NY Court Clarifies Pleading Standard for “Consequential Damages” in Coverage Litigation

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The Appellate Division of New York’s Supreme Court, First Department, recently overturned a trial court’s dismissal of an insured’s claim for consequential damages on a pre-answer motion to dismiss.  While the decision sheds light on the degree of specificity required at the pleading stage to sustain an insured’s claim for consequential damages, it does little to clarify the level of proof required to prevail on such claim at trial.      

The coverage dispute among the parties in D.K. Property, Inc. v. National Union Fire Insurance Company of Pittsburgh, Pa., arose from alleged property damage to the insured building caused by construction activities on an adjacent lot in New York City.  According to the amended complaint, the insurer neither paid the claim nor disclaimed coverage despite its consultants’ agreement with the insured regarding the cause of loss, but“made unreasonable and increasingly burdensome information demands throughout the three year period since the property damage occurred.” 

Based on the foregoing, the insured asserted causes of action sounding in breach of contract for failure to pay the claim, and breach of the implied covenant of good faith and fair dealing, and sought consequential damages and attorneys fees (among other alleged damages) on account of its claim for bad faith, including engineering costs, painting, repairs, loss of rent, and other expenses incurred by the insured to mitigate further damage to the property.  The appellate court further noted that the insured was caused to incur significant legal fees when the insurer intervened as subrogor in an action commenced by the insured against the adjoining property owner, even though it had not paid the claim. The insurer moved the trial court to dismiss the insured’s demand for consequential damages and bad faith claim on a pre-answer motion to dismiss for failure to state a claim, arguing that the insured had failed to meet the heightened pleading requirement for consequential damages, and that the bad faith claim was duplicative of its breach of contract claim. 

The trial court refused to dismiss the insured’s bad faith claim because it was not premised on the insurer’s alleged breach of the policy, but other, distinct conduct — e.g.,

“by refusing to effectuate a prompt, fair, and equitable settlement of [the insured’s] property damage claim; by making unreasonable and burdensome demands for information; by ignoring [the insured’s] documentation demonstrating the nature, extent and cause of the damage; and by forcing [the insured] to bring a lawsuit against the tortfeasors for damages and the instant lawsuit against [the insurer] for a determination as to coverage under the Policy.”  The trial court did, however, dismiss the insured’s claim for consequential damages (except for legal fees) on grounds that the insured did not alleged with sufficient specificity “the particular types of consequential damages sought, i.e., attorneys’ fees, engineering fees, cost of monitoring services, cost of mitigation of water damages, painting repairs, and lost rent, were a natural and probable result of [the insurer’s] breach of its duty of good faith.”

In its review, and ultimate reversal, of the trial court’s decision, the appellate court framed the issue as follows: “At issue is whether, at the pleading stage, a claim for consequential damages arising from defendant’s processing of plaintiff’s insurance claim requires a detailed, factual description or explanation for why such damages, which do not directly flow from the breach, are also recoverable.” (The insurer did not appeal the trial court’s decision to sustain the bad faith claim).  Citing to the New York precedent and the pleading standard promulgated under New York’s rules of civil procedure, the appellate court held that the insured is not required “to explain or describe how and why the ‘specific’ categories of consequential damages alleged were reasonable and forseeable at the time of contract. There is no heightened pleading requirement for consequential damages. Furthermore, an insured’s obligation to ‘take all reasonable steps to protect the covered property from further damage by a covered cause of loss’ supports [the insured’s] allegation that some or all the alleged damages were forseeable.”

Nevertheless, the appellate court affirmed that an insured may pursue “consequential damages resulting from an insurer’s failure to provide coverage if such damages (risks) were foreseen or should have been foreseen when the contract was made.”  The appellate court went on to add that “[a]lthough proof of such consequential damages will ultimately rest on what liability the insurer is found to have ‘assumed consciously,’ or from the [insured’s] point of view, have warranted the [insured] to reasonably suppose the insurer assumed when the insurance contract was made, a determination of whether such damages were, in fact, foreseeable should not be decided on a motion to dismiss and must await a fully developed record.”  

Thus, the appellate court found that the insured met the pleading requirement with respect to its claim for breach of contract, as well as its claim for breach of the covenant of good faith and fair dealing, stating that “[w]e find that the motion court erred in dismissing the consequential damages claim, because [the insured] fulfilled its pleading requirement by specifying the types of consequential damages claimed and alleging that such damages were reasonably contemplated by the parties prior to contracting.”

The appellate court’s decision will likely induce policyholders to consider the potential recovery of consequential damages as part of their claim resolution analysis.  And while this decision may assist policyholders in surviving a pre-answer motion to dismiss, and thus expanding the scope of discovery in the course of litigation, parties should still consider the high bar needed to prove such damages at trial.  Despite the appellate court’s discussion regarding the degree of specificity required at the pleading stage to survive a pre-answer motion to dismiss for failure to state a claim, the decision did not address the level of proof required to prevail on a claim for consequential damages at trial.  Indeed, the policyholder must still prove by a preponderance of the evidence that the consequential damages it seeks to recover were foreseeable and contemplated by the parties at the time contracting, and “assumed consciously” by the insurer.  Lastly, the appellate court’s decision in this case was premised on New York statutes and jurisprudence regarding the pleading requirements that apply to cases venued in state court.  It is questionable whether federal courts applying New York law will adopt the appellate court’s holding or abide by precedent and the pleading requirement promulgated under the Federal Rules of Civil Procedure.

The appellate court’s decision can be found here and the trial court’s decision can be found here.