CGS Industries, Inc. v The Charter Oak Fire Insurance Company

Filing 112

MEMORANDUM AND ORDER: Charter Oak's motion for partial summary judgment is granted in part and denied in part, without costs. Trial is scheduled for May 3, 2011. The parties shall submit trial briefs and proposed findings of facts and law seven days before trial. Ordered by Senior Judge Jack B. Weinstein, on 4/15/2011. (Barrett, C)

HLfD

IN CLERK'S OFFICE
U.S. DISTRICT COURT EUNY

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UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
CGS INDUSTRIES, INC.

APR 2 0 2011

BROOKLYN OFFICE
MEMORANDUM &
ORDER

Plaintiff,
IO-CV-3186
- againstTHE CHARTER OAK FIRE
INSURANCE COMPANY,
Defendant.

JACK B. WEINSTEIN, Senior United States District Judge:
Appearances:
David A. Gauntlett, Gauntlett & Associates, Irvine, CA, for plaintiff CGS Industries, Inc.
Lawrence A. Levy & Celeste M. Butera, Rivkin Radler LLP, Uniondale, NY, for
defendant The Charter Oak Fire Insurance Company.
I. Introduction ................................................................. '" ................................................. 2
II. Facts and Procedural Background .................................................................................. 3
A. Web Xtend Liability Policy ....................................................................................... 3

B. Underlying Five-Four Litigation ................................................................................ 4
C. Charter Oak's Refusal to Defend CGS ...................................................................... 5
D. Instant Suit ................................................................................................................. 5
E. Resolution of the Five Four Litigation in a Settlement wholly Paid by CGS ............ 6
F. supplier agreement between CGS and Wal-Mart ....................................................... 7
G. Motion for Partial Summary Judgment ...................................................................... 7
III. Contentions of the Parties, Law, and Application to Facts ........................................... 7
A. Contentions of the Parties .......................................................................................... 8
I. Charter Oak ............................................................................................................. 8
2. CGS ......................................................................................................................... 8
B. Legal Standard ........................................................................................................... 9
C. Application of Law to the Facts ................................................................................. 9
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1. Issues Presented ...................................................................................................... 9
2. Coverage under the Insurance Agreement.. .......................................................... 10
a. Wa1-Mart's Imputed Damages .......................................................................... 11
b. Wa1-Mart's Defense Costs ................................................................................ 15
IV. Conclusion .................................................................................................................. 18

I. Introduction
CGS Industries, Inc. ("CGS") sues The Charter Oak Fire Insurance Company
("Charter Oak") for (1) breach of contract for its failure to defend CGS in an underlying
litigation; and (2) indemnification of CGS for damages covered under an insurance
contract.
It is alleged that Charter Oak breached its insurance contractual duties by failing
to defend CGS in a trademark suit brought by Five Four Clothing, Inc. and FiveFour
Group LLC (collectively, "Five Four") against CGS and Wal-Mart Stores, Inc. ("WalMart") in the United States District Court for the Central District of California ("Five
Four litigation"). The complaint seeks declaratory relief holding that in the Five Four
litigation Charter Oak: (I) had a duty to defend CGS; (2) pay CGS's attorney fees, costs,
and damages (to itself and Wal-Mart); and the legal fees ofWal-Mart.
Plaintiff moved for partial summary judgment finding Charter Oak had a duty to
defend CGS in the Five Four litigation. See Fed. R. Civ. P. 56; Docket Entry No. 10. On
Nov. 16,2010, the court granted CGS's motion for partial summary judgment as to
Charter Oak's duty to defend. Docket Entry No. 46, 2010 U.S. Dist. LEXIS
120671 (E.D.N.Y., Nov. 15,2010).
Charter Oak now moves for partial summary judgment seeking a declaration that
CGS is not entitled to indemnification for: (I) Wal-Mart's imputed portion ofa $250,000
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settlement paid by CGS to resolve the Five Four litigation; or (2) defense costs, including
attorney's fees, in the sum of$57,379.44 incurred by Wal-Mart in the Five Four
litigation. See Fed. R. Civ. P. 56; Docket Entry No. 95.
On March 18, 2011, the court heard oral argument on this motion and denied it.
Tr. of Or. Arg., p. 30: 16-17; Docket Entry No. 108. Because the law on the subject is
unclear and to some extent presents issues of first impression, the parties were permitted
to submit further written argument.
Upon consideration of these submissions, Charter Oak's motion for partial
summary judgment is denied in part. It has no obligation to reimburse CGS for WalMart's fees and costs in the Five Four litigation; to that extent only Charter Oak's motion
for partial summary judgment is granted.
II. Facts and Procedural Background
A. Web Xtend Liability Policy

Charter Oak issued a commercial general liability policy to CGS covering the
period of August 31, 2009 through August 31, 2010. See Charter Oak's Local Rule 56.1
Statement in Supp. of Mot. for Summ. Judg., Docket Entry No. 96 ("Charter Statement"),
~

26; Dec!. of Celeste M. Butera in Supp. of Charter Oak's Mot. for Summ. Judg., Docket

Entry No. 98 ("Butera Dec!."), Ex. 12. Included in the policy is an endorsement titled
"Web Xtend Liability - New York." See Charter Statement, ~ 27; Butera Dec!. (Ex. 12).
This endorsement ("Web Xtend Policy" or the "insurance agreement") obligates Charter
Oak to pay damages of "'advertising injury,' caused by an offense committed in the
course of advertising [CGS' s1goods, products or services." Ex. 12, at form no. CG F2
100305, p. I. "Advertising injury" is defined in the Web Xtend Policy as "injury,

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arising out of ... [i]nfringement of copyright, title or slogan.... " Charter Statement, ~~
29-30; Ex. 12, at form no. CO F2 1003 OS, p. 4.
The Web Xtend Policy is subject to several exclusions. As relevant to this
motion, excluded is "Contractual Liability," '''advertising injury' ... for which the
insured assumed liability in a contract or agreement." (the "contractual liability
exclusion"). Charter Statement, ~ 31; Ex. 12, at form no. CO F2 10 03 OS, p. 2.
The exclusion is subject to several exceptions; the relevant one reads: "This
exclusion does not apply to: ... 'advertising injury' ... that the insured would have in
the absence of contract or agreement." (the "exception"). Id.

B. Underlying Five-Four Litigation
On December 23,2009, Five Four filed a complaint against Wal-Mart for
trademark and trade dress infringement relating to Five Four's trademarks and trade
dress. See Charter Statement, ~ 1; Butera Decl., Ex 1. On March 24, 2010, Five Four
filed its second amended complaint, adding COS as a defendant. See, Butera Dec!., Ex. 3
at p. 1. On July 18,2010, a third amended complaint (the "Five Four Complaint") was
filed alleging eight claims, entitled "Federal Trademark Counterfeiting," "Federal
Trademark Infringement," "Federal False Designations of Origin and False
Descriptions," "Trade Dress Infringement," "False Advertising," "Common Law
Trademark Infringement and Unfair Competition," "State Statutory Unfair Competition,"
and "Constructive Trust." See id., Ex. 5 ("Five Four Comp!.") at 6-10.
Five Four alleged that Wal-Mart and COS, among other things, "have
counterfeited and/or infringed [its] trademarks by advertising, distributing, selling and/or
offering for sale unauthorized goods including without limitation apparel bearing

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unauthorized reproductions of [its1trademarks." Five Four Compl. at '\129. These
trademarks allegedly "embod[y1the spirit of modem culture," and through "longstanding
use, advertising and registration, ... have achieved a high degree of consumer
recognition." !d. at '\1'\113,17. They are purportedly "highly recognized by the public and
serve to identify the source of the goods as from Five Four." [d. at '\120.
CGS and Wal-Mart were jointly referred to as the "defendants" throughout the
complaint. See Butera Decl., Ex 5. No separation was made between damages caused by
Wal-Mart and those caused by CGS. !d. Nor did the complaint specifically allege that
CGS and Wal-Mart were jointly and severally liable for the alleged damages.
C. Charter Oak's Refusal to Defend CGS
After CGS informed Charter Oak of the Five Four litigation, Charter Oak denied
CGS's requests for a defense. See Charter Statement, '\1'\12, 5, 8; Butera Decl., Exs. 2,4,
6. Charter Oak maintained it had no duty to defend, claiming that there was no alleged
"advertising injury" and that several policy exclusions applied, including the contractual
liability exclusion. [d.
D. Instant Suit
CGS commenced the instant suit on July 13,2010. See Compl. for (1)
Declaratory Judgment; and (2) Breach of Contract; Docket Entry No. I. Sought were a
declaratory judgment stating that Charter Oak has a duty to defend CGS in the Five Four
litigation and to pay its costs and damages resulting from Charter Oak's alleged breach of
the insurance contract. See Am. Compl. at '\1'\1 54, 58. CGS also sought to recover its
costs and attorneys' fees in the instant proceedings. [d., Prayer for Relief, at '\14.

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After filing an amended complaint on August 4, 2010, CGS moved for partial
summary judgment contending Charter Oak had a duty to defend CGS in the Five Four
litigation. See Docket Entry Nos. 10-16. On November 16, 2010 the Court granted
CGS's motion for summary judgment on the duty to defend. It ruled that Charter Oak
was obligated to defend CGS in connection with the Five Four litigation. Charter
Statement, ~ 11; Docket Entry No. 46, 2010 U.S. Dist. LEXIS 120671 (E.D.N.Y., Nov.
15,2010).
Thereafter, CGS moved for summary judgment regarding the quantification of its
damages in connection with Charter Oak's duty to defend. Docket Entry No. 49. On
November 30,2010, the Court denied the motion, holding that quantification of damages
was an issue for trial. Docket Entry No. 56.
E. Resolution of the Five Four Litigation in a Settlement wholly Paid by CGS

On January 31, 2011, Charter Oak took the deposition of Leonard M. Braun, the
Treasurer ofCGS. Charter Statement, ~ 16; Butera Decl., Ex 14. Braun testified that
Wal-Mart demanded indemnification from CGS for the underlying litigation based upon
a supplier agreement between Wal-Mart and CGS. Charter Statement, ~ 17; Butera
Decl., Ex 14, at p. 40.
Thereafter, settlement negotiations commenced in the Five Four litigation, with
CGS making settlement offers on behalf of both CGS and Wa1-Mart. Charter Statement,
~

18; Butera Decl., Ex 14, at pp. 64-65 and 85-86. Following mediation, a settlement in

the total amount of$250,000 was paid by CGS to Five Four on behalf of both CGS and
Wal-Mart. Charter Statement, ~ 18; Butera Decl., Ex 14, at p. 133.

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In the instant suit, CGS seeks to recover defense costs in the Five Four litigation,

including attorney's fees, incurred by Wal-Mart, its co-defendant. CGS alleges it has
incurred $57,379.44 in legal fees on behalf ofWal-Mart. Charter Statement, ~ 13; Butera
Dec!., Ex. 10, at p. 17. CGS also seeks to recover the $250,000 settlement amount in the
Five Four litigation. Charter Statement, ~ 14; Butera Dec!., Ex 10, at p. 14-16.
F. supplier agreement between CGS and Wal-Mart

On December 22,2008, CGS and Wal-Mart entered into a supplier agreement for
the sale and delivery of merchandise by CGS to Wal-Mart (the "supplier agreement").
Charter Statement, ~ 32; Butera Dec!., Ex. 13. The supplier agreement includes a
comprehensive indemnification provision providing, in relevant part:
14. INDEMNIFICATION. Supplier [CGS] shall protect,
hold harmless and indemnify Company [Wal-Mart]. " from
and against any and all lawsuits, claims, demands, actions,
liabilities, losses, damages, costs and expenses (including
attorney's fees and court costs), regardless of the cause or
alleged cause thereof, and regardless of whether such
matters are groundless, fraudulent or false, arising out of
any actual or alleged:
(a) Misappropriation or infringement of any patent,
trademark, trade dress, trade secret, copyright or other
right relating to any merchandise ... "
Charter Statement, ~ 33; Butera Dec!., Ex 13, § 14.
G. Motion for Partial Summary Judgment

On February 14,2011, Charter Oak moved for partial summary judgment, seeking
a declaration that Charter Oak is not obligated to indemnify CGS for (1) Wal-Mart's
defense costs in the Five Four litigation; and (2) the portion of the settlement imputed to
Wal-Mart for its liability in the Five Four Litigation.
III. Contentions of the Parties, Law, and Application to Facts
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A. Contentions of the Parties

1. Charter Oak
Charter Oak contends that the insurance agreement does not cover CGS' s claim
for reimbursement ofWal-Mart's defense costs in the Five Four litigation or the part of
the settlement attributed to Wal-Mart's liability. The insurance agreement issued by
Charter Oak to CGS contains a contractual liability exclusion that provides there is no
coverage for advertising injury "for which the insured has assumed liability in a contract
or agreement." Charter Oak maintains that CGS' s claim for reimbursement of WalMart's liability and defense costs arises solely from CGS's assumption ofliability in
connection with the indemnification provision in their supplier agreement. CGS is not, it
concludes, obligated to pay for Wal-Mart's defense costs in the Five Four litigation, or
for the portion of the settlement attributable to Wal-Mart's liability, based upon any legal
basis other than its contract with its vendee, Wal-Mart.
2. CGS

CGS contends that the contractual liability exclusion does not apply in this case
because of the exception for "damages that [CGS] would have had in the absence of
contract." The exception bars the exclusion's effect because Wal-Mart sought and was
entitled to defense and indemnification from CGS automatically, as a matter oflaw, and
not just under the supplier agreement. Charter Oak's contention that it is entitled to
allocate the settlement amount between sums paid to settle CGS's and Wal-Mart's
liability and to reimburse CGS only for the sum paid to settle CGS's liability is wrong
because: (I) allocation is not required or possible given the joint and several liability
arising from CGS's sale ofaUegedly infringing products to Wal-Mart as aUeged in the

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Five Four complaint; and (2) the cases Charter Oak relies upon to establish allocation
rights require a factual basis for the allocation; no such basis exists here.
B. Legal Standard

Summary judgment is appropriate if "the movant shows that there is no genuine
dispute as to any material fact and the movant is entitled to judgment as a matter ofIaw."
Fed. R. Civ. P. 56(a); see Anderson v. Liberty Lobby Inc., 477 U.S. 242, 248 (1986);
Powell v. Nat'! Bd. ofMed. Exam'rs, 364 F.3d 79, 84 (2d Cir. 2004). Dismissal is
warranted when after construing the evidence in the light most favorable to the nonmoving party and drawing all reasonable inferences in its favor, there is no genuine issue
as to any material fact. Fed. R. Civ. P. 56(a); see Anderson, 477 U.S. at 247-50, 255;
Sledge v. Kooi, 556 F.3d 137, 140 (2d Cir. 2009).
The burden rests on the moving party to demonstrate the absence of a genuine
dispute of any material fact. Celotex v. Catrett, 477 U.S. 317, 323 (1986); Goenaga v.
March ofDimes Birth Defects Found., 51 F.3d 14, 18 (2d Cir. 1995). If the moving party
appears to meet this burden, the opposing party must produce evidence that raises a
material question offact to defeat the motion. See Fed. R. Civ. P. 56(e). "Mere
conclusory allegations, speculation, or conjecture" will not suffice. Cifarelli v. Village of
Babylon, 93 F.3d 47,51 (2d Cir. 1996); see also Delaware & Hudson Ry. v. Consolidated
Rail Corp., 902 F.2d 174, 178 (2d Cir. 1990).
C. Application of Law to the Facts
1. Issues Presented

Presented is the fundamental question whether the sums paid by COS to or on
behalf ofWal-Mart pursuant to the settlement agreement in the Five Four litigation are

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covered by the insurance agreement. More specifically, it is whether the contractual
exclusion applies; and ifit does, whether the exception to the exclusion supports CGS's
right to indemnification from Charter Oak.
The answer to this question depends on whether another legal rule, independent of
contract liability under the supplier agreement, obligates 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 answer to this
question is examined separately with respect to (\) the relative portion of the damages in
the Five Four litigation that Charter Oak seeks to impute to Wal-Mart ("Wal-Mart's
imputed damages"); and (2) Wal-Mart's defense costs in the Five Four litigation ("WalMart's defense costs").
2. Coverage under the Insurance Agreement
It is undisputed that the contractual liability exclusion applies to CGS's claims for

reimbursement of the damages and costs incurred by Wal-Mart in the Five Four
litigation. CGS concedes it "has assumed liability in contract or agreement," Under
supplier agreement between CGS and Wal-Mart. CGS's Memo. of Law in Opp. of
Charter Oak's Mot. for Summ. Judg. ("brief in opposition"), Docket Entry No. 103, at p.
2.
CGS bears the burden of establishing that an exception to the contractual liability
exclusion applies. "[A]n insured must demonstrate that an exception to an exclusion
applies where coverage rests on the application of such exception." Monteleone v. Crow

Constr. Co., 637 N.Y.S.2d 408, 411 (lst Dep't 1998); see also Bedford Affiliates v.

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Manheimer, 86 F. Supp. 2d 67, 75 (E.D.N.Y. 1999). CGS must satisfy this burden with
regard to each of its claims -- i.e. (I) Wal-Mart's imputed damages for its own trademark
violations; and (2) Wal-Mart's defense costs. As explained below, CGS has satisfied its
burden with respect to the former, but not with respect to the latter.

a. Wal-Mart's Imputed Damages
The exception to the contractual liability exclusion applies to "'advertising injury'
... that the insured would have in the absence of contract or agreement." Charter
Statement, ~ 31; Butera Decl., Ex. 12, at form no. CG F2 10 03 OS, p. 2. To satisfy the
exception, CGS must show a duty to indemnify Wal-Mart under an independent source of
law other than the supplier agreement obligation. CGS argues that its duty existed not
primarily pursuant to the supplier agreement, but as a matter of common law and
statutory law.
Five Four brought the underlying Five Four litigation against CGS and Wal-Mart,
identifying them throughout the pleading as "Defendants;" accusing both, without
distinguishing between them, of the same wrongdoing, and seeking damages jointly from
both of them. CGS's liability to Wal-Mart was based on CGS's initial sale of the
infringing merchandise to Wal-Mart. CGS's Local Rule 56.1 Statement in Opp. to
Charter Oak's Mot. for Summ. Judg., Docket Entry No. lOS,

~~

4,7 ("CGS Statement").

These facts, coupled with the facts pled in the Five Four complaint, suffice to
charge CGS with a breach of warranty to Wal-Mart. Under New York law the buyer's
(Wal-Mart's) remedies for breach of warranty include the right to obtain indemnification
from the seller (CGS) of resulting economic loss. The relevant statute reads:
Unless otherwise agreed, a seller that is a merchant
regularly dealing in goods of the kind warrants that the
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goods shall be delivered free of the rightful claim of any
third person by way of infringement or the like but a buyer
that furnishes specifications to the seller must hold the
seller harmless against any such claim that arises out of
compliance with the specifications. N.Y. u.e.e. § 2-312(3)
(Emphasis added)
Section 2-312(3) entitles the buyer of an infringing good to indemnification from
the seller for any claims by a third party for infringement. Johnson Elec. N. Am. Inc. v.

Mabuchi Motor Am. Corp., 98 F. Supp. 2d 480, 489 (S.D.N.Y. 2000); see also Dolori
Fabrics, Inc. v. Limited, Inc., 662 F. Supp. 1347, 1358 (S.D.N.Y. 1987) (granting
defendant-retailer's cross claim for indemnification from defendant-manufacturer for
damages incurred by plaintiff-designer out of a breach of warranty by way of
infringement under N.Y. U.C.e. § 2-312(3)).
In order to recover damages under section 2-312(3) the plaintiff-buyer must show
that the seller (1) was a merchant regularly dealing in goods of the kind; (2) the goods
were subject to a rightful infringement claim of any third party upon delivery; (3) the
buyer did not furnish specifications to the seller; and (4) the parties did not form another
agreement. See Phoenix Solutions, Inc. v. Sony Elecs., Inc. 637 F. Supp. 2d 683,693
(N.D.Ca. 2009); 84 Lumber Co. v. MRK Technologies, Ltd., 145 F. Supp. 2d 675,678-79
(W.D. Pa. 2001) (mentioning only the first three elements out the aforementioned four as
required under § 2-312(3)).
There is no dispute the first three elements are satisfied in this case: (1) CGS is a
merchant who regularly deals in goods of the kind of the infringed goods; (2) the goods
were subject to a rightful infringement claim of Five Four; and (3) Wal-Mart did not
furnish specifications of the goods to CGS. See CGS statement, ~~ 4, 7.

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The fourth element -- the parties did not form another agreement -- is satisfied as
well. Unpersuasive is Charter Oak's argument that the supplier agreement constitutes
"another agreement" between CGS (the seller) and Wal-Mart (the buyer) which negates
CGS's independent legal duty to indemnify Wal-Mart under section 2-312(3).
As Charter Oak concedes, section 2-312(3) exists to protect buyers against thirdparty infringement claims in case the contract between the seller and the buyer does not
speak of this issue of infringement. See Charter Oak's Letter in Supp. of Mo. for Summ.
Judg., Docket Entry No. Ill, at p. 4. Every sale of goods is made by contract. But not
all contracts impose warranty liability. Section 2-312(3) imposes such liability, as a
matter oflaw, whenever the four elements stated above are met.
The forth element -- which requires that the parties did not form another
agreement -- is articulated in the opening of section 2-312(3) as "[u ]nless otherwise
agreed." These words clarifY that section 2-312(3) is a default rule which the parties are
free to opt out of. It enables the parties to waive the default warranty liability which
otherwise applies as a matter oflaw, whenever the other three elements are satisfied.
Section 2-312(3) is reasonably construed to apply when a contract between the buyer and
seller does not exclude warranty liability and the other three enumerated elements are
satisfied.
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).

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The cases Charter Oak relies upon to contradict this conclusion are not on the
point. CBS Inc. v. Ziff-Davis Publishing Co., 75 N.Y.2d 496, 503 (1990), stands for the
proposition, which is not disputed by CGS, that a breach of warranty claim is grounded in
contract. Section 2-312(3) applies to the sale from SCG to Wal-Mart providing
indemnification whether or not there is an independent explicit warranty agreement.
In Fantasia Accessories, Ltd. v. Northern Assurance Co. of America, 2001 U.S.
Dist. LEXIS 18865 (S.D.N.Y. 2001) the court held the insurers did not have a duty to
indemnify the insured in the breach of statutory warranty action based upon patent
infringement since that claim did not fit within the definition of advertising injury. The
court also held that the exclusion for breach of contract claims in the insurance policy
excluded the breach of statutory warranty claim since the breach of warranty claim did
not exist without the breach of contract claim. Charter Oak does not argue for a breach of
contract exclusion but contractual liability exclusion. Hecht v. Component International,
Inc. 22 Misc 3d 360, 365 (Sup. Ct. 2007) does not control the meaning of the statutory
warranty as well.
Because a duty of indemnification exists "in the absence of the [supplier
agreement]," Charter Oak is obligated to pay damages for "injury," that arises "out of ...
[i]nfringement of copyright, title or slogan .... " Butera Decl., Ex. 12, at form no. CG F2
10 03 05, p. 4. The $250,000 amount paid by CGS was paid as compensation for such

damages. See Memo. & order dated November 14,2010, Docket Entry No. 46, at pp. 811,2010 U.S. Dist. LEXIS 120671, at *10-17. Hence, the exception applies to this kind
of damage, covered by the insurance agreement. Whether the sums paid in settlement
was reasonable will be determined by trial.

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b. Wal-Mart's Defense Costs
CGS contends that Charter Oak has a duty under the insurance agreement to
indenrnify CGS for Wal-Mart's defense costs, including attorney's fees in the Five Four
litigation. To bear its burden, CGS must show that: (I) the exception to the contractual
liability exclusion applies to these damages -- namely that there was a source oflaw,
other than the supplier agreement, obligating CGS to pay Wal-Mart's defense costs; and
(2) that damages of this kind are covered by the insurance agreement. The question to be
decided, then, is whether the exception to the contractual liability exclusion applies to
this kind oflitigation damage; namely, assuming the supplier agreement did not exist,
was CGS obligated, as a matter oflaw, to indemnify Wal-Mart for defense costs it
incurred.
CGS fails to provide convincing authority supporting its case. In Lamborn v.
Czarnikow-Rionda Compo 221 A.D. 737 (1st Dep't 1927), plaintiff-buyer brought suit

under section 151 of the Sales of Goods Act against defendant-seller for damages
incurred by defendant as a result of breach of warranty. Plaintiff sought to recover, as
special damages, defense costs it has incurred from a suit brought by a third party who
bought the goods and suffered damages. The court held that "[i]f it appears that the
special damage claimed was fairly within the contemplation of the parties when the
contract was entered into, there is no reason why [defense costs] should not be
recovered." !d, at 738. Lamborn does not stand for the proposition that the defendant in
a breach of warranty claim is entitled to defense costs as special damages whenever a
contract is silent about this question. Lamborn merely held that plaintiff could plead that

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a right for indemnification for defense costs was within the contemplation of the parties.

Id.
As for statutory law, CGS relies on section 2-7 I 5(2)(b) of New York Uniform
Commercial Code. It reads: "Consequential damages resulting from the seller's breach
include ... injury to person or property proximately resulting from any breach of
warranty." No New York cases applying this provision to include defense costs ofa third
party -- here Wal-Mart's -- when the contract is silent on the issue, have been cited by the
parties. There are a few cases in other jurisdictions supporting CGS's interpretation of
section 2-7 I 5(2)(b), but the balance of authority is contra. See, e.g., Note, David T.
Schaefer, Attorney's Fees for Consumers in Warranty Actions -- An Expanding Role of

the Uc.c.?, 61 Ind. L.J. 495, 498, n. II (1986) (virtually every court considering the
question of whether the U.C.C. allows recovery of attorney's fees as incidental or
consequential damages has denied recovery).
General policy supports rejection ofCGS's position. 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." "In
the United States, the prevailing litigant is ordinarily not entitled to collect a reasonable
attorneys' fee from the loser." Alyeska Pipeline Servo Co. v. Wilderness Society, 421 U.S.
240,247 (1975). "[A]n award of attorneys' fees may be authorized by agreement
between the parties, statute or court rule. In the case of an agreement between the parties,
the obligation to pay attorneys' fees must be unmistakably clear in the language of the
contract." Wuhan Airlines V. Air Alaska, Inc., 1999 U.S. Dist. LEXIS 5204, 5-6
(S.D.N.Y. 1999); see also Bridgestone!Firestone Inc.

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V.

Recovery Credit Services, Inc.,

,

.
98 F,3d 13,20-21 (2d Cir. 1996). "[A]ttorneys' fees may be included as damages where
such an award is clearly implied from the language and purpose of the entire agreement
and the surrounding facts and circumstances." Bonnie & Co. Fashions, Inc. v. Bankers

Trust Co., 955 F. Supp. 203, 218 (S.D.N.Y. 1997) (quotation marks and citations
omitted).
"The New York approach to the interpretation of contracts of insurance is to give
effect to the intent ofthe parties as expressed in the clear language of the contract."

Federal Insurance Company v. American Home Assurance Co., 2011 U.S. App. LEXIS
7057 (2d Cir. Apr. 7, 2011) (quoting Mount Vernon Fire Ins. Co. v. Belize NY, Inc., 277
F.3d 232, 236 (2d Cir. 2002)) (internal quotation marks omitted). Here, there is no
indication in any contractual language suggesting an intent to depart from the American
rule.
The insured must pay for the buyer's litigation costs in contradiction of the
general American rule since it has contracted to do so -- thus converting its lack of
automatic obligation under law into a burden assumed by contract. See, e.g., Mary
Frances Drefner & Arthur D. Wolf, 1 Court Awarded Attorney Fees, 'Il6.02 (1983).
It should be recognized that in the instant case the insured has made an appealing

argument that the litigation burden of the buyer is assumed by the seller-insured's as a
matter of sales law and through an implied warranty under law against unsatisfactory
goods (including those causing the indirect damages oflitigation expenses). See, Note,
David T. Schaefer, Attorney's Feesfor Consumers in Warranty Actions -- An Expanding

Role of the Uc.c.?, 61 Ind. L.J. 495, 501-509 (1986). But, on balance, Charter Oak
wins in this dispute because it has assumed a burden contrary to the American Rule only

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·

.
to the limited degree that it has explicitly done so in the insurance agreement covering its
own liability for litigation expenses.
Because the insurance agreement does not explicitly include coverage for defense
costs as either consequential or incidental damages arising out of the insured's breach of
warranty, the presumption of the American rule stands. Those damages ofWal-Mart for
its legal fees in the underlying litigation are not covered by the insurance agreement. It is
unnecessary to consider the issue of proximate cause since this case is controlled by an
interpretation of an unambiguous insurance agreement and applicable sales law.

IV. Conclusion
Charter Oak's motion for partial summary judgment is granted in part and denied
in part as indicated above, without costs.
Trial is scheduled for May 3, 2011. The parties shall submit trial briefs and
proposed findings of facts and law seven days before trial.

SO ORDERED.

Jack B. Weinstein
Senior United States District Judge
Date: April 15, 2011
Brooklyn, New York

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