First Department Holds That Out of Pocket Damages Are Requirement to Claim for Common Law and Contractual Indemnification

Osowski v. AMEC Const. Management, Inc.
--- N.Y.S.2d ----, 2009 WL 3200042
N.Y.A.D. 1 Dept.,2009.

In a case filled with insurance company intrigue and recriminations the First Department issued an eminently reasonable decision, but once again, saw fit to throw the bar another unnecessary head scratcher from left field. As you may recall, I wrote in a NYLJ piece from October 6, 2006, the First Department stated that affirmative defenses which were not complete defenses to an action, such as offsets, comparative negligence and Article 16, were actually counterclaims and suggested they could be dismissed as improperly plead if labeled affirmative defenses!! See
http://www.gordon-silber.com/pdf/7-13-09-NYLJ-1st-Dept-Decisions-in-Conflict-Over-Other-Insurance-Provisions-Jon-Lichtenstein.pdf

Now the Court claims that in order to be able to plead a valid claim for common law or contractual indemnification, you need to be able to show “out of pocket” damages. While “out of pocket” damages has been held to define the scope of damages that may be recovered in a breach of contract to procure insurance cause of action (see Inchaustegui v. 666 5th Avenue, 96 N.Y.2d 111, 725 N.Y.S.2d 627 (2001), I am aware of no prior suggestion that out of pocket damages is a necessary element to a claim for indemnification. Not surprisingly, the First Department did not cite to any authority for its pronouncement. Osowski, 2009 WL 3200042 at *4.

The decision written by Judge James Catterson and joined unanimously by judges David B. Saxe, James M. Mcguire, Karla Moskowitz, and Rolando T. Acosta arose out of a construction accident where the plaintiff lost his left leg and multiples toes from his right foot when a four-ton steel beam fell on him while he was unloading a truck.

Plaintiff brought a claim against the owner of the project (“NYT”) as well as the construction manager (“AMEC”). The plaintiff was employed by the steel erectors (“DCM”). The NYT/AMEC and DCM were all insured under a construction wrap up “OCIP” insurance program which prohibited subrogation actions between the three aforementioned co-insureds. However, when the excess carrier in the OCIP program AIG disclaimed coverage, the manager brought a third-party claim against DCM for common-law and contractual indemnification, on the theory that in the absence of excess coverage the anti-subrogation provision did not apply. NYT/AMEC also commenced a declaratory judgment action against AIG.

During the damages trial in the main action, a Confidential Settlement Agreement” was made between the plaintiffs and NYTB and AMEC for a total of $12 million. Of this amount, $2 million would be paid by the primary carrier (Travelers) and $10 million would be paid by a letter of credit “provided for” by NYTB and AMEC.

When the settlement was announced, the attorneys for DCM smelled something fishy. For one thing, it was unclear who was funding the letter of credit. DCM seemed to immediately comprehend that if the letter of credit was funded by AIG that the third-party action might be barred by the anti-subrogation doctrine as well as the anti-subrogation provision in the OCIP. DCM moved to compel disclosure of the settlement documents and AMEC/NYTB cross-moved to for a protective order. After the judge Jane Solomon reviewed the settlement documents AMEC/NYTB was ordered to turn them over.

It turned out that the terms of the settlement agreement provided that AIG would fund the letter of credit, that AMEC/NYTB would dismiss the declaratory judgment action with prejudice, that AMEC/NYTB would assign AIG its claims against DCM in the third-party action, and that the settlement was without prejudice to AIG's disclaimer of coverage with respect to DCM.

Based on this disclosure the trial court dismissed the third-party action based on the waiver of subrogation provision in the OCIP.

The matter went up on appeal. AMEC/NYTB argued that AIG had not rescinded its disclaimer, and nothing in the settlement agreement implied otherwise.

If the reader is surprised that AMEC/NYTB took such a position in the first place, let alone took an appeal, it might also come as a surprise that AMEC/NYTB appealed the trial judge’s order disclosing the terms of the settlement agreement.

"It is not surprising that the First Department affirmed Judge Solomon’s decision. The settlement agreement clearly smacked of self-dealing. In fact, the First Department went so far as stating that “[w]e believe that counsel's continued prosecution of the third-party action against DCM after AMEC/NYTB entered into the settlement agreements raises substantial questions under the Code of Professional Responsibility.” It also stated that the attempt to prevent the disclosure “cannot be viewed as anything but a clear attempt to perpetrate a fraud on the court.” Osowski, 2009 WL 3200042 at *5.

It thus should have been a simple matter for the First Department. A fairly straight forward affirmance. However, instead of simply affirming the trial court’s finding that AIG’s funding of the settlement constituted a revocation of the disclaimer, thereby triggering the applicability of the anti-subrogation provision, the Court went on to do violence to the ancient law underpinning claims for indemnification. The Court stated:

"…the question…who funded the settlement of the main action [is] critical to whether AMEC/NYTB could continue to maintain the third-party action. In other words, if AMEC/NYTB's alleged losses were not “out-of-pocket,” no suit could be maintained for common-law or contractual indemnification, either by AMEC/NYTB or by AIG as its assignee." Osowski, 2009 WL 3200042 at *4.

Further the court held:

In funding the $10 million for the letter of credit, AIG effectively paid on the policy on which it had disclaimed. As a result, it foreclosed any claims AMEC/NYTB could have pursued against DCM in any third-party action because AMEC/NYTB were not out of pocket in connection with the settlement. Thus, AMEC/NYTB had no claims left to pursue or to assign to any other party, least of all to AIG since the effective payment on the policy triggered the waiver of subrogation clause. Osowski, 2009 WL 3200042 at *5.

The First Department here, seems to be announcing a new and somewhat revolutionary concept: that a party does not have a claim for contractual indemnification in the absence of out-of-pocket damages. It remains to be seen whether this pronouncement will be roundly ignored, reversed by the Court of Appeals or subsequently adopted. In the meantime, this blawger is armed with yet another reason to deny on behalf of my clients, demands for contractual indemnification.

First Department Suggests It is an Insurance Carrier's Obligation to Notify Potential Claimants of its Change of Address

American Transit Ins. Co. v. Brown
--- N.Y.S.2d ----, 2009 WL 3199800
N.Y.A.D. 1 Dept.,2009.

ANDRIAS, J.P., CATTERSON, RENWICK, DeGRASSE, FREEDMAN, JJ.

In a stunning decision, the First Department seems to have held that it is the insurance carrier’s burden to notify potential claimants of a change in its address, not the claimant’s burden to verify the carrier’s current location. The decision contains a stinging dissent from Justices Catterson and Andrias.

This declaratory judgment action arose out of an automobile accident between Arthur Brown (“Brown”) and Albertano Batista (“Batista”) in November 2002. Batista’s insurance carrier, American Transit Insurance Company (“ATIC”) sent a written acknowledgement of Brown’s property damage claim in January 2003 which it subsequently settled (date not supplied).

In November 2005 Brown commenced a personal injury action against Batista. Brown forwarded the summons and complaint to ATIC in January 2006, using the address on ATIC’s acknowledgement letter from three years before. Unbeknownst to Brown, ATIC had moved its offices in November 2003. Upon Batista's failure to appear in the action, Brown obtained a default judgment for $81,830 and served a copy of the unsatisfied judgment with notice of entry upon ATIC at its current offices. ATIC promptly issued a letter of disclaimer and commenced this declaratory judgment action on the ground that neither Batista nor Brown gave it timely notice of the underlying lawsuit as required by the policy. The Supreme Court denied the parties' motions for summary judgment to allow for further discovery.

On appeal, the majority acknowledged that the failure to satisfy a notice requirement “may allow an insurer to disclaim its duty to provide coverage” (see American Tr. Ins. Co. v. Sartor, 3 NY3d 71, 76 [2004]), but also observed that “a failure to satisfy an insurance policy's notice requirement does not vitiate coverage where there is a valid excuse (cf. Matter of Allcity Ins. Co. [Jimenez], 78 N.Y.2d 1054, 1055 [1991]).

Brown claimed a valid excuse, arguing that ATIC had never notified him of its change of address. The Court was not swayed by the fact that the carrier’s new address was printed on the check forwarded to Brown's counsel in settlement of the property damage matter and that ATIC had taken all normal and customary actions to announce and document its current address.

Judge Catterson in dissent, flatly denied that there is a legal obligation for a defendant's insurer to notify a potential plaintiff or plaintiff's counsel of the insurer's change of address. In addition, he harshly criticized the majority’s justification for Brown’s failure to notify ATIC of the pending litigation. He noted that it had been years since ATIC had settled the property damage case with Brown. Moreover, ATIC had sent a mass mailing announcing its change of address at the time of the move, notified the State Insurance Department and the post office of its change of address, and had changed its address on its web site and all phone listings. His withering dissent concludes by stating that “the majority is willing to accept an attorney's lack of diligence in failing to spend three-tenths of a second to verify an address on the Internet as a valid excuse for the failure to satisfy an insurer's notice requirement.”

This reporter wonders whether this case will have the effect of watering down the concept of due diligence in other scenarios. Hopefully, ATIC will take advance of the split decision to appeal the case to the Court of Appeals. I will of course, report on any further developments.

Addendum to Last Post Involving P.J.P. Mechanical Corp. v. Commerce and Industry Ins. Co.

The day after my article was published in the NYLJ, the attorney for P.J.P. Mechanical Corp., Arthur Semetis called me. He told me that the article was right on the money. Notably, he stated that the only substantive defense raised by the general contractor against his client with respect to its invoice for $650,000 was PJP's negligence, thus clarifying that the sole issue in the case was the insured's negligence and not other issues relating to contract.

He likewise was mystified by the Court's comment that he should have moved to dismiss the offset affirmative defense early in the case in order to force the issue to be brought as a counterclaim. Despite his close involvement, he also had no clue as to what theory he could have utilized to have the defense dismissed. He agreed with me that presumably the Court believed such a defense was improperly plead and was really a counterclaim.

Mr. Semetis stated that his client was considering seeking leave to appeal to the Court of Appeals. The $930,000 settlement was reflective of the additional costs of being forced to fire PJP's subcontractor and hire a new one. Nice job Artie!

First Department Finds No Duty to Defend Insured Based on Negligence Based Affirmative Defense in Breach of Contract Action

The Court Suggests that Offsets are Counterclaims Not Affirmative Defenses, and thus Subject to Dismissal

P.J.P. Mechanical Corp. v. Commerce and Industry Ins. Co.
--- N.Y.S.2d ----, 2009 WL 1687773
N.Y.A.D. 1 Dept., June 18, 2009.

This article can be found online at:
http://www.law.com/jsp/nylj/index.jsp

This controversial case of first impression in New York addresses the question “does an insurer have a duty either to fund or to reimburse for separate litigation commenced by its insured, where the responsive pleadings raise an affirmative defense based on a claim of offset?” The First Department affirmed the decision of Judge Karla Moskowitz that no such duty exists.

However, the decision’s real impact will likely result from the unintended consequences of its dual holding, that affirmative defenses that seek to offset damage verdicts are subject to dismissal since they are really counterclaims. Such a proposition if accepted by the trial courts of the First Department, would lead to extreme practical consequences for practitioners of negligence law.

Plaintiff was a contractor retained to perform HVAC work in a commercial building in 2001. A pipe separated from a riser causing $500,000 in damages. The defendant insurance carrier was put on notice of the incident and conducted an investigation. The result of the investigation did not conclusively establish fault. When the plaintiff presented its invoice for services performed in the amount of $650,000, the general contractor refused on the grounds that plaintiff’s negligence caused $500,000 in damages which it claimed as an offset to the amount due. (It is unclear whether a payment of $150,000 was made).

Plaintiff requested its carrier to assign counsel to defend the allegation that it was negligent (and presumably to fund the affirmative claim for the balance that was due and owing), which the carrier refused in the absence of a lawsuit. In February 2003, plaintiff hired its own counsel to bring a breach of contract claim against the general contractor and the owner. When the general contractor and owner asserted an affirmative defense of offset, plaintiff again requested a defense from its carrier which was again refused. In November 2004, plaintiff served an amended complaint and this time, the general contractor and owner counterclaimed against the plaintiff for property damage.

When plaintiff presented the counterclaim to its carrier, the carrier offered to assign counsel, but only to defend the counterclaim.

In December 2005, the plaintiff instituted the declaratory judgment action. The First Department affirmed the lower court’s decision in favor of the carrier finding “there is nothing in the policy language that requires defendant to either prosecute affirmative claims or reimburse plaintiff for the fees paid its counsel for such affirmative claims” National City Bank v. New York Central Mut. Fire Ins. Co., 6 A.D.3d 1116, 1117, 775 N.Y.S.2d 679 [2004], lv. denied 3 N.Y.3d 605, 785 N.Y.S.2d 21, 818 N.E.2d 663 [2004]; Goldberg v. American Home Assur. Co., 80 A.D.2d 409, 411-12, 439 N.Y.S.2d 2 [1981].

The Court found that the assertion of an affirmative defense did not constitute a “suit” which needed to be defended, since “suit” was defined in pertinent part in the policy as:

“a civil proceeding in which damages to which this insurance applies are alleged.”

The issue thus was whether the assertion of an offset was an allegation of damages against the insured. In answering this question as no, the Court focused on the difference between an affirmative defense and a counterclaim. The Court distinguished the former by stating: “[t]he effect of a successful affirmative defense is the dismissal of a plaintiff's complaint or cause of action. It does not give the defendant any affirmative relief against a plaintiff, such as monetary damages.” The Court further noted that “a claim that does not defeat the plaintiff's cause of action, but constitutes an independent cause of action for the defendant, should be pleaded as a counterclaim, and not as an affirmative defense.” (Citing 84 N.Y. Jur. 2d, Pleading § 166).

If this definition seems a bit off, it should. In defining an affirmative defense as something that defeats or dismisses the complaint, the Court ignored that the affirmative defense in the subject action was one of several affirmative defenses which do not attack the viability of cause of action, but merely seek to reduce the plaintiff’s damages. Practitioners are familiar with such affirmative defenses such as those relating to collateral sources, Article 16 and comparative negligence.

Although the First Department in P.J.P. Mechanical Corp. did not broadly address how its decision would affect these types of affirmative defenses, its definition would now seem to exclude them from the pantheon.

As unlikely as this may sound, this is exactly what the Court appears to have had in mind. In colloquy, the Court pointed out that the plaintiff would have been better off if it had:

“move[d] to strike the defense [in order to] force [the general contractor] to replead the claim as a counterclaim. This would have triggered the insurer's duty to defend. Had these steps been taken in the instant action, defendant would have been forced to defend plaintiff at the beginning of the case, rather than when the counterclaim was voluntarily asserted…several months later.”

There was no explanation as to why the affirmative defense was subject to dismissal other than the Court’s assertion it was really a counterclaim – and thus improperly pleaded.

The Court’s decision raises some fairly fundamental questions. If affirmative defenses, such as comparative negligence, Article 16 and collateral sources reimbursement are not proper affirmative defenses and can be stricken if they are not designated as counterclaims, does that mean that negligence practitioners need to amend every answer in their offices?

Before panic sets in, it should be noted that it is doubtful that the First Department has the authority to change the definition of an affirmative defense, given that they are defined by statute by CPLR §3019, which provides in pertinent part:

(b) Affirmative defenses. A party shall plead all matters which if not pleaded would be likely to take the adverse party by surprise or would raise issues of fact not appearing on the face of a prior pleading such as arbitration and award, collateral estoppel, culpable conduct claiming in diminution of damages as set forth in article fourteen A [other examples omitted]…..The application of this subdivision shall not be confined to the instances enumerated.

No where in the statutory definition is there a requirement that the defense result in the dismissal of the complaint. In fact, the definition explicitly cites “diminution of damages” (an offset) as an example of an affirmative defense.

The First Department’s attempt to re-define affirmative defenses seems to have been done in an attempt to blunt the fact that from the point of view of its insured, there was no difference between a dollar offset and a dollar claimed in counterclaim. In fact, this was the basis of the only apparent authority on the matter, Construction Protective Servs. v. TIG Specialty Ins. Co., 29 Cal.4th 189, 126 Cal.Rptr.2d 908, 57 P.3d 372 [2002], which plaintiff relied upon. The California court held in Construction that the carrier was obligated to assign counsel precisely because “the effect of pleading a setoff defense is the same as if it were pleaded as a counterclaim…”

In view of the ambiguity in the policy language, the Court should have instead analyzed the issue by addressing the question what was the reasonable expectation of the parties? If so analyzed, plaintiff arguably would have prevailed. The broken pipe and resulting property damage was clearly an occurrence under the policy. Such property damage was a fundamental aspect of the underlying litigation even prior to the assertion of the counterclaims. Indeed, the counterclaims did not fundamentally alter the litigation in any way.

Notably, the underlying action was ultimately settled in plaintiff’s favor for $930,000, apparently reflecting years of interest. Ironically, the defendant argued that this was evidence that “plaintiff's demand for reimbursement of legal costs incurred in connection therewith did not constitute a claim for property damage or bodily injury…” It is odd that the Court thought it appropriate to cite this argument since it is the equivalent of claiming that the insured did not deserve a defense, because it was ultimately found not negligent.
Notwithstanding that the First Department’s definition of affirmative defenses contradicts CPLR §3019, defense counsel should nevertheless be forewarned that the plaintiff’s bar may in the context of an in limine motion, seek to have affirmative defenses seeking reduction in damages based on collateral sources, Article 16 and comparative negligence, dismissed on the ground they were not asserted as counterclaims, pursuant to the authority of P.J.P. Mechanical Corp. v. Commerce.