Insurer Must Pay Insured's Attorney's Fees Incurred In Defending A Declaratory Judgment Action Against Insurer, Regardless Of Whether Insurer Defended The Underlying Action
January, 2005
The New York Court of Appeals held in U.S. Underwriters Insurance Company v. City Club Hotel, LLC, 2004 WL 2902402 (N.Y. 2004), that an insured can recover attorneys' fees expended in defending a declaratory judgment action against its insurer regarding the insurer's duty to defend, regardless of whether the insurer defended the underlying action. In deciding this issue, the Court resolved a previously unsettled question of state law.
Plaintiff, U.S. Underwriters Insurance Company, issued a commercial general liability policy to defendants City Club Hotel, LLC and Shelby Realty, LLC. The Policy covered renovation work which City Club was performing on Shelby's property. During renovation, on April 27, 2000, Marek Szpakowski, a City Club construction worker, sustained serious injuries when he fell from a scaffold. In July, 2000, U.S. Underwriters received notice of the claim and a copy of a letter from Mr. Szpakowski's counsel informing Shelby that it might be sued. Later that year, Mr. Szpakowski and his wife commenced a personal injury litigation. A copy of the complaint was sent to U.S. Underwriters. Five months after U.S. Underwriters received notice of the claim, it disclaimed coverage based on an employee exclusion clause in the Policy. Nevertheless, it provided Shelby with a defense in the underlying action.
In September, 2002, U.S. Underwriters commenced an action against Shelby, City Club, and other named defendants seeking a declaration that it had no duty to defend or indemnify. The District Court granted Defendants' summary judgment motion, holding that the disclaimer was untimely as a matter of law. The court, however, denied Defendants' request for attorneys' fees because U.S. Underwriters did not breach its duty to defend.
On appeal, the Second Circuit upheld the District Court's decision that U.S. Underwriter's disclaimer of coverage was untimely. It also noted a division in case law as to whether attorneys' fees should be granted. The Second Circuit explained that New York courts have carved out a narrow exception to the general rule that a prevailing party cannot recover attorneys' fees. The exception allows an insured, who prevails in a declaratory judgment action brought by the insurer seeking to deny a duty to defend and indemnify, to recover attorneys' fees incurred in defending the action. However, in Mighty Midgets, Inc. v. Centennial Ins. Co., 47 N.Y.2d 12, 416 N.Y.S.2d 559, 389 N.E.2d 1080 (1979), the New York Court of Appeals broadly stated this exception. According to Mighty Midgets, an insured is allowed fees “when he has been cast in a defensive posture by the legal steps an insurer takes in an effort to free itself from its policy obligations.” Id. at 21. This language has since created a division between a majority of New York lower courts and a majority of federal district courts.
Since Mighty Midgets, the courts have consistently disagreed about an issue not addressed in the case -- whether the exception applies in cases where the insurer, who sought a disclaimer of liability and lost, had earlier discharged its duty to defend the insured in the underlying action. See U.S. Underwriters Insurance Co. v. City Club Hotel, LLC, 369 F.3d 102 (2d Cir. 2004). Under these circumstances, most federal district courts hold that a prevailing insured should not be awarded attorneys' fees, whereas most New York lower courts have ruled in favor of the insured.
A majority of federal district courts disfavor permitting attorneys' fees when the insurer defended the insured in the underlying action. They have expressed concern that allowing fees in this situation would create an incentive for the insurer to refuse to defend in the underlying suit, thus forcing the insured to bring a declaratory action seeking coverage. This is a valid concern because, under Mighty Midgets, a prevailing insured is not entitled to attorneys' fees in any declaratory action that it initiates. As such, an insurer can avoid attorneys' fees by refusing to defend the underlying action, thereby coercing the insured into moving for declaratory judgment. See U.S. Underwriters Insurance Co. v. City Club Hotel, LLC, 369 F.3d 102 (2d Cir. 2004). Accordingly, most district courts retreat from the broad exception stated in Mighty Midgets, and do not award attorneys' fees to the insured when the insurer discharged its duty to defend. They reason that to rule otherwise would reduce the incentives for insurance companies to defend the underlying action. See U.S. Underwriters Insurance Co., 369 F.3d at 112.
In contrast, a majority of New York courts have held that, under the language of Mighty Midgets, attorneys' fees should be awarded whenever the insurer brings a disclaimer declaratory judgment action, regardless of whether the insurer defended the underlying action. Given the clear division among courts on this issue, its importance, and its likelihood for reoccurrence, the Second Circuit certified the following question to the New York Court of Appeals:
Whether, in a case in which an insurance company has brought a declaratory judgment action to determine that it does not have obligations under the policy but has defended in the underlying suit, a defendant prevailing in the declaratory judgment action should be awarded attorneys' fees expended in defending against that action?
U.S. Underwriters Insurance Company v. City Club Hotel, LLC, 369 F.3d 102, 113 (2d Cir. 2004). The New York Court of Appeals in U.S. Underwriters Insurance Company v. City Club Hotel, LLC, 2004 WL 2902402 (N.Y. 2004) answered the question affirmatively. The Court of Appeals held that an insured is entitled to attorneys' fees, regardless of whether the insurer defended the underlying action.
In reaching its holding, the Court of Appeals relied on its previous decision in Mighty Midgets. The Court explained that the reasoning behind Mighty Midgets was that the insurer's duty to defend encompasses any action arising out of the original occurrence. “[A]n insurer's duty to defend extends to the defense of any action arising out of the occurrence, including a defense against an insurer's declaratory judgment action.” Id. at *2. In this case, U.S. Underwriters, who defended Shelby in the underlying personal injury action, placed Shelby in a defensive posture when it brought a declaratory judgment action seeking to disclaim its duties to defend and indemnify. Since the expenses incurred by Shelby in the declaratory judgment action were the direct consequence of U.S. Underwriters' attempt to free itself from its policy obligations, the Court concluded that Shelby was entitled to recover those expenses. “Shelby's recovery of attorneys' fees is incidental to the insurer's contractual duty to defend.” Id. As such, the Court awarded Shelby attorneys' fees despite the fact that U.S. Underwriters had defended Shelby in the underlying action.
Learning Point:
Under New York law, it is now settled that an insured is entitled to recover attorneys' fees incurred in defending a declaratory judgment action against an insurer seeking to disclaim its duties to defend and indemnify, even if the insurer defended the insured in the underlying action.
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