FKB's Andrew S. Kowlowitz was a featured columnist in the New York Law Journal. Mr. Kowlowitz' article is titled, "Mighty Midgets' Fee Shifting Rule: a Study in Exceptions." 5/25/11

'Mighty Midgets' Fee Shifting Rule: A Study in Exceptions

Andrew S. Kowlowitz
New York Law Journal
May 25, 2011

The general rule followed in New York (and all 50 states), often referred to as the "American Rule," provides that a successful litigant typically may not recover its legal fees from its adversary except where authorized by statute, agreement or court rule. The New York courts have recognized a narrow exception to the "American Rule" in the context of insurance coverage litigation. The courts permit an insured who prevails in insurance coverage litigation to recover its attorney's fees from its insurer if the insured has been cast into a "defensive posture" as a result of legal steps taken by its insurer seeking to free itself of its policy obligations. As is typically the case, this "fee shifting" exception also contains exceptions, and its application may at times appear inconsistent.

Most recently, in Estee Lauder v. OneBeacon Ins. Group, LLC, 2011 WL 488711 (2011), the New York County Supreme Court examined the application of the attorney fee shifting rule from the seminal decision, Mighty Midgets v. Centennial Insurance Co.¹ The court confirmed that an insured may only recover its coverage litigation costs from its insurer if the insured prevails in the coverage litigation, and is cast into a "defensive posture" as a result of steps taken by its insurer to avoid providing coverage.

Mighty Midgets provides that when an insured (as opposed to an insurer) commences litigation to settle its rights under the policy against its insurer, an insured typically may not recover its attorney's fees even if it prevails. In Mighty Midgets, an insured filed a declaratory judgment action against its commercial general liability insurer, Centennial Insurance Co., seeking a declaration that Centennial owed a duty to defend and indemnify Mighty Midgets in connection with an underlying personal injury action.

On summary judgment, the trial court ruled in favor of Mighty Midgets finding that Centennial owed a duty to defend and indemnify, and also awarded Mighty Midgets attorney's fees incurred in connection with the prosecution of the declaratory judgment action. On appeal, the Appellate Division, Second Department, affirmed the decision, yet struck the award of attorney's fees. Cross-appeals were taken, and the Court of Appeals heard the dispute.

The Court affirmed the Appellate Division's decision, finding that Mighty Midgets was entitled to coverage, as Centennial improperly disclaimed coverage, yet declined to award the insured its legal fees. The Court found that since the insured had taken the "offensive" and initiated the coverage litigation, it was not entitled to an award of attorney's fees. In other words, since the insured commenced the coverage litigation, it could not argue that it was cast in a "defensive posture" by its insurer and, therefore, was not entitled to recover its attorney's fees.

On the other hand, New York courts have routinely held that when an insurer brings a declaratory judgment action against its insured seeking a declaration that no coverage is afforded under a policy, an insured defendant who prevails in coverage litigation is entitled to recover its legal fees. For example, in Specialty National Insurance Company v. English Brothers Funeral Home,² an insurer who provided combination general liability/professional insurance to an insured funeral home filed a declaratory judgment action against its insured.

The insurer argued that it had neither a duty to defend nor indemnify its insured under its policy for a series of lawsuits which alleged intentional acts. In that case, the court in the Southern District of New York ruled that since the underlying lawsuits also alleged negligence (in addition to intentional misconduct), the insurer's duty to defend was triggered. Pursuant to Mighty Midgets, the court also awarded the successful insured the legal fees incurred defending the declaratory judgment action, since it was cast into a "defensive posture" by its insurer when Specialty filed the declaratory judgment action to "free itself from its policy obligations."

Declaratory Judgments

The New York courts have limited the application of the Mighty Midgets fee shifting rule to declaratory judgment actions involving "duty to defend" insurance policies. For example, in Employers Mutual Casualty Co. v. Key Pharmaceuticals,³ an excess insurer sought a declaration that it had no obligation to contribute to the settlement of an underlying tort action against its insured and parent company.

In Employers Mutual, the U.S. Court of Appeals for the Second Circuit affirmed the District Court's ruling finding that the insurer was obligated to indemnify its insured for those portions of the underlying settlement which fell within the excess insurer's layer of coverage. The Second Circuit also affirmed the District Court's ruling that the insured was not entitled to an award of attorney's fees, despite being cast in a "defensive posture." The court reasoned that the duty to defend was "not at issue" in this case, and the Mighty Midgets exception extended only to those limited circumstances where a "policyholder has been cast in a defensive posture by its insurer in a dispute over the insurer's duty to defend."⁴

It is worth noting that an insurer who owes a "duty to defend" cannot escape the Mighty Midgets fee shifting rules by providing a defense to an insured while simultaneously pursuing a declaratory judgment action. In U.S. Underwriters Insurance Co. v. City Club Hotel, LLC,⁵ a commercial general liability insurer sought a declaration that it had no duty to defend and indemnify its insured, City Club, for an underlying personal injury action. While pursuing its declaratory judgment action, U.S. Underwriters simultaneously provided City Club a defense to the underlying claim.

The District Court found for the insured defendants, finding the insurer waived its rights to disclaim coverage, yet denied the insured's request for an award of attorney's fees. The Second Circuit affirmed that decision, ruling that U.S. Underwriters owed a defense obligation, but certified for question the narrow issue concerning the award of attorney's fees under Mighty Midgets.

The Court of Appeals reversed the District Court's findings, ruling that City Club was entitled to an award of attorney fees under Mighty Midgets. The Court reasoned that "an insurer's duty to defend an insured extends to the defense of any action arising out of the occurrence, including a defense against an insurer's declaratory judgment action."⁶ In this instance, since the "expenses incurred by [the insured] in defending against the declaratory judgment action arose as a direct consequence of [the insurer's] unsuccessful attempt to free itself of its policy obligations, [the insured] is entitled to recover those expenses from the insurer."⁷

Defensive Posture

While at "first blush" it may appear that the New York courts have traditionally applied a bright line rule to the application of Mighty Midgets, permitting fee shifting awards for those prevailing insured defendants in coverage litigation, this is not always the case. In some instances, an insured plaintiff may be found to have been cast in a "defensive posture," warranting an award of legal fees under Mighty Midgets.

For example, in City of New York v. Zurich-America Insurance Group,⁸ the City of New York filed a declaratory judgment action against Zurich after the insurer failed to respond to its tender of an underlying tort claim. On summary judgment, the Supreme Court, New York County, ruled that the city was an additional insured under the Zurich policy, the underlying claim fell within the scope of coverage and that Zurich was obligated to defend and indemnify the city.

Subsequently, the city's answer was stricken in the underlying negligence litigation, for failing to comply with discovery orders. Apparently, during the time in which the city provided its own defense to the underlying claim (before the court ruled that Zurich owed a defense obligation), it failed to comply with two discovery orders. Thus, the underlying court struck the city's answer after the note of issue was filed. As a result, Zurich moved to amend its answer in the declaratory judgment action and assert an affirmative defense that the city's failure to adequately defend the underlying action was a breach of the covenant of implied good faith in the Zurich policy, as Zurich's rights have now been prejudiced. Zurich also moved for summary judgment on the basis that the city's breach barred coverage for the claim. The city cross-moved for summary judgment and an award of attorney's fees under Mighty Midgets.

The court ruled in favor of the city, finding that Zurich breached its contractual duty to defend the city when it failed to respond to the city's tender of the claim initially. Thus, the court found that Zurich waived its rights under the policy, and the city's non-compliance was, therefore, excused. The court also granted the city's application for an award of legal fees under Mighty Midgets. While the city was technically the plaintiff, the court nevertheless found that the city was cast into a "defensive posture by affirmatively requiring the city to re-litigate anew the declaration of coverage based upon a new theory." The court found that since the "new" coverage defense was initiated after the determination and conclusion of the city's declaratory judgment action, it was "tantamount to an action brought by the insurer seeking to free itself from its policy obligation."⁹ As such, the court ruled that an award of legal fees to the city was warranted.

In comparison, most recently in Estee Lauder v. OneBeacon Ins. Group, LLC,¹⁰ the New York County Supreme Court (Carol R. Edmead, J.S.C.), ruled that an insured was not cast into a "defensive posture" when having to defend an insurer's counterclaims in a declaratory judgment action. In this case, an insured, Estee Lauder, commenced a declaratory judgment action against its insurer, OneBeacon, alleging that OneBeacon failed to provide defense and indemnity for an environmental pollution claim.

In its answer, OneBeacon raised for the first time the affirmative defense of late notice (OneBeacon had previously disclaimed on the basis that it could not locate the policy). In support of its claim for attorney's fees, Estee Lauder argued that OneBeacon's late notice affirmative defense was never previously raised and did not "mirror" Estee Lauder's affirmative claims in the declaratory judgment action. Estee Lauder argued that, as a result, it was cast into a "defensive posture," as it now had to defend a "new" coverage defense.

The court ruled in favor of Estee Lauder, finding the coverage existed under the OneBeacon policy, but denied Estee Lauder's request for an award of attorney's fees under Mighty Midgets. The court found that OneBeacon's late notice affirmative defense was not tantamount to affirmative action, as timely notification of the claim was a condition precedent to coverage. The court reasoned that the insured was "never forced to debate facts different from those necessary for Lauder to make out its own prima facie case for coverage."

Indeed, the court found that Estee Lauder pled in its amended complaint that "it fulfilled all obligations on its part, and timely notified OneBeacon that it has been named as a third-party defendant..."¹¹ Thus, the court found that although OneBeacon had not previously raised the late notice defense, it was nevertheless a "mirror image" of the claims asserted by Estee Lauder, namely that it complied with all conditions to coverage.

Conclusion

One may argue that the Mighty Midgets fee shifting rule creates poor public policy as it encourages insurers to categorically deny coverage for otherwise valid claims, thereby forcing its insured to either file a declaratory judgment at its own cost, or simply abandon its right to coverage under the policy. This concern, however, may be alleviated by the practical commercial considerations. Insurers who routinely wrongfully disclaim coverage will quickly lose clients; insureds will cease renewing its policies, and insurance brokers will cease referring new business. Further, an insurer who wrongfully abandons an insured will lose the right to control the defense of an underlying action and the related costs.

Andrew S. Kowlowitz is a partner of Furman Kornfeld & Brennan.

Endnotes:
1. 47 N.Y.2d 12, 416 N.Y.S.2d 559 (1979).
2. 606 F.Supp.2d 466 (S.D.N.Y. 2009).
3. 75 F.3d 815 (2d Circ. 1996).
4. Id., at 824.
5. 3 N.Y.3d 592, 789 N.Y.S.2d 470 (2004).
6. Id., at 597-8.
7. Id., at 598.
8. 5 Misc.3d 1008 (A), 798 N.Y.S.2d 708 (N.Y. Cty, Sup. 2004).
9. Id., at 6.
10. —N.Y.S.2d—, 2011 WL 488711 (N.Y. Cty Sup. 2011).
11. Id., at 9.

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