N.Y. Magistrate Narrowly Construes “Conducted Against Liability” Doctrine

N.Y. Magistrate Narrowly Construes “Conducted Against Liability” Doctrine

By David A. Gauntlett[1]

Introduction

The New Year starts off with a long awaited decision by a New York Federal Magistrate Judge which implicitly concluded that New York’s construction of the “conducted against liability” doctrine was limited to the “mirror image” cross-complaints in the same pending action. In so concluding, the court necessarily rejected the strategically defensive legal action such as the pending ITC action while the Federal Court Action asserting trade dress claims was stayed. The court failed to conduct the requisite choice of law analysis which would have recognized that under New York choice of law rules, California coverage law applied and a defense of the ITC action was compelled.

N.Y. Magistrate Narrowly Construes “Conducted Against Liability” Doctrine

The Magistrate Judge’s order Arrow Lighter, Inc. v. North American Capacity Insurance Company, 1:19cv1828 (E.D.N.Y. 2024) (the “Arrow Action”) ignores a thoughtful decision that encompasses a conclusion that New York would follow the California case authority Legion Partners Asset Mgmt., LLC v. Underwriters at Lloyd’s London, 2020 Del. Super. 2804, at *5-6 (Sept. 25, 2020).[2] Therein, the court concluded that defensive activity is “conducted against liability” and need not be a mirror image.[3] The only court of note to adopt the “mirror image” test applying Pennsylvania law is Post v. St. Paul Travelers Ins. Co., 691 F.3d 500, 522 (3d Cir. 2012). The Magistrate cited VR Optics, LLC v. Peloton Interactive, Inc., No. 16-CV-6392 (JPO), 2021 WL 1198930, at *2 (S.D.N.Y. Mar. 30, 2021) for its rationale but failed to note that this case ignored the plethora of opinions that have rejected that narrow policy construction.[4] The Magistrate cited for its rationale, VR Optics, LLC, which relied on the “inextricably intertwined” rationale. Id. at *12-13.

“Conducted Against Liability” Embraces a Broad Construction of Defense Action

Addressing coverage for affirmative claims asserted against the policyholder in an arbitration against a former employee, the court determined that such claims in that separate proceeding were “strategically defensive.”[5]

Arrow had no affirmative claims to measure whether they were inextricably-intertwined or the mirror-image of defended claims. All of Arrow’s defensive conduct was in defense of the same claims brought by BIC in the two actions at the same time. Arrow’s defense fees were, therefore, for defense against liability that was fully overlapping for the two actions.

The Magistrate Failed to Conduct the Essential Choice of Law Analysis

Under the Magistrate’s ruling, a conflict arises between California and New York requiring choice of law analysis that would determine that California law can apply it. Under California’s “conducted against liability” construction, the ITC action was “strategically defensive”, and therefore within the scope of potential coverage.[6] The Magistrate Judge elected not to follow the decisions of courts in California (and other states including Delaware, Illinois, and the majority of the U.S.) that have held that almost any work “conducted against the liability” of a lawsuit can be defensive in nature (either to avoid liability entirely or to limit damages).[7]

New York “choice of law” analysis requires following the law of the relevant other state (here, California) if that state has a greater interest in the legal issue than does New York under its “center of gravity” or “grouping of contacts” choice of law analysis under which court will apply law of place possessing most “significant contacts” with contract or dispute.[8]

An analogous case held that where an insured was a citizen, resident, and domiciliary of Florida and the policy at issue was registered and delivered under Florida law, Florida was the state where the risk was principally located and Florida law applied.[9] Here, California has a greater interest than New York because the suit affects a California corporation based on its conduct in California, the policy negotiation was in California, the insured is incorporated in California, and the insured is a California resident. The Underlying ITC Action was pending in Washington D.C. It is evident that no element of New York law supports any other view than the applicable test requires California law apply. California law requires that the “conducted against liability test” is applicable.[10]

Citation to a “Voluntary Payments” Provision Is of No Moment

Smart Style addresses only whether fees incurred prior to notice to an insurer are recoverable under New York law.[11]  A subsequent statute modifies the applicable rules where an insurer denies where a defense was raised, given that the operative event is filing of the complaint that notice to the insurer, its logic is still questionable.

The Magistrate Judge relies on Smart Style[12] to conclude that the duty to defend applied in a D.C. based ITC Action as its only interest was North American’s New York residency. Smart Style provides no support for the Magistrate construction as its duty arose.  The contrary rationale of Smart Style depends upon the insurer’s right to control a defense[13] which is absent here where New York laws application was uncontested under a “Voluntary Payments” provision in Smart Style. Such provisions are often enforced narrowly.[14]  

A recent case[15] suggests that California no longer allows insurers to deny coverage based on late notice without prejudice due to a “Voluntary Payments” provision, along with the distinction of New York embracing the Complaint-trigger rule, invalidates the Smart Style court’s reliance on California cases as authority.[16]

Conclusion

Arrow demonstrates the conceptual limitation of a decision that only addresses a narrow aspect of an insurance coverage dispute by avoiding any discussion of choice of law despite implicitly concluding that there is a conflict between New York and California law. The court avoids addressing an issue despite the fact that its own policy required it to address the issue. 

[1] David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 553-1010 by voicemail or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[2] David A. Gauntlett, Three 2020 Coverage Cases Clarify Coverage Availability, Feb. 17, 2021, https://www.gauntlettlaw.com/news/three-2020-coverage-cases-clarify-coverage-availability.

[3] Legion Partners Asset Mgmt., Ltd. Liab. Co. v. Underwriters at Lloyds London, No. N19C-08-305 AML CCLD, 2021 Del. Super. LEXIS 618, at *6 (Super. Ct. Sep. 30, 2021)

[4] KLA-Tencor Corp. v. Travelers Indem. Co. of Ill., No. C-02-05641 RMW, 2004 U.S. DIST. LEXIS 15376, at *12-13 (N.D. Cal. Aug. 4, 2004); IBP, Inc. v. Nat'l Union Fire Ins. Co., 299 F. Supp. 2d 1024, 1031 (D.S.D. 2003); D.R. Horton, Inc. v. Mt. States Mut. Cas. Co., 69 F. Supp. 3d 1179, 1183 (D. Colo. 2014).

[5] Legion Partners, 2021 Del. Super. LEXIS 618, at *18, *20-21.

[6] Id. at *19 n.84 (citing Hewlett-Packard Co. v. Ace Prop. & Cas. Ins. Co., 2006 U.S. Dist. LEXIS 109538, at *217 (N.D. Cal. June 12, 2008) (proof that affirmative claims served as defenses to (or part of an effort to avoid or minimize) the potential liability posed by counterclaims.).

[7] David A. Gauntlett, Insurance Coverage for Intellectual Property Assets (2nd Ed. 2023-2 Suppl.) §6.06, Claims That Are “Conducted Against Liability” Render Prosecution of Claims.

[8] Arch Specialty Ins. Co. v. Kajavi Corp., 2019 U.S. Dist. LEXIS 116490, at *5 (E.D.N.Y. July 11, 2019) (adopted by 2019 U.S. Dist. LEXIS 132694 (E.D.N.Y. Aug. 7, 2019)).

[9] Cartagena v. Homeland Ins. Co., 2019 U.S. Dist. LEXIS 219044, at *10-11 (S.D.N.Y. Dec. 16, 2019)

[10] Aerojet-General Corp. v. Transp. Indem. Co., 17 Cal. 4th 38, 62, 70 Cal. Rptr. 2d 118, 132, 948 P.2d 909, 923 (1997)

[11] Smart Style Indus. v. Pa. Gen. Ins. Co., 930 F. Supp. 159, 164 (S.D.N.Y. 1996).

[12] Id.

[13] Id. (“Once H.W. Carter notified Penn. General of the Underlying Action, however, Penn General was in a position to control or influence the litigation, and it was obligated at that point to provide a defense. Penn General could not avoid that obligation simply by delaying its consent and then relying on the voluntary payments provision of the Policy. . . .  [Eventually] it consented to the continued use of Townley & Updike’); Consolidated Edison Co. of N.Y. v. Lexington Ins. Co., 2015 U.S. Dist. LEXIS 101339, *21–22 (S.D.N.Y. Jul 30, 2015) (“The undisputed facts show that Lexington . . . accepted Con Ed’s tender of defense and was prepared to defend (albeit under a reservation of rights). . . which, as Judge Chin noted in Smart Style, is the right of every insurer with a duty to defend. Smart Style, supra. 930 F. Supp.at 164.”)

[14] Burgett, Inc. v Am. Zurich Ins. Co., 875 F. Supp. 2d 1125, 1128 n.4 (E.D. Cal. 2012) as corrected (Aug. 24, 2012) (“[T]he court finds that, under California law, the duty to Defendant does not arise until tender, and thus, Defendant is not required to pay pre-tender expenses.”)

[15] Pitzer Coll. v. Indian Harbor Ins. Co., 8 Cal. 5th 93, 97 (2019) (Concluding that, absent prejudice, “California's strong preference to avoid technical forfeitures of insurance policy coverage” prevented enforcement of a “Voluntary Payments” provision in the first-party context.)

[16] David A. Gauntlett, Enforceability of “Voluntary Payments” Provisions, Aug. 24, 2023, https://www.gauntlettlaw.com/news/enforceability-of-voluntary-payments-provisions.