Insurer has duty to pay insured's customer's share of damages

CGS Industries, Inc. v. Charter Oak Fire Ins. Co., --- F. Supp. 2d ----, 2011 WL 1449618 (E.D.N.Y.)

CGS sued Charter Oak for breach of contract for failure to defend CGS in a trademark lawsuit brought by Five Four Clothing against CGS and its vendee Wal-Mart, and for indemnification of CGS for damages. The court initially found that Charter Oak had a duty to defend, and Charter Oak then moved for partial summary judgment on whether CGS was entitled to indemnification for (1) Wal-Mart's imputed portion of a $250,000 settlement paid by CGS to resolve the Five Four litigation; and (2) defense costs, including attorney's fees, of around $57,000 incurred on behalf of Wal-Mart.

Charter Oak’s policy included a provision insuring “advertising injury,” including injury arising out of infringement of copyright, title or slogan but excluding injury for which the insured assumed liability in a contract or agreement. But that exclusion does not apply to liability that the insured would have in the absence of contract or agreement. The underlying complaint didn’t separate damages caused by CGS (supplier) and damages caused by Wal-Mart (retailer).

Wal-Mart demanded indemnification from CGS for the underlying litigation based on their supplier agreement, which included a comprehensive indemnification provision. CGS then negotiated a settlement on behalf of both entities for the total amount of $250,000.

CGS argued that Wal-Mart was entitled to defense and indemnification from CGS automatically, as a matter of law, and not just under the supplier agreement. In addition, CGS argued that Charter Oak was not entitled to allocate the settlement amount between the parties and pay only for the sum paid to settle CGS’s liability because allocation was not required or possible given the parties’ alleged joint and several liability.

Charter Oak’s responsibility depended on “whether another legal rule, independent of contract liability under the supplier agreement, obligated CGS to indemnify Wal-Mart for damages and defense attributed to Wal-Mart. Put differently, assuming the supplier indemnification agreement between CGS and Wal-Mart did not exist, would CGS have had a duty under law to indemnify Wal-Mart for those damages?”

The insured had the burden of showing that an exception to the exclusion applied. CGS succeeded in satisfying this burden with respect to Wal-Mart’s imputed damages for Wal-Mart’s trademark violations, but not for Wal-Mart’s defense costs.

Given the way the underlying claims were pled, they sufficed to charge CGS with a breach of warranty to Wal-Mart, and under NY law Wal-Mart’s remedies include the right to indemnification from the seller for resulting economic loss. N.Y. U.C.C. § 2-312(3) (“Unless otherwise agreed, a seller that is a merchant regularly dealing in goods of the kind warrants that the goods shall be delivered free of the rightful claim of any third person by way of infringement or the like ….”). The requirements for damages are that the seller is a merchant regularly dealing in goods of the kind, the goods were subject to a rightful third-party infringement claim upon delivery, the buyer didn’t furnish specifications to the seller, and the parties did not make another agreement. The first three elements were indisputably satisfied, and the court rejected Charter Oak’s argument that the supplier agreement was “another agreement” negating CGS’s independent legal duty to indemnify. The provision starts with the words "[u]nless otherwise agreed," indicating that this section of the UCC is a default rule that the parties can waive, and that applies if the other three elements are satisfied and the contract doesn’t exclude warranty liability.

“The critical question is not what the supplier agreement provides with respect to CGS's duty to indemnify Wal-Mart. It is whether section 2-312(3) confers on Wal-Mart an independent legal right to indemnification from CGS. The contract between CGS and Wal-Mart is, for the purpose of this insurance agreement, a mere decorative counterpane over the blanket protection of the law--section 2-312(3).”

Thus, the full $250,000 was subject to a duty of indemnification, and was paid as compensation for covered advertising injury damages. Whether the settlement sum was reasonable was left for trial.

As to Wal-Mart’s defense costs, matters were different. Assuming the supplier agreement didn’t exist, would CGS still be obligated as a matter of law to indemnify Wal-Mart for its defense costs? CGS failed to provide convincing authority supporting its case. NY hasn’t decided the issue, and the weight of case law from other UCC jurisdictions is the contrary, with the majority of courts considering the question holding that the UCC doesn’t allow recovery of attorney’s fees as incidental or consequential damages.

In addition, general policy favored Charter Oak. “There is a strong principle, peculiar to our jurisprudence against one party's paying for the legal costs of another, even when the other wins in a litigation. This presumption is ‘the American rule.’” There was no indication in the insurance contract of an intent to depart from the American rule. CGS had to pay for Wal-Mart’s litigation costs because it contracted to do so.

The court noted that, here, CGS’s argument had some appeal: that it assumed Wal-Mart’s litigation burden as a matter of sales law, through an implied-in-law warranty against unsatisfactory goods, including the indirect damages caused by litigation expenses. But, on balance, Charter Oak prevailed because it only assumed the burden of CGS’s litigation expenses.