You have been served with a summons and complaint by an unhappy customer, business competitor, neighbor, guest injured on your premises, or some total stranger. You believe the lawsuit is frivolous and that the court will eventually rule in your favor. However, until then, you are worried about paying expensive legal bills. As insurance coverage counsel, we can help you determine if your insurance company is obligated to pay for your legal defense, even if there is an issue regarding insurance coverage.
You’ve been paying expensive insurance premiums for years and have never made a claim. Now, when you finally need policy coverage and a defense for a 3rd party lawsuit, your insurance agent and/or insurer may tell you that your policy doesn’t cover such claims. Rather than give up, you should promptly seek advice from an attorney who can review your policy and advise you if the insurer has a duty to defend you (even if they contest whether they must indemnify you for any judgment).
The Insurer’s Duties to Indemnify and to Defend
Most policies, regardless of whether it’s a CGL or homeowners policy, include at least two liability-related promises by the insurer. The first promise, which is commonly referred to as the duty to indemnify, is the insurer’s agreement to pay for the insured’s legal liability up to the stated policy limits. The second promise, which is broader than the first promise, is referred to as the promise to defend, and it means that the insurer agrees to hire legal counsel to defend the insured (you) against a potentially covered suit. The duty to defend also includes a promise to cover all legal fees and costs. Therefore, if a policyholder is faced with a potentially covered third-party claim, the insurer has an immediate duty to defend against the claim, in addition to a duty to eventually pay any monetary award entered against the insured for covered claims. Even if your company’s policy provides that the insured must pay a self-insured retention (“SIR”), which is like a deductible, a recent California decision (American Safety) held that the insurer’s duty to defend arises as soon as the claim is tendered, and is not conditioned on the insured’s payment of the SIR.
Determining the Duty to Defend
The insurer’s duty to defend is controlled by the allegations contained in the complaint. The first step is a careful reading of the complaint to determine the nature of the underlying allegations. Even if only one claim in a suit is potentially covered by the policy, the insurer typically has a duty to defend the entire suit. Therefore, all allegations in the complaint must be analyzed for potential coverage, even if clearly non-covered claims (e.g., fraud) are included. The second step is to consider “extrinsic evidence” outside of the complaint, such as evidence obtained during the pre-suit investigation by the insured and the coverage investigation by the insurer. The California Supreme Court in Gray v. Zurich held, “Any doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured’s favor.”
Reimbursement of Defense Costs
An insurer will generally not be able to recover from an insured the cost of defending any claim. Therefore, even after defending the insured, and later proving that the allegations against the insured were not covered by the policy, the insurer still is unlikely to recover from the insured any money already paid for the insured’s defense.
This is significant when the cost to defend a claim may equal, or even exceed, the policy limits under the policy. In other words, the insurer may pay over $1 million to defend against a lawsuit where the policy limits are only $500,000. Thus, for the insured, the value of appointed defense counsel could far outweigh the value of indemnity from any monetary award entered against you. This illustrates the potential value of a liability insurance policy.
There are exceptions to this general rule, one of which is where a com- plaint contains arguably covered allegations and undisputedly non- covered allegations. Where an insurer “reserves its rights” to obtain reimbursement, it may later seek reimbursement from an insured, but only for defense costs paid to defend against non-covered allegations. However, reimbursement is “extremely difficult” (per the Supreme Court in Buss) and unlikely as a practical matter because the burden is on the insurer to demonstrate the specific defense costs allocated to the covered versus non -covered claims. Conversely, a number of insureds have successfully obtained reimbursement for “pre-tender” defense costs, i.e., costs the insured incurs before the insurer even becomes aware of the claim.
Termination Of The Duty To Defend
It is a common misconception that the duty to defend lasts only until the limits of the insurance policy have been exhausted. An insurance company cannot simply tender the policy limits up front to avoid paying the defense costs. One common example of this issue arising is when the policy limits are clearly insufficient to cover the potential liability. For example, if an insured has only $1 million in liability coverage, but is faced with liability for a catastrophic injury or massive environmental cleanup, the settlement or judgment will almost certainly exceed the policy limits; however, the insurer may still have a duty to defend the insured even after it tenders the policy limits to satisfy the claim. Simply tendering the policy limits without retaining defense counsel runs counter to the concept of separate duties to defend and indemnify. In fact, courts have found this practice in violation of the insurer’s duty to defend, and consequently the insurer’s duty of good faith. Therefore, insurers must be cautious when denying or withdrawing defense of an insured before the underlying action is resolved or there is a conclusive showing of no coverage for the claim. The potential consequences for refusing to defend an insured for an arguably covered claim can be severe. An insurer’s denial of coverage could cause a breach of the insurance contract, which can also lead to a bad faith claim.
Bad Faith Claims
Generally, bad faith occurs when the insurer unreasonably breaches the insurance policy, i.e., fails to defend its insured (you) without a reasonable belief that the underlying suit is not covered. There is also an implied duty
to settle a lawsuit within policy limits when there is a likelihood of recovery in excess of such limits.
It is essential to evaluate insurance coverage at the outset of a lawsuit. By delaying, you run the risk that you will not be able to recover your defense costs. As attorneys with coverage and litigation defense experience, we’re here to help and advise you. Don’t navigate this legal minefield alone