Servidone Construction Corp. v. Security Insurance
64 N.Y. 2d 419, 477 N.E.2d 441, 488 N.Y.S.2d 139 (1985)
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Rule of Law:
An insurer that breaches its duty to defend does not automatically become liable to indemnify a non-covered loss, but the burden of proof shifts to the insurer to demonstrate that the loss from a subsequent reasonable settlement was not within the policy's coverage.
Facts:
- John Cuttino, an employee of Servidone Construction Corporation, was paralyzed after falling from a tower during a government construction project in 1972.
- In 1976, Cuttino sued the United States, alleging he was not provided a safe workplace.
- The United States filed a third-party action against Servidone for indemnity, asserting claims based on both common law and a contractual agreement.
- Servidone's insurer, Security Insurance Company, initially agreed to defend the action but reserved its right to deny coverage for the contractual indemnity claim, which it argued was excluded by the policy.
- Following a pretrial order defining the third-party action as one 'in contract for indemnity,' Security withdrew its defense entirely, contending the only remaining claim was excluded from coverage.
- Left without a defense, Servidone negotiated and paid a $50,000 settlement to Cuttino.
- Servidone notified Security of the settlement opportunity and its intent to settle, but Security did not respond.
Procedural Posture:
- Servidone Construction Corporation filed a declaratory judgment action against Security Insurance Company in the New York Supreme Court, Special Term (the trial court).
- Special Term first entered an order finding that Security had breached its duty to defend but found the indemnification issue premature.
- After Servidone paid the settlement, it moved to reopen the case, and Special Term granted summary judgment to Servidone for the $50,000 settlement amount.
- Security, as appellant, appealed to the Appellate Division of the Supreme Court (the intermediate appellate court).
- A majority of the Appellate Division affirmed the trial court's judgment in favor of Servidone, the appellee.
- Security, as appellant, then appealed to the Court of Appeals of New York (the state's highest court).
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Issue:
When an insurer breaches its contractual duty to defend and the insured subsequently settles the underlying claim, does the insurer bear the burden of proving that the loss was not within the policy's coverage in order to avoid indemnifying the insured for the settlement?
Opinions:
Majority - Kaye, J.
Yes. When an insurer breaches its duty to defend and the insured settles the claim, the insurer bears the burden of proving the loss was not covered by the policy. The duty to defend is broader than the duty to indemnify; the former arises from the allegations in a complaint, while the latter is determined by the actual basis of liability. A breach of the duty to defend does not create coverage where none existed, as this would improperly enlarge the bargained-for contract as a penalty. However, because the insurer's breach created the uncertainty by forcing a settlement rather than allowing a trial to determine the basis of liability, fairness dictates that the burden shifts. The insurer must prove that the settled loss falls entirely within a policy exclusion to avoid its duty to indemnify.
Analysis:
This decision establishes a critical procedural rule that significantly impacts the consequences of an insurer's breach of the duty to defend. By shifting the burden of proof to the insurer to disprove coverage, the court creates a strong disincentive for insurers to wrongfully abandon their insureds. This holding protects policyholders by ensuring that if an insurer creates a situation of uncertainty by its own breach, it cannot then benefit from that uncertainty. This precedent forces insurers to either defend under a reservation of rights or risk having to indemnify a settlement unless they can definitively prove the claim was not covered, a difficult task without a trial record.
