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.