Second Department Distinguishes Treatment of Claims and Damages against Insurance Company in Breach of Duty to Defend Case

On November 17, 2021, in East Ramapo Cent. Sch. Dist. v New York Schs. Ins. Reciprocal, 2021 NY Slip Op 0634, the Second Department reversed the decision of Justice Stephen A. Bucaria that dismissed a claim arising from an insurer’s bad-faith denial of coverage and reduced by 65% damages relating to a breach of the duty to defend. The Court explained that in the context of insurance liability litigation, at the pretrial stage courts are reluctant to dismiss complaints alleging bad faith and damages for breach of the duty to defend, unlike in a fee shifting case, are presumed reasonable:

In the context of an insurance-related dispute, the implied covenant of good faith and fair dealing means that the insurer must investigate claims for coverage in good faith, must not manufacture factually incorrect reasons to deny insurance coverage, must not deviate from its own practices or from industry practices, and must not act with "'gross disregard' of the insured's interests" (Smith v General Accident Ins. Co., 91 NY2d 648, 653, quoting Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d 445, 453; see McBride v New York Prop. Ins. Underwriting Assn., 152 AD3d 505, 506; 25 Bay Terrace Assoc., L.P. v Public Serv. Mut. Ins. Co., 144 AD3d 665, 667). Because claims arising from an insurer's bad-faith denial of coverage are "generally proven by evidence largely circumstantial in nature" (Reifenstein v Allstate Ins. Co., 92 AD2d 715, 716 [internal quotation marks omitted]), courts are "reluctant to dismiss complaints alleging bad faith at the pretrial stage" (id. at 716; see Roldan v Allstate Ins. Co., 149 AD2d 20, 37-38).

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Here, the Supreme Court, in the August 2017 order, erred in grating the defendant's motion pursuant to CPLR 3211(a)(7) to dismiss the cause of action to recover damages for breach of the implied covenant of good faith and fair dealing. The plain language of the complaint reflects the plaintiff's allegation that the defendant breached the implied covenant of good faith and fair dealing. The complaint alleged, inter alia, that the defendant failed to investigate in good faith the claims in the underlying action, denied coverage to the plaintiff based upon a manufactured and/or "nonexistent" assertion, deviated from industry practices by denying coverage to the plaintiff where "[n]o reasonable insurer would have denied [such] coverage," and "[disclaimed] coverage with gross disregard for the facts and applicable law" (see Smith v General Accident Ins. Co., 91 NY2d 654-655; Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d 453-454; McBride v New York Prop. Ins. Underwriting Assn., 152 AD3d at 506; 25 Bay Terrace Assoc., L.P. v Public Serv. Mut. Ins. Co., 144 AD3d at 667). In determining the defendant's motion to dismiss, the court was required to accept as true the facts alleged in the complaint, accord the plaintiff the benefit of every possible favorable inference, and determine only whether the facts as alleged by the plaintiff fit within any cognizable legal theory (see Leon v Martinez, 84 NY2d at 88; JDI Display Am., Inc. v Jaco Elecs., Inc., 188 AD3d at 845; Palero Food Corp. v Zucker, 186 AD3d at 495). Instead, the court improperly focused upon whether the plaintiff had "shown how sharing the disclaimer letter with the plaintiffs in the underlying action was collusion or bad faith," and thus erroneously determined that the plaintiff had failed to state a cause of action because the plaintiff did not make such a showing (emphasis added).

Moreover, where, as here, the cause of action to recover damages for breach of the policy and the cause of action to recover damages for breach of the implied covenant of good faith and fair dealing allege different conduct on the part of the defendant and seek different categories and/or types of damages, the cause of action seeking damages for breach of the implied covenant of good faith and fair dealing should not be dismissed as "duplicative" of the cause of action alleging breach of contract (25 Bay Terrace Assoc., L.P. v Public Serv. Mut. Ins. Co., 194 AD3d at 672; McBride v New York Prop. Ins. Underwriting Assn., 152 AD3d at 506; Gutierrez v Government Empls. Ins. Co., 136 AD3d at 976; Elmhurst Dairy, Inc. v Bartlett Dairy, Inc., 97 AD3d 781, 785). Accordingly, the defendant's motion pursuant to CPLR 3211(a)(7) to dismiss the cause of action to recover damages for breach of the implied covenant of good faith and fair dealing should have been denied (see Twinkle Play Corp. v Alimar Props., Ltd., 186 AD3d 1447, 1449; Tiffany Tower Condominium, LLC v Insurance Co. of the Greater N.Y., 164 AD3d 860, 861-862; 25 Bay Terrace Assoc., L.P. v Public Serv. Mut. Ins. Co., 144 AD3d at 667).

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An insured's application to recover, as damages for breach of contract, the out of [*3 ]pocket costs the insured incurred in paying its own attorney's fees as a result of the insurer's breach of its duty to defend should be treated differently from an application to have another party pay one's attorney's fees under a fee-shifting statute (see Medcom Holding Co. v Baxter Travenol Laboratories, Inc., 200 F3d 518, 520-521 [7th Cir] ). When determining breach of contract damages for breach of an insurer's duty to defend, the attorney's fees paid by the insured "are presumed to be reasonable and the burden shifts to the insurer to establish that the fees are unreasonable" (Columbus McKinnon Corp. v Travelers Indemnity Company, 367 FSupp3d 123, 155 [SD NY], quoting Olin Corp. v Ins. Co. of N. Am., 218 FSupp3d 212, 228 [SD NY] [applying New York law]). Here, the plaintiff submitted evidence that it spent $1,710,118.27 in attorneys' fees and costs in defending against the underlying action as a result of the defendant's breach of its duty to defend. However, in its December 2017 order, the court reduced by more than 65% the $1,710,118.27 in damages sought by the plaintiff and awarded the plaintiff the total sum of only $647,052.62. In so doing, the court erroneously treated the actual damages incurred by the plaintiff as if they were presented via an application for attorneys’ fees, when it should have instead treated the fees as presumptively reasonable.

The attorneys at Schlam Stone & Dolan LLP frequently litigate claims against insurance companies. Contact the Commercial Division Blog Committee at commercialdivisionblog@schlamstone.com if you or a client have questions about denial of insurance coverage.