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Include It or Lose It: Insurance Policies v. Reservation of Rights and the Recovery of Defense Costs (NY)

February 26, 2021

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<p style="text-align: justify;">Insurance policies act as binding contracts setting the scope of coverage and exclusions as the insurer sees fit, pursuant to the laws of the state. A recent court decision in New York has established that insurance policies must be confined to the four corners of its content.</p>
<p style="text-align: justify;">The recent Second Department decision in <em> <a href="">American W. Home Ins. Co. v Gjonaj Realty &amp; Mgt. Co. </a></em>held that upon determining a duty to defend does not exist, an insurer may not recover defense costs when the policy does not explicitly provide for such recovery, regardless of its reservation of right to do so.</p>
<p style="text-align: justify;">In this case, a personal injury action was brought against the insured for injuries sustained on the insured’s property. Consequently, the insured did not notify its insurance company until four years after the incident when a judgment was made against them. While the insurer denied coverage due to the late notice, it agreed to defend the insured after the judgment was vacated under a reservation of rights to deny coverage if the default judgment was reinstated. The insurer also reserved its right to recover from the insured any fees and costs incurred while defending them. However, such a provision was not expressly included in the insured’s policy.  When the default judgment was reinstated, the insurer denied coverage and pursuant to its reservation of rights letter, sought to recoup fees and costs from the insured.</p>
<p style="text-align: justify;">The Appellate Division held that while the insurance company correctly had no obligation to indemnify or defend the insured, it was not entitled to recoup the defense costs because the insured’s policy did not expressly provide for such reimbursement. The court’s most notable reason for its conclusion was that insurance companies should include language in its policy permitting recovery of defense costs. Such language in a reservation of rights letter only does not create a new implied contract with the insured.</p>
<p style="text-align: justify;">This decision goes against prior New York state and federal cases which permitted recovery of defense costs. However, whether recovery is appropriate has never been explicitly addressed before. Moving forward, the outcome of this case will require insurance companies to re-examine their policies to include such specific language without relying solely on a reservation of rights to recover defense costs.</p>
<p style="text-align: justify;">Thank you to Gabriella Scarmato for her contribution to this post.  Please email <a href="">Georgia Coats</a> with any questions.</p>

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