The New York Appellate Division for the First Department recently reversed a decision of a lower court that had granted summary judgment to the plaintiff, an excess insurer, on a count of insurance bad faith against a primary insurer. Federal Ins. Co. v. North Amer. Spec. Ins. Co. et al., Docket No. 603926/05 (N.Y.A.D., 1st Dep’t, April 5, 2011).

In the underlying claim, an injured worker on a construction project brought a lawsuit against both the general contractor and the project owner. Prior to the lawsuit, the general contractor had obtained two primary liability policies with limits of $1 million: one for itself, and one for the owner. The general contractor also obtained an excess policy for itself (but not for the project owner) with a limit of $10 million.

According to the Court, the primary insurer at first retained one defense firm to defend both the general contractor and the owner under the two primary insurance policies. During the pendency of the underlying litigation, however, the primary insurer split the defense and retained separate counsel for each insured. The owner then brought a cross-claim against the general contractor for indemnification on the basis that the owner had not been present at the work site and had no responsibility to supervise the work.

The Court explained that the primary insurer, in defending the contractor against the owner’s cross-claim, failed to timely assert the antisubrogation rule as a defense. (Under New York law, the antisubrogation rule provides that an insurer has no right of subrogation against its own insured for a claim arising from the very risk for which the insured was covered.) As a consequence, the owner prevailed in its indemnification claim and its policy limits were not available to fund the eventual settlement of $3 million.

The excess insurer then brought suit against the primary insurer, including a claim for bad faith. The excess insurer alleged that the primary insurer engaged in a deliberate plan to protect one of its two policies by not asserting the antisubrogation rule as a defense, and that as a consequence, the excess insurer was compelled to provide $2 million, rather than $1 million, to fund its portion of the settlement. The trial court granted summary judgment to the excess insurer on its claim of bad faith.

In reversing the judgment, the First Department explained that a primary insurer has a duty of good faith that runs to an excess insurer, and that pursuant to that duty a primary insurer must give as much consideration to an excess insurer’s interests as to its own. The Court explained further, however, that an insurer does not breach its duty of good faith when it makes a mistake in judgment or behaves negligently. The Court concluded that there remained a material issue of fact as to whether the primary insurer had been merely negligent in failing to raise the antisubrogation rule as a defense, or whether it deliberately failed to assert the defense in order to allow the project owners to escape liability.

Please click here to read a copy of the decision.