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.

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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.