATE DISCLOSURE STATEMENTS) ....................... A-1 iv TABLE OF AUTHORITIES Page(s) CASES Advanced Network, Inc. v. Peerless Ins. Co., 119 Cal. Rptr. 3d 17 (Ct. App. 2010) ................................................................. 29 Am. Transit Ins. Co. v. Mendon Leasing Corp., 241 A.D.2d 436 (1st Dep’t 1997) ....................................................................... 17 Amato v. Mercury Casualty Co., 61 Cal. Rptr. 2d 909 (Ct. App. 1997) ........................................................... 29, 30 Atlanta Cas. Ins. Co. v. Gardenhire, 545 S.E.2d 182, 184 (Ga. Ct. App. 2001) ........................................................... 31 Auto. Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131 (2006) ..................................................................................... 18, 20 Avondale Indus., Inc. v. Travelers Indem. Co., 123 F.R.D. 80 (S.D.N.Y. 1988) .......................................................................... 12 Baker Marine Corp. v. Weatherby Eng’g Co., 710 S.W. 2d 690 (Tex. App. 1986) ..................................................................... 15 BP Air Conditioning Corp. v. One Beacon Ins. Grp., 33 A.D.3d 116 (1st Dep’t 2006) ......................................................................... 11 Buss v. Super. Ct., 939 P.2d 766 (Cal. 1977) .............................................................................. 12-13 Michigan Millers Mut. Ins. Co. v. Bronson Plating Co., 519 N.W.2d 864 (1994) ...................................................................................... 12 Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A.3d 961 ................................................................................................... 23, 25 Cardinal v. State, 304 N.Y. 400 (1952) ........................................................................................... 17 Christian v. Am. Home Assurance Co., 577 P.2d 899 (Okla. 1977) .................................................................................. 31 v Clarke v. Fid. & Cas. Co. of New York, 55 Misc. 2d 327 (Sup. Ct. 1967) ......................................................................... 13 Clemmons v. Travelers Ins. Co., 430 N.E.2d 1104 (Ill. 1981) ................................................................................ 25 Cont’l Cas. Co. v. Rapid-Am. Corp., 80 N.Y.2d 640 (1993) ......................................................................................... 18 Coors v. Sec. Life of Denver Ins. Co., 112 P.3d 59 (Colo. 2005) .................................................................................... 16 Corwin Chrysler-Plymouth, Inc. v. Westchester Fire Ins. Co., 279 N.W.2d 638 (N.D. 1979) ............................................................................. 30 DeCapua v. Dine-A-Mate, Inc., 292 A.D.2d 489 (2d Dep’t 2002) ........................................................................ 15 Emerald Bay Cmty. Ass’n v. Golden Eagle Ins. Corp., 31 Cal. Rptr. 3d 43 (Cal. Ct. App. 2005) ............................................................ 29 Emp’rs Ins. of Wausau v. Ehlco Liquidating Trust, 708 N.E.2d 1122 (Ill. 1999) ................................................................................ 25 Estee Lauder Inc. v. OneBeacon Ins. Grp., LLC, 62 A.D.3d 33 (1st Dep’t 2009) ........................................................................... 17 Farmers Union Mut. Ins. Co. v. Staples, 90 P.3d 381 (Mont. 2004) ....................................................................... 23, 26, 27 Feliberty v. Damon, 129 A.D.2d 207 (4th Dep’t 1987) ....................................................................... 12 Fieldston Prop. Owners Ass’n v. Hermitage Ins. Co., 16 N.Y.3d 257 (2011) ......................................................................................... 18 Gen. Accident Ins. Grp. v. Cirucci, 46 N.Y.2d 862 (1979) ......................................................................................... 17 Gen. Motors Acceptance Corp. v. Nationwide Ins. Co., 4 N.Y.3d 451 (2005) ....................................................................................... 8, 18 vi George Campbell Painting v. Nat’l Union Fire Ins. Co., 92 A.D.3d 104 (1st Dep’t 2012) ......................................................................... 16 Grube v. Daun, 496 N.W.2d 106 (Wis. Ct. App. 1992) ......................................................... 23, 27 Int’l Paper Co. v. Cont’l Cas. Co., 35 N.Y.2d 322 (1974) ......................................................................................... 11 Isadore Rosen & Sons, Inc. v. Sec. Mut. Ins. Co., 31 N.Y.2d 342 (1972) ................................................................................... 15, 16 K2 Inv. Grp., LLC v. Am. Guar. & Liab. Ins. Co., 21 N.Y.3d 384 (2013) ..................................................................................passim Katz v. Umansky, 92 Misc. 2d 285 (Sup. Ct. 1977) ......................................................................... 11 Kirk v. Mt. Airy Ins. Co., 951 P.2d 1124 (Wash. 1998) .................................................................. 23, 27, 28 Lang v. Hanover Ins. Co., 3 N.Y.3d 350 (2004) ....................................................................................passim Lawrence v. Texas, 539 U.S. 558 (2003) ............................................................................................ 22 Lee v. USAA Cas. Ins. Co., 86 P.3d 562 (Mont. 2004) ............................................................................. 25-26 Lunsford v. Am. Guar. & Liab. Ins. Co., 18 F.3d 653 (9th Cir. 1994) ................................................................................ 30 MBIA Inc. v. Fed. Ins. Co., 652 F.3d 152 (2d Cir. 2011) ............................................................................... 13 Missionaries of the Company of Mary, Inc. v. Aetna Cas. & Sur. Co., 230 A.2d 21 (Conn. 1967) ............................................................................ 23, 25 Montrose Chem. Corp. v. Super. Ct., 861 P.2d 1153 (Cal. 1993) ............................................................................ 11, 13 vii Mullen v. Glens Falls Ins. Co., 73 Cal. App. 3d 163 (Cal. Ct. App. 1977) .......................................................... 13 N. Star Reins. Corp. v. Cont’l Ins. Co., 82 N.Y.2d 281 (1993) ......................................................................................... 19 Pennsylvania General Ins. Co. v. Austin Powder Co., 68 N.Y.2d 465 (1986) ......................................................................................... 19 Radke v. Fireman’s Fund Ins. Co., 577 N.W.2d 366 (Wis. Ct. App. 1998) ......................................................... 23, 27 Ray Indus., Inc. v. Liberty Mut. Ins. Co., 974 F.2d 754 (6th Cir. 1992) .............................................................................. 12 S. Farm Bureau Cas. Ins. Co. v. Logan, 119 So. 2d 268 (Miss. 1960) ............................................................................... 28 Safeco Ins. Co. of Am. v. Butler, 823 P.2d 499 (Wash. 1992) .......................................................................... 27-28 Seaboard Sur. Co. v. Gillette Co., 64 N.Y.2d 304 (1984) ......................................................................................... 11 Servidone Construction Corp. v. Security Ins. Co., 64 N.Y.2d 419 (1985) ............................................................................. 21, 22, 23 Smith v. Am. Family Mut. Ins. Co., 294 N.W.2d 751 (N.D. 1980) ............................................................................. 31 St. Louis Dressed Beef & Provision Co. v. Maryland Cas. Co., 201 U.S. 173 (1906) ............................................................................................ 16 State Farm Fire & Cas. Co. v. Martin, 710 N.E.2d 1228 (Ill. 1999) .......................................................................... 23, 24 Thomas v. Atlanta Cas. Co., 558 S.E.2d 432, 440 (Ga. Ct. App. 2001) ........................................................... 31 Tibbs v. Great Am. Ins. Co., 755 F.2d 1370 (9th Cir. 1985) ............................................................................ 30 viii Transcare New York, Inc. v. Finkelstein, Levine & Gittlesohn & Partners, 23 A.D.3d 250 (1st Dep’t 2005) ......................................................................... 12 Truax v. State Farm Ins. Cos., 101 Misc. 2d 1031 (Sup. Ct. 1979) ..................................................................... 11 Twin City Fire Ins. Co. v. City of Madison, 309 F.3d 901 (5th Cir. 2002) ........................................................................ 24, 28 Vasquez v. Hillery, 474 U.S. 254 (1986) ............................................................................................ 22 STATUTES Mont. Code Ann. § 28-11-316 (2013) ..................................................................... 26 N.Y. Ins. Law § 3420 ....................................................................................... 5, 6, 16 OTHER AUTHORITIES American Law Institute, “Principles of the Law of Liability Insurance,” Tentative Draft No. 1 (Apr. 9, 2013) ...................................................... 10, 33-34 Couch on Insurance § 200:4 (3d ed. 2013) .............................................................. 12 Robert H. Jerry, II, Understanding Insurance Law (1987) ...................................... 35 1 INTERESTS OF AMICI CURIAE This brief is submitted on behalf of Amici Coltec Industries Inc. and SPX Corporation. Amici are diversified companies that manufacture a wide variety of products that are marketed and distributed throughout the United States and the world. Amici face lawsuits, some of which are filed in New York, by claimants seeking damages for alleged bodily injury or property damage as a result of Amici’s operations or products. In defending against these lawsuits, Amici regularly call for assistance from their insurers, which have issued liability policies that provide a duty to defend against third party suits. Amici believe that the duty to defend is of critical importance to the successful resolution of third party lawsuits, regardless of the size of the litigants and the nature of the claims. Amici respectfully submit that they can provide a helpful perspective to assist the Court in the resolution of this appeal, which presents an important question concerning the proper incentives needed to ensure that insurers with a duty to defend against third party claims step up at the outset of third party litigation to provide the litigation services for which their policyholders paid substantial premiums. For the reasons stated below, Amici believe it essential that this Court establish a rule providing proper incentives to make sure that insurers do not abandon their policyholders at the point of claim, when they are 2 most vulnerable, and that policyholders in New York receive the benefit of the duty to defend promise in their insurance policies. 3 QUESTION PRESENTED ON REARGUMENT The question presented is whether, as this Court unanimously concluded in its decision of June 11, 2013, “when a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.” K2 Inv. Grp., LLC v. Am. Guar. & Liab. Ins. Co., 21 N.Y.3d 384, 387 (2013) (“Opinion”). Amici submit that the Court’s ruling correctly recognizes the critical importance of the defense promise in protecting policyholders at the outset when they have been sued by third parties. The ruling provides the proper incentive for insurers to honor their duty to defend, which is a fundamental contractual right that is essential to the proper functioning of the adversary system. STATEMENT Jeffrey Daniels is a lawyer who was insured under a professional malpractice liability policy issued by American Guarantee and Liability Insurance Company (“American Guarantee”). K2 Investment Group, LLC and ATAS Management Group, LLC (collectively, “K2”) sued Daniels, alleging legal malpractice and other related claims. K2 obtained a default judgment of more than $3 million against Daniels after American Guarantee disclaimed coverage and refused to defend Daniels. Daniels, in turn, assigned to K2 all of his rights against 4 American Guarantee. In this insurance coverage action, K2 seeks to collect from American Guarantee under the policy it issued to Daniels. A. The Underlying Action The underlying malpractice action arose out of a series of loans K2 made to Goldan, LLC (“Goldan”), a real-estate company jointly owned by Daniels and Mark Goldman. The loans were supposed to be secured by mortgages owned by Goldan. Daniels was responsible for recording the mortgages and obtaining title insurance for the loans. He failed to do either, leaving the loans unsecured. Goldan was unable to repay the loans and was eventually forced into bankruptcy. K2 filed suit against Goldan, Daniels, and Goldman. The complaint included claims against Daniels for legal malpractice. K2 alleged that Daniels served as their attorney and that his failure to secure the loans amounted to malpractice. Daniels gave notice of the suit to his malpractice carrier, American Guarantee. The insuring agreement in the policy requires American Guarantee to indemnify Daniels for claims “based on an act or omission in the Insured’s rendering or failing to render Legal Services for others.” (R. 200.) The policy also includes a broad duty to defend, stating that American Guarantee “shall have the right and duty to defend any Claim based on an act or omission in the Insured’s rendering or failing to render Legal Services for others, seeking Damages that are 5 covered by this policy . . . even if any of the allegations of the Claim are groundless, false or fraudulent.” (R. 204.) American Guarantee initially agreed to defend Daniels under a reservation of rights. (R. 220.) On March 9, 2009, however, American Guarantee disclaimed coverage entirely. (R. 134.) It asserted that two exclusions in the policy barred coverage for the alleged malpractice. (R. 205.) Daniels’s defense attorney, who had been paid by American Guarantee, then withdrew from the representation, leaving Daniels defenseless. (R. 276.) After Daniels was left without representation, K2 obtained a default judgment against him on the malpractice claims totaling more than $3 million. (R. 149-50.) Daniels assigned to K2 all of his rights against American Guarantee. B. The Proceedings Below As Daniels’s assignee, K2 brought this action against American Guarantee under N.Y. Ins. Law § 3420(a)(2), (b)(1), seeking to recover on the default judgment award up to the limits of Daniels’s malpractice policy. The complaint included a claim for bad faith breach of the insurance policy, based on American Guarantee’s refusal to defend Daniels. (R. 67-83.) American Guarantee moved for summary judgment, relying on the same policy exclusions it previously cited in disclaiming coverage. It argued that the exclusions barred coverage because the claimed malpractice allegedly arose out of 6 actions that Daniels took in his capacity as a principal of Goldan, and not in his capacity as a lawyer. The Supreme Court, New York County, entered summary judgment for K2 on the § 3420 claim. (R. 48-50.) On appeal, a divided Appellate Division affirmed. (R. 363.) The majority held that American Guarantee could not rely on the policy exclusions, because in order to do so it would have to challenge the basis for the underlying malpractice judgment: “Having disclaimed its duty to defend its insured in an action that culminated in a default judgment, [American Guarantee] ‘cannot challenge the liability or damages determination underlying the judgment.’” (R. 365, quoting Lang v. Hanover Ins. Co., 3 N.Y.3d 350, 356 (2004)). The complaint against Daniels alleged—and the default judgment in effect accepted as true—that Daniels was acting as K2’s attorney when he failed to secure the loans. American Guarantee’s exclusion-based argument to avoid coverage would have required the court hearing the insurance action to make findings that directly contradicted the basis of the default judgment in the malpractice action against Daniels, which the insurer had wrongfully refused to defend. The Appellate Division refused to sanction such a conflict. Accordingly, the majority held that the policy exclusions were “patently inapplicable.” (R. 368.) The dissent concluded that there were 7 disputed questions of fact as to whether the policy exclusions applied that precluded summary judgment. (R. 383.) C. This Court’s Opinion This Court unanimously affirmed the decision of the Appellate Division without deciding whether the policy exclusions applied to Daniels’s conduct. Opinion, 21 N.Y.3d at 389. The Court pointed out that American Guarantee did not dispute that it breached its duty to defend Daniels. Id. It held that by breaching that duty, the insurer lost its right to rely on exclusions in the policy to avoid its obligation to satisfy the default judgment. Relying on its prior decision in Lang, the Court stated: “If the disclaimer [of a defense] is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify.” Id. at 391. The Court stressed that this rule was necessary to give insurers an adequate incentive to honor their duty to defend: 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 of their bargain. It would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer, having wrongfully abandoned its insured’s defense, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify. Id. 8 On September 3, 2013, this Court granted American Guarantee’s motion for reargument. ARGUMENT The defense promise is a fundamental contractual right included in many liability policies. It is often regarded as equally (if not more) important to the policyholder as the promise to indemnify against adverse judgments or to pay for settlements. A policyholder pays a substantial premium for the right to a defense and expects that the insurance company will step forward at the outset of a lawsuit to protect it against any third party suits that potentially implicate the policy.1 The duty to defend has been described by this Court as “litigation insurance”; it requires the insurer to go far beyond simply paying defense counsel’s fees. A typical policyholder (whether an individual, a small business or even a large corporation) is not in the business of defending lawsuits and can often be disadvantaged when facing lawsuits seeking substantial damages for alleged negligence or other misconduct. An insurer, on the other hand, markets itself as an expert at defending and settling lawsuits. It typically has the ability to call upon an established network of defense counsel who are experienced in handling different 1 See Gen. Motors Acceptance Corp. v. Nationwide Ins. Co., 4 N.Y.3d 451, 457 (2005) (“Relieving primary insurers of this duty to defend would provide a windfall to the carrier insofar as the costs of defense—litigation insurance—are contemplated by, and reflected in, the premiums charged for primary coverage.”). 9 types of claims and whom the insurer can retain to defend its policyholder in underlying lawsuits. Moreover, the insurer has superior in-house case management resources, including claim handlers with experience in evaluating and settling a wide variety of liability claims. When the policyholder pays a premium, it receives an executory promise from the insurer that all of these litigation resources will be brought to bear on its behalf as soon as they are needed—when an underlying suit is filed. In this respect, the insurer’s duty to defend is essential to the proper functioning of the adversary system. In this case, the Court got it right the first time: An insurer that abandons its policyholder at the point of claim by breaching its duty to defend should not be allowed to challenge its indemnity obligation following entry of a default judgment against its policyholder by relying on an exclusion in the insurance policy. This ruling recognizes the critical importance of having insurers furnish a prompt and effective defense to their policyholders as soon as they are sued, rather than remaining on the sidelines and shirking their defense obligation on the assumption that many beleaguered policyholders will not want to wage parallel coverage litigation against a breaching insurer. The ruling also is consistent with a long line of cases holding that a party that commits a material breach of a contract may not invoke the contract’s provisions to avoid its contractual obligations. 10 In addition, as this Court properly recognized, strong incentives are needed to ensure that insurance companies fulfill their defense obligations. Otherwise, insurers will have every economic incentive to breach their defense promise with impunity, secure in the knowledge that many such breaches will go unchallenged, and those that are successfully challenged will leave the insurer no worse off (and perhaps better off) than if it had timely complied with its obligation to provide a meaningful defense when it counted—while the underlying action was pending. Many courts around the country agree, and they have fashioned rules that encourage insurers to provide a defense and not abandon their policyholders at the point when they are most vulnerable. The American Law Institute has also recognized the wisdom of this approach. In its Tentative Draft of the “Principles of the Law of Liability Insurance,” the ALI proposes a rule under which “a liability insurer that breaches the duty to defend loses the right to contest coverage for the claim. This rule properly aligns the defense incentives of the insurer and the policyholder in situations in which the insurer’s potential coverage defense otherwise would reduce the incentive to defend the claim.” ALI, Principles of the Law of Liability Insurance, Tentative Draft No. 1, § 21 (Apr. 9, 2013). I. The Duty to Defend Is a Critical Component of a Liability Policy The policy at issue in this case imposes a “duty to defend” on American Guarantee, which charged substantial premiums for providing that litigation 11 service. (R. 200.) Courts in New York and across the country have recognized the importance of the duty to defend. It is “an essential component” of the policy and “an integral part of the benefit of the insured’s bargain.” BP Air Conditioning Corp. v. One Beacon Ins. Grp., 33 A.D.3d 116, 124 (1st Dep’t 2006); see also Truax v. State Farm Ins. Cos., 101 Misc. 2d 1031, 1033 (Sup. Ct. 1979) (“The duty to defend . . . is one of the most important items of protection afforded the insured.”). Indeed, “[t]he insured’s desire to secure the right to call on the insurer’s superior resources for the defense of third party claims is, in all likelihood, typically as significant a motive for the purchase of insurance as is the wish to obtain indemnity for possible liability.” Montrose Chem. Corp. v. Super. Ct., 861 P.2d 1153, 1157-58 (Cal. 1993); see also Katz v. Umansky, 92 Misc. 2d 285, 289 (Sup. Ct. 1977) (“The duty to defend may even be more important than the duty to indemnify, at least where the action is for more than the policy limits.”). The duty to defend has been described as a form of “litigation insurance,” obligating the insurer to actually “furnish a defense” to a policyholder who has been sued. See, e.g., Seaboard Sur. Co. v. Gillette Co., 64 N.Y.2d 304, 310 (1984); Int’l Paper Co. v. Cont’l Cas. Co., 35 N.Y.2d 322, 326 (1974). An insurance company typically maintains existing relationships with law firms that specialize in defending various types of claims, and it is thus in a position to 12 identify and retain defense counsel with experience in defending against the claims asserted in the specific suit against its policyholder. New York courts have long recognized, moreover, that “the insurer’s duty to defend is broader than simply retaining counsel. Appointment of counsel without any underlying support would be an illusory satisfaction of the carrier’s duty.” Feliberty v. Damon, 129 A.D.2d 207, 211 (4th Dep’t 1987), aff’d, 72 N.Y.2d 112, 117 (1988) (“When an insured has been sued, the insurer does not satisfy its duty to defend merely by designating independent counsel to defend the litigation.”); see also Transcare New York, Inc. v. Finkelstein, Levine & Gittlesohn & Partners, 23 A.D.3d 250, 251 (1st Dep’t 2005); Avondale Indus., Inc. v. Travelers Indem. Co., 123 F.R.D. 80, 83 (S.D.N.Y. 1988) (duty to defend involves “taking on the burden of decision-making regarding litigation strategy” and “effective management of litigation in a multi-front liability war”), aff’d., 887 F.2d 1200 (2d Cir. 1989). Other authorities agree that an insurer cannot fulfill its defense obligation merely by writing a check. Ray Indus., Inc. v. Liberty Mut. Ins. Co., 974 F.2d 754, 770 (6th Cir. 1992), abrogated on other grounds by Michigan Millers Mut. Ins. Co. v. Bronson Plating Co., 519 N.W.2d 864 (1994); Couch on Insurance § 200:4 (3d ed. 2013) (“The duty to defend is . . . distinct from . . . the duty to reimburse defense costs.”). That is because “[t]he duty to defend constitutes the provision of a service.” Ray Indus., 974 F.2d at 770; see also, e.g., Buss v. Super. Ct., 939 P.2d 13 766, 773 (Cal. 1977) (The duty to defend “entails the rendering of a service, viz., the mounting and funding of a defense.”). Here, by accepting a duty to defend in its policy, American Guarantee agreed to provide an affirmative litigation service, including “research and analysis, consultation and advice as to the issues of procedure and merits, strategy and tactics, related to” the malpractice claim against Daniels. Clarke v. Fid. & Cas. Co. of New York, 55 Misc. 2d 327, 348 (Sup. Ct. 1967). The value of that litigation service directly depends on the timeliness with which it is rendered. The duty to defend is valuable to a policyholder because the insurance company, which has the resources and expertise to investigate and assess claims, is usually in a far better position than the policyholder to resolve an underlying lawsuit. See, e.g., Montrose Chem. Corp., 861 P.2d at 1157-58; MBIA Inc. v. Fed. Ins. Co., 652 F.3d 152, 167 (2d Cir. 2011) (acknowledging that insureds “may lack the expertise and experience of an insurer”); Mullen v. Glens Falls Ins. Co., 73 Cal. App. 3d 163, 174 (Cal. Ct. App. 1977) (recognizing that a breach of the duty to defend “could deprive [the insured] of the expertise and resources available to insurance carriers in making prompt and competent investigations as to the merits of lawsuits”). Based on its superior knowledge and experience, the insurance company can often better negotiate an equitable settlement. MBIA, 652 F.3d at 167-68 (noting the importance of the insurer’s role in negotiating a settlement). 14 The insurance company is also better able to identify and seek contribution or indemnification from third parties, thereby minimizing the exposure of both the insurance company and the policyholder. In short, a policyholder pays valuable premiums in exchange for the insurance company’s knowledge, expertise and track record of litigating similar lawsuits. An insurance company that refuses to deploy that expertise in service of its insured has denied the insured the core benefit of the “litigation insurance” it purchased. II. An Insurer That Breaches Its Duty to Defend Should Not Be Permitted to Rely on Policy Exclusions to Avoid Its Obligation to Pay an Adverse Judgment A. This Court’s Ruling is Consistent With Basic Principles of Contract Law The duty to defend is a material term in a contract of insurance. There is no question that the insurer here breached that material term. As this Court noted: “It is quite clear that American Guarantee breached its duty to defend―indeed, it does not seem to contend otherwise now.” Opinion, 21 N.Y. 3d at 389. Having committed a material breach of the insurance contract by refusing to provide a defense, American Guarantee cannot be allowed to invoke exclusions in that same contract to avoid its duty to pay the default judgment award entered as a consequence of its breach of the duty to defend. 15 This result follows from basic principles of contract law. It is well settled that a party that breaches a material provision in a contract cannot invoke other provisions in that contract for its own advantage. For example, in DeCapua v. Dine-A-Mate, Inc., 292 A.D.2d 489 (2d Dep’t 2002), the Appellate Division stated: The plaintiff was not entitled to enforce the restrictive covenant in the contract since he breached the contract first by failing to make royalty payments. When a party benefiting from a restrictive covenant in a contract breaches that contract, the covenant is not valid and enforceable against the other party because the benefiting party was responsible for the breach. Id. at 491 (citations omitted). See also, e.g., Baker Marine Corp. v. Weatherby Eng’g Co., 710 S.W. 2d 690, 696 (Tex. App. 1986) (“the breaching party[] cannot take advantage of provisions favorable to it contained in the very contract which it was found to have breached”). In New York and elsewhere, courts have applied the same principle to breaches of insurance policies. Thus, in Isadore Rosen & Sons, Inc. v. Sec. Mut. Ins. Co., 31 N.Y.2d 342 (1972), this Court held that a triable issue existed as to whether an insurer’s unreasonable delay in responding to notice of an underlying construction defect lawsuit waived its right to insist on strict compliance with a policy provision prohibiting settlement without its consent. In reversing the lower court’s entry of summary judgment for the insurer, this Court relied on the “general rule” that “provision against settlement by insured cannot be taken 16 advantage of by insurer, where it unreasonably delays to take any action, after notice of the claim.” Id. at 348. The Court squarely equated such unreasonable delay with a repudiation of liability under the policy. Id. See also, e.g., St. Louis Dressed Beef & Provision Co. v. Maryland Cas. Co., 201 U.S. 173, 181 (1906) (Holmes, J.) (by wrongfully disclaiming coverage, the insurer “cut at the very root of the mutual obligation and put an end to its right to demand further compliance with the supposed term of the contract on the other side”); Coors v. Sec. Life of Denver Ins. Co., 112 P.3d 59, 64 (Colo. 2005) (because the insurer materially breached a life insurance policy, the insurer “is not entitled to enforce the early termination penalty provision”). B. This Court’s Ruling Is Consistent With Existing Law Encouraging Insurers to Honor the Duty to Defend The remedy this Court announced in its original Opinion has deep roots in New York case law applying principles of waiver and estoppel in the insurance context. New York law recognizes several circumstances in which an insurer may waive or forfeit its right to raise policy defenses. For example, an insurer that disclaims coverage on one or more grounds but fails to provide timely notice to its insured of another ground for disclaiming coverage generally waives that unasserted ground and may not invoke it later as a basis for avoiding its coverage obligations. See, e.g. George Campbell Painting v. Nat’l Union Fire Ins. Co., 92 A.D.3d 104 (1st Dep’t 2012); N.Y. Ins. Law § 3420(d)(1)(B). To avoid the 17 application of waiver, a notice of disclaimer must provide “‘a high degree of specificity of the ground or grounds on which the disclaimer is predicated.’” Estee Lauder Inc. v. OneBeacon Ins. Grp., LLC, 62 A.D.3d 33, 35 (1st Dep’t 2009) (quoting Gen. Accident Ins. Grp. v. Cirucci, 46 N.Y.2d 862, 864 (1979)). Otherwise, an insurer is deemed to have waived any other defenses that it had sufficient knowledge to assert at the time it issued its disclaimer notice. Id. Likewise, an insurer that agrees to provide a defense without a reservation of rights may be equitably estopped from denying coverage based on defenses it could have preserved by way of an explicit reservation of rights. See, e.g., Am. Transit Ins. Co. v. Mendon Leasing Corp., 241 A.D.2d 436, 437 (1st Dep’t 1997). By the same token, an insurer that has breached its duty to defend may not enforce a policy provision requiring the policyholder to obtain the insurer’s consent to a settlement. See Cardinal v. State, 304 N.Y. 400, 410 (1952): What we have here is a suit on an insurance policy, alleging a breach by the insurer in refusing to defend, and demanding damages therefor. The applicable law, as well stated in Appleman’s Insurance Law and Practice (Vol. 8, s 4690), is this: ‘If an insurer unjustifiably refuses to defend a suit, the insured may make a reasonable settlement or compromise of the injured person’s claim, and is then entitled to reimbursement from the insurer, even though the policy purports to avoid liability for settlements made without the insurer's consent.’ Application of waiver or estoppel in these situations is consistent with this Court’s repeated admonition that the duty to defend is a valuable right that must be 18 “liberally construed.” See, e.g., Fieldston Prop. Owners Ass’n v. Hermitage Ins. Co., 16 N.Y.3d 257, 264 (2011); Auto. Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131, 137 (2006); Gen. Motors Acceptance Corp. v. Nationwide Ins. Co., 4 N.Y.3d 451, 456 (2005). An insurer is required to provide a defense whenever the complaint alleges facts that suggest even “a reasonable possibility of coverage.” Cook, 7 N.Y.3d at 137. It follows that an insurer cannot refuse to provide a defense based on its assessment of the merits of the case. As long as the complaint states a claim that could rationally be considered to be covered by the policy, the insurer must defend, even if the allegations are “groundless, false or baseless.” Id. Moreover, this Court imposes a “heavy burden” on any insurer that tries to avoid its threshold duty to defend by invoking a policy exclusion. Cont’l Cas. Co. v. Rapid-Am. Corp., 80 N.Y.2d 640, 654-55 (1993). The exclusion will be “subject to strict construction and must be read narrowly.” Cook, 7 N.Y.3d at 137. The insurer must prove that the allegations lie “solely and entirely within the policy exclusions, and, further, that the allegations, in toto, are subject to no other interpretation.” Id. (citation and internal quotation marks omitted). These protections are designed “to ensure the . . . defense of an insured, regardless of the insured’s ultimate likelihood of success on the merits.” Gen. Motors Acceptance Corp., 4 N.Y. 3d at 456. These decisions reflect a strong judicial policy of encouraging insurers to step up and provide a defense as soon as an underlying complaint is filed against 19 the policyholder, and to resolve any ambiguity or uncertainty in favor of the promised defense. This policy was made explicit in Pennsylvania General Ins. Co. v. Austin Powder Co., 68 N.Y.2d 465 (1986), in which this Court held that an insurer does not have a right of subrogation against its own policyholder. Id. at 468. The Court explained that a policyholder depends on its insurance company to provide a “vigorous defense.” Although insurers generally have a broad right of subrogation, this Court refused to extend that right to claims against policyholders, because in that case, the insurer “would have less incentive to defend” its insured. Id. at 472 In a later decision, this Court further explained that “[p]ublic policy requires this exception to the general rule [of subrogation] . . . to guard against the potential for conflict of interest that may affect the insurer’s incentive to provide a vigorous defense for its insured.” N. Star Reins. Corp. v. Cont’l Ins. Co., 82 N.Y.2d 281, 295-96 (1993). This Court’s original decision in this case is therefore thoroughly consistent with existing law and policy encouraging insurers to honor their duty to defend. C. This Court’s Ruling Protects the Interests of Insurance Companies The rule articulated in this Court’s original Opinion provides adequate protection for the insurer. First, the insurer retains the right to “‘litigate . . . the validity of its disclaimer.’” Opinion, 21 N.Y.3d at 390-91 (quoting Lang, 3 N.Y.3d at 356). This right to litigate the validity of the disclaimer is a valuable 20 right: the duty to defend is considerably broader than the duty to indemnify. Cook, 7 N.Y.3d at 137. If an insurer can prove that it had no duty to defend because the allegations in the complaint were so far outside the scope of the policy that there was no reasonable possibility of coverage, then, a fortiori, the insurer has no duty to indemnify. Therefore, the present decision will not affect insurers who correctly conclude that they do not owe a duty to defend. The insurer will only be barred from relying on policy exclusions to avoid coverage if the court first determines that the insurer had a duty to defend and that it breached that duty. Here, there is no question that American Guarantee had, and breached, a duty to defend. As this Court noted, American Guarantee “does not seem to contend otherwise.” Opinion, 21 N.Y.3d at 389. Second, as the Opinion and Lang both make clear, there are existing procedures in place for resolving disputes over whether the insurer has a duty to defend its policyholder against a particular claim. Opinion, 21 N.Y.3d at 390-91; Lang, 3 N.Y.3d at 356. As this Court has repeatedly recommended, an insurer faced with legitimate uncertainty over its defense obligations may bring a declaratory judgment action seeking a determination as to its duty to defend an underlying lawsuit. See, e.g., Lang, 3 N.Y.3d at 356. In addition, the insurer has the option of defending its policyholder under a reservation of its right to disclaim indemnity coverage of any adverse judgment or settlement. Or, the insurer can do 21 both; it can defend under a reservation of rights and also file a declaratory judgment action seeking judicial clarification of its duty to defend. Under any of these options, the insurer would preserve its right to argue that the underlying claims fall within a policy exclusion. The insurer would only be barred from invoking a policy exclusion to avoid coverage if it chose not to avail itself of these traditional options and, instead, unilaterally refused to defend the policyholder. An insurer that chooses to “roll the dice” in this fashion and expose its policyholder to an adverse judgment or forced settlement cannot plausibly expect to suffer no consequences if its refusal to defend was unjustified. That would only encourage further derelictions. American Guarantee argues that this Court’s Opinion is contrary to its previous decision in Servidone Construction Corp. v. Security Ins. Co., 64 N.Y.2d 419 (1985), and that stare decisis militates against estoppel. Supplemental Brief for Defendant-Appellant-Cross-Respondent at 30-32 (filed Nov. 15, 2013). Servidone is distinguishable from this case in at least two ways. First, the policyholder in Servidone voluntarily settled an uncovered claim and a potentially covered claim, without allocating the settlement amount between the two claims. Under those circumstances, this Court held that the insurer should be afforded the opportunity to prove that at least some portion of the settlement was excluded. Id. at 424-25. Here, in contrast, the policyholder did not voluntarily settle, but instead 22 was forced into a default by American Guarantee’s breach of its defense promise, and the default judgment can only be based on the covered claim of legal malpractice, which was the only claim asserted against Daniels. That brings this case squarely within the holding of Lang v. Hanover Insurance Co., 3 N.Y.3d 350 (2004), as this Court expressly noted in its Opinion. Second, there was no evidence in Servidone that the insurer’s withdrawal from the defense had “coerced” the policyholder into settling with the underlying plaintiff. Servidone, 64 N.Y.2d at 425. Here, by contrast, American Guarantee’s breach led directly and inexorably to the withdrawal of defense counsel and the entry of a default judgment against Daniels. (R. 276-77.) Payment of the default judgment thus falls squarely within the scope of damages foreseeably resulting from the insurer’s breach of the duty to defend. Moreover, even if Servidone was not readily distinguishable on its facts, stare decisis is not an “inexorable command.” Lawrence v. Texas, 539 U.S. 558, 577 (2003). It is a matter of judicial policy, intended to “ensure that the law will not merely change erratically, but will develop in a principled and intelligible fashion.” Vasquez v. Hillery, 474 U.S. 254, 265 (1986). Stare decisis is at its weakest ebb where, as here, no legitimate reliance interests are at stake. Lawrence, 539 U.S. at 577. This Court’s ruling would negatively impact only those insurance companies that have—contrary to their solemn promise and the dictates of public 23 policy—both (1) breached their duty to defend; and (2) failed to avail themselves of the proper process for resolving disputes over the duty to defend. To the extent that Servidone might induce an insurer to abandon its policyholders in the way American Guarantee left Daniels in the lurch here, this Court should clarify that such a result was not intended and will not be condoned. III. This Court’s Ruling Is Consistent With Mainstream Authority This Court’s ruling is consistent with the decisions of numerous courts nationwide. For example, Illinois, Connecticut, Montana, and Wisconsin have adopted this approach. See, e.g., State Farm Fire & Cas. Co. v. Martin, 710 N.E.2d 1228, 1230-31 (Ill. 1999); Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A.3d 961, 993 (Conn. 2013); Missionaries of the Company of Mary, Inc. v. Aetna Cas. & Sur. Co. (“Missionaries”), 230 A.2d 21, 25-26 (Conn. 1967); Farmers Union Mut. Ins. Co. v. Staples, 90 P.3d 381, 386-87 (Mont. 2004); Radke v. Fireman’s Fund Ins. Co., 577 N.W.2d 366, 371 (Wis. Ct. App. 1998); Grube v. Daun, 496 N.W.2d 106, 123 (Wis. Ct. App. 1992). Other states apply a similar approach. In Washington, for instance, an insurer that has breached its duty to defend in bad faith—which is essentially what American Guarantee did here—may not rely on policy exclusions to deny coverage. Kirk v. Mt. Airy Ins. Co., 951 P.2d 1124 (Wash. 1998). In Mississippi, an insurer may be deemed to have waived its policy defenses when the 24 policyholder has been prejudiced by the insurer’s breach of its defense promise. Twin City Fire Ins. Co. v. City of Madison, 309 F.3d 901 (5th Cir. 2002). Other states that allow insurers to raise policy defenses nonetheless recognize the need to provide appropriate incentives to ensure that policyholders receive the benefit of the litigation insurance they have purchased. Many states allow policyholders to bring tort actions for a breach of the implied covenant of good faith and fair dealing. In some cases, the insurer may be exposed to punitive damages for its bad faith refusal to defend. Additionally, leading insurance law authorities have recommended an approach similar to that adopted by this Court. A. Many States Prohibit Insurers From Raising Policy Defenses When They Have Breached Their Duty to Defend Illinois: In Illinois, if the insurer wishes to challenge coverage, it must either defend the action under a reservation of rights or seek an immediate declaratory judgment that the policy does not cover the claim. State Farm Fire & Cas. Co. v. Martin, 710 N.E.2d 1228, 1230-31 (Ill. 1999). “If the insurer fails to take either of these actions, it will be estopped from later raising policy defenses to coverage.” Id. The Illinois Supreme Court has noted that an insurer has adequate means for contesting coverage, by providing a defense under a reservation of rights or by filing a declaratory judgment action. An insurer that chooses not to avail itself of these protections and, instead, unilaterally breaches the contract, has acted 25 inequitably. As the Court explained in Clemmons v. Travelers Ins. Co., 430 N.E.2d 1104 (Ill. 1981), “because the insurer breached one of its duties under the contract of insurance . . . , the insurer cannot later turn around and enforce another clause of the contract, to its complete protection.” Id. at 1109; see also Emp’rs Ins. of Wausau v. Ehlco Liquidating Trust, 708 N.E.2d 1122, 1135 (Ill. 1999) (“[A]n insurer’s duty to defend . . . is so fundamental an obligation that a breach of that duty constitutes a repudiation of the contract.”). Connecticut: In Connecticut, as in Illinois, an insurer may defend a policyholder under a reservation of rights if the insurer believes that the claim falls within a policy exclusion. See, e.g., Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A.3d 961, 993 (Conn. 2013); Missionaries of the Company of Mary, Inc. v. Aetna Cas. & Sur. Co., 230 A.2d 21, 25-26 (Conn. 1967). An insurer that chooses not to defend under a reservation of rights has, “in effect, waived the opportunity which was open to it.” Id. at 26. Having breached the insurance contract by its “unqualified refusal to defend,” the insurer cannot then “seek the protection of that contract” by asserting a policy exclusion to avoid paying a settlement or judgment resulting from its refusal to defend. Id. Montana: In Montana, when an “insurer refuses to defend a claim and does so unjustifiably, that insurer becomes liable for defense costs and judgments.” Lee 26 v. USAA Cas. Ins. Co., 86 P.3d 562, 565 (Mont. 2004). This principle is codified in the Montana Code: The person indemnifying is bound, on request of the person indemnified, to defend actions or proceedings brought against the person indemnified in respect to the matters embraced by the indemnity. . . . If, after request, the person indemnifying neglects to defend the person indemnified, a recovery against the person indemnified suffered by the person indemnified in good faith is conclusive in favor of the person indemnified against the person indemnifying. Mont. Code Ann. § 28-11-316 (2013). If the insurer wants to deny coverage, it must defend the policyholder under a reservation of rights and seek a declaratory judgment that the claim is not covered. Farmers Union Mut. Ins. Co. v. Staples, 90 P.3d 381, 386-87 (Mont. 2004). Staples arose out of a suit brought by a driver who collided with a horse that had wandered onto a highway. The insurance company, which had issued a ranch liability policy to the owner of the nearby ranch, refused to defend the suit, on the ground that the policyholder did not own the horse. Although the trial court found that the insurer had breached its duty to defend, it agreed with the insurer that the policyholder did not own the horse and it therefore granted summary judgment to the insurer. The Supreme Court of Montana reversed, holding that the trial court erred when it tried to resolve the factual dispute over who owned the horse. Id. at 387. Once the trial court “correctly determined that [the insurer] had a duty to 27 defend, the court should have ended the analysis and concluded that since [the insurer] breached that duty, it was estopped from denying coverage.” Id. Wisconsin: In Wisconsin, “[w]hen an insurer wrongfully refuses to defend on the grounds that a claim against its insured is not within the coverage of the policy, the insurer cannot later contest coverage, but is liable to the insured.” Radke v. Fireman’s Fund Ins. Co., 577 N.W.2d 366, 371 (Wis. Ct. App. 1998). If the insurer wants to contest coverage under the policy, the issue must be resolved by the court. Grube v. Daun, 496 N.W.2d 106, 123 (Wis. Ct. App. 1992). The insurer can ask the court to determine coverage either through a bifurcated trial or a declaratory judgment action. Id. But the insurer “cannot deliberately reach its own conclusion on coverage”, breach its duty to defend, “and then maintain that a clause in the policy would have excused it from indemnifying” the policyholder. Id. Washington: In Washington, an insurer that acts in bad faith in refusing to defend its insured is estopped from denying coverage. Kirk v. Mt. Airy Ins. Co., 951 P.2d 1124, 1127 (Wash. 1998). Washington courts have recognized that “insurance contracts are different” from other contracts because an insurer has a quasi-fiduciary obligation to protect its insured. Id. In particular, the “insurer has an enhanced obligation of fairness toward its insured” that goes beyond “the standard contractual duty of good faith.” Safeco Ins. Co. of Am. v. Butler, 823 P.2d 28 499, 505 (Wash. 1992) (citation and internal quotation marks omitted). Moreover, there is a serious “potential for abuse” when the insurer acts in bad faith. Kirk, 951 P.2d at 1127. Therefore, estoppel is necessary to provide a “strong incentive for the insurer to act in good faith” when it assumes control of the policyholder’s defense. Id. at 1128; see also Butler, 823 P.2d at 506. Mississippi: In Mississippi, an insurer that breaches its duty to defend may be estopped from relying on policy exclusions to deny coverage when the insurer’s conduct has prejudiced the insured. “When the alleged misconduct of the insurer concerns the duty to defend, the insurer may be liable despite an exclusion otherwise applicable.” Twin City Fire Ins. Co. v. City of Madison, 309 F.3d 901, 906 (5th Cir. 2002). A default judgment resulting from an insurer’s refusal to defend is a glaring example of the type of prejudice that would trigger the application of estoppel under this state’s regime. See S. Farm Bureau Cas. Ins. Co. v. Logan, 119 So. 2d 268, 272 (Miss. 1960). B. Other States Provide Incentives to Encourage Insurers to Honor Their Duty to Defend Even those states that allow an insurer to raise policy defenses after breaching its duty to defend recognize the need to provide appropriate incentives to discourage the insurer from breaching that duty. For example, California recognizes that “[i]nsurance contracts are unique in nature and purpose,” because the policyholder “does not enter an insurance contract seeking profit, but instead 29 seeks security and peace of mind through protection against calamity.” Emerald Bay Cmty. Ass’n v. Golden Eagle Ins. Corp., 31 Cal. Rptr. 3d 43, 55 (Cal. Ct. App. 2005). In order to “avoid or discourage conduct” that would deny the policyholder the security for which it paid premiums, California courts impose “special and heightened implied duties of good faith” on insurers. Id. at 56. An insurer that unreasonably refuses to defend a policyholder breaches its duty of good faith and will be subject to tort damages based on ordinary negligence principles. Advanced Network, Inc. v. Peerless Ins. Co., 119 Cal. Rptr. 3d 17, 23 (Ct. App. 2010). The insurer will be required to compensate the insured for all damages proximately caused by the breach, regardless of whether those damages could have been anticipated. Id. In Amato v. Mercury Casualty Co., 61 Cal. Rptr. 2d 909 (Ct. App. 1997), the insurer refused to defend a policyholder who had negligently injured a passenger in an automobile accident. A default judgment was entered against the policyholder. In the subsequent coverage action, the court concluded that the insurer breached its duty of good faith by unreasonably refusing to provide a defense. Id. at 912. In addition, the court found that because the insured was financially unable to mount his own defense, the default judgment was a proximate result of the insurer’s breach. Id. at 913. Therefore, the court held the insurer liable for the entire 30 judgment, even though it was later determined that the policy did not cover the accident. Id. California also allows a policyholder to recover punitive damages if the insurer’s breach of the implied covenant of good faith and fair dealing is the result of “malice, oppression or fraud.” Tibbs v. Great Am. Ins. Co., 755 F.2d 1370, 1375 (9th Cir. 1985); see also Lunsford v. Am. Guar. & Liab. Ins. Co., 18 F.3d 653, 656 (9th Cir. 1994). In Tibbs, American Guarantee refused to provide a defense despite the fact that several of the insurance company’s own claims employees had advised that Tibbs was entitled to a defense. Tibbs, 755 F.2d at 1375. The insurer also failed to conduct a reasonable investigation to determine whether it had a duty to defend. Id. The Court of Appeal upheld the jury’s award of punitive damages, finding that there was sufficient evidence that the insurer had “consciously disregarded” its obligations to Tibbs and was guilty of malice, oppression or fraud for deliberately repudiating its duty to defend. Id. California is not alone. Other jurisdictions have adopted similar policies. For example, the Supreme Court of North Dakota has held that “‘an insurer has an implied duty to deal fairly and act in good faith with its insured and that the violation of this duty gives rise to an action in tort for which consequential and, in a proper case, punitive, damages may be sought.’” Corwin Chrysler-Plymouth, Inc. v. Westchester Fire Ins. Co., 279 N.W.2d 638, 645 (N.D. 1979) (quoting 31 Christian v. Am. Home Assurance Co., 577 P.2d 899, 904-05 (Okla. 1977)). In particular, an unreasonable refusal to defend can give rise to tort liability and imposition of punitive damages. The Court explained that such remedies were necessary so as not to “encourage insurance companies to exert whatever coercion in whatever manner and under whatever circumstances as would serve their financial interest.” Smith v. Am. Family Mut. Ins. Co., 294 N.W.2d 751, 759 (N.D. 1980) (internal quotation marks omitted). Georgia also allows for enhanced damages against an insurer that refuses to defend a policyholder. The insurer may be liable for the full amount of any judgment against the insured, even in excess of the policy limits. Atlanta Cas. Ins. Co. v. Gardenhire, 545 S.E.2d 182, 184 (Ga. Ct. App. 2001). When the conduct of the insurer demonstrates “such entire want of care amounting to a conscious indifference to the consequences” to the insured, the insurer may also be liable for punitive damages. Thomas v. Atlanta Cas. Co., 558 S.E.2d 432, 440 (Ga. Ct. App. 2001). The foregoing authorities confirm that there is no merit to the suggestion of American Guarantee and its amici that this Court’s original Opinion is a jurisprudential outlier, and that the sole remedy available to redress an insurer’s breach of its defense promise is to reimburse the policyholder, often years later, for the cost of defending itself. That remedy is often insufficient to provide incentives 32 for insurers to honor their defense obligation, because insurers know that many such breaches will go unchallenged, and those that are contested will only result in a judgment requiring the insurer to reimburse the insured after the fact for defense expenses that should have been paid contemporaneously by the insurer. Reimbursement is also a poor substitute for the litigation service of a managed defense that was promised in the contract. And it is entirely unavailing to insureds like Daniels, who lacked the resources to defend himself and was forced to take a default judgment as a result of American Guarantee’s dereliction. In this respect, American Guarantee’s demand to be relieved of the obligation to pay the default judgment against Daniels is nothing more than an attempt to absolve itself of any financial responsibility for the consequences of forcing its insured into absorbing a default judgment. It is difficult to conceive of a result that would more thoroughly undermine the value of the defense promise. This is why courts in many states have struggled with the imperative of providing incentives for insurers to act responsibly in discharging their defense promise. Those same courts have concluded that the fundamental importance of the defense promise to the proper functioning of the adversary system, when combined with the serious adverse consequences imposed on policyholders who are arbitrarily deprived of an effective defense by their insurers’ repudiation of that promise, requires incentives greater than merely reimbursing defense expenses in 33 order to assure that the defense promise functions as a meaningful source of “litigation insurance” rather than an illusion. This Court’s opinion is well within the mainstream of judicial efforts to establish real incentives for encouraging insurers to honor their duty to defend. C. Leading Authorities Agree That Courts Should Fashion Rules That Encourage Insurers to Honor Their Duty to Defend The Tentative Draft of the American Law Institute’s “Principles of the Law of Liability Insurance” makes clear that the trend of the law is that insurers that breach their duty to defend should be estopped from relying on policy exclusions to deny coverage. See ALI, Principles of the Law of Liability Insurance, Tentative Draft No. 1, § 21 (Apr. 9, 2013). Although noting that some courts have disagreed, the Tentative Draft concludes that “[t]he better rule” is that “a liability insurer that breaches the duty to defend loses the right to contest coverage for the claim. This rule properly aligns the defense incentives of the insurer and the policyholder in situations in which the insurer’s potential coverage defense otherwise would reduce the incentive to defend the claim.” Id. As the Tentative Draft explains: “The forfeiture of coverage defense rule discourages insurers from attempting to convert a duty-to-defend policy into an after-the-fact defense-cost-reimbursement policy. . . . By encouraging insurers to defend claims that they would not otherwise, the forfeiture of coverage defense rule may increase the cost of liability 34 insurance, but it provides a benefit to all insureds by increasing the certainty that insurers will defend them from liability claims.” Id. (citation omitted). A leading insurance commentator has reached the same conclusion. The author of “Understanding Insurance Law” recommends that an insurer be estopped from denying coverage when it has breached its duty to defend. Robert H. Jerry, II, Understanding Insurance Law § 111 (1987). The author notes that the insurer has the option of defending under a reservation of rights or of bringing a declaratory judgment action to clarify its duty to defend. He concludes that “the existence of these time-honored procedural alternatives is the best reason for estopping the insurer.” Id. The author also stresses the asymmetry between the insurer and the insured when it comes to defending third party lawsuits. Whatever slight risks estoppel may pose to the insurer, the insurer “is in a better position to bear these risks than the typical insured is to assume a defense obligation that an insurer is not performing.” Id. A-1 ADDENDUM (CORPORATE DISCLOSURE STATEMENTS) DISCLOSURE STATEMENT OF COLTEC INDUSTRIES INC. Pursuant to Rule 500.1(f) of the Rules of Practice of the Court of Appeals, Coltec Industries Inc. states as follows: Coltec Industries Inc. is a wholly owned subsidiary of EnPro Industries, Inc. Coltec Industries has the following subsidiaries and affiliates: Coltec do Brasil Productos Industries Ltda Coltec Finance Company Limited Coltec Industries Pacific Pte Ltd CPI Service (Thailand) Ltd. CPI Asia Co., Ltd. CPI Service (Thailand) Ltd. Garlock India Private Limited Garlock Singpore Pte. Ltd. Link Seal Japan Ltd. PSI [SEA] SDN BHD Coltec International Services Co. Coltec do Brasil Productos Industriais Ltda. Stempro de Mexico, S. de R.L. de C.V. Compressor Products Holdings, Limited Compressor Products International Ltd. Compressor Products International Ltda. Industria de Compressores Ltda. CPI Investments Limited Compressor Products International Ltda. CPI Pacific Pty Limited CPI S.a.r.l. Player & Cornish Limited Robix Limited A-2 Compressor Products International LLC CPI Service Baton Rouge, Inc. EnPro Industries Int’l Trading (Shanghai) Co., Ltd. EnPro Hong Kong Holdings Company Limited Garlock Sealing Technologies (Shanghai) Co., Ltd. EnPro Corporate Management Consulting (Shanghai) Co. Ltd. Compressor Products Int’l (Shanghai) Co., Ltd. Stemco Vehicle Technology (Shanghai) Co. Ltd. GGBLLC Garlock (Great Britain) Limited Garlock Pipeline Technologies Limited Technetics Group U.K. Ltd. Technetics UK Limited Garlock Pipeline Technologies, Inc. Garlock Sealing Technologies LLC Garlock International Inc. Garlock of Canada Ltd. Garlock de Mexico, S.A. Garlock Overseas Corporation Garlock de Mexico, S.A. Garlock Pty Limited Garlock Valqua Japan, Inc. Garrison Litigation Management Group, Ltd. The Anchor Packing Company GGB Brasil Industria de Mancais E Componentes Ltda. GGB, Inc. EnPro Luxembourg Holding Company S.a.r.l. Alpha Engineering SRL Compressor Products International Canada, Inc. Compressor Producst International Colombia S.A.S. Enpro German Holding GmbH GGB Heilbronn GmbH GGB Kunststoff-Technologie GmbH Garlock GmbH Compressor Products International GmbH Franken Plastiks GmbH PSI Products GmbH Technetics Group Germany GmbH A-3 GGB Slovakia s.r.o. Coltec Industries France SAS CPI-LIARD SAS Technetics Group France SAS GGB Austria GmbH GGB Bearing Technology (Suzhou) Co., Ltd. GGB Brasil Industria de Mancais E Components Ltda. GGB Italy s.r.l. GGB Real Estate GmbH GGB Slovakia s.r.o. GGB Tristar Suisse S.A. GGB Holdings E.U.R.L. GGB France E.U.R.L. Stemco Holdings, Inc. Motorwheel Commercial Vehicle Systems, Inc. Stemco LP Stemco Crewson LLC Stemco LP Stempro de Mexico, S. de R.L. de C.V. Stemco Kaiser Incorporated Technetics Group LLC Best Holdings I, Inc. KenLee Daytona LLC Technetics Group Daytona, Inc. Applied Surface Technology Belfab, Inc. Technetics Group Singapore Pte. Ltd. A-4 DISCLOSURE STATEMENT OF SPX CORPORATION Pursuant to Rule 500.1(f) of the Rules of Practice of the Court of Appeals, SPX Corporation states as follows: SPX Corporation does not have a parent corporation. SPX Corporation has the following subsidiaries and affiliates: Administraciones Directas Interactive Especializadas, S.C. Anhydro (Hong Kong) Limited Anhydro China Co., Ltd. Anhydro North America, Inc. Anhydro S.A.S. APV (China) Co., Ltd. APV Benelux B.V. APV Benelux NV APV Hills and Mills (Malaysia) Sdn Bhd APV Middle East Limited APV Overseas Holdings Limited Arrendadora Korco, S.A. de C.V. Balcke-Duerr Italiana, S.r.l. Balcke-Dürr GmbH Balcke-Dürr GmbH, Hungarian Branch Balcke-Dürr Polska Sp. Z o.o. Ballantyne Company Ballantyne Holding Company Ballantyne Holdings LLC BDT Limited Carnoustie Finance Limited Clyde Pumps India Pvt Limited Clyde Pumps Limited Clyde Pumps, Inc. Clyde Union (AR) (Holdings) Limited Clyde Union (France) S.A.S. Clyde Union (Holdings) Limited Clyde Union (Holdings) S.á.r.l. A-5 Clyde Union (Indonesia) (Holdings) Limited Clyde Union (US) Inc. Clyde Union Canada Limited Clyde Union China Holdings Limited Clyde Union DB Limited Clyde Union IMBIL Ltda. Clyde Union Inc. Clyde Union Limited Clyde Union Middle East LLC Clyde Union Pumps Middle East FZE Clyde Union Pumps Technology (Beijing) Co. Limited Clyde Union S.á.r.l. Clyde Union S.A.S. Clyde Union South East Asia Pte. Ltd. DBT Technologies (Pty) Ltd Delaney Holdings Co. Drysdale & Company Limited EGS Electrical Group LLC Fairbanks Morse India Limited Fairbanks Morse Pump Corporation Flash Technology, LLC General Signal (China) Co., Ltd. General Signal India Private Limited General Signal Ireland B.V. Genfare Holdings, LLC Girdlestone Pumps Limited GS Automation A/S Hangzhou Kayex Zheda Electromechanical Co., Ltd. Heat Transfer Services Pte Ltd. Invensys Philippines, Inc. Johnson Pumps of America, Inc. Johnston Ballantyne Holdings Limited Jurubatech Technologia Automotiva Ltda. Kayex China Holdings, Inc. Kayex Holdings LLC Kent-Moore Brasil Indústria e Comércio Ltda. Kiawah Holding Company Mactek Pty Limited Marley Canadian Inc. Marley Cooling Tower (Holdings) Limited Marley Engineered Products (Shanghai) Co. Ltd. A-6 Marley Engineered Products LLC Marley Mexicana S.A. de C.V. Mather & Platt Machinery Limited MCT Services LLC Medinah Holding Company Medinah Holding GmbH Menk USA, LLC Muirfield Finance Company Limited Newlands Junior College Limited Oakmont Finance S.á.r.l. Pinehurst Holding Company Prepared Response, Inc. PT. Clyde Union Pumps Indonesia Radiodetection (Canada) Ltd. Radiodetection (China) Limited Radiodetection Australia Pty Limited Radiodetection B.V. Radiodetection Limited Radiodetection Sarl Rathi Lightnin Mixers Private Limited S & N International, L.L.C. S & N Pump Company S & N Pump Middle East, LLC S&N Pump (Africa) Ltda. S&N Pump and Rewind Limited Seminole Holding Company Shanghai SEC-SPX Engineering & Technologies Co., Ltd. Shinnecock Holding Company South Eastern Europe Services Limited SPX (China) Industrial Manufacturing Center Co., Ltd. SPX (Guangzhou) Cooling Technologies Co., Ltd. SPX (Shanghai) Flow Technology Co., Ltd. SPX (Tianjin) Cooling Technologies Co. Ltd. SPX Air Treatment Limited SPX Canada Co. SPX Chile Limitada SPX Clyde Luxembourg S.á.r.l. SPX Clyde UK Limited SPX Cooling Technologies (Beijing) Co. Ltd. SPX Cooling Technologies (Zhangjiakou) Co. Ltd A-7 SPX Cooling Technologies Belgium SPRL SPX Cooling Technologies Canada, Inc. SPX Cooling Technologies France SAS SPX Cooling Technologies GmbH SPX Cooling Technologies Leipzig GmbH SPX Cooling Technologies Malaysia Sdn Bhd SPX Cooling Technologies Singapore Pte. Ltd. SPX Cooling Technologies UK Limited SPX Cooling Technologies, Inc. SPX Corporation SPX Corporation (China) Co., Ltd. SPX Corporation (Shanghai) Co., Ltd. SPX Denmark Holdings ApS SPX Europe Shared Services Limited SPX Flow Technology (India) Private Limited SPX Flow Technology (Pty) Limited SPX Flow Technology (Thailand) Limited SPX Flow Technology Argentina S.A. SPX Flow Technology Assen B.V. SPX Flow Technology Australia Pty Ltd. SPX Flow Technology Belgium NV SPX Flow Technology Canada Inc. SPX Flow Technology Copenhagen A/S SPX Flow Technology Crawley Limited SPX Flow Technology Danmark A/S SPX Flow Technology do Brasil Indústria e Comércio Ltda. SPX Flow Technology Dublin Limited SPX Flow Technology Etten-Leur B.V. SPX Flow Technology Finland Oy SPX Flow Technology Hanse GmbH SPX Flow Technology Hong Kong Limited SPX Flow Technology Hong Kong Limited, Taiwan Branch SPX Flow Technology Hungary Kft. (SPX Flow Technology Hungary Mérnöki és Képviseleti Kft.) SPX Flow Technology Ibérica S.A. A-8 SPX Flow Technology Italia S.p.A. SPX Flow Technology Japan, Inc. SPX Flow Technology Kerry Limited SPX Flow Technology Korea Co., Ltd. SPX Flow Technology Limited SPX Flow Technology London Limited SPX Flow Technology Mexico, S. A. de C.V. SPX Flow Technology Moers GmbH SPX Flow Technology New Zealand Limited SPX Flow Technology Norderstedt GmbH SPX Flow Technology Norway AS SPX Flow Technology Poland sp. z.o.o. SPX Flow Technology Rosista GmbH SPX Flow Technology s.r.o. SPX Flow Technology Santorso S.r.l. SPX Flow Technology SAS SPX Flow Technology Singapore Pte. Ltd. SPX Flow Technology Sweden AB SPX Flow Technology Systems, Inc. SPX Flow Technology Unna GmbH SPX Flow Technology USA, Inc. SPX Flow Technology Warendorf GmbH SPX France Holdings SAS SPX Heat Transfer LLC SPX Holding HK Limited SPX Holding Inc. SPX India Private Limited SPX Industrial Equipment Manufacturing (Suzhou) Co., Ltd. SPX International (Thailand) Limited SPX International e.G. SPX International Holding GmbH SPX International Limited SPX International Management LLC SPX Korea Co., Ltd. SPX Latin America Corporation SPX Luxembourg Acquisition Company S.á.r.l. SPX Luxembourg Holding Company S.á.r.l. SPX Middle East FZE SPX Netherlands B.V. SPX Pension Trust Company Limited A-9 SPX Precision Components LLC SPX Process Equipment Pty Ltd. SPX Rail Systems HK Limited SPX Receivables, LLC SPX Russia Limited SPX Singapore Pte. Ltd. SPX Technologies (Pty) Ltd. SPX TPS HK Limited SPX Transformer Solutions, Inc. SPX U.L.M. GmbH SPX UK Holding Limited TCI International, Inc. The Harland Engineering Co. Limited The Marley Company LLC The Marley-Wylain Company Thermax SPX Energy Technologies Limited Tiros Sdn. Bhd. Torque Tension Systems (Asia Pacific) Pty Limited Torque Tension Systems (SEA) SDN. BHD Torque Tension Systems Limited TPS, LLC Turnberry Rubicon Limited Turnberry Rubicon Limited Partnership U.D.I. Mauritius Limited UD-RD Holding Company Limited Union Pump Limited United Dominion Industries Corporation Valhalla Holding Company Vokes Limited Wuxi Balcke Durr Technologies Company, Ltd. XCel Erectors, Inc.