Is a policyholder entitled to recover less from its insurance carrier when it wins a trial of the underlying liability claims that triggered the insurance coverage than when it loses those underlying claims?  To ask the question is to suggest the answer: “Of course not; how ridiculous.”  But there is, apparently, sufficient doubt about the answer that the question has reached the New Jersey Supreme Court.

In a number of states, an insurer must reimburse a policyholder the attorneys’ fee incurred in a coverage action if the policyholder prevails against the insurer.  This is an exception to what is commonly called the “American Rule,” which provides that each side in a lawsuit pays its own attorneys and costs, irrespective of the outcome of the case.  This is distinct from the so-called “English Rule,” which requires the loser to pay the winner’s attorneys’ fees and costs.  Many states, in fact, have a significant number of exceptions to the American Rule.

In New Jersey, there is a special Court Rule that provides for the payment of attorneys’ fees “[i]n an action upon a liability or indemnity policy of insurance, to a successful claimant.”  It’s Rule 4:42-9(a)6 of the New Jersey Rules of Court.  Over the years, a number of cases have interpreted this Rule.  For example, courts have decided what it means to be a “claimant.” (One doesn’t necessarily have to be a “Named Insured” to be a “claimant.”  An insurer can’t qualify as a “claimant.”)  New Jersey courts have also concluded that the Rule does not apply to successful claimants under a first-party property policy, such as the kind of policy that covers a home.

The New Jersey Supreme Court has recently granted Certification (the New Jersey equivalent of Certiorari in the U.S. Supreme Court) in a case that asks what it means to be “successful” as a claimant.  The case is Occhifinto v. Olivo Constr. Co., LLC (get a copy of the New Jersey Appellate Division opinion here.)  The dispute came up in a way that is quite common.

A policyholder, Keppler Mason Contractors, was sued by a business owner, Occhifinto, for the allegedly faulty construction of an addition to a warehouse.  The carrier, Mercer Insurance Company, defended Keppler under a reservation of rights (an agreement that reserves to the carrier the right to deny coverage and back out of its defense obligation at some later time if it decides that there is no coverage under the policy).  Mercer then sued its policyholder, seeking a declaration that it had no duty to provide coverage.  The carrier lost that coverage action and the court declared that Mercer was obligated to pay any adverse judgment or settlement against its insured in the underlying construction-defect case.  (In a somewhat unusual twist to this case, Occhifinto — that is, the plaintiff in the underlying construction-defect case — stepped into the shoes of the insured, Keppler, as a third-party beneficiary to pursue the coverage claim because Keppler was, by that time, out of business.)

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Having the right to indemnification under the policy, whether ultimately needed or not, is the heart of the protection a liability policy provides.

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As it happens, the defense Mercer provided to the policyholder was very effective because the jury found that Keppler was not liable for the damages claimed in connection with construction of the warehouse addition.  This fact became important in the coverage case because the carrier argued that Occhifinto was not a “successful” claimant under the Rule and was therefore not entitled to an award of attorneys’ fees.  The argument went like this: (1) Occhifinto was not “successful” in forcing the carrier to provide a defense because the carrier was already providing one at the time of the coverage action; (2) Keppler never got the benefit of indemnity under the policy because it was found not to have been liable; (3) therefore, Occhofinto didn’t “succeed” in getting any benefit under the policy that wasn’t either already being provided or later determined to be unnecessary.

The trial court agreed with Mercer and the New Jersey Appellate Division affirmed, finding that Occhifinto “never received the benefits of the policy provisions obligating Mercer to indemnify Keppler.”  It’s worth thinking about the implications of that ruling.

Let’s begin by talking about the “benefits” a policyholder is supposed to receive from the payment of up-front premiums in exchange for the promises contained in a liability insurance policy.  First is the obvious: peace of mind that, if someone files a lawsuit that is covered by the policy, the insured will have protection.  Second, and specific to that peace of mind, the insured is supposed to get a defense, paid for by the carrier.  Third, the insurer must indemnify the insured for any adverse judgment or any settlement of the lawsuit.  Did the policyholder in Occhifinto obtain any of those benefits in the coverage action?

Mercer sued its insured in an effort to get out of coverage.  In doing so, it attempted to deny the insured its right to peace of mind.  It certainly put that benefit at risk.  What is the opposite of peace of mind?  Turmoil of mind?  When the insurance company to which you have paid a great deal of money for a liability policy sues you to get out of coverage, the very least that can be said about it is this: It will cause turmoil of mind.  But the policyholder won the coverage case.  And what can be said about the effect of that win?  Among the things that can be said is that it restored peace of mind.

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 If Mercer had prevailed, not only would there have been no indemnity obligation, but the defense obligation would have ended, too.

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Yet, courts might not think that something as amorphous and difficult to pin down as “peace of mind” is really the kind of benefit that can serve as a benchmark for deciding future cases under the Court Rule.  Perhaps, though, there are more concrete benefits that flow from peace of mind.  For instance, after winning the coverage case the insured no longer had to make any interim plans against the possibility that it would have to pay an adverse judgment.  Similarly, the insured did not have to raise funds of its own to provide for a settlement of the claims against it.  These are solid financial benefits of which a business person will be acutely aware.  The lack of these benefits stings; it directly affects the bottom line.  Having the right to indemnification under the policy, whether ultimately needed or not, is the heart of the protection a liability policy provides.  It is the very risk against which the business owner purchases insurance in the first place; so that the company’s own money will not be in play in the event of a lawsuit.  By prevailing in the coverage action, Occhifinto secured a benefit that is fundamental to the insurance relationship.

Next, did Occhifinto secure the benefit of a defense in the coverage action?  Absolutely it did.  Indeed, here is the heart of the flaw in the insurer’s argument and in the Appellate Division’s reasoning.  By suing its insured for a declaration of no coverage, Mercer put the insured’s right to a defense in peril.  If Mercer had prevailed, not only would there have been no indemnity obligation, but the defense obligation would have ended, too.  Make no mistake: Mercer fully intended to quit defending if it, rather than Occhifinto, had been the successful party in the coverage action.

Thus, it is simply, and completely, wrong to say that the only thing that was won in the coverage action was a duty to indemnify in the event of an adverse judgment that never came to pass.  By prevailing in the coverage action, Occhifinto not only secured the benefit of indemnity, should it ever be needed, it preserved the duty to defend going forward — something that the carrier intended to deny if it had won the coverage case.

Finally, of course, Occhifinto prevailed in preserving the right to indemnification, with the tangible economic benefits that flow from that preservation, discussed above.  When one considers that all of the benefits available under the policy were at risk of being lost in the coverage action, and that by prevailing in the coverage action, instead of losing, Occhifinto won those benefits instead of forfeiting them, how can anyone reasonably conclude that Occifinto wasn’t “successful?”  Stated another way: One can — and should — be equally considered a “successful claimant” under the Rule by avoiding the forfeiture of a policy benefit that the carrier has placed in peril as by gaining the actual payment of an obligation under the policy.

The N.J. Supreme Court will review the decisions of the lower courts in Occhifinto on an “abuse of discretion” standard.  This is a high hurdle.  In addition to considering the indicia of success and the tangible benefits Occhifinto obtained by prevailing in the coverage action, it might be worth contemplating the incentives that the lower courts’ decisions impose on future parties to coverage litigation.  Under the reasoning of those courts, Occhifinto would have been reimbursed its coverage fees under the applicable Court Rule if it had lost the underlying construction-defect case.  So, why would an insured that had secured a duty to indemnify, as Occhifinto did here, ever put up a vigorous defense in the underlying action?  If the lower court opinions in Occhifinto get affirmed, the only reasonable answer to that question will be: It shouldn’t.