The New York Court of Appeals’ recent decision in K2 Investment Group, LLC, et al. v American Guarantee & Liability Insurance Company may—or may not—be a game changer. Under New York law, the duty to defend is exceedingly broad. If the complaint contains any facts or allegations that bring the claim potentially within the policy, then the insurer must defend. The duty to defend arises when the allegations within the four corners of the complaint potentially give rise to a covered claim, or where the insurer has knowledge of facts establishing a reasonable possibility of coverage. Even if a purportedly covered claim is frivolous or groundless, the allegations still trigger the duty to defend.

Generally, an insurer has no duty to defend where the allegations in the complaint raise no possibility that the insurer would be required to indemnify its insured. While facts beyond the complaint cannot be used to disclaim the duty to defend, they must be taken into account if the insurer has actual knowledge of facts that, if pled, would trigger its duty to defend. The duty to indemnify is narrower, arising only where the claim for which the insured is liable falls within the policy’s coverage.

The K2 Decision

In K2, the Court of Appeals recently held—in what may be new law—that because an insurer breached its duty to defend, it could not later rely on otherwise potentially applicable exclusions to deny coverage for indemnification. In other words, an insurer’s wrongful failure to defend may mean that the insurer is liable in an amount up to its policy limits, even if a policy exclusion might preclude coverage for indemnification. The unanimous ruling potentially expands insurers’ indemnity obligations beyond the coverage afforded by the policy and, as the court suggests, makes a pre-denial declaratory judgment action an important strategic consideration.

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