(Article from Insurance Law Alert, January 2021)
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Reversing a lower court, a New York appellate court ruled that an insurer is not entitled to reimbursement of defense costs following a ruling that it had no duty to defend or indemnify the underlying claims. American Western Home Ins. Co. v. Gjonaj Realty & Management Co., 2020 WL 7767944 (N.Y. App. Div. 2nd Dep’t Dec. 30, 2020).
The insured was sued in a personal injury action, but failed to notify its insurer for more than four years after the accident and after a default judgment had been entered against it. The insurer initially denied coverage, but after a court vacated the default judgment, the insurer agreed to defend under a reservation of rights. In particular, the insurer sought to investigate whether it was prejudiced by the delay in notice. Thereafter, an appellate court reinstated the default judgment against the insured. The insurer again denied coverage and reserved its right to recover any fees and costs it had incurred in defending the insured. In the present suit, the insurer sought a declaration that it had no duty to defend or indemnify the insured and that it was entitled to recover the fees and costs incurred on the insured’s behalf. A New York trial court granted the insurer’s summary judgment motion on all issues.
The appellate court reversed in part, ruling that although the insurer had no duty to defend or indemnify, it was not entitled to reimbursement of defense costs already spent. Addressing this “novel issue” under New York law, the appellate court held that there was no contractual basis for recoupment of defense costs. The court expressly rejected the assertion that an “implied contract” establishes a right of reimbursement where the insurer expressly reserves a right to reimbursement in a reservation of rights, stating that a “unilateral reservation of rights ‘cannot create rights not contained in the insurance policy.’” In addition, the court rejected reimbursement based on unjust enrichment, finding that “New York law precludes claims of unjust enrichment where an insurance policy governs the subject matter at issue.” Finally, the court held that even if an unjust enrichment claim were available, it would fail because the insured was not unjustly enriched given the broad duty to defend provided by the policy.
The court acknowledged that a few New York federal district and state trial courts and at least one appellate court applying New York law (and courts in other jurisdictions) have allowed such reimbursement following a ruling that the insurer has no duty to defend or indemnify, but deemed those cases unpersuasive or factually distinguishable.