Insurance Coverage
DECEMBER 2004
GOOD NEWS OR BAD NEWS FOR POLICYHOLDERS?
NEW YORK’S HIGHEST COURT UNANIMOUSLY CONFIRMS A POLICYHOLDER’S RIGHT TO
RECOVER COUNSEL FEES WHEN SUED BY ITS INSURANCE COMPANY IN A LIABILITY
INSURANCE COVERAGE DISPUTE, EVEN WHEN ITS INSURANCE COMPANY DEFENDED THE
POLICYHOLDER IN THE UNDERLYING LITIGATION.
INTRODUCTION
“In contrast with other legal systems, such as that in
Great Britain, it has now long been the universal rule in
this country not to allow a litigant to recover damages
for the amounts expended in the successful
prosecution or defense of its rights.”1 Exceptions exist
where provided for by rule, statute or agreement of the
parties. One exception, notable to policyholders,
exists under New York law: when an insurance
company sues its policyholder for a declaratory
judgment that it has no duty to defend or indemnify
the policyholder, a prevailing policyholder may
recover the fees incurred in defending that action.2 By
its decision this month in U.S. Underwriters Insurance
Company v. City Club Hotel, LLC, et al,3 the New York
Court of Appeals reaffirmed this exception and
extended it to apply even when the insurer has
defended the policyholder in the underlying litigation.
BACKGROUND
The rationale for the exception permitting a
policyholder to recover defense fees incurred in
defending an insurance coverage action by its insurer,
discussed by the New York Court of Appeals in Mighty
Midgets, is rooted in the theory that an insurance
company’s duty to defend includes the defense of any
action arising out of a particular accident or
occurrence—including a declaratory judgment by an
insurance company against its policyholder. The court
in Mighty Midgets, however, refused to allow a plaintiff
policyholder to recover its attorneys’ fees in an insurance
coverage action because those fees were incurred in the
prosecution as opposed to the defense of the action.
THE COURT OF APPEALS DECISION
In City Club, the policyholder, Shelby Realty, was sued
for personal injuries allegedly sustained by a
construction worker (the “underlying action”). The
insurance company, U.S. Underwriters, sued Shelby
Realty in the United States District Court for the
Southern District of New York for a declaration that it did
not owe defense or indemnity for the underlying action.
During the coverage action, however, U.S. Underwriters
defended Shelby Realty in the underlying action.
Shelby Realty ultimately was successful in the coverage
action; the District Court granted summary judgment to
defendants on the issue of disclaimer of coverage,
finding that the insurer’s disclaimer was untimely as a
matter of law. The District Court, however, denied
Shelby Realty’s motion to recover attorneys’ fees
incurred in successfully defending the U.S. Underwriters
declaratory judgment action. The court did not follow
the exception discussed in Mighty Midgets and ruled
that attorneys’ fees were not warranted because U.S.
Underwriters did not breach the duty to defend.
On appeal to the Second Circuit, U.S. Underwriters
challenged the District Court’s finding that its disclaimer
of coverage was untimely, and Shelby Realty challenged
the denial of attorneys’ fees in the coverage action.
1
Mighty Midgets, Inc. v. Centennial Insurance Company, 47 N.Y.2d 12, 22 (1979) (“Mighty Midgets”) (denying recovery of attorneys’ fees by policyholder where policyholder
sued insurance company for declaratory relief).
2
Id. at 21.
3
(“City Club”) 2004 WL 2902402 *2 (2004 N.Y. Slip Op. 09321, New York Court of Appeals, December
16, 2004).
Kirkpatrick & Lockhart LLP
Noting a division in interpreting the relevant law, the
Second Circuit certified the following question to the
New York Court of Appeals: whether a policyholder
may recover attorneys’ fees expended in successfully
defending a declaratory judgment action brought by
its insurance company to determine that it has no
obligations under its insurance policy, even though its
insurance company defended the policyholder in the
underlying suit.
On review, the New York Court of Appeals rejected the
District Court’s ruling in denying Shelby Realty’s
motion for attorneys’ fees. Citing the rationale set forth
in Mighty Midgets, the Court of Appeals unanimously
reaffirmed that a prevailing policyholder is entitled to
recover attorneys’ fees incurred in defending an
insurer’s declaratory judgment action by holding that
Shelby Realty was entitled to recover its attorneys’
fees. The Court of Appeals explained:
IMPLICATIONS OF THE CITY CLUB
DECISION
First, the New York Court of Appeals’ decision in City
Club unanimously confirms that a policyholder who
successfully defends itself in a coverage suit initiated
by its insurance company will be reimbursed for the
costs incurred in defending that suit. Second, such a
policyholder will be reimbursed regardless of whether
the insurance company provided a defense in the
underlying action. An insurance company, however,
now has less incentive to defend its policyholder—
under a reservation of rights or otherwise—if it
intends to sue its policyholder for declaratory
judgment in New York or under New York law. These
implications should carefully be considered by a
policyholder that potentially is subject to New York
law in a dispute with its insurance company—before
it or its insurance company files suit.
Given that the expenses incurred by Shelby [Realty] in
defending against the declaratory judgment action arose as a
direct consequence of U.S. Underwriters’ unsuccessful
attempt to free itself of its policy obligations, Shelby is entitled
to recover those expenses from [U.S. Underwriters]. In other
words, Shelby [Realty]’s recovery of attorneys’ fees is
incidental to the insurer’s contractual duty to defend
To be sure, City Club is a policyholder-friendly
decision. At the same time, the decision may
negatively impact policyholders.
DAVID S. KWON
dkwon@kl.com
973.848.4025
ROBERT F. PAWLOWSKI
rpalowski@kl.com
973 .848.4032
The Insurance Coverage practice group at Kirkpatrick & Lockhart
LLP is one of the nation’s largest policyholder-oriented practices.
Its attorneys have authored Policyholder’s Guide to the Law of
Insurance Coverage and edited the Journal of Insurance Coverage.
FOR ADDITIONAL INFORMATION about these issues, please consult
the authors or any of Kirkpatrick & Lockhart’s office contacts listed below:
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