February 2, 2000
TO: Interested Claims Professionals
Re: Recent Second Circuit Decision on Breach of Cooperation Clause
We are writing to let you know about a Second Circuit decision handed down yesterday, concerning the circumstances under which an insurer can disclaim coverage because of an insured’s breach of a cooperation clause. New York City Housing Authority v. Housing Authority Risk Retention Group, N.Y.L.J., 2/2/00, p. 25, col. 3 (2nd Cir., 99-7264, 2/1/00). In that decision, the Second Circuit Court of Appeals held that, even though the policyholder had breached the policy by obstructing the insurer’s efforts to settle a claim, the insurer was nevertheless not entitled to disclaim, because it had not made a diligent effort to persuade the insured to accept the proposed settlement and, therefore, the insured’s breach did not amount to “willful and avowed obstruction” of the insurer’s settlement efforts.
The underlying case arose from a 1993 incident, in which unidentified assailants entered a public housing development and shot one Amado Sanchez, leaving him paralyzed. Mr. Sanchez sued the NYC Housing Authority, alleging that its negligent failure to fix a broken front door lock was a proximate cause of the incident. The Housing Authority retained the firm of Wilson, Elser, Moskowitz, Edelman & Dicker to defend it against the Sanchez claim.
The Housing Authority had a $500,000 SIR applicable to the Sanchez claim, above which was insurance provided by the Housing Authority Risk Retention Group (“HARRG”). The policy gave HARRG discretion to settle claims with a “reasonable chance” of exceeding the insured’s SIR.
During the trial of the Sanchez action in 1997, HARRG asked the Housing Authority to tender its $500,000 SIR as part of a $1 million settlement that HARRG wanted to offer Mr. Sanchez. The Housing Authority refused to tender its SIR. Nevertheless, at HARRG’s request, Wilson Elser proposed a $1 million settlement to Mr. Sanchez, who rejected it.
The insured strongly objected to the settlement offer because it erroneously believed the plaintiff would be unable to make out a prima facie case at trial and, even in the event of an adverse verdict, the case would be dismissed on appeal. Nevertheless, HARRG persisted and asked defense counsel to offer Mr. Sanchez a “high-low” settlement of $1 million / $2.5 million. This time, however, the Housing Authority instructed Wilson Elser not to make the offer. Defense counsel followed the insured’s direction, not the insurer’s, and therefore did not make the offer to the plaintiff. The Housing Authority also wrote a letter, informing HARRG of what it had done. Citing the Housing Authority’s “obstructive conduct,” HARRG disclaimed in writing the next day.
The day after the disclaimer, the jury returned a verdict in favor of the plaintiff, in the amount of $5.5 million. HARRG refused to indemnify the Housing Authority for the resulting judgment, citing the Housing Authority’s breach of the cooperation clause and HARRG’s written disclaimer. The Housing Authority then sued HARRG in U.S. District Court, seeking indemnification for the amount of the judgment in excess of the $500,000 SIR. The District Court agreed with HARRG that (a) the insured had breached the cooperation clause and (b) HARRG’s disclaimer had been effective.
The Second Circuit reversed. Although the Second Circuit agreed that the Housing Authority had breached the policy by frustrating HARRG’s settlement efforts, it nevertheless held that HARRG’s disclaimer had been ineffective. The Court reached that result because New York law permits an insurer to disclaim under these circumstances only where it has acted diligently and in a manner reasonably calculated to get the insured’s cooperation and, even after such a diligent, reasonable effort, the insured’s attitude has remained one of “willful and avowed obstruction.” Here, HARRG’s disclaimer did not suggest or ask that the Housing Authority change its mind or allow the settlement, and thereby restore coverage. On the contrary, the tone of HARRG’s disclaimer was final and unconditional. There was also no evidence that HARRG had ever explained to the insured why settlement was appropriate, or that HARRG had made any effort to secure the insured’s cooperation. Because HARRG had never even attempted to persuade the Housing Authority to change its mind and cooperate, the Housing Authority’s conduct fell short of “willful and avowed obstruction.”
HARRG then argued that, even if it had to indemnify the Housing Authority, it should not have to indemnify it for more than the $2.5 million upper limit that HARRG had wanted to offer as part of the high-low settlement. The Second Circuit disagreed, holding that HARRG could not limit its duty to indemnify to the high end of the unmade settlement offer unless it could prove that Mr. Sanchez would have accepted that high-low settlement offer. The Second Circuit remanded the case to the District Court for the sole purpose of determining whether, if such a high-low settlement offer had been made, Mr. Sanchez would have accepted it. (Would anyone care to bet on what his testimony will be on that score?)
The moral of the story is that, under New York law, an insured’s mere breach of the cooperation clause is not enough to support a disclaimer of coverage. Instead, the disclaimer must be supported by evidence that:
- the insurer made a diligent, good-faith effort to get the insured to change its mind and cooperate, and
- the insurer’s efforts were reasonably calculated to secure the insured’s cooperation, and
- even after the insurer’s diligent and reasonable efforts to secure his cooperation, the insured’s attitude was one of “willful and avowed obstruction.”
That rule would apply in situations such as this, where an insured frustrates settlement efforts. It would also apply to such situations as an insured’s failure to appear for his own deposition, or an insured’s failure to turn over documents needed for the defense or in discovery.
If any of you would like a copy of the Second Circuit’s decision, please let us know.
Sincerely,
Thomas M. Bower
