Failure to Give Notice and Opportunity to Defend Fatal to Indemnification Claim

On November 17, 2016, the First Department issued a decision in Conergics Corp. v. Dearborn Mid-West Conveyor Co., 2016 NY Slip Op. 07750, holding that failure to give notice and an opportunity to defend an action was fatal to a plaintiff's demand for indemnification.

In Conergics Corp., the parties entered into a stock purchase agreement under which the defendant ("DMW") "agreed to purchase from the plaintff ("Conergics") 100% of the shares of" a DMW subsidiary, Dearborn. Conergics agreed to indemnify Dearborn for any tax audits, but only if there was prompt notice and if Conergics was given an opportunity to take over the defense of the audit.

On April 19, 2012, the [Mexican tax authorities (the "SAT")] sent a letter to Dearborn announcing its intention to reopen the audit of Dearborn's 2004 tax year (hereinafter, the second audit). . . It is undisputed that DMW and Dearborn (collectively, defendants) did not furnish plaintiffs with written notice of the second audit in the manner specified by section 13.8 of the SPA until January 24, 2014, 21 months after defendants had received notice of the second audit from the SAT in April 2012. In the interim, Dearborn undertook its own defense of the second audit, both in dealing directly with the SAT and in court.

After the SAT issued a ruling unfavorable to DMW, Dearborn finally gave Conergics notice of the second audit. Conergics subsequently added a claim to an existing action relating to the SPA seeking "a declaration that plaintiffs are not obligated to indemnify defendants for the second audit by reason of defendants' failure to provide the notice required by the SPA and the consequent deprivation of plaintiffs' contractual right to control the defense of the audit." The defendants asserted counterclaims for indemnification; both sides moved for summary judgment, which the trial court denied.

On appeal, the Second Department held that the notice was untimely and that Conergics was prejudiced thereby, explaining that:

late notice actually prejudices the indemnitor when it results in a material deprivation of the indemnitor's right to control the defense of the claim . . . . For example, in Wainco Funding v First Am. Title Ins. Co. of N.Y., the "no prejudice" rule did not apply to the title insurance policy at issue because, although the policy required the insured give the insurer prompt notice of lien foreclosure proceedings, it further provided — much like the SPA in this case — that failure to provide such notice would not affect the insured's rights "unless the insurer shall be actually prejudiced by such failure". The Second Department held that the insured's 20-month delay in notifying the insurer of a tax lien foreclosure proceeding "actually prejudiced" the insurer "by depriving it of the opportunity to participate in the tax lien proceeding in any way."

. . .

In this case, we need not define the lower limit of what would constitute a material deprivation of plaintiffs' "sole right" to control the defense of the second audit under the SPA. The 21-month period in which Dearborn defended the audit itself, without notice to plaintiffs — during which the SAT completed its review of the relevant records and reached an initial tax deficiency assessment, and including the entire pendency of an Amparo court proceeding that unsuccessfully sought to terminate the audit on constitutional grounds, as well as the unsuccessful appeal from the dismissal of the Amparo — unquestionably constituted a material deprivation of plaintiffs' "sole right to represent [Dearborn's] interests" in the second audit under section 8.5(b) of the SPA and, therefore, "actually prejudiced" plaintiffs within the meaning of section 8.1(c) of the SPA. We note that this construction of section 8.1(c) does not leave the provision's actual prejudice requirement without effect, since notice that is not prompt may still come before the indemnitor has been materially deprived of its right to control the defense of an audit. Here, however, such was not the case.

(Internal citations and quotations omitted).