United States: New York's Highest Court Sends Strong Signal That Insurance Companies Will Be Held To Their Coverage Obligations

On June 11, 2013, the New York Court of Appeals decided two groundbreaking insurance coverage cases on public policy grounds. These cases, in combination, send a strong signal from New York's highest court that insurance companies will be strictly held to their coverage obligations in the absence of clearly applicable policy exclusions, and that they may lose the right to rely on policy exclusions if they are found to have breached their duty to defend.

1. The J.P. Morgan Decision Upholding Coverage for Disgorgement

In the first case, J.P. Morgan Securities, Inc. v. Vigilant Insurance Co., No. 113 (N.Y. June 11, 2013), in which Proskauer represented the policyholder, the Court of Appeals reversed a lower court decision that had dismissed, on public policy grounds, a coverage action brought by Bear Stearns (now part of J.P. Morgan Chase). Bear Stearns, a broker-dealer, had sought coverage for settlement of claims brought by the SEC and the New York Stock Exchange, which had charged it with facilitating late trading and market-timing in mutual funds by its customers in violation of the securities laws. In settlement of these claims, without admitting or denying the facts recited by the SEC pursuant to an Administrative Order entered on consent, Bear Stearns agreed to make two payments: $160 million denominated as disgorgement, for which Bear Stearns sought insurance coverage; and an additional $90 million penalty for which it did not.

Bear Stearns argued that the SEC had not precluded it from seeking coverage for the disgorgement payment and, in fact, had allowed it to obtain an offset in the amount of the payment against compensatory damages liability in connection with pending civil actions brought by mutual fund shareholders. Moreover, the amount of the disgorgement payment had not been calculated on the basis of gains that Bear Stearns itself received but, instead, was based almost entirely on the trading gains allegedly achieved directly by its customers and clients as a result of their own misconduct. Thus, Bear Stearns argued, although certain courts had rejected coverage for disgorgement payments where the insured had returned its own improper gain — some on public policy grounds (to prevent the insured's unjust enrichment) and others on the ground that the return of ill-gotten gains is not a loss — neither rationale was applicable to the situation at hand. It urged the court to be very wary of extending public policy prohibitions to insurance coverage expressly provided by the policy — which included coverage for regulatory claims by the SEC and other governmental and self-regulatory bodies — by endorsing the Appellate Division's rationale that insurance should be disallowed in order to preserve the deterrent effect of an SEC disgorgement remedy.

The Court of Appeals accepted Bear Stearns's arguments. Noting the complete absence of precedent from any other court prohibiting coverage for disgorgement where the insured was not required to return gains that it had received, the court declined to adopt a public policy-based prohibition of insurance coverage for the disgorgement payment made by Bear Stearns. Instead, the court found that public policy mandated enforcement of insurance contracts freely entered into by the parties according to their terms. It explained that the court previously had recognized countervailing exceptions to this public policy in only two narrowly defined circumstances: for punitive damages, where the purpose of the remedy is to punish as well as deter wrongdoing, and where the insured had engaged in conduct specifically intended to harm third parties. On the record before it, which included the SEC's Administrative Order and findings, the court found that neither exception applied: Bear Stearns was not seeking coverage for punitive damages and had not been found to have engaged in intentionally harmful conduct. The court emphasized that the public policy exception for intentionally harmful conduct is a narrow one, under which it must be established not only that the insured acted intentionally but, further, that it acted with the intent to harm or injure others. The SEC's findings that Bear Stearns willfully committed securities law violations did not establish that it acted with the requisite intent to cause harm. The court left open for determination on remand the impact of a policy provision that expressly promised that coverage would be provided for allegations of deliberate, dishonest, fraudulent or criminal acts or omissions by the insured that had not been established by a judgment or other final adjudication in the underlying action.

The J.P. Morgan decision not only creates a potential for coverage of SEC disgorgement remedies; in addition, the Court of Appeal's strong endorsement of enforcement of the express terms of freely negotiated insurance contracts will make it harder for insurance companies to rely on public policy arguments about insurability as a basis to avoid their coverage obligations.

2. K2 Investment Group and the Perils of Breach of the Duty to Defend

In the second case, K2 Investment Group, LLC. v. American Guarantee & Liability Insurance Co., No. 106 (N.Y. June 11, 2013), the Court of Appeals held that where a liability insurer breaches its duty to defend, it will not be permitted to rely on policy exclusions (other than possibly the public policy-based exclusion of coverage for intentional infliction of harm) to avoid the duty to indemnify its insured for a resulting judgment.

In K2 Investment Group, a malpractice insurer wrongfully refused to defend an attorney for a legal malpractice claim. In doing so, the insurer relied on two policy exclusions: an "insured status" exclusion and a "business enterprise" exclusion. Upon the insurer's refusal to defend, the attorney defaulted, leading to entry of a default judgment. The attorney then assigned his rights under the policy to the claimants, who sued the insurer.

The Appellate Division, First Department, with two justices dissenting, granted summary judgment in favor of the insured. All of the justices agreed that the insurer had breached its duty to defend and that the insurer was therefore prohibited from attacking the basis for the judgment against the insured. This meant the insurer could not invoke the "insured status" exclusion, as the judgment had conclusively determined that the attorney was liable for legal malpractice, which would be inconsistent with application of the exclusion. However, with respect to the "business enterprise" exclusion, the justices differed on whether the exclusion was clearly inapplicable, with the majority concluding that it was and, therefore, summary judgment in favor of the insured was appropriate, and the minority concluding that it was not, and therefore a material question of fact existed precluding summary judgment.

Rather than resolve the issue that divided the Appellate Division, the Court of Appeals took the occasion to articulate a broader rationale for affirmance: that where an insurance company breaches its duty to defend, its sole recourse is to litigate the validity of the disclaimer of the defense obligation. If that disclaimer is found wanting, the insurance company must indemnify its insured for a resulting judgment — even if policy exclusions would otherwise have negated the duty to indemnify. According to the court, this rule is intended to incentivize insurers to give their insured the full benefit of bargained-for defense coverage, rather than forcing the insured to litigate the effect of policy exclusions after having been abandoned by the insurer in defense of the underlying case, a result that the court considered unfair to the insured and conducive to unnecessary and wasteful litigation. The only possible exception to the rule announced by the court, which it left open for future consideration, is where the insurer asserts that public policy bars coverage because the insured injured the claimant intentionally.  

The rule announced by the court in K2 Investment Group barring assertion of coverage defenses where the insurance company breaches its duty to defend is a welcome and powerful endorsement of the breadth and paramount importance of an insurance company's defense obligation, and a stern admonishment to insurers of the risk of failing to discharge that obligation without prior court sanction. Although the decision involved a default judgment, the same rationale should apply to good faith settlements entered into following breach of the duty to defend.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Hunton Andrews Kurth LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Hunton Andrews Kurth LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions