K2 Investment Group, LLC, et al., Respondents-Appellants,v.American Guarantee & Liability Insurance Company, Appellant-Respondent.BriefN.Y.January 7, 2014To be Argued by: MICHAEL A. HASKEL (Time Requested: 30 Minutes) APL-2012-00055 New York County Clerk’s Index No. 117902/09 E 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 CO., Defendant-Appellant-Cross-Respondent. SUPPLEMENTAL BRIEF FOR PLAINTIFFS- RESPONDENTS-CROSS-APPELLANTS K2 INVESTMENT GROUP, LLC and ATAS MANAGEMENT GROUP, LLC LAW OFFICES OF MICHAEL A. HASKEL Attorneys for Plaintiffs-Respondents-Cross- Appellants K2 Investment Group, LLC and ATAS Management Group, LLC 167 Willis Avenue Mineola, New York 11501 Tel.: (516) 294-0250 Fax: (516) 294-0854 Dated: December 20, 2013 i DISCLOSURE STATEMENT Pursuant to Rules 500.1(f) and 500.13(a) of the New York Court of Appeals Rules of Practice, the Plaintiffs-Respondents-Cross-Appellants are K2 Investment Group, LLC and ATAS Management Group, LLC. K2 Investment Group, LLC and ATAS Management Group, LLC have no parents, affiliates, or subsidiaries. ii TABLE OF CONTENTS Disclosure Statement ................................................................................................... i Table of Contents ...................................................................................................... ii Table of Authorities ................................................................................................... v Preliminary Statement ................................................................................................ 1 Statement of Facts and Procedural History ................................................................ 2 A. The Underlying Action .......................................................................... 2 1. K2 and ATAS Bring Legal Malpractice Claims ......................... 2 2. Guarantee Withdraws from Defending Daniels ......................... 3 3. Guarantee Rejects K2 and ATAS’s Settlement Offer ................ 4 4. Daniels Defaults .......................................................................... 5 B. The Instant Action ................................................................................. 5 1. Judgment in the Supreme Court, New York County .................. 5 2. All Parties Appeal to the Appellate Division, First Department ..................................................................................................... 6 3. All Parties Appeal to the Court of Appeals ................................ 8 4. The Decision ............................................................................... 8 5. Guarantee Is Granted Reargument but Not Vacatur ................... 9 ARGUMENT ........................................................................................................... 10 Introduction .................................................................................................... 10 POINT I: The Court Did Not Misapprehend Lang ................................... 11 (a) The Lang Decision .................................................................... 11 iii (b) The Decision Confirms the Rule Articulated in Lang .............. 12 POINT II: This Court Did Not Overlook Servidone .................................. 14 (a) The Servidone Decision ............................................................ 14 (b) Servidone and the Decision Peacefully Coexist ....................... 15 POINT III: The Decision Is Consistent With Established Principles of Law ................................................................................................... 18 (a) The Decision is Harmonious with Contract Law Principles .... 18 (b) The Decision Does Not Overstep Judicial Authority ............... 24 (c) The Decision Does Not Call for “Automatic” Indemnity ........ 27 (d) Reversal Proponents Exaggerate the Decision’s Reach and Impact ........................................................................................ 28 (i) Settlement Cases Are Not Governed by the Decision .... 29 (ii) Public Policy Exclusions Are Not Governed by the Decision .......................................................................... 32 (iii) The Decision Only Applies Where There Is Coverage and a Wrongful Disclaimer ............................................. 33 (iv) The Decision Is Consistent with National Jurisprudence ........................................................................................ 36 The Decision Does Not Adopt the So-Called Illinois Rule ........................................................................................ 37 Had the Court Adopted the So-Called Illinois Rule, It Had a Sound Basis for Doing So .................................... 38 (v) The Decision Deals with an Insurer’s Loss of the Right to Raise Policy Exclusions in Defense of an Insurance Law § 3420 Action, Where Such Insurer has Wrongfully Disclaimed ...................................................................... 41 iv Hypothetical Scenarios Posed by NYIA Are Inapplicable ........................................................................................ 42 POINT IV: The Decision Favors Public Policy ........................................... 45 POINT V: The Decision Does Not Overlook Exclusions .......................... 53 POINT VI: Should This Court Revise Its Ruling, K2 and ATAS Should Still Prevail on Alternate Grounds ............................................ 54 CONCLUSION ........................................................................................................ 56 v TABLE OF AUTHORITIES Cases 23 Grouse Drive LLC v. Hermitage Ins. Co., No. 315/10, 2012 N.Y. Misc. LEXIS 1238, 2012 WL 985230 (Sup. Ct. Nassau County Mar. 6, 2012) ........................................................................................... 35 Albert J. Schiff Assocs. Inc. v. Flack, 51 N.Y.2d 692 (1980) ........................................................................................... 35 Aldrich v. National Chiropractic Mut. Ins. Co., No. 96-cv-8475, 1997 LEXIS 23729, 1997 WL 662509 (W.D.N.Y. Oct. 14, 1997) .............................................. 33 Allianz Ins. Co. v. Lerner, 416 F.3d 109 (2d Cir. 2005) ................................................................................. 34 Alvarez v. Prospect Hosp., 68 N.Y.2d 320 (1986) ........................................................................................... 54 Am. Nat'l Fire Ins. Co. v. Nat'l Union Fire Ins. Co., 343 Ill. App. 3d 93 (1st Dist. 2003) ...................................................................... 50 American Guar. & Liab. Ins. Co. v Moskowitz, 58 AD3d 426 [2009] ............................................................................................... 7 Apache Foam Prods. Div. of Millmaster Onyx Group of Kewanee Indus. Inc. v. Cont'l Ins. Co., 139 A.D.2d 933 (4th Dep't 1988) ......................................................................... 29 Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131 [2006] ............................................................................................. 27 Bainbridge Inc. v. Travelers Cas. Co. of Conn., 159 P.3d 748 (Colo. App. 2006)........................................................................... 48 Barber v. Nylund, 158 Wis. 2d 192 (Ct. App. 1990) ......................................................................... 18 Bovis Lend Lease LMB Inc. v. Garito Contr., Inc., 65 A.D.3d 872 (1st Dep't 2009), app. withdrawn, 14 N.Y.3d 884 (2010) ........... 34 Bowdren v. Peters, 208 A.D.2d 1020 (3d Dep't 1994) ........................................................................ 17 Bowker v. NVR Inc., 39 A.D.3d 1162 (4th Dep't 2007) .................................................................. 34, 56 BP Air Conditioning Corp. v. One Beacon Ins. Group, 8 N.Y.3d 708 (2007) ...................................................................................... 18, 47 Burroughs Wellcome Co. v. Commercial Union Ins. Co., 713 F. Supp. 694 (S.D.N.Y. 1989) ....................................................................... 30 vi Camp Dresser & McKee Inc. v. Home Ins. Co., 30 Mass. App. Ct. 318 (1991) .............................................................................. 49 Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 308 Conn. 760 (2013) ........................................................................................... 41 Cardinal v. State, 304 N.Y. 400 (1952) ............................................................................................. 21 CGS Indus. v. Charter Oak Fire Ins. Co., 720 F.3d 71 (2d Cir. 2013) ................................................................................... 31 Colon v. Aetna Life & Cas. Ins. Co., 66 N.Y.2d 6 (1985) ............................................................................................... 42 Conanicut Marine Servs., Inc. v. Ins. Co. of N. Am., 511 A.2d 967 (R.I. 1986) ...................................................................................... 40 Consol. Edison Co. of New York, Inc. v. Allstate Ins. Co., 98 N.Y.2d 208 (2002) ........................................................................................... 41 County of Massac v. U.S. Fid. & Guar. Co., 113 Ill. App. 3d 35 (5th Dist. 1983) ..................................................................... 20 D'Arata v. N.Y. Cent. Mut. Fire Ins. Co., 76 N.Y.2d 659 (1990) ........................................................................................... 32 Devoe Props. LLC v. Atl. Cas. Ins. Co., 2011 U.S. Dist. LEXIS 114574, 2011 WL 4711864 (E.D.N.Y. Oct. 4, 2011) .... 34 Empire Ins. Co. v. Miguel, 2013 WL 1562162, 2013 N.Y. Misc. LEXIS 1238 (Sup. Ct. N.Y. County Apr. 8, 2013) ..................................................................................................................... 33 Employers Ins. of Wausau v. Ehlco Liquidating Trust, 186 Ill. 2d 127 [1999] .................................................................................... 20, 38 Fed. Ins. Co. v. Stroh Brewing Co., 127 F.3d 563 (7th Cir. 1997) ................................................................................ 40 Fireman's Fund Ins. Co. v. Burman, Inc., 391 A.2d 99 [R.I. 1978] ........................................................................................ 25 Gallery at Fulton St., LLC v Wendnew LLC, 30 A.D.3d 221 (1st Dep't 2006) ........................................................................... 21 Gen. Mut. Ins. Co. v Coyle, 207 Misc. 362 (Sup. Ct. Onondaga County 1954) ............................................... 25 George A. Fuller Co. v. U.S. Fidelity & Guaranty Co., 200 A.D.2d 255, lv. denied, 84 N.Y.2d 806 (1994) ............................................. 43 Giovanielli v. Certain Underwriters at Lloyds, London, No. 9091/08, 23 Misc. 3d 1128(A) (Sup. Ct. Queens County May 14, 2009 ............................................. 34-35 Goldstein v. Engel, 240 A.D.2d 280 (1st Dep't 1997) ......................................................................... 16 vii Grindheim v. Safeco Ins. Co. of Am., 908 F. Supp. 794 (D. Mont. 1995) ....................................................................... 39 Guillen ex rel. Guillen v. Potomac Ins. Co. of Illinois, 203 Ill. 2d 141 (2003) ........................................................................................... 41 Hearst Corp. v. Clyne, 50 N.Y.2d 707 (1980) ........................................................................................... 42 HK Systems, Inc. v. Eaton Corp., 2006 U.S. Dist. LEXIS 33695, 2006 WL 314408 (E.D. Wis. Feb. 9, 2006), order amended on reconsideration, 2006 WL 1440857 (E.D. Wis. May 24, 2006), rev’d in part, 2007 WL 1747016 (E.D. Wis., Jun. 18, 2007), aff’d, 563 F.3d 1086 (7th Cir. 2009) ...................................................................................................... 30 Home Federal Savings Bank v. Ticor Title Insurance Co., 695 F.3d 725 (7th Cir. 2012) ......................................................................... 50, 51 Hotel Des Artistes Inc. v. Gen. Accident Ins. Co. of Am., 9 A.D.3d 181, app. dism'd 4 N.Y.3d 739 (2004) ................................................. 30 Hough v. USAA Cas. Ins. Co., 93 A.D.3d 405 (1st Dep't 2012) ........................................................................... 33 In re Abrams & Abrams, P.A., 605 F.3d 238 (4th Cir. 2010) ................................................................................ 40 Int'l Paper Co. v Cont'l Cas. Co., 35 N.Y.2d 322 (1974) .................................................................................... 16, 18 K2 Investment Group, LLC v. American Guar. & Liab. Ins. Co., 21 N.Y.3d 384 .............................................................................................. passim K2 Investment Group, LLC v. American Guar. & Liab. Ins. Co., 91 A.D.3d 401 (1st Dep't 2012) ................................................................... passim Lang v. Hanover Insurance Co., 3 N.Y.3d 350 (2004) ..................................................................................... passim Lawrence v. Continental Casualty Co., 2013 U.S. Dist. LEXIS 116144, 2013 WL 4458755 (E.D.N.Y. Aug. 16, 2013) ....................................................................................................................... 31, 32 Lazar v. Riggs, 79 P.3d 105 (Colo. 2003) ..................................................................................... 19 Lee v. Evergreen Regency Cooperative & Management Systems, Inc., 151 Mich. App. 281 (1986) ........................................................................................ 20-21, 50 Lionel Freedman, Inc. v. Glens Falls Ins. Co., 27 N.Y.2d 364 (1971) ........................................................................................... 34 Litton Systems, Inc. v. Shaw’s Sales & Serv., Ltd., 119 Ariz. 10 (Ct. App. 1978) .. 49 Lodge v. Bern, 328 Mass. 42 (1951) ............................................................................................. 48 viii Martin v. Safeco Ins. Co., 19 A.D.3d 221 (1st Dep't 2005) ........................................................................... 35 Matijiw v. N.Y. Cent. Mut. Fire Ins. Co., 292 A.D.2d 865, app. denied, 743 N.Y.S.2d 771 (4th Dep’t 2002) .................... 32 Matter of Liberty Mut. Ins. Co. (Hogan), 82 N.Y.2d 57 (1993) ............................................................................................. 43 Matychak v. Security Mut. Ins. Co., 181 A.D.2d 957, lv. denied, 80 N.Y.2d 758 (1992) ............................................. 55 Miller v. United States & Fidelity, Corp., 291 Mass. 445 (1935) ......................................................................... 48, 49 Missionaries of Co. of Mary, Inc. v. Aetna Cas. & Sur. Co, 155 Conn. 104 (Sup. Ct. 1967) ...................................................................... 20, 40 Monaghan v. Meade, 91 A.D.2d 1014 (2d Dep't 1983) .......................................................................... 25 Nahshon Aaron Council v. Utica First Ins. Co., 77 A.D.3d 1433 (4th Dep't 2010), lv. denied, 16 N.Y.3d 702 ............................. 33 Newhouse v. Citizens Sec. Mut. Ins. Co., 176 Wis. 2d 824 (Sup. Ct. 1993) .......................................................................... 48 Pavia v State Farm Mut. Auto. Ins. Co., 82 N.Y.2d 445 (1993) .................................................................................... 23, 47 Plaza Constr. Corp. v. Zurich Am. Ins. Co., No. 112070108, 2011 N.Y. Misc. LEXIS 1234, 2011 WL 1212719 (Sup. Ct. N.Y. County Mar. 23, 2011) ................................................................................. 31 Polan v. State of N.Y. Ins. Dep't, 3 N.Y.3d 54 (2004) ............................................................................................... 24 Prashker v. United States Guar. Co., 1 N.Y.2d 584 (1956) ............................................................................................. 16 Presley v. Williams, 57 A.D.2d 947 (2d Dep't 1977) ............................................................................ 25 QSP Inc. v. Aetna Cas. & Sur. Co., 1998 Conn. Super. LEXIS 3542 (Conn. Super. Ct. Dec. 7, 1998), aff’d, 256 Conn. 343 (2001) ............................................. 30-31 Quigley v. Coco's Water Cafe, Inc., 43 A.D.3d 1132 (2d Dep't 2007) .......................................................................... 17 Ramos v. Nat'l Cas. Co., 227 A.D.2d 250 (1st Dep't 1996) ......................................................................... 55 Republic Franklin Ins. Co. v Pistilli, 16 A.D.3d 477 (2d Dep't 2005) .................................................................... passim RJC Realty Holding Corp. v Republic Franklin Ins. Co., 2 NY3d 158 [2004] ................................................................................................. 7 ix Robbins v. Mich. Millers Mut. Ins. Co., 236 A.D.2d 769 (3d Dep't 1997) .......................................................................... 33 Rosenberg v. Litas Inv. Co., 212 A.D.2d 686 (2d Dep't 1995) .................................................................... 15-16 Rourke v. Travelers Ins. Co., 254 A.D.2d 730 (4th Dep't 1998) ......................................................................... 33 Rucaj v. Progressive Ins. Co., 19 A.D.3d 270 (1st Dep't 2005) .................................................................... 35, 41 Saragan v. Bousquet, 322 Mass. 14 (1947) ............................................................................................. 48 Sauer v. Home Indem. Co., 841 P.2d 176 (Alaska 1992) ................................................................................. 40 Servants of the Paraclete v. Great Am. Ins. Co., 857 F. Supp. 822, amended by 866 F. Supp. 1560 (D.N.M. 1994) ...................... 33 Servidone Construction Corp. v. Security Insurance Co., 64 N.Y.2d 419 (1985) ................................................................................... passim Shoretz v. Nationwide Ins. Co., No. 01 CIV. 9352(CSH), 2002 U.S. Dist. LEXIS 12622, 2002 WL 1492135 (S.D.N.Y. July 11, 2002) .......................................................................... 35, 55-56 Slayko v. Security Mutual Insurance Co., 98 N.Y.2d 289 (2002) .................................................................................... 26, 33 Sphere Drake, P.L.C. v. 101 Variety, Inc., 35 F. Supp. 2d 421 (E.D. Pa. 1999) ............................................................... 47, 50 State Farm Mut. Auto. Ins. Co. v. Paynter, 122 Ariz. 198 (1979) ............................................................................................ 49 Stellar Mech. Servs. of N.Y. Inc. v. Merchants Ins. of N.H., 74 A.D.3d 948 (2d Dep't 2010) ............................................................................ 30 Sucrest Corp v. Fisher Governor Co., 83 Misc. 2d 394 (Sup. Ct. N.Y. County 1975) .............................................. 22, 23 Sweeney v. Frew, 318 Mass. 595 (1945) ........................................................................................... 59 Truck Ins. Exch. v. Vanport Homes, Inc., 147 Wash. 2d 751 (2002) ..................................................................................... 39 U.S. Fire Ins. Co. v. Good Humor Corp., 173 Wis. 2d 804, review denied, 501 N.W.2d 458 (1993) ............................ 39, 40 United Pacific Insurance Co. v. Meyer, 305 F.2d 107 (9th Cir. 1962) ................................................................................ 51 United Servs. Auto. Ass'n v. Glens Falls Ins. Co., 350 F. Supp. 869 (D. Conn. 1972) ....................................................................... 39 x West American Ins. Co. v. Midwest Open MRI, Inc., __ Ill. App. 3d __, 989 N.E.2d 252 (1st Dist. Apr. 16, 2013) .............................. 29 White Mountain Cable Constr. Co. v. Transamerica Ins. Co., 137 N.H. 478 (1993) ...................................................................................... 39, 49 Statutes CPLR § 3212 ............................................................................................................ 54 CPLR § 5601(a) ......................................................................................................... 8 Insurance Law § 3420 ........................................................................................ 27, 45 Other Authorities Am. Law Inst., Principles of the Law of Liability Insurance § 21 (Tentative Draft No. 1, 2013) ........................................................................................... 18, 46, 51-52 20 Appleman, Insurance Law & Practice, § 11332 ................................................ 25 Charles A. Booth, Michael L. Anania & Douglas J. Steinke, Another View on K2 Investment v. American Insurance, available at Law360.com (published 9/10/13) .................................................................................................................................... 9 6A Moore, Federal Practice [2d ed.], par. 57:19 .................................................... 25 16 Williston on Contracts § 49:103 ......................................................................... 20 H. A. Wood, Annotation, Application of Declaratory Judgment Acts to Questions in Respect of Insurance Policies, 142 A.L.R. 8 (Originally published in 1943) . 26 1 PRELIMINARY STATEMENT This Court, in its decision of June 11, 2013, 21 N.Y.3d 384 (the “Decision”), unanimously affirmed the order of the Appellate Division in K2 Investment Group, LLC. et ano v. American Guar. & Liab. Ins. Co., 91 A.D.3d 401 (1st Dep’t 2012) (“First Department Decision”), which itself affirmed the judgment entered by the trial court in favor of Plaintiffs-Respondents-Cross-Appellants K2 Investment Group, LLC (“K2”) and ATAS Management Group, LLC (“ATAS”). The Decision addresses the inequity and judicial waste that would result “if an insurer, having wrongfully abandoned its insured’s defenses, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify” (Decision, 21 N.Y.3d at 391) and held that, in order to avoid such unfairness and inefficiency, insurers encountering circumstances such as those faced by the insurer herein cannot raise policy exclusions following a wrongful disclaimer (id.). Defendant-Appellant-Cross-Respondent American Guarantee and Liability Insurance Company (“Guarantee”) and Amici Curiae Complex Insurance Claims Litigation Association and American Insurance Association (together, “CICLA”) and New York Insurance Association, Inc., National Association of Mutual Insurance Companies, Property Casualty Insurers Association of America and Federation of Defense and Corporate Counsel (together, “NYIA”) (Guarantee, CICLA and NYIA shall be collectively referred to herein as “Reversal 2 Proponents”) would have this Court believe that the Decision “upends decades of insurance law” (Supplemental Brief For Defendant-Appellant-Cross-Respondent [“Supp. Br.”] p. 1, see also Brief of CICLA in Support of Defendant-Appellant- Respondent [“CICLA Br.”] p. 5 [purporting that the Decision departs from settled New York law]; Amici Curiae Brief on Behalf of NYIA [“NYIA Br.”] p. 1.) In truth, the Decision is wholly consistent with this Court’s prior precedent including Lang v. Hanover Insurance Co., 3 N.Y.3d 350 (2004) (“Lang”), and, in fact, only confirms that Lang intended the consequences it articulated be faced by the narrow class of insurance companies which, contrary to their clear legal obligations and industry best practices, choose to wrongfully refuse to provide defense coverage without first bringing a declaratory judgment action. STATEMENT OF FACTS AND PROCEDURAL HISTORY A. The Underlying Action 1. K2 and ATAS Bring Legal Malpractice Claims On January 16, 2009, K2 and ATAS brought the Underlying Action, known as K2 Investment Group, LLC et ano. v. Daniels et al., Supreme Court, Nassau County, Index No. 883/2009. (See R1 84-94 [“Underlying Complaint”].) K2 and ATAS sued, among other defendants, Jeffrey Daniels, Esq. (“Daniels”), alleging that Daniels, as attorney for K2 and ATAS, was responsible for providing certain 1 All references to the Record on Appeal will be designated by an “R” followed by the page number. 3 legal services and that Daniels acted negligently with regard to those services, causing K2 and ATAS to suffer damages (R85-88). In particular, the Underlying Complaint alleged that Daniels had agreed to record mortgages for K2 and ATAS as security for a series of loans totaling approximately $3 million dollars to a company known as Goldan, and to arrange for title insurance on the mortgages in favor of K2 and ATAS (R85, R86 ¶¶ 9, 10, 13), but that Daniels ultimately did neither (R86 ¶¶ 11-12, R87 ¶¶ 14-15). Goldan became insolvent and was unable to pay back the principal or, after a certain time, interest on the loans (R87 ¶ 21, R88 ¶ 27). K2 and ATAS each asserted claims against Daniels for legal malpractice. (See R87-88 ¶¶ 18-23; R88 ¶¶ 24-29 [collectively, “Legal Malpractice Claims”].) The Underlying Complaint alleged that Daniels’s failure to record the mortgages and obtain title insurance constituted legal malpractice, and rendered K2 and ATAS’s interest in the loans unsecured, resulting in approximately $2.9 million in damages. (R85-88.) 2. Guarantee Withdraws from Defending Daniels Guarantee, Daniels’s legal malpractice insurance carrier pursuant to a Lawyers Professional Liability Insurance Policy (Policy No. LPL 9014185-4; Renewal of No. LPL 9014185-3) (R190-212 [“Policy”]), initially retained defense counsel to represent Daniels in the Underlying Action under a reservation of rights (R220). However, by letter to Daniels dated March 9, 2009 (the “3/9/09 4 Disclaimer” [R134-43]), Guarantee disclaimed coverage in the Underlying Action (R138), asserting, as bases for noncoverage, inter alia, that the Legal Malpractice Claims fell within two exclusions, a “Non-Attorney Exclusion” (see R205 ¶ III(D)(1)) and a “Control of Business Entity Exclusion” (see R205 ¶ III(E)) (together, “Exclusions”)2. Guarantee’s disclaimer was indisputably wrongful, as the Underlying Complaint clearly and unequivocally asserted a claim for legal malpractice which fell entirely within the Policy’s coverage. See Decision, 21 N.Y.3d at 389 (“It is quite clear that American Guarantee breached its duty to defend—indeed, it does not seem to contend otherwise now.”); see also First Department Decision, 91 A.D.3d at 403 (finding that the “essence of the complaint, or the basis of liability… is that Daniels committed legal malpractice in his representation of plaintiffs”). 3. Guarantee Rejects K2 and ATAS’s Settlement Offer On June 8, 2009, counsel to K2 and ATAS in the Underlying Action wrote to Daniels demanding $450,000 in full settlement of the claims asserted in the Underlying Action. (R145.) This demand was well within the $2 million aggregate and $2 million per claim limits of the Policy (see R190), but was nonetheless rejected by Guarantee (R147). 2 These exclusions will not be given in-depth treatment herein, having been extensively discussed in earlier submissions to this Court, including the Brief (“K2 Opening Brief”) for Plaintiffs-Respondents-Cross-Appellants K2 Investment Group, LLC and ATAS Management Group, LLC dated October 2, 2012. 5 4. Daniels Defaults Following Guarantee’s refusal to pay Daniels’s defense costs in the Underlying Action, Daniels’s defense counsel withdrew (R276 ¶ 6), and Daniels, unrepresented, thereafter defaulted (see R149). Upon the application of K2 and ATAS, a judgment (the “Legal Malpractice Judgment”) was entered against Daniels (R149-50), holding Daniels liable to K2 for $2,404,378.36, and to ATAS for $688,716.00 (id.), each of which awards was solely based on the Legal Malpractice Claims of K2 and ATAS against Daniels (see R150 [Legal Malpractice Judgment in the Underlying Action, which states that the fifth and sixth causes of action against Daniels are discontinued without prejudice].) Daniels thereafter assigned to K2 and ATAS all of his claims against Guarantee. (R279- 80.)3 B. The Instant Action 1. Judgment in the Supreme Court, New York County On December 22, 2009, K2 and ATAS commenced the within action against Guarantee in the Supreme Court, New York County (see R67-81), asserting direct claims pursuant to N.Y. Ins. L. §§ 3420(a)(2) and 3420(b)(1) on their respective portions of the Legal Malpractice Judgment obtained by K2 and ATAS in the Underlying Action, up to the policy limits (“Policy Indemnity Claims”). K2 and 3 While CICLA suggests there may be an issue of collusion between claimants and insured (CICLA Br. p. 7), Guarantee has not argued this to this Court and indeed, this Court has noted there is no support for such a contention. See Decision, 21 N.Y.3d at 390. 6 ATAS sought to recover the balance of the Legal Malpractice Judgment through separate claims for bad faith breach of the Policy (R77-80 ¶¶ 59-80) (“Bad Faith Claims”), assigned by Daniels to K2 and ATAS (R279-80). Subsequent to joinder of issue, Guarantee moved for summary judgment dismissal of K2 and ATAS’s claims, and K2 and ATAS cross-moved for summary judgment on their claims (see R58-230; R273-80). Following oral argument, the transcript of which (R9-39) was so-ordered (R39), the Supreme Court (Ira Gammerman, J.H.O.) entered an order dated June 9, 2010 and entered June 14, 2010 (the “6/9/10 Order”) (R7), granting the cross-motion of K2 and ATAS, finding Guarantee liable to them on the Policy Indemnity Claims in an aggregate amount equal to the policy limit (see R38). However, the 6/9/10 Order granted Guarantee summary judgment as to the Bad Faith Claims, which were dismissed. (See R38.) Judgment was entered on the 6/9/10 Order on June 23, 2010 (the “6/23/10 Judgment”) (R48-50). 2. All Parties Appeal to the Appellate Division, First Department All parties appealed from the 6/23/10 Judgment to the Appellate Division, First Department. (R5-6 [Guarantee Notice of Appeal, electronically filed and served June 25, 2010]; R46-47 [K2 and ATAS’s Notice of Cross-Appeal, electronically filed and served June 30, 2010]). In a Decision and Order dated January 3, 2012 and entered January 18, 2012 (the “First Department Decision”), 7 the First Department affirmed the 6/23/10 Judgment in all respects. Three of the Justices on the panel voted to affirm the grant of summary judgment to K2 and ATAS on the Policy Indemnity Claims, holding that Guarantee had a duty to indemnify because the Exclusions it sought to raise were resolved by the Legal Malpractice Judgment; that is, Guarantee was not permitted to contest the finding of malpractice, which was necessarily determined in the Underlying Action. The First Department Decision thus held that the Exclusions were “patently inapplicable” (91 A.D.3d at 403) in light of the facts established by the Legal Malpractice Judgment, which necessarily included that Daniels was attorney for K2 and ATAS and that he was negligent in performing legal services to K2 and ATAS in that capacity. As the First Department explained: That Daniels was an owner of Goldan or might have been acting in the interests of Goldan instead of those of his clients may explain why Daniels acted as he did, but it does not change the essence of the complaint, or the basis of liability, which is that Daniels committed legal malpractice in his representation of plaintiffs (see American Guar. & Liab. Ins. Co. v Moskowitz, 58 AD3d 426 [2009] [rejecting similar arguments advanced by defendant]). Daniels committed legal malpractice while he was an owner, officer, etc., of Goldan. However, the policy does not exclude coverage for all conduct occurring while he was an owner or officer but only for claims arising out of his capacity as such (see RJC Realty Holding Corp. v Republic Franklin Ins. Co., 2 NY3d 158, 165 [2004]). 8 Id. (emphases in original). Two Justices, however, dissented on this point, holding that there was an issue of fact as to the applicability of the Exclusions and that summary judgment should have been denied to all parties on the Policy Indemnity Claims. See id. at 411. All of the Justices concurred in the summary judgment dismissal of the Bad Faith Claims. 3. All Parties Appeal to the Court of Appeals Guarantee appealed to this Court as of right (see CPLR § 5601(a)). K2 and ATAS moved for permission to cross-appeal dismissal of the Bad Faith Claims, which permission was granted by this Court’s Order of June 7, 2012. 4. The Decision Following written submissions and oral argument, on June 11, 2013, this Court issued its Decision unanimously affirming the First Department Decision. Relying upon the threshold approach taken in Lang, this Court declined to reach the issue that divided the First Department, viz., whether Guarantee could raise the specified policy exclusions to avoid payment of the Legal Malpractice Judgment. Instead, the Court held that in “situation[s]” such as the one at bar, 21 N.Y.3d at 390, “an insurance company that has disclaimed its duty to defend ‘may litigate only the validity of its disclaimer’,” id. at 390-91 (quoting Lang) and, should that disclaimer be adjudicated “bad,” id. at 391, “the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would 9 otherwise have negated the duty to indemnify,” id. The Court specifically noted that its rule might not govern cases involving public policy exclusions, including coverage exclusions for intentional torts. See id. These two last points are critical on reargument and therefore merit repetition now: the Decision’s rule was explicitly limited to circumstances similar to those at bar, which did not include a defense based on the absence of basic coverage, viz., coverage without regard to exclusions, and it does not address public policy-based exclusions. The ramifications of these limiting features, which are ignored by Reversal Proponents’ submissions, are discussed more fully below, but essentially they bring the Decision wholly in line with prior precedent and belie Reversal Proponents’ depiction of the Decision as “radical” (e.g., Supp. Br. p. 27). See discussion below pp. 18-38; see also Charles A. Booth, Michael L. Anania & Douglas J. Steinke, Another View on K2 Investment v. American Insurance, available at Law360.com (published 9/10/13) (cited at CICLA Br. pp. 8, 18) (disagreeing with view that the Decision adopts the Illinois Rule [defined infra] and calling K2 a “routine opinion that reached the right result under established legal principles applied to the facts of that case”). 5. Guarantee Is Granted Reargument but Not Vacatur Guarantee’s motion to reargue, based upon its contention that the Decision overlooks and/or misapprehends Lang and Servidone Construction Corp. v. 10 Security Insurance Co., 64 N.Y.2d 419 (1985) (“Servidone”), was granted on September 3, 2013, but its motion to withdraw or vacate the Decision pending reargument was denied on October 10, 2013. Amicus curiae briefs have been submitted by CICLA and NYIA in support of Guarantee’s position. United Policyholders (“Policyholders”) and Coltec Industries Inc. and SPX Corp. (together, “Coltec”) have submitted amicus curiae briefs in support of K2 and ATAS. ARGUMENT Introduction Contrary to the arguments raised by Guarantee in its Supplemental Brief, this Court’s unanimous Decision: (I) does not misapprehend Lang; (II) cannot be said to overlook Servidone; (III) in no way otherwise contravenes established principles of law; (IV) is wholly consistent with public policy; and (V) does not overlook applicability of policy exclusions. Indeed, as is discussed more fully below, this Court considered and applied legal principles enunciated in Lang; had no reason to address Servidone, which is distinguishable from the Decision; the Decision is in complete harmony with established legal principles; and far from overlooking the applicability of policy exclusions, determined they were inapplicable in the circumstances presented herein. Finally, general principles of well-established law relied upon in the First Department Decision favor the 11 outcome at which the Decision arrived; as such, even if, assuming arguendo, this Court was to revise its Decision, it nonetheless should affirm. POINT I: The Court Did Not Misapprehend Lang In its Supplemental Brief, Guarantee contends that the Court misapprehended Lang as it concerns an insurer’s ability to invoke policy exclusions to escape liability following a breach of its duty to defend. (See Supp. Br. pp. 9-10.) While Guarantee contends that Lang “states that an insurer that has breached its duty to defend may assert policy defenses to indemnity coverage of a judgment, but may not seek to alter the judgment itself” (id. at p. 1; see also id. at p. 10), this is a blatant mischaracterization of Lang, which says no such thing. Far from misapprehending Lang, the Decision explicitly confirms the reach of Lang’s clear warning against wrongful disclaimer. (a) The Lang Decision In Lang, Plaintiff-Appellant David Lang (“Lang”) brought the underlying action for personal injury sustained when he was struck in the eye by a paintball fired by a guest of the homeowners where the incident occurred. 3 N.Y.3d at 352. Hanover Insurance Co. (“Hanover”) disclaimed coverage under the homeowner’s liability policy, id., and Lang thereafter commenced a declaratory judgment action against Hanover challenging the disclaimer, id. at 353. This Court held Lang had no standing to bring the declaratory judgment action. See id. at 355. Based upon 12 the facts before it, the Lang Court nonetheless took the opportunity to warn, in no uncertain terms, that an insurer in Hanover’s position would have been “well advised” to seek a declaratory judgment prior to declining defense, and that failure to do so would later limit the insurer’s ability to raise coverage defenses: Finally, we note that an insurance company that disclaims in a situation where coverage may be 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. Id. at 356.4 (b) The Decision Confirms the Rule Articulated in Lang Here, there is no question that the disclaimer was bad, and even Guarantee does not contend otherwise. See Decision, 21 N.Y.3d at 389 (“It is quite clear that American Guarantee breached its duty to defend—indeed, it does not seem to contend otherwise now.”). Thus, both the instant appeal and Lang address a common issue, viz., an insurer’s wrongful disclaimer of defense coverage. Indeed, 4 Guarantee cites Lang for the proposition that the pre-Decision rule was that wrongful disclaimer did not preclude the insurer from asserting coverage defenses. (See Supp. Br. p. 10, citing Lang, 3 N.Y.3d at 356.) Lang does not support this contention. 13 this Court’s unanimous Decision was explicitly intended to reinforce Lang’s mandate that the carrier which wrongfully disclaimed may litigate only the validity of its disclaimer. Following extensive quotation of Lang, Decision, 21 N.Y.3d at 390, the Decision states: “Lang … means what it says: an insurance company that has disclaimed its duty to defend ‘may litigate only the validity of its disclaimer.’” Id. at 390-91. This language could not more clearly express this Court’s intent to apply Lang’s rule that if an insurer invalidly disclaims defense coverage, it is not allowed to challenge a judgment against the insured. As the Court went on to state, consistent with Lang’s analysis: “if the disclaimer 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. By applying the principles of Lang in this manner, this Court provided valuable guidance for insurers contemplating disclaiming their duties to defend in questionable circumstances. Here, despite Lang’s mandate and Guarantee’s clear, undisputed duty to defend, Guarantee chose to deny defense coverage prior to seeking any determination of the merits of Guarantee’s interpretation of the policy’s application. It was Guarantee’s conscious choice to breach its duty to defend in this manner -- abandoning its insured in circumstances that bore a risk of a default by the unrepresented Daniels in the Underlying Action -- that resulted in Guarantee’s loss of exclusion defenses. 14 Moreover, far from “misapprehending” applicable law, the Decision clearly and carefully considered the broader policy intent underlying its holding: 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. 21 N.Y.3d at 391. As such, there is no reason whatsoever to believe that this Court misapprehended Lang or ran afoul of that precedent in any way, and there is no sound basis for reversal herein. POINT II: This Court Did Not Overlook Servidone Guarantee next argues that this Court overlooked its decision in Servidone. (See Supp. Br. pp. 19-30.) This, too, is unfounded, as Servidone is clearly inapplicable to the facts herein. (a) The Servidone Decision In Servidone, the underlying complaint involved claims that fell both within and outside of an insurance policy exclusion. The carrier initially supplied defense under a reservation of rights, but it withdrew the defense after a pretrial order described the underlying action as including only a claim within the exclusion; according to the insurance carrier, this constituted abandonment of the covered 15 claim. Servidone, 64 N.Y.2d at 422. The insured thereafter settled with the injured party, and sued the carrier. Id. While the Court observed that there was no dispute as to the validity of the disclaimer, id. at 423, it also observed there was no determination as to whether the loss was covered by the policy, see id. at 423, and thus held that coverage had not been established as a matter of law, id. at 425. In other words, the record in Servidone left unclear whether, or to what extent, the settlement may have been attributable to an uncovered claim. The Court therefore remanded for further fact finding, noting that “the burden of proof will rest with the insurer to demonstrate that the loss compromised by the insured was not within policy coverage. If the insurer does not establish that this loss falls entirely within the policy exclusion as claimed, it will have failed to sustain its burden.” Id. at 425 (citations omitted). (b) Servidone and the Decision Peacefully Coexist In contrast to the facts underlying Servidone, here the Underlying Complaint falls squarely and entirely within the coverage provisions of the Policy, and the Legal Malpractice Judgment rested wholly on Daniels’s liability for acts and omissions falling within the Policy, e.g., the Legal Malpractice Claims, which were established by virtue of Daniels’s default.5 See Rosenberg v. Litas Inv. Co., 212 5 NYIA, using a hypothetical scenario, suggests that the judgment herein did not establish Guarantee’s obligations (NYIA Br. p. 12), although it never explains why. This is untrue. (See below pp. 54-57.) 16 A.D.2d 686, 687 (2d Dep’t 1995) (“It is well settled that upon the entry of a default judgment, the allegations contained in the plaintiff’s complaint insofar as they pertain to the question of liability, must be deemed admitted”) (citation and internal quotation marks omitted); see also Goldstein v. Engel, 240 A.D.2d 280, 280-81 (1st Dep’t 1997) (default judgment against corporation precluded parties in privity with corporation from raising defense). Under these circumstances, Guarantee could not argue that the judgment subsumed any liability for uncovered claims. As such, Servidone was not overlooked by this Court; it simply did not apply herein. Had the Legal Malpractice Judgment included an unspecified award for uncovered claims, the outcome of the Decision would have been different. Here, the Legal Malpractice Judgment eliminated any question over whether a non-covered claim was encompassed.6 Here, as a matter of law the Legal Malpractice Judgment falls within the indemnity afforded by the subject Policy, Servidone compels Guarantee’s liability for the Legal Malpractice Judgment. Also, here, there is a safeguard against including uncovered claims: the Court approves a default judgment prior to its entry. Therefore, contrary to the assertions by Reversal Proponents that the Decision’s rule will visit unfair and 6 Moreover, Servidone instructs that “[i]f the insurer does not establish that this loss falls entirely within the policy exclusion as claimed, it will have failed to sustain its burden.” Servidone, 64 N.Y.2d at 425 (emphasis added) (citing Prashker v. United States Guar. Co., 1 N.Y.2d 584, 592 (1956); Int’l Paper Co. v. Cont’l Cas. Co., 35 N.Y.2d 322, 327 (1974)). Because, as a matter of law, the Legal Malpractice Judgment falls within the subject Policy, Servidone compels Guarantee’s liability for the Legal Malpractice Judgment. 17 disproportionate liability on insurers, CPLR provisions and courts’ inherent powers protect defendants against excessive or arbitrary judgments and by extension will protect the indemnifying insurers. See, e.g., Quigley v. Coco’s Water Cafe, Inc., 43 A.D.3d 1132, 1133 (2d Dep’t 2007) (“It has long been held that courts have inherent power beyond that which is contained in the CPLR ... to open defaults ... and where the amount awarded on a default judgment has been perceived as excessive the courts have exercised their inherent power to modify or reduce the amount”) (citations and internal quotation marks omitted); Bowdren v. Peters, 208 A.D.2d 1020, 1021 (3d Dep’t 1994) (inquest should have been held prior to entering default judgment where plaintiff adduced insufficient evidence to permit the calculation of damages). In contrast, settlement cases such as Servidone have no such safeguard, as private parties negotiate a settlement. As such, Servidone and the Decision peacefully coexist. Servidone governs cases in which the facts underlying a settlement or judgment are not sufficiently established to apportion liability to the covered claim. In such an instance, indemnity cannot be determined absent further fact finding and summary judgment is unavailable. In contrast, the Decision applies to cases in which the judgment establishes the facts underlying both liability and coverage, and clearly apportions damages to the covered claim. In such an instance, the insurer must indemnify the insured for the judgment in the 18 underlying action, unless the insurer is able to prove that the disclaimer was valid. See Decision, 21 N.Y.3d at 391. POINT III: The Decision Is Consistent With Established Principles of Law (a) The Decision Is Harmonious with Contract Law Principles Contrary to the contentions of Reversal Proponents, the Decision is consistent with, rather than contradicts, fundamental contract principles. An insurance policy is a contract by virtue of which the insured pays a premium in exchange for a promise by the insurer to perform, not merely to pay. See Int’l Paper Co. v Cont’l Cas. Co., 35 N.Y.2d 322, 325 (1974) (“An insured’s right to be accorded legal representation is a contractual right and consideration upon which his premium is in part predicated”); see also Barber v. Nylund, 158 Wis. 2d 192, 196 (Ct. App. 1990) (“The duty to defend is a contractual obligation of the insurer in line with the insured’s reasonable expectation of protection”); Am. Law Inst., Principles of the Law of Liability Insurance § 21 cmt. c (Tentative Draft No. 1, 2013). Performance in this instance includes providing representation; the right to representation and the insurer’s “correlative duty to defend suits, however groundless, false or fraudulent, are in a sense ‘litigation insurance’ expressly provided by the insurance contract’.” BP Air Conditioning Corp. v. One Beacon Ins. Group, 8 N.Y.3d 708, 714 (2007) (quoting Servidone, 64 N.Y.2d at 423-24). 19 Indeed, the Decision explicitly serves the basic contract principle of providing a party to a contract (here the insured), with the benefit of his or her bargain. (See Decision, 21 N.Y.3d at 391 [rule gives insureds benefit of their bargain and avoids “unnecessary and wasteful litigation” by an insurer which, “having wrongfully abandoned its insured’s defense, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify.”].) In the context of an insurance contract, the insurer, in providing a defense, supervises, investigates, evaluates, settles or decides to try claims, where appropriate. See, e.g., Lazar v. Riggs, 79 P.3d 105, 108 (Colo. 2003) (“Where an insurance contract includes a right and duty to defend (as it typically does), in addition to an obligation to investigate and settle claims arising under the policy, an insurance company’s investigation of third-party claims may very well ‘shift from an ordinary business activity to conduct in anticipation of litigation’”) (citation omitted). The rule urged by the Reversal Proponents therefore fails to acknowledge an important benefit of the insured’s bargain – a benefit the insured has paid for via premiums, viz., the assurance that it will be afforded a defense, including the services a defense entails, until a court determines that it is not entitled to same—by insisting that the sole damages awardable for a breach of the defense duty is defense costs. The rule articulated in Lang and applied in the Decision is essentially one of 20 estoppel, to wit: having breached its agreement, a party cannot raise defenses under the same agreement. Estoppel is a common law doctrine that traditionally has been applied in the insurance law context, including in case law relating to limitation of an insurer’s ability to contest a default judgment following a wrongful disclaimer. See 16 Williston on Contracts § 49:103 (4th ed.) (“The estoppel doctrine has deep roots [in Illinois jurisprudence]…It arose out of the recognition that an insurer’s duty to defend under a liability insurance policy is so fundamental an obligation that a breach of that duty constitutes a repudiation of the contract…”) (quoting Employers Ins. of Wausau v. Ehlco Liquidating Trust, 186 Ill. 2d 127, 151 [1999] [internal quotation marks omitted]); see also Missionaries of Co. of Mary, Inc. v. Aetna Cas. & Sur. Co, 155 Conn. 104, 114 (Sup. Ct. 1967) (“The defendant, after breaking the contract by its unqualified refusal to defend, should not thereafter be permitted to seek the protection of that contract in avoidance of its indemnity provisions.”); see also County of Massac v. U.S. Fid. & Guar. Co., 113 Ill. App. 3d 35, 42 (5th Dist. 1983) (“The theory to support this type of estoppel is that once the insurer has not complied with those portions of the policy which benefit the insured, it may not rely upon those clauses which favor the insurer”) [citations omitted]. This principle operates much like the judicial doctrine of collateral estoppel. As the Michigan Court of Appeals explained in Lee v. Evergreen 21 Regency Cooperative & Management Systems, Inc.: [C]ompanies which have rejected claims of coverage and declined to defend their insureds in the underlying litigation…cannot later raise issues that were or should have been raised in the underlying action. These cases are closely akin to the principle behind collateral estoppel… 151 Mich. App. 281, 286-87 (1986) (citations omitted). Even though the Decision does not cover situations in which a settlement has been reached, New York courts have long applied the doctrine of estoppel in the insurance context where the insured settles following the insurer’s unjustifiable refusal to defend. See, e.g., Cardinal v. State, 304 N.Y. 400, 410 (1952). Equally important, contrary to the contention of Reversal Proponents, the Decision does not prevent an insurer from raising an exclusion, nor does it deprive an insurer of any rights under the insurance contract; rather, the Decision simply sets forth procedural and temporal requirements for how and when the insurer should raise these exclusions, viz., in situations like the one faced by Daniels herein, the favored approach is for the insurer to bring a declaratory judgment action to determine coverage, see Lang, 3 N.Y.3d at 356. The Decision provides an incentive to the insurer to continue to defend – a duty clearly breached by Guarantee below—under a reservation of rights until its obligations have been litigated. If the insurer does not do so, and factors delineated in the Decision are met (disclaimer was wrongful, there is a final judgment attributing damages 22 entirely to a covered claim, etc.), the insurer will lose the ability to invoke the exclusion in a later declaratory judgment action. The Decision, moreover, is in line with precedent that enables a court to hold a party estopped from raising a defense, where such estoppel promotes fairness and efficiency. See, e.g., Gallery at Fulton St., LLC v Wendnew LLC, 30 A.D.3d 221, 221 (1st Dep’t 2006) (“The court properly ruled that defendants, in this action for breach of a commercial lease, were estopped from raising the defense of constructive eviction after they were given the opportunity to litigate this claim in the prior summary proceeding, but failed to do so”). There is also precedent for the court’s determination of the timeframe for disclaiming – indeed, insurers are already required to disclaim promptly or else waive the defense to coverage. See e.g. Republic Franklin Ins. Co. v Pistilli, 16 A.D.3d 477, 479 (2d Dep’t 2005). In contrast, the rule urged by CICLA—limiting the liability for an insurer’s breach of the duty to defend to the insured’s defense costs (see CICLA Br. p. 11) — is untenable. Indeed, the authority offered by CICLA in support of this purported rule requires the opposite of the result CICLA advocates. In Sucrest Corp v. Fisher Governor Co., 83 Misc. 2d 394 (Sup. Ct. N.Y. County 1975), cited by CICLA for the proposition that damages for breach of duty to defend are limited to defense costs, the court held the insured is entitled to reimbursement for 23 a reasonable settlement contribution, reasoning that it was proper to go beyond defense costs because the insurer unjustifiably refused to defend. Id. at 405-06. In K2, as in Sucrest, there was an unjustifiable refusal to defend, but here the case for indemnification is even stronger because the disclaimer led to a default judgment rather than a settlement with the safeguards this entails. (See supra p. 17.) In the context of a settlement following an insurer’s failure to defend, Sucrest notes that where the insurer “unjustifiably refuses to defend, the insured may make a reasonable settlement or compromise of the injured party’s claim, and will thereafter be entitled to reimbursement from the carrier, despite the fact that the policy purports to avoid liability for settlement made without the insurer’s consent [citations omitted].” 83 Misc. 2d at 406. As such, the court awarded $265,000, the insured’s total contribution to the settlement in the underlying action. Id. Indeed, this is similar to awarding damages beyond policy limits where the insurance carrier has acted in bad faith. See, e.g., Pavia v State Farm Mut. Auto. Ins. Co., 82 N.Y.2d 445, 452 (1993) (“[I]nsurers typically exercise complete control over the settlement and defense of claims against their insureds, and, thus, under established agency principles may fairly be required to act in the insured’s best interests…”) 24 (b) The Decision Does Not Overstep Judicial Authority As an extension of its stare decisis argument, Guarantee purports that the Decision supplants legislative authority. (See Supp. Br. pp. 31-32.) This argument, too, is unfounded. First, Guarantee’s argument that a “radical change” should be left to the legislature (Supp. Br. p. 31) presupposes that the Decision represents a revolutionary departure from precedent; this is untrue. Indeed, as shown below (pp. 28-36), the rule of law articulated in the Decision will impact only a small number of cases in which the insurer disclaims in the underlying action without bringing a declaratory judgment action, the disclaimer was wrongful, and the final judgment falls entirely within basic coverage. Moreover, the authority cited by Guarantee for the proposition that the Decision usurps legislative authority appears in a context wholly distinct from that at bar. Polan v. State of N.Y. Ins. Dep’t, 3 N.Y.3d 54 (2004) (cited at Supp. Br. pp. 31, 32), for example, involved this Court’s rejection of a statutory interpretation which would have “upset longstanding industry practice.” Polan, 3 N.Y.3d at 63. In contrast, it is undisputed here –a situation that does not involve interpretation of legislation—that the Decision is entirely consistent with favored insurance industry practice, viz., bringing a declaratory judgment action prior to disclaiming. As the Second Department stated 30 years ago: 25 [T]he appropriate vehicle to resolve [the insurer’s right to disclaim liability or deny coverage] would be a declaratory judgment action brought by the disclaiming insurer (cf. Presley v. Williams, [57 A.D.2d 947 (2d Dep’t 1977)]). Indeed, the utility of a declaratory judgment action in cases involving a dispute as to coverage cannot be denied. It is a remedy readily adaptable to controversies in which there is a dispute over the coverage offered by a policy as applied to a crystalized set of facts. Oftentimes it is the most expeditious and fairest method by which an insurer can secure an advance determination as to its contractual duty to defend or indemnify one of its policyholders (Fireman’s Fund Ins. Co. v. Burman, Inc., 391 A.2d 99, 101 [R.I. 1978]; 20 Appleman, Insurance Law & Practice, § 11332; 6A Moore, Federal Practice [2d ed.], par. 57:19). Monaghan v. Meade, 91 A.D.2d 1014, 1015 (2d Dep’t 1983). See also Lang, 3 N.Y.3d at 356 (“[W]e note that an insurance company that disclaims in a situation where coverage may be arguable is well advised to seek a declaratory judgment concerning the duty to defend or indemnify the purported insured.”); Gen. Mut. Ins. Co. v Coyle, 207 Misc. 362, 363-64 (Sup. Ct. Onondaga County 1954) (“Declaratory judgment proceedings [seeking a determination of the final relation between parties to a contract and other persons] are encouraged under such circumstances, particularly upon contracts of insurance in order to avoid multiplicity of suits and potentially expensive litigation.”); Pistilli, 16 A.D.3d at 479 (“When in doubt, an insurer should issue a prompt disclaimer and then seek a declaratory judgment concerning its duty to defend or indemnify…”). See 26 generally H. A. Wood, Annotation, Application of Declaratory Judgment Acts to Questions in Respect of Insurance Policies, 142 A.L.R. 8 (Originally published in 1943) (describing declaratory judgment actions in the insurance context variously as a “convenient and advantageous” method of determining controversies). Slayko v. Security Mutual Insurance Co., 98 N.Y.2d 289 (2002) (cited at Supp. Br. p. 31) and Pistilli, supra (cited at Supp. Br. p. 32) are also unavailing. In Slayko, the Court upheld the legality of a criminal acts exclusion in a homeowner’s general liability insurance policy, reasoning that the legislature did not prohibit such an exclusion and therefore it should not be declared unenforceable. 98 N.Y.2d at 295. This is clearly distinguishable from the case at bar, which does not involve interpreting whether an exclusion is permissible, but only whether it may be raised following a breach by the insurer of the underlying insurance policy. In Pistilli, the Second Department noted that once an insurer discovers sufficient facts entitling it to disclaim, the insurer should promptly disclaim and thereafter file a declaratory judgment action. 16 A.D.3d at 479. As the insurer in Pistilli failed to disclaim promptly, the Second Department determined that it waived its right to raise an exclusion notwithstanding the merits of the disclaimer. Id. As such, Pistilli actually supports K2 and ATAS’s position herein, to wit: in certain situations, the insurer’s reliance on an exclusion as a justification for a clear breach of the duty to defend will result in the insurer’s waiver of the ability to raise that 27 exclusion against its insured in a later action. (c) The Decision Does Not Call for “Automatic” Indemnity CICLA repeatedly purports that the Decision imposes an “automatic penalty” for breaching the duty to defend. See, e.g., CICLA Br. pp. 7, 8-11, 19-21, 22-24, 24-27. This is a mischaracterization of the Decision. Contrary to CICLA’s depiction of the Decision as imposing “automatic” liability on an insurer, and thereby allegedly conflating the duties to defend and indemnify, the Decision analyzed the obligations (see Decision, 21 N.Y.3d at 389 (quoting Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131 [2006]), and ultimately held that in the specific context of this case the insurer, which withdrew its defense in the underlying action without seeking judicial determination of coverage, could not later invoke exclusions to avoid indemnity for a resulting judgment if the judgment falls squarely within coverage under the relevant policy. (See Decision, 21 N.Y.3d at 389-91.)7 Hardly “automatic,” the insurer’s indemnification obligation here flowed directly from its decision to withdraw defense coverage in the face of an underlying complaint that was “unmistakably” for legal malpractice falling within 7 It should be noted that CICLA’s analysis (Brief pp. 24-25, n.8) of the supposed “tension” between the Decision’s purported “automatic indemnity” and Insurance Law § 3420(d)’s requirement that the insurer promptly disclaim claims underscores CICLA’s failure to appreciate the duty to defend, which involves only a comparison of the language of the claim and the language of the applicable policy and no investigation. See Cook, 7 N.Y.3d at 137. It seems that CICLA is arguing that an insurer should not face appropriate consequences for disclaiming its defense duty without investigating the facts. 28 policy coverage (id. at 389); Guarantee could have avoided that end by continuing to defend under a reservation of rights or bringing a declaratory judgment action prior to withdrawing defense. Furthermore, if the Legal Malpractice Judgment had not been based on claims within policy coverage, Guarantee would not have been liable. (d) Reversal Proponents Exaggerate the Decision’s Reach and Impact Because Guarantee fails to appreciate the distinction between Lang, Servidone, and the Decision, and because Guarantee ignores language of the Decision that clearly narrows its application, it purports that the Decision is at odds with the vast body of New York case law (see, e.g., Supp. Br. p. 1). This is simply not the case. First, this Court expressed a clear intention to limit application of the rule articulated in the Decision to “situation[s] like the one we have here.” (Decision, 21 N.Y.3d at 390.) The “situation” in this case included that the facts alleged in the Underlying Complaint were established by the entry of the Legal Malpractice Judgment and were consistent only with a finding of coverage, and inconsistent with invoking any of the exclusions upon which Guarantee disclaimed. In other words, in this case the insurer could not point to a single fact underlying the Legal Malpractice Judgment that opened the door to disclaiming coverage. To the contrary, in determining certain facts, e.g., Daniels was K2 and ATAS’s attorney 29 and committed legal malpractice, resulting in damages to K2 and ATAS, the Legal Malpractice Judgment rendered the Exclusions inapplicable. See First Department Decision, 91 A.D.3d at 403. As such, the Decision does not explicitly address situations in which there is a settlement or a judgment that does not apportion liability entirely to a covered claim, nor does it apply to instances in which a ground for exclusion appears within the four corners of the final determination. Secondly, the Decision explicitly does not apply to public policy exclusions. See Decision, 21 N.Y.3d at 391. Finally, as will now be discussed, Reversal Proponents’ prediction that the Decision will create industry upheaval is unfounded. (i) Settlement Cases Are Not Governed by the Decision Reversal Proponents’ argument that the Decision represents a departure from established law is belied by Guarantee’s own Supplemental Brief. Applying the Decision’s rule of law to the case authority cited in Guarantee’s submission would leave most of the outcomes wholly undisturbed, as will now be shown. Of the case law authority cited by Guarantee in its brief, nine decisions involve settlements or judgments that did not establish the amount of award attributable to a covered act. See Apache Foam Prods. Div. of Millmaster Onyx Group of Kewanee Indus. Inc. v. Cont’l Ins. Co., 139 A.D.2d 933 (4th Dep’t 1988) (cited at Supp. Br. p. 23) (involving a settlement that left undetermined how much 30 liability was apportioned to covered claim); Hotel des Artistes Inc. v. Gen. Accident Ins. Co. of Am., 9 A.D.3d 181 (1st Dep’t), app. dism’d 4 N.Y.3d 739 (2004) (cited at Supp. Br. passim) (involving a settlement that left undetermined how much liability was apportioned to covered claim); Stellar Mech. Servs. of N.Y. Inc. v. Merchants Ins. of N.H., 74 A.D.3d 948 (2d Dep’t 2010) (cited at Supp. Br. p. 25) (involving settlement that did not determine that there was a covered loss, coupled with unrefuted evidence that the loss was outside of the policy); Burroughs Wellcome Co. v. Commercial Union Ins. Co., 713 F. Supp. 694 (S.D.N.Y. 1989) (cited at Supp. Br. p. 25) (denying summary judgment on issue of coverage for settlement costs where there were insufficient facts on the record to determine issues such as whether the insured was forced to settle due to financial hardship); HK Systems, Inc. v. Eaton Corp., 2006 U.S. Dist. LEXIS 33695, 2006 WL 314408 (E.D. Wis. Feb. 9, 2006) (cited at Supp. Br. p. 26) (involving question of whether indemnification clause in commercial agreement, i.e., not insurance agreement, applied to settlement that did not resolve facts), order amended on reconsideration, 2006 WL 1440857 (E.D. Wis. May 24, 2006), rev’d in part, 2007 WL 1747016 (E.D. Wis., Jun. 18, 2007), aff’d, 563 F.3d 1086 (7th Cir. 2009); QSP Inc. v. Aetna Cas. & Sur. Co., 1998 Conn. Super. LEXIS 3542 (Conn. Super. Ct. Dec. 7, 1998), aff’d, 256 Conn. 343 (2001) (cited at Supp. Br. p. 26) (not only involving a settlement, but also distinguishable as the court found no duty to 31 defend); CGS Indus. v. Charter Oak Fire Ins. Co., 720 F.3d 71 (2d Cir. 2013) (cited at Supp. Br. pp. 16, 26, 28) (involving a settlement and claims falling outside of coverage provisions); Plaza Constr. Corp. v. Zurich Am. Ins. Co., No. 112070108, 2011 N.Y. Misc. LEXIS 1234, 2011 WL 1212719 (Sup. Ct. N.Y. County Mar. 23, 2011) (cited at Supp. Br. 26) (as settlement did not determine whether accident arose from insured subcontractor’s work for general contractor, determination of duty to indemnify additional insureds, including general contractor, required fact finding). In fact, while Guarantee argues (Supp. Br. p. 28) that comparison of the holdings of CGS – one of the settlement cases listed above—and the recent federal district court decision in Lawrence v. Continental Casualty Co., 2013 U.S. Dist. LEXIS 116144, 2013 WL 4458755 (E.D.N.Y. Aug. 16, 2013), illustrates the purported conflict between Servidone and the Decision, this is not the case. CGS, like Servidone, involved a settlement. See CGS, 720 F.3d at 75. The underlying action in CGS was for trademark infringement as to which the defendant’s insurer disclaimed defense and indemnity. Id. Examining the validity of the insurer’s disclaimer, the Second Circuit held that the insurer breached its duty to defend by failing to provide its insured a defense. Id. However, because it was clear from the underlying action that ultimately the policy did not cover the claims, there was no duty to indemnify for the settlement. See id. at 81, 83. The Decision does not 32 compel a different result, as it does not apply to settlements, nor does the Decision govern situations where there is no basic coverage. In contrast, Lawrence involved a default judgment and exclusions. There, Eastern District (Gleeson, J.) applied the rule of the Decision to hold an insurer liable for a default judgment against its insured, a salon. As the complaint in the underlying action clearly set forth a covered claim for negligence resulting in bodily injury of a patron, see 2013 WL 4458755 at *6, and the exclusion the insurer sought to invoke was not established by allegations in the complaint, see id. at *7, which were established by the entry of the default judgment, the insurer clearly breached its duty to defend, id. The Eastern District properly held that, having abandoned its insured in the underlying action, the insurer was prevented from litigating an exclusion in the later coverage action. (ii) Public Policy Exclusions Are Not Governed by the Decision Another ten cases cited by Guarantee involve exclusions that implicate public policy; these situations would not be affected by the Decision insofar as it explicitly does not extend to this category of exclusion. See D’Arata v. N.Y. Cent. Mut. Fire Ins. Co., 76 N.Y.2d 659 (1990) (cited at Supp. Br. pp. 11, 17, 23, 26) (involving claims related to bodily injury resulting from first degree assault); Matijiw v. N.Y. Cent. Mut. Fire Ins. Co., 292 A.D.2d 865, app. denied, 743 N.Y.S.2d 771 (4th Dep’t 2002) (cited at Supp. Br. pp. 11, 14, 23) (involving 33 personal injury claims related to criminal assault); Rourke v. Travelers Ins. Co., 254 A.D.2d 730 (4th Dep’t 1998) (cited at Supp. Br. p. 11) (involving personal injury claims related to barroom brawl); Robbins v. Mich. Millers Mut. Ins. Co., 236 A.D.2d 769 (3d Dep’t 1997) (cited at Supp. Br. pp. 11, 23) (involving bodily injury claim related to criminal assault); Hough v. USAA Cas. Ins. Co., 93 A.D.3d 405 (1st Dep’t 2012) (cited at Supp. Br. pp. 13, 17, 25, 27) (involving personal injury that may have been intentionally inflicted); Nahshon Aaron Council v. Utica First Ins. Co., 77 A.D.3d 1433 (4th Dep’t 2010), lv. denied, 16 N.Y.3d 702 (2011) (cited at Supp. Br. p. 13, 25) (involving injury resulting from an assault); Empire Ins. Co. v. Miguel, 2013 WL 1562162, 2013 N.Y. Misc. LEXIS 1238 (Sup. Ct. N.Y. County Apr. 8, 2013) (cited at Supp. Br. p. 15) (involving injury from intentional assault); Aldrich v. National Chiropractic Mut. Ins. Co., No. 96-cv- 8475, 1997 LEXIS 23729; 1997 WL 662509 (W.D.N.Y. Oct. 14, 1997) (cited at Supp. Br. p. 24) (involving sexual assault and criminal acts exclusions); Servants of the Paraclete v. Great Am. Ins. Co., 857 F. Supp. 822, amended by 866 F. Supp. 1560 (D.N.M. 1994) (cited at Supp. Br. p. 24) (involving sexual abuse, but holding no coverage on alternate grounds); Slayko, 98 N.Y.2d 289 (cited at Supp. Br. p. 31) (upholding criminal activity exclusion). (iii) The Decision Only Applies Where There Is Coverage and a Wrongful Disclaimer Similarly, Guarantee cites a multitude of additional cases which present 34 circumstances outside the purview of the Decision, including cases in which the Court found no coverage at all; the insurer brought a declaratory judgment action prior to withdrawing coverage; a jury verdict established no duty to indemnify; or the exclusion is raised by allegations alleged in the complaint. See e.g., Lionel Freedman, Inc. v. Glens Falls Ins. Co., 27 N.Y.2d 364 (1971) (cited in Servidone, 64 N.Y.2d at 424 and at Supp. Br. p. 21) (ultimately holding there was no duty to defend); Bovis Lend Lease LMB Inc. v. Garito Contr., Inc., 65 A.D.3d 872 (1st Dep’t 2009), app. withdrawn, 14 N.Y.3d 884 (2010) (cited at Supp. Br. p. 25 ) (jury finding in underlying litigation compelled determination that insurer did not have duty to indemnify); Allianz Ins. Co. v. Lerner, 416 F.3d 109 (2d Cir. 2005) (cited in Supp. Br. p. 26) (discussing the distinction between the duty to defend and indemnify only in the context of lower court’s erroneous application of indemnification standard to find no duty to defend); Bowker v. NVR Inc., 39 A.D.3d 1162 (4th Dep’t 2007) (cited at Supp. Br. pp. 14, 19) (default judgment established facts that brought claims within coverage); Devoe Props. LLC v. Atl. Cas. Ins. Co., 2011 U.S. Dist. LEXIS 114574, 2011 WL 4711864 (E.D.N.Y. Oct. 4, 2011) (cited at Supp. Br. p. 26) (it is unclear whether the pleadings did, but the proof showed work and damage that was sole basis for underlying judgment “fell squarely within the policy exclusions”); Giovanielli v. Certain Underwriters at Lloyds, London, No. 9091/08, 23 Misc. 3d 1128(A) (Sup. Ct. Queens County May 35 14, 2009) (cited at Supp. Br. p. 16) (insurer provided defense in the underlying action, and therefore not alleged to have wrongfully disclaimed); Martin v. Safeco Ins. Co., 19 A.D.3d 221 (1st Dep’t 2005) (lower court decision cited at Supp. Br. p. 12) (holding that insurer was collaterally estopped from contesting judgment or raising defenses with respect to its merits because insurer failed to defend in the underlying action); Shoretz v. Nationwide Ins. Co., No. 01 CIV. 9352(CSH), 2002 U.S. Dist. LEXIS 12622, 2002 WL 1492135 (S.D.N.Y. July 11, 2002) (cited at Supp. Br. 12) (denying insurer’s motion to obtain discovery related to the merits of default judgment in underlying case); 23 Grouse Drive LLC v. Hermitage Ins. Co., No. 315/10, 2012 N.Y. Misc. LEXIS 1238, 2012 WL 985230 (Sup. Ct. Nassau County Mar. 6, 2012) (cited at Supp. Br. pp. 15, 16, 27) (default judgment in underlying action, together with evidence, established applicability of exclusion which was unambiguously invoked by the complaint, so there was no coverage at all); Albert J. Schiff Assocs. Inc. v. Flack, 51 N.Y.2d 692 (1980) (cited at Supp. Br. pp. 10, 19, 20) (underlying claim, which involved a competitor’s suit against the insured for unfair competition, clearly did not fall within the purview of the policy, which insured against claims for professional errors, omissions and negligence, and specifically excluded claims for dishonest and fraudulent acts and acts by which the insured gained a personal profit or advantage to which the insured was not legally entitled); Rucaj v. Progressive Ins. Co., 19 A.D.3d 270 (1st Dep’t 2005) 36 (cited at Supp. Br. p. 14) (facts of default judgment precluded insurer from raising defenses extending to merits of underlying action, and defenses not going to merits of underlying action failed as a matter of law); Pistilli, 16 A.D.3d at 477 (cited at Supp. Br. p. 32) (coverage waived by virtue of failure to timely disclaim, and also stating general rule that “[w]hen in doubt, an insurer should issue a prompt disclaimer and then seek a declaratory judgment concerning its duty to defend or indemnify, rather than seeking such a judgment in lieu of issuing a disclaimer, as the plaintiff has done here.”) (iv) The Decision Is Consistent with National Jurisprudence Reversal Proponents would have this Court believe the Decision is not only contrary to established New York law, but that the Decision places New York in line with a minority of states that have adopted the coverage defense forfeiture rule, sometimes referred to as the Illinois Rule, and supposedly out of step with jurisprudence in the “vast majority” of jurisdictions that have rejected the Illinois Rule. As noted herein (infra pp. 37-38), K2 and ATAS disagree with Reversal Proponents’ broad reading of the Decision as placing New York within the Illinois Rule. However, even assuming arguendo that the Court did intend that end, it is not a ground for overturning the Decision. A large number of states follow the Illinois Rule, and New York is not obliged to adopt a “majority” rule just because that rule is more popular than the minority approach. Amici Curiae United 37 Policyholders and Coltec both provide an in-depth overview of jurisdictions following the forfeiture rule and providing similar incentives to induce insurers to honor their duty to defend, to which this Court is respectfully referred for a synopsis of national jurisprudence. See Brief of Policyholders, dated Nov. 8, 2013, pp. 13-36 (noting that approaches similar to the estoppel rule articulated in Lang are followed in Illinois, North Carolina, Connecticut, Montana, Wisconsin, Mississippi, Alaska, Kentucky, Michigan, Kansas, Louisiana and Hawaii); Brief of Coltec, dated Dec. 5, 2013, pp. 24-33 (noting that Illinois, Connecticut, Montana, Wisconsin, Washington and Mississippi have adopted estoppel rule and California, North Dakota and Georgia have adopted rules aimed at encouraging insurers to honor their duty to defend). The Decision Does Not Adopt the So-Called Illinois Rule First, the contention that the Decision runs far afoul of the approach of a majority of states rests on a tortured interpretation of the Decision as mandating that every breach of the duty to defend will hereinafter forfeit “all rights to contest coverage.” This is a blatant misinterpretation of the Decision which ignores its clear limitations to the context herein -- namely, an indisputably wrongful denial of defense resulting in a final judgment that rests upon only covered events and involved no public policy exclusions. (See above pp. 28-36.) The holding’s application in other situations (e.g., settlements, situations in which an underlying 38 judgment includes a finding of facts establishing exclusions, cases involving the absence of basic coverage, cases involving public policy exclusions) is not addressed directly, and there is no basis for Reversal Proponents’ claim that the Decision will (or should) be interpreted to situations arising from circumstances distinct from those herein. Had the Court Adopted the So-Called Illinois Rule, It Had a Sound Basis for Doing So Second, assuming arguendo this Court intended to adopt the coverage defense forfeiture rule, it had a sound basis for doing so. Under that rule, an insurer wishing to contest coverage must seek a declaratory judgment that there is no coverage or defend the action under a reservation of rights; failing to do either estops the insurer from raising defenses under the insurance policy. See Employers Ins. of Wausau v. Ehlco Liquidating Trust, 186 Ill. 2d 127, 150-51 (1999). This longstanding approach has been adopted by a number of additional states, including Connecticut, and it has a sound basis in law and policy. In particular, the Illinois Rule recognizes that insurers and insureds are not merely arms’ length contract counterparties, but rather that insurers owe insureds a fiduciary duty: [I]f the action on its face appears to be within the coverage of the policy, an insurer is obligated to defend even if the insurer’s investigation demonstrates that the claim is groundless or one not covered by any provision in the policy. An insurer that wrongfully refuses to defend may be liable for the amount of the subsequent verdict or settlement, plus attorneys’ fees and expenses of 39 litigation. Some courts consider the relationship of an insurer to its insured to be a fiduciary one, and one which compels the insurer not only to defend but also to conduct an effective defense. United Servs. Auto. Ass’n v. Glens Falls Ins. Co., 350 F. Supp. 869, 871 (D. Conn. 1972) (applying Conn. law) (citations omitted) (insured stated claim for emotional distress related to insurer’s withdrawal of coverage). The Decision’s approach, which is not dependent on the existence of a fiduciary relationship between insured and insurer, is consistent with, if not more conservative than, that of a number of jurisdictions applying an estoppel rule. See West American Ins. Co. v. Midwest Open MRI, Inc., __ Ill. App. 3d __, 989 N.E.2d 252, 261 (1st Dist. Apr. 16, 2013) (articulating general rule that insurer in breach of duty to defend is estopped from disputing coverage but finding no estoppel where there was no duty to defend); Truck Ins. Exch. v. Vanport Homes, Inc., 147 Wash. 2d 751, 759 (2002) (“an insurer that refuses or fails to defend in bad faith is estopped from denying coverage”); Grindheim v. Safeco Ins. Co. of Am., 908 F. Supp. 794, 798 (D. Mont. 1995) (applying Montana Law) (“An insurer who refuses, without justification, to defend its insured, will be estopped from denying coverage”) (citation omitted); White Mountain Cable Constr. Co. v. Transamerica Ins. Co., 137 N.H. 478, 485 (1993) (“a final judgment, even by default, made by a court of competent jurisdiction, is conclusive upon an insurer disclaiming coverage and refusing to defend when it had a duty to do so”); U.S. Fire Ins. Co. v. Good 40 Humor Corp., 173 Wis. 2d 804, 818 (Ct. App.), review den’d, 501 N.W.2d 458 (1993); Sauer v. Home Indem. Co., 841 P.2d 176, 184 (Alaska 1992) (“an insurance company which wrongfully refuses to defend is liable for the judgment which ensues even though the facts may ultimately demonstrate that no indemnity is due [citation omitted]”); Conanicut Marine Servs., Inc. v. Ins. Co. of N. Am., 511 A.2d 967, 971 (R.I. 1986) (“where an insurer refuses to defend an insured pursuant to a general-liability policy, the insurer will be obligated to pay, in addition to the costs of defense and attorneys’ fees, the award of damages or settlement assessed against the insured”); In re Abrams & Abrams, P.A., 605 F.3d 238, 241 (4th Cir. 2010) (“Under North Carolina law, if an insurer improperly refuses to defend a claim, it is estopped from denying coverage and must pay any reasonable settlement—even if it made an honest mistake in its denial.”); Fed. Ins. Co. v. Stroh Brewing Co., 127 F.3d 563, 571 (7th Cir. 1997) (applying Indiana law) (“choosing to deny coverage based on non-coverage by the insuring clause, thus leaving the insured to fend for itself, bars the insurer from recourse to its exclusions”); see also Missionaries of Co. of Mary, Inc., 230 A.2d at 26 (cited above at pp. 20-21); Lee, 151 Mich. App. at 286-87 (cited above at p. 21). Moreover, contrary to CICLA’s arguments (see CICLA Br. pp. 7, 8-11, 19- 21, 22-24), even in the Illinois Rule jurisdictions, the insurer’s liability is not “automatic”; rather, an insurer that breached the duty to defend is still permitted to 41 contest and litigate certain aspects of its indemnity obligation. See, e.g., Guillen ex rel. Guillen v. Potomac Ins. Co. of Illinois, 203 Ill. 2d 141 (2003) (determining breach of duty to defend but remanding to determine whether decision to settle and amount of settlement were reasonable); Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 308 Conn. 760, 818-19 (2013) (insured has duty to prove that global settlement encompassing multiple claims is reasonable in proportion to claims that, considered independently, the insurer had a duty to defend). In any event, the fact that this Court adopted a rule of law that more closely resembles the Illinois Rule than the majority rule is not grounds for overturning the Decision. (v) The Decision Deals with an Insurer’s Loss of the Right to Raise Policy Exclusions in Defense of an Insurance Law § 3420 Action, Where Such Insurer has Wrongfully Disclaimed. The Decision deals with exclusions, not basic coverage under the Policy. By so limiting its scope, the Decision did not consider the effect of wrongful disclaimer on basic policy coverage questions. Since basic coverage is the insured’s burden to show, but exclusions are the burden of the carrier to prove, see Consol. Edison Co. of New York, Inc. v. Allstate Ins. Co., 98 N.Y.2d 208, 218 (2002), the Decision would apply only when a judgment against the insured establishes facts representing a covered event, and would not allow the insurer to attack the facts underlying the judgment. See Decision, 21 N.Y.3d at 390; Rucaj, 19 A.D.3d at 273. This may be said to be a part of what the Decision meant in 42 referring to “situation[s] like the one we have here,” 21 N.Y.3d at 390. Hypothetical Scenarios Posed by NYIA Are Inapplicable In its brief, NYIA argues, via various abstract hypothetical scenarios, that the Decision will have an undesirable impact on insurance law. It is axiomatic, however, that the Court should only pass on the rights of persons actually before the tribunal. See Hearst Corp. v. Clyne, 50 N.Y.2d 707, 713-14 (1980). That said, examination of the hypotheticals posed by NYIA is helpful to K2 and ATAS’s position. Looking at each hypothetical, we ask the Court to consider what type of behavior it would like to encourage and which rule of law provides that encouragement. Before doing so, however, it is worth noting that none of the fictional scenarios posed by NYIA clearly falls within the rule of the Decision. First, the fact scenarios posed by NYIA are too vague to analyze, as even the type of resolution achieved is unspecified, e.g. “a default judgment or settlement or judge or jury award” (see NYIA Br. pp. 13, 16, 17). As argued above (pp. 29-32, 34-36), a case ending in settlement or a judgment that does not establish the facts underlying liability is outside of the rule articulated in the Decision. Second, to the extent that the hypotheticals posit that the underlying action yielded a fact determination that established an exclusion, see, e.g., “Non- Permissive User Hypothetical” (posed at NYIA Br. p. 18), citing Colon v. Aetna Life & Cas. Ins. Co., 66 N.Y.2d 6 (1985), this is distinguishable from the Decision, 43 which had no such determination. NYIA’s hypothetical involving an unlicensed taxicab driver (NYIA pp. 16-17) appears to involve an exclusion that itself is unenforceable, and therefore that hypothetical should be disregarded. See Matter of Liberty Mut. Ins. Co. (Hogan), 82 N.Y.2d 57, 60-61 (1993) (“[E]nforcement of the livery exclusion in the uninsured motorists coverage endorsement of a liability insurance policy would be inconsistent with the strong public policy underlying the compulsory uninsured motor vehicle statutes, ‘to ensure that innocent victims of motor vehicle accidents be recompensed for their injuries and losses’.”) (citation omitted). Similarly, NYIA’s hypothetical related to George A. Fuller Co. v. U.S. Fidelity & Guaranty Co., 200 A.D.2d 255 (1st Dep’t), lv. denied 84 N.Y.2d 806 (1994), is irrelevant because in the cited case, the complaint did not raise a covered claim, see 200 A.D.2d at 259. Such an instance falls outside of the Decision, as a disclaimer would not be wrongful if there is no coverage on the face of the pleading. NYIA’s hypothetical involving the “business pursuit” exception may or may not fall within the purview of the Decision; as we are not given the terms of the final determination of the underlying action, there is no way to tell. See NYIA Br. p. 13 (“Assume that the insured…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”). 44 Moreover, the “business pursuit” hypothetical supports the Decision’s application. Faced with a complaint that clearly falls within defense coverage, the insurer nonetheless disclaims and abandons its insured in the underlying litigation, betting that the exclusions will protect it from indemnity in a later declaratory judgment action. In the “business pursuit” hypothetical, the insurer could easily have brought a declaratory judgment action, presented the court with whatever evidence it had that purportedly invoked the exclusion, and allowed the issue to be resolved before abandoning its insured. Absent this Court’s mandate in Lang and now the Decision, however, the insurance carrier has little motivation to bring a declaratory judgment action prior to disclaiming: its exposure is reimbursing the insured for defense costs, a cost it would have had to pay anyway under the policy. Examination of the “builder” hypothetical (NYIA Br. p. 17) further illustrates the wastefulness of allowing the insurer to litigate the question of coverage after judgment is issued in the underlying action. In the “builder” scenario (p. 17), the insurer disclaims defense based on the insurer’s conclusion – which is outside of the four corners of the complaint in the action—that the contractor used defective materials and methods. It is difficult to imagine how the insurer could have been so certain that the materials and methods were defective from its own investigation, as determining the issue of whether materials and methods were defective would be fact sensitive and complex. In fact, we can 45 assume that determination of whether the materials and methods were defective might be a central point to be resolved in the underlying action. Despite this, in NYIA’s hypothetical, the insurer refuses to defend in the hopes that it will be afforded the chance to litigate the exclusion in a later declaratory judgment action and only be exposed there to reimbursing defense costs; it has nothing to lose since if it were under a duty to defend, it would owe these payments anyway. The insured, however, has much to lose, since in the meantime, it had to procure its own defense, at its own cost, or face default. The judicial system also potentially loses, since a court in an action to determine coverage, brought subsequent to an underlying judgment, would have to hear legal argument and find facts that overlap with issues that would have been more efficiently resolved had the insurer brought a declaratory judgment action earlier. The Decision expressed this Court’s resounding rejection of this practice, and its desire to avoid the unfairness and inefficiency inherent in that scenario, by placing the burden on the insurer to litigate the exclusion upfront. POINT IV: THE DECISION FAVORS PUBLIC POLICY It is contrary to public policy to allow an insurer that wrongfully disclaims to raise defenses in a later § 3420 action that could have been raised in the underlying case in defense of the insured. See Decision, 21 N.Y.3d at 391. For example, here, if true, Guarantee could have defended Daniels on the basis that he was not K2 and 46 ATAS’s attorney in relation to all or some of their claims; that, if true, he was acting as attorney for Goldan; or that, if true, he was acting in his capacity as an officer, director or shareholder of Goldan and not for K2 and ATAS. These positions would not have placed the insurer in conflict with the insured and would, if true, have defeated K2 and ATAS’s claims. Having failed to raise these defenses on behalf of its insured, public policy forecloses Guarantee from doing so now to protect itself after abandoning its insured. Moreover, permitting an insurer to raise defenses against insureds post- judgment in the underlying action encourages insurers to place insureds at risk of a massive judgment, acting only at the point at which the insurer itself is in direct financial jeopardy. It also ignores the nature of a promise to defend, which is not simply a promise to pay ordinary contract damages, but rather a promise to perform. See Am. Law Inst., Principles of the Law of Liability Insurance § 21 cmt. c (Tentative Draft No. 1, 2013). To avoid such an unseemly practice, this Court has already warned insurers that they risk liability to injured parties when they precipitously disclaim their obligation to defend. See Lang, 3 N.Y.3d at 356. Guarantee did not heed Lang and abandoned its insured before any fact finding had occurred; after Daniels defaulted in the Underlying Action and the Legal Malpractice Judgment was entered against him, Guarantee first raised, in the § 3420 Action, issues that could have, if true, potentially aided Daniels in 47 defending the Legal Malpractice Claims. This conduct constitutes an effort to obtain “two bites at the apple,” Sphere Drake, P.L.C. v. 101 Variety, Inc., 35 F. Supp. 2d 421, 432 (E.D. Pa. 1999). Significantly, in Sphere Drake the insurer had filed a declaratory judgment action to litigate the issue of coverage, id. at 426, 432, but the court there found that because the insurer had failed to seek a stay of the underlying action, the insurer was still bound by the judgment against the insureds in the underlying action, id. at 432. At bar, Guarantee did not even file a declaratory judgment action, notwithstanding this Court’s advice that insurers do so rather than abandon insureds at the defense stage. Lang, 3 N.Y.3d at 356. Such opportunistic conduct is a far cry from the “litigation insurance” that an insurer’s duty to defend is supposed to provide, see, e.g., BP Air Conditioning Corp., 8 N.Y.3d at 714. Although Pavia concerns insurer liability for bad faith, as opposed to indemnity liability under an insurance policy, it is instructive as to public policy as concerns the latter. Guarantee’s “abandon our insured first, defend ourselves later” strategy runs directly counter to the requirement in Pavia that insurers place their insureds’ interests on an equal footing with their own, see Pavia, 82 N.Y.2d at 453. If such misconduct is sufficient to give rise to bad faith liability, it is certainly sufficient to trigger the indemnity obligation. 48 On public policy grounds, a number of courts have held that where, as here, an insurance company, which is contractually bound to defend, unjustifiably disclaims, it is bound by all matters decided in the underlying action that are material to recovery by the insured in actions on the policy. See Miller v. United States & Fidelity Corp., 291 Mass. 445, 448 (1935); Sweeney v. Frew, 318 Mass. 595, 597 (1945); Saragan v. Bousquet, 322 Mass. 14, 20 (1947); Lodge v. Bern, 328 Mass. 42, 45 (1951). Application of these contract principles in this context motivates insurers to provide a defense. See Bainbridge Inc. v. Travelers Cas. Co. of Conn., 159 P.3d 748, 751 (Colo. App. 2006) (“Generally, the appropriate course of action for an insurer who believes it has no duty to defend is to provide a defense…under a reservation of its rights to seek reimbursement, or to file a declaratory judgment action after the underlying case has been adjudicated.”); Newhouse v. Citizens Sec. Mut. Ins. Co., 176 Wis. 2d 824, 837 (Sup. Ct. 1993) (“The best approach is for the insurance company to defend under a reservation of rights.”) As the Supreme Judicial Court of Massachusetts held in Miller: Where an action against the insured is ostensibly within the terms of the policy, the insurer, whether it assumes the defense or refuses to assume it, is bound by the result of that action as to all matters therein decided which are material to recovery by the insured in an action on the policy. This case is but one instance under a rule of broad application that an indemnitor, after notice and an opportunity to defend, is bound by material facts established in an action against the indemnitee. 49 291 Mass. at 448-49 (citations omitted).8 Arizona applies this logic both to defenses raised, and defenses that could have been raised, in the underlying action (but not to defenses that could not have been earlier raised). See State Farm Mut. Auto. Ins. Co. v. Paynter, 122 Ariz. 198, 200 (1979). The basic idea is one of fairness, articulated by the Supreme Court of New Hampshire: [If the indemnitor fails to give assistance] at the time when it is of greatest importance, it is fair that he should abide by the result of the trial. The fact that it may be inconvenient to him to respond at the time when the indemnitee is sued does not change the equities of the situation, because of his primary duty to satisfy the claim of the creditor or the injured person; if he permits the matter to result in an action his should be the responsibility to see that it does not result in an improper judgment. White Mountain Cable Constr. Co., 137 N.H. at 485 (quoting Litton Systems, Inc. v. Shaw’s Sales & Serv., Ltd., 119 Ariz. 10, 13 (Ct. App. 1978) (internal quotation marks omitted) (alteration in White Mountain). Illinois takes an even stronger approach. There, if an insurance carrier fails to either defend a suit under a reservation of rights, or seek a declaration of no 8 Indeed, Massachusetts courts go even farther by requiring carriers that unjustifiably disclaim defense coverage to indemnify insureds for the full amount of a reasonable settlement reached subsequent to denial without any opportunity to argue coverage defenses. See Camp Dresser & McKee Inc. v. Home Ins. Co., 30 Mass. App. Ct. 318, 326 (1991) (“Our cases generally have recognized the peril implicit in unjustified disclaimer decisions, and held an insurer making such a decision liable for the reasonable costs of both defense and settlement”) (citations omitted). Here, the Legal Malpractice Judgment constituted a final determination of the material facts – including Daniels’s representation of K2 and ATAS, his legal malpractice and its proximate injury to K2 and ATAS—on the merits, and is therefore a stronger case for preclusion against Guarantee than a settlement would have been. 50 coverage, and it is later held that the insurer’s disclaimer was wrongful, the insurer is later estopped from raising any policy defenses to coverage. See Am. Nat’l Fire Ins. Co. v. Nat’l Union Fire Ins. Co., 343 Ill. App. 3d 93, 101 (1st Dist. 2003). Sphere Drake, 35 F. Supp. 2d 421, briefly quoted above, was a declaratory judgment action by an insurer against insureds arising from civil litigation related to a shooting. There, the district court, applying Pennsylvania law, held that the insurer could not invoke the policy’s assault and battery exclusion because the court in the underlying state court action held that shooting was an accident, and the insurer did not provide a defense or otherwise appear in the state court action. See id. at 433. As noted above, the decision specifically notes that allowing the insurer to fail to defend or stay the underlying litigation, and then to raise the coverage defense in a declaratory judgment action, would give the insurer a second opportunity to defend itself. Id. at 432. In Home Federal Savings Bank v. Ticor Title Insurance Co., 695 F.3d 725 (7th Cir. 2012), subsequent to the insurance company’s denial of coverage, the plaintiff bank settled the counterclaim against it; the bank then filed a proceeding against the insurer alleging bad faith and breach of duty to defend and indemnify. Id. at 728-29. Applying Indiana law, the Seventh Circuit first held that the insurer breached its duty to defend unless an exclusion applied, id. at 732, and then looked to the applicability of the exclusions invoked by the insurer. Finding them 51 inapplicable, the court held that the insurer was “precluded from arguing it was under no duty to indemnify [the insured] for liability it incurred as a consequence of that litigation,” id. at 735. Specifically the district court stated: “An insurer that refuses to defend its insured does so ‘at its peril,’ and where it breaches its duty to defend, ‘an insurer is ordinarily bound by the result of litigation to which its insured is a party, so long as the insurer had notice and the opportunity to control the proceedings.” Id. at 736 (citations omitted). In United Pacific Insurance Co. v. Meyer, 305 F.2d 107 (9th Cir. 1962), the insurer argued to the Ninth Circuit that the district court erred in applying res judicata effect in the coverage proceeding to a finding in the underlying litigations that a certain individual was a subcontractor. See id. at 111, 112. The appellate court rejected the provider’s argument, holding that because the fact finding was “essential to the maintenance of the state court actions,” it was material and therefore binding on the insurer in the coverage action. Id. at 118-19. Here, Daniels’ attorney-client relationship with K2 and ATAS, his legal malpractice and the resulting damages were all “essential to the maintenance” of the Underlying Action and were, in fact, the basis of the Legal Malpractice Judgment. The non-profit independent organization ALI Council, which provides scholarly work aimed at addressing topics of legal significance, has addressed the public policy issues implicated by the Decision in its draft of Principles of the Law 52 of Liability Insurance § 21, comment c (Tentative Draft No. 1, 2013), which says of the consequences of breaching a duty to defend: The better rule is that stated here: 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. In a full-coverage case, the insurer faces all of the legal risks posed by the claim and has the appropriate incentive to fulfill the duty to defend in a manner that reflects all of those legal risks. When the insurer has a potential coverage defense, however, the insurer does not face all of the legal risks posed by the claim and, therefore, does not have the same incentive to fulfill the duty to defend despite being legally obligated to do so. See § 16, Comment b. The rule stated in this Section addresses this incentive problem. Because a breach of the duty to defend exposes the insurer to all of the legal risks posed by the claim, the insurer has the appropriate incentive to defend the claim as if it faced all of those risks. In that sense, the forfeiture of coverage defense rule is analogous to the duty to settle, which encourages an insurer to evaluate a settlement as if the insurer would be obligated to pay the full amount of any judgment. See § 27. In contrast to this well-reasoned analysis, Reversal Proponents’ argument that public policy favors allowing insurers to wrongfully disclaim and later enjoy the benefit of exclusions, as opposed to encouraging the insurers to bring a declaratory judgment action prior to breaching the policy, is unpersuasive. 53 POINT V: The Decision Does Not Overlook Exclusions Guarantee argues that this Court overlooked the applicability of the Exclusions, incorporating by reference its earlier submissions to this Court. (See Supp. Br. p. 32.) As with Lang, it is difficult to understand how this Court could have overlooked the issue of the Exclusions in light of the extensive treatment of the issue by the First Department and in the briefs submitted on this Appeal. To the contrary, the Court acknowledged the issue of the exclusions, specifically stating that it was affirming the First Department Decision “without reaching the question that divided the Appellate Division: the applicability of the insured’s status exclusion and the business enterprise exclusion to American Guarantee’s duty to indemnify Daniels for a judgment based on legal malpractice.” Decision, 21 N.Y.3d at 389. This does not mean that the Court overlooked the issue dividing the Appellate Division; it simply demonstrates the Court reached its determination on the basis of a more basic question, viz., whether Guarantee forfeited its ability to raise exclusions when it unjustifiably refused to defend a clearly covered claim. There was, therefore, no reason to reach the applicability of the exclusions, notwithstanding the First Department Decision’s lengthy treatment of this issue. Should the Court reach this issue, it should affirm on the grounds articulated by the First Department, as will be discussed in the next point. 54 POINT VI: Should This Court Revise Its Ruling, K2 and ATAS Should Still Prevail on Alternate Grounds Summary judgment was properly granted to K2 and ATAS and affirmed as to the Legal Malpractice Claims, as there were no material issues of fact that concerned those claims. See CPLR § 3212; Alvarez v. Prospect Hosp., 68 N.Y.2d 320, 324 (1986) (summary judgment should be granted where there are no material issues of fact). Here, the Legal Malpractice Claims involve allegations entirely within Policy coverage, viz., that Daniels was attorney to K2 and ATAS, that in that capacity, Daniels undertook to perform legal services to K2 and ATAS but negligently failed to do so, that as a proximate cause of that negligence, K2 and ATAS suffered damages. (See R85-88.) Those same allegations are incompatible with circumstances that would have triggered the Exclusions. (Compare R85-88 [Legal Malpractice Claims] [alleging malpractice in performance of legal services to K2/ATAS] with R213 [assertion that Daniels rendered legal services to Goldan].) The First Department Decision recognized this, holding: the basis of the legal malpractice action was that Daniels agreed to act as plaintiffs’ attorney in the preparation of mortgages and related notes, in arranging for title insurance at Goldan’s expense, and in recording the mortgage liens, that he failed to record the mortgages and obtain title insurance, and that his failure was a departure from good and accepted legal practice, and caused injury to plaintiffs. It was not alleged that Daniels was negligent in rendering legal services to his business enterprise, 55 Goldan. The action was based exclusively on his obligation to plaintiffs, not to Goldan. 91 A.D.3d at 403. The Majority went on to note: “[t]hat Daniels was an owner of Goldan or might have been acting in the interests of Goldan instead of those of his clients…does not change the essence of the complaint, or the basis of liability, which is that Daniels committed legal malpractice in his representation of plaintiffs.” Id. (citation omitted). The First Department Decision therefore held that there was no issue of fact as to coverage or the applicability of the Exclusions based on allegations in the Legal Malpractice Claims, and awarded summary judgment on Guarantee’s obligation to indemnify. (See id.) This analysis was correct. The factual assertions in the Underlying Complaint rolled into the Legal Malpractice Judgment, unchallenged, and the ensuing Judgment established not only coverage, but also under the facts of this case, the inapplicability of the Exclusions. Guarantee’s efforts to avoid the consequences of the Legal Malpractice Judgment involved an impermissible collateral attack upon a now unassailable judgment. See, e.g., Ramos v. Nat’l Cas. Co., 227 A.D.2d 250, 250 (1st Dep’t 1996) (“An insurer with a duty to defend which refuses to do so is bound by the court’s determination of the underlying action and cannot thereafter collaterally attack the judgment or raise defenses with respect to its merits”) (citing Matychak v. Security Mut. Ins. Co., 181 A.D.2d 957, 958-59 (3d Dep’t), lv. denied, 80 N.Y.2d 758 (1992)); see also Shoretz, 2002 WL 56 1492135, at *2 (“New York courts have made it clear that a judgment entered against an insured person in an underlying suit is binding on the insurance company, and the insurance company cannot contest the merits of the plaintiff’s claim in a subsequent suit under Insurance Law § 3420”); Bowker, 39 A.D.3d at 1164 (Workers’ Compensation Law § 11 defense could not be raised by insurer, which had disclaimed in the underlying action, in coverage action where default judgment in the underlying action established that the employer’s negligence had proximately caused the employee’s injuries). The inapplicability of the Exclusions herein is more fully addressed in the K2 Opening Brief at Point I, A-F, to which the Court is respectfully referred. Should the Court decide to revise the Decision, K2 and ATAS respectfully refer the Court to arguments raised in their original briefs on this appeal and urge the Court to, notwithstanding the adoption of a narrower rule of law, still affirm the outcome arrived at by the Appellate Division, First Department and the unanimous panel of this Court. CONCLUSION The Decision should be affirmed. 57 Dated: Mineola, New York December 20, 2013 Respectfully submitted, LAW OFFICES OF MICHAEL A. HASKEL By:_________________________ Michael A. Haskel Attorneys for Plaintiffs-Respondents- Cross-Appellants, K2 and ATAS 167 Willis Avenue Mineola, NY 11501-2621 (516) 294-0250 Of Counsel: Michael A. Haskel Susan Haskel Brandon M. Zlotnick Leonard Gekhman