- Insurance coverage
Partner - London. United Kingdom
In American West Home Insurance Co. v. Gjonaj Realty & Management Co., 2018-03435, 2020 WL 7767944 (N.Y. App. Div. 2d Dep’t Dec. 30, 2020), the New York Appellate Division, Second Department addressed an issue of first impression – that is, whether an insurance company may recover the costs of defending its insureds in an underlying personal injury action “where there has been a reservation of rights by the insurance company and a determination by the court that the insurance company has no obligation to defend and provide insurance coverage to the insureds” in such action.
The court found that, under those circumstances, while the insurer at issue no longer owed a continuing obligation to defend its insureds or an obligation to pay any judgment obtained against the insureds in the underlying lawsuit, the insurer was not entitled to recover from its insureds the defense fees and costs it had incurred on their behalf without an express provision in the policy permitting such recovery.
First, the court explained the axiomatic principles of the duty to defend under New York law, and noted that an “insured need only establish that there is a potential for coverage under a policy to give rise to the insurer’s duty to defend and such a duty may exist even where coverage is in doubt and ultimately does not apply.” In light of these principles, the court explained that “[a]llowing the insurance company to cover the costs it incurred in defending . . . risks eroding this well established doctrine and effectively would make the duty to defend merely coextensive with the duty to indemnify.”
Second, the court noted that the insurer’s policy at issue did not contain a provision “that expressly grants the [insurer] the right to recoup defense costs.” Although the court acknowledged certain New York state and federal precedent allowing insurers to recover defense fees/costs, the court rejected those cases on the basis that they did not address “whether recouping defense costs is appropriate or authorized” and, in some cases, there was no indication that the request for defense costs was opposed by the insured on appeal.
Third, citing New York’s rules governing the construction of contracts, the court reasoned that the insurer did not have a right to recoup defense costs because the policy did not expressly afford it that right, even though the insurer could have included such a provision had it intended such a result.
Fourth, the court rejected the contention that the insured’s decision to accept a defense under a reservation of rights created a new “implied contract” allowing for recoupment. To allow the insurer the ability to create rights beyond the contract in that manner would, in the court’s view, improperly “impose a condition on its defense that was not bargained for and ‘amount[s] to a pro tanto supersession of the policy without separate agreement and separate consideration.’”
Fifth and last, the court rejected the insurer’s argument that it would be unjustly enriched if forced to bear the costs of the insureds’ defense without the right to recoupment. The court explained that “equity and fairness weigh against allowing the insurance company to obtain reimbursement of its defense costs because an insurer benefits unfairly if it can hedge on its defense obligations by reserving its right to reimbursement while potentially controlling the defense and avoiding a bad faith claim from its insured.”
The prevailing takeaway from the Second Department’s ruling in Gjonaj Realty is that, in the case of a finding of no coverage, an insurer may not be able to recover defense costs incurred on behalf of its insured without an express provision allowing it to do so in its policy. This Second Department decision is only binding on New York trial courts within the Second Department and the Second Department itself, although it likely will be influential to trial courts in other Departments that have not yet spoken to the issue. By contrast, certain jurisdictions including California, Florida, and Connecticut, permit reimbursement when the insurer has no duty to defend or indemnify and reserves its right to reimbursement even without an express policy provision providing for reimbursement.