Primary Insurer Found Liable To Excess Insurer For Bad Faith Defense of Mutual Insured

CGL – OCP – ANTISUBROGATION RULE – PRIMARY TO EXCESS INSURER BAD FAITH
Federal Ins. Co. v. North Amer. Specialty Assur. Co.
(Sup. Ct., New York Co., decided 12/5/2008)

If a primary insurer manipulates the defense of its two named insureds -- an owner under a $1 million OCP policy and the general contractor (GC) under a $1 million CGL policy -- in a way that violates the antisubrogation rule and results in its payment of only $1 million instead of $2 million towards a personal injury action's settlement, can it be held liable to the GC's excess insurer in "bad faith" for the extra $1 million? Yes, says this court.

Galaxy General Contracting entered into a construction contract with NYC Partnership Housing Development Fund Company, Inc., Morningside-117 LLC and Harlem Community Development Corporation. Pursuant to that contract, Galaxy purchased from Commercial Underwriters Insurance Company (which became Allied World Assurance Company (U.S.), Inc.) a $1 million OCP policy for the owners. Galaxy itself was insured under a $1 million primary CGL policy with CUIC, and a $10 million excess policy with Federal.

A subcontractor's employee, Rafael Bermejo, fell from a scaffold and was injured during the construction project. He commenced a personal injury action against the owners and Galaxy, alleging causes of action for negligence and violations of Labor Law §§ 240(1) and 241(6). CUIC initially assigned one law firm to defend both Galaxy and the owners, and a single answer on their behalves was interposed.

Bermejo filed his note of issue and certificate of trial readiness in February 2002. In June 2002, based on its realization that there was a conflict of interest between the owners and Galaxy, CUIC assigned separate counsel to defend Galaxy. In December 2002, the owners' defense counsel moved to amend the owners' answer to assert cross claims against Galaxy for common-law and contractual indemnity and breach of contract, and for summary judgment on their indemnity claims against Galaxy. The motion court granted the owners' motion and granted conditional judgment to them against Galaxy on their indemnity claims.

Galaxy's defense counsel moved to reargue or renew the owners' motion on the ground that the antisubrogation rule barred Galaxy from indemnifying the owners. The court denied that motion, holding that Galaxy should have, but did not, raise the antisubrogation argument in its opposition to the owners' motion. The court found that that Galaxy had no reasonable excuse for failing to raise the antisubrogation issue at the appropriate time. It appears that the orders granting conditional judgment and denying Galaxy's motion to reargue/renew were not appealed.

At a settlement mediation in the Bermejo action, Galaxy's defense counsel offered Galaxy's $1 million CGL policy toward settlement but the owners refused to offer anything, contending that they were passive tortfeasors only. In a letter dated November 18, 2003, Federal memorialized its position that CUIC was required to exhaust the limits of both the CGL and OCP policies before Federal would become obligated to make any payment. According to Federal, irrespective of any indemnity rights that the owners might have over against Galaxy, since CUIC, the insurer of both the CGL and the OCP policies, "was obligated to defend each of its insureds, CUIC was barred by the antisubrogation doctrine from becoming subrogated to the right of any one of its insureds against any of its other insureds."

Bermejo ultimately agreed to settle his action for $3 million. Galaxy was the only defendant that participated in that settlement, and the owners‘ cross claims against Galaxy were not settled. CUIC paid Bermejo the $1 million limit of Galaxy's CGL policy, and Federal paid $2 million under Galaxy's excess policy. Federal agreed with CUIC that a settlement of $3 million was reasonable, that if Bermejo’s case were tried, the jury would find the owners and Galaxy liable under the Labor Law statutes, and that the settlement was without prejudice to Federal’s right to recover from CUIC.

Federal then commenced this action to recover what it asserted was its $1 million overpayment from CUIC. Federal alleged that CUIC manipulated the litigation in the Bermejo action so that the settlement was against Galaxy only. If the $3 million settlement had been against the owners and Galaxy, CUIC would have paid Bermejo $2 million: $1 million on behalf of Galaxy under the CGL policy, and $1 million on behalf of the owners under their OCP policy. Federal’s excess coverage would have applied to the extent of $1 million only. But as the settlement involved Galaxy alone, CUIC only had to pay $1 million and Federal had to pay $2 million in excess coverage.

Federal asserted five causes of action—three against the CUIC defendants (North American Specialty Assurance Company and Allied World Assurance Company (US), Inc.), alone and two against CUIC together with Galaxy's defense counsel in the Bermejo action. In its first cause of action, Federal alleged that CUIC violated the antisubrogation rule in that, as the real party in interest, it claimed in the names of the owners a right of indemnity against Galaxy, its own insured. In its second cause of action, Federal alleged that CUIC acted in bad faith in defending Galaxy against the owners' indemnity claims by failing to raise the antisubrogation rule in opposition to the owners' motion for summary judgment. Had the rule been invoked, Federal claimed, the court in the Bermejo action "would have applied [it] to bar CUIC from becoming subrogated to the rights of some of its insureds...against another of its insureds...and limited any right of indemnity to the amount above the $1,000,000 limit of CUIC's OCP." Federal's third cause of action against CUIC alleged a similar theory of liability, but as Galaxy's subrogee.

Federal's fourth cause of action, against both CUIC and Galaxy's defense counsel, alleged legal malpractice. Without asserting a client relationship with Galaxy's defense counsel or alleging the existence of privity or any allegations of "near privity," Federal claimed merely that CUIC and Galaxy's defense counsel owed Galaxy a duty to defend. Federal further alleged that Galaxy's defense counsel was negligent in opposing the owners' motion for summary judgment on their indemnification claims by failing to assert antisubrogation or to apprise Federal in a timely manner that the owners had asserted such cross claims. According to the complaint, had Galaxy's defense counsel raised the antisubrogation rule, the court would have "limited any right of indemnity to the amount above the $1,000,000 limit of CUIC's OCP." Federal's fifth cause of action, also against CUIC and Galaxy's defense counsel, alleged a similar theory of liability, but as Galaxy's subrogee.

Galaxy's defense counsel moved, pre-answer, pursuant to CPLR 3211 (a)(1), (3) and (7), to dismiss the complaint against it. CUIC cross-moved for similar relief, arguing that Federal suffered no damages, individually or on behalf of Galaxy, and that Federal's complaint failed to state a cause of action for bad faith.

In modifying the motion court's order denying both motions, the First Department dismissed Federal's legal malpractice claims against Galaxy's defense counsel but sustained its direct claim against CUIC for its alleged bad faith failure to defend Galaxy in the Mermejo action. Federal Ins. Co. v North Am. Specialty Ins. Co., 47 AD3d 52 (1st Dept 2007). The case then returned to New York Supreme, and both Federal and CUIC moved for summary judgment.

In granting Federal's cross motion, New York County Supreme Court Justice Charles Ramos first reviewed New York caselaw regarding the antisubrogation rule and then held:

Federal asserts that CUIC conducted itself in the litigation so as to ensure that Galaxy, through Federal's policy, paid what the Owners should have paid. CUIC thus avoided paying from the Owners' policy and saved itself $1 million.

The Appellate Division set forth the state of the law in its opinion sustaining Federal's cause of action for bad faith:

The first cause of action presents a collision of two competing principles: antisubrogation and the right of a party, such as a premises owner, which is only vicariously responsible by virtue of the absolute liability imposed for a violation of Labor Law § 240 (1) (see e.g. Songui v City of New York, 2 AD3d 706 [2003]), to indemnification from the party actually responsible for the accident (see Kelly v City of New York, 32 AD3d 901 [2006]), such as general contractor Galaxy in the instant situation. Even though CUIC issued two separate policies (one to Galaxy and the other to the owners), the antisubrogation rule is applicable (North Star Reins. Corp. v Continental Ins. Co., 82 NY2d 281 [1993], supra). As the Court of Appeals has made clear, "a potential conflict of interest arises where the insurer that issued both policies seeks indemnification against [one of the parties to which it issued a policy]" (id. at 295-296). As relevant here, the Court observed that an insurer could manipulate the litigation in such a way as to "trigger coverage under other insurance policies held by the contractor such as a workers' compensation or excess policy" (id. at 296).

Thus, the antisubrogation rule, if asserted, would have defeated the owners' claims for indemnification from Galaxy. CUIC's exposure, at the time it entered negotiations to settle the Bermejo claim, would have been $2,000,000, not $1,000,000 as was the case after the owners successfully moved for summary judgment on their indemnification claims against Galaxy. Since, however, the conditional award of summary judgment was never appealed or vacated as part of the settlement process, it has res judicata effect and serves to bar any claim that Galaxy has an antisubrogation defense to the owners' indemnification claims (see Allstate Ins. Co. v American Home Assur. Co., 43 AD3d 113 [2007]) or that Federal has an indemnification claim against CUIC based on that nonasserted defense. (Federal Ins. Co . v North American Specialty Ins. Co., 47 AD3d 52, 63 [lst Dept. 2007]).

It is clear that by failing to abide by the antisubrogation rule, CUIC kept the Owners out of the settlement, thus reducing the amount of money that CUIC had to pay Bermejo, and increasing the amount that Federal had to pay Bermejo under the excess policy.

Federal may assert a bad faith claim on its own and as subrogee even though the claim rests on the same allegations as the antisubrogation claim. A primary carrier owes its insured and the excess insurer a duty to exercise good faith in handling a claim (Hartford Acc. and Indem. Co. v Michigan Mut. Ins. Co., 93 AD2d 337, 341 [4th Dept 19831, affd 61 NY2d 569 [19841). A prima facie case of bad faith must include allegations that the insurer deliberately or recklessly failed to place its insured's interests on an equal footing with its own interests (see Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d 445, 453 [1993]). The complaint and the moving affidavits sufficiently demonstrate bad faith, Federal at 64, insofar as CUIC violated the antisubrogation doctrine by acting against the interests of its insured Galaxy.

The only question left is to determine if CUIC alleges facts sufficient to establish a defense. The defense appears to be that the events that led up to the settlement of the Bermejo Action happened without any active participation by CUIC. This ignores the fact that CUIC, by taking a position contrary to the antisubrogation doctrine, violated its duty to Federal. It is not required, as CUIC suggests, that its failure to abide by its duty was directed by it.

Nor is a defense established by merely appointing independent counsel. When a primary insurer appoints counsel to defend an excess insurer involved ini a suit, the primary insurer is a fiduciary of the excess insurer. Hartford Acc. & Indem. Co. v Michigan Mut. Ins. Co., 93 AD2d 337, 341 (1st Dept 1983) , aff’d, 61 NY2d 569 (1984)(“the primary carrier owes to the excess insurer the same fiduciary obligation which the primary insurer owes to its insured, namely, a duty t o proceed in good faith and in the exercise of honest discretion”). After such appointment has been made, the primary insurer's obligation is not necessarily satisfied. Feliberty v Damon, 72 NY2d 112, 117 (1988) (“when an insured has been sued, the insurer does not satisfy its duty t.o defend merely by designating independent counsel to defend the litigation”). Therefore, although Federal has no claim under the antisubrogation doctrine itself, because of its failure to appeal, the violation of the doctrine is sufficient evidence of bad faith to warrant entry of judgment, absent an affirmative defense, which is neither effectively pled nor proven.

As the record fails to rebut the prima facia case and otherwise does not contain any extrinsic evidence that. would establish a defense, the motion by plaintiff for summary judgment is granted and the cross-motion is denied.

Judgment for Federal for $1 million plus interest, presumably from the date Federal paid that extra million. With that much at stake, a trip for the case back to the First Department seems likely.