After rattling the framework of well-established New York insurance law, the Court of Appeals conceded that it was wrong and reversed its prior decision in K2-II Investment Group, LLC v. American Guarantee & Liability Insurance Company.
In its earlier K2-I decision, the court held that an insurer waives any policy exclusions if the duty to defend is breached. The response to K2-I was immediate: commentators criticized the decision, noting that the Court of Appeals did not mention, let alone analyze, its prior decision of Servidone Construction Corp. v. Security Insurance Co., which came to the opposite conclusion. In September 2013, the Court granted a motion to reargue K2-I, signaling some second thoughts about its prior ruling.
In a 4-2 decision, the Court framed the issue as follows: “In short, to decide this case we must either overrule Servidone or follow it. We choose to follow it.” It stressed that “when our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise.” In short, the Court acknowledged the uncertainty that K2-I had caused, affirmed the value of predictability in the law, and took the bold step of reversing itself.
The lesson learned is that Servidone remains the controlling case in New York on the consequences of an insurer’s breach of its duty to defend. When an insurer breaches its contractual duty to defend its insured, the insurer is not automatically barred from relying on policy exclusions to dispute any obligation to indemnify the policyholder.