HNRK Coverage Corner

In this edition of Hoguet Newman’s Coverage Corner Blog, we look at a recent case from New York’s Appellate Division that considered a situation where an insured settled litigation with plaintiffs by assigning them its right to sue its insurers—and, specifically, whether the insured was “released” by the settlement such that any indemnification obligation was extinguished.   The case, Geiger v Hudson Excess Insurance Co., also considered whether an establishment serving food and drinks misrepresented the true nature of its business when it applied for insurance. 

By way of brief background, Geiger arose from a federal action that a group of professional models and social media influencers brought against Vola Corp (“Vola”).  The plaintiffs alleged that Vola improperly used their likenesses to advertise its business, a Queens establishment called “Sorry not Sorry,” without their consent.  Vola sought defense and indemnity for the federal action from its two insurers, Hudson Excess Insurance Company and Lancer Indemnity, and both insurers denied coverage. 

Vola eventually settled the case by entering into a consent judgment with the plaintiffs and, in consideration for the plaintiffs’ agreement not to execute on that judgment, assigning them Vola’s right to pursue coverage claims—for defense costs and for the amount of the judgment—against Hudson and Lancer. 

Restaurant or Nightclub?

Hudson escaped coverage because the trial court found, and the First Department affirmed, that its policy was void ab initio because Vola materially misrepresented its business in its insurance application.  The facts here are interesting even if the ruling is not particularly notable.   On its application, Vola made a number of assertions: that Sorry not Sorry was a restaurant and bar that derived 70% of its income from food and only 30% from alcohol; that it did not have promotional events such as “happy hour” and “ladies night”; that it did not provide entertainment or have a dance floor; and that it did not stay open past 2 a.m.

Hudson submitted evidence that Sorry not Sorry promoted itself on social media as having an open bar from 11 p.m. to 1 a.m., offering “$150 bottles of alcohol until 4AM,” as well as featuring exotic dancing, DJs, and drink specials.  Hudson’s underwriter submitted an affidavit that Hudson would not have issued the policies had it known the truth because the establishment would not qualify for insurance under the company’s unwriting guidelines.

The underwriter’s testimony established Hudson’s prima facie case that its policies were void ab initio, and the burden shifted to the plaintiffs to raise a question of fact.   The plaintiffs offered an affidavit from Vola’s owner, who testified that Sorry not Sorry was not an entertainment lounge with dancers, but in the same affidavit also said that the establishment was “primarily a bar, that also served food.”  The court found that this statement conflicted with Vola’s insurance application (where it said it was a restaurant with 70% food sales).  And although the materiality of a misrepresentation is often a jury question, the court noted that it can be resolved as a matter of law when  the evidence is “clear and substantially uncontradicted.”  Finding that to be the case here, the court affirmed summary judgment for Hudson.

Did the Plaintiffs Release Vola?

Lancer’s coverage obligations presented a different and seemingly more interesting legal question for the court.  The trial court held that Lancer had a duty to defend but not a duty to indemnify Vola.  The Appellate Division agreed that Lancer had a duty to defend based on the allegations the plaintiffs asserted against Vola in the federal action.  It held, however, that Lancer also had the duty to indemnify. 

The appellate court’s analysis turned on its interpretation of the underlying settlement agreement between plaintiffs and Vola, which contained what was titled a “release.”  Lancer argued that because the plaintiffs “released” Vola, the settlement relieved its insured of liability and extinguished any duty to indemnify. 

The appellate court agreed that, generally speaking, a general release in favor of an insured absolves an insurer of a duty of indemnity.  But in what it noted was a case of first impression in New York, the court framed the issue as whether an insurer remains liable where, as part of a settlement, its insured agrees to a consent judgment that incorporated an assignment of the insured’s rights coupled with a covenant not to execute on the judgment. 

A covenant not to execute a judgment is different than a release, the court explained, because a release is an agreement that requires “no further performance, effecting an outright cancellation or discharge of the entire obligation.”  A covenant not to execute, on the other hand,  is “an agreement to exercise forbearance from asserting any claim which either exists or which may accrue regardless of any potential liability.” 

In this case, the court noted that although the plaintiffs’ settlement with Vola was titled “Settlement Agreement and Release,” it should be read together the consent judgment as a covenant not to execute.  And after a brief survey of cases in other jurisdictions, it concluded that the majority view is that a covenant not to execute does not extinguish an insurer’s liability. 

Further, the court explained that the majority view is sounder because “any scenario” where an insured assigns its claims against its insurer to a plaintiff “necessarily takes place where the insured has been abandoned by its insurer.”  Because an insurer that breaches its duty to defend will also be liable for a reasonable settlement, the insured “is justified in taking affirmative steps to limit its own liability” by assigning its claims against its insurer as long as the insured is acting reasonably and in good faith (which the court noted was not in dispute in this case).