Insurance Claims - Duty to Defend
The Duty to Defend: The 3 Primary Sources of Insurer Litigation
Joseph M. Junfola | Property Casualty 360°
December 30, 2014
It's not much of a stretch to say that an insurer's duty to defend has been litigated over the years at a cost of hundreds of millions of dollars. There are three issues that have accounted for a substantial amount of that litigation.
It is well-established that the duty to defend is broader than the duty to indemnify. Often touted as being “axiomatic,” if there is a potential for coverage under the CGL policy, there is a duty to defend a suit. The duty to indemnify, on the other hand, is narrower because it depends on the insured proving that a loss is actually covered.
Is it possible to have a duty to indemnify but not a corresponding duty to defend? Is the duty to indemnify without a corresponding duty to defend an anomaly, or at least a bit illogical? Or is it perfectly logical in the context of an “eight-corners” state like Texas?
The analysis of the duty to defend begins with an examination of the facts and the policy. It is necessary to determine, however, what facts an insurer must or can review when determining its defense obligation in a particular jurisdiction. Is the examination of the facts limited to those stated in the lawsuit or can information extrinsic to the lawsuit be consulted?
While it is universally accepted that the duty to defend is broader than the duty to indemnify, jurisdictions differ as to what information can be used to determine that duty. For instance, in an “eight-corners” state, the decision to defend must be based on a review of the policy and the lawsuit. Use of information outside of the complaint is generally not permitted. In other states, information extrinsic to the complaint must be considered. In some cases, this information can be used to defeat coverage as well as afford it. In other cases, the information can be used only to afford coverage.
So, while it appears that the defense duty is broad because only a potential for coverage need be established, an eight-corners state restricts the amount of information that can be examined. Does this restriction detract from the axiom that the duty to defend is broader than the duty to indemnify when only limited information can be used?
Common rationale for rejecting the eight-corners rule can be persuasive. First, the denial of a defense based on information restricted to the lawsuit would appear to be contrary to the broad duty to defend, which is universally recognized; and, second, the decision to defend, or not, would be based on the pleadings, which could be limited in its recitation of the facts and be subject to “the pleading strategies, whims, and vagaries of third-party claimants to control the rights of parties to an insurance contract.” (Maniloff and Stempel, 2011.)
On March 21, 2013, a federal district court in Texas ruled that the duty to defend and duty to indemnify are distinct duties under Texas law and that one can exist without the other. (Colony Ins. Co. v. Price, 2013)
Citing the Supreme Court of Texas in D.R. Horton-Tex., Ltd. v. Markel Inter’l Ins. Co, 300 S.W.3d 740, 743, the Colony court stated that “although the duty to defend is ‘strictly circumscribed by the eight-corners doctrine, it is well settled that the facts actually established in the underlying suit control the duty to indemnify.’”
Is the duty to defend truly broader than the duty to indemnify if determination of the duty to defend is “strictly circumscribed by the eight-corners doctrine?” To answer this question, it is helpful to distinguish the “potential v. actual” criterion for determining duties from any constraints on the information to which this criterion can be applied.
When the duty to defend must be determined from the lawsuit only and not from extrinsic information, it is possible that no duty to defend exists given the way the lawsuit is drafted. On the other hand, there may be a duty to indemnify because it can be determined based on information outside of the complaint.
In D.R. Horton-Texas, Ltd., the Court ruled that the defense and indemnity duties are independent of each other and that an indemnity duty can exist without a defense duty: “We hold that even if Markel has no duty to defend D.R. Horton, it may still have a duty to indemnify… That determination hinges on the facts established and the terms and conditions of the CGL policy.”
Hence, the anomaly...the duty to defend is broader than the duty to indemnify, but in an eight-corners jurisdiction, the information used to determine the duty to defend is limited. And while the duty to indemnify is narrower, the information used to determine that duty is broad. Since the duties exist independent of each other, it is possible to have a duty to indemnify without a duty to defend.
Two's company and sometimes three's a crowd in the “tripartite relationship,” that frequently complicated and contentious relationship among the insurer, the defense attorney hired by the insurer to defend its insured, and the insured.
The Insuring Agreement in the CGL form provides that the insurer “…will have the right and duty to defend the insured against any ‘suit’ seeking those damages.” (Commercial General Liability Form) The right to defend includes the right to select defense counsel. Whether that right can be exercised depends on whether a conflict of interest arises when the insurer hires an attorney to defend its insured, but also reserves its rights to deny coverage. In such circumstances, the potential for conflict in the “tripartite relationship” among the insured, insurer, and defense counsel hired by the insurer can play havoc with the insurer's right to select counsel.
When the insurer has an obligation to defend, it will retain an attorney to defend its insured and frequently the attorney is selected from the insurer's “panel.” If the defense is conducted subject to reservations, however, the insurer must determine whether and under what conditions the insured is entitled to independent counsel at the insurer's expense. When an insurer reserves its rights while defending, warning that there may be no coverage for indemnity, a potential conflict of interest may arise as to the attorney retained by the insurer to defend the insured and that attorney's ability to impact insurance coverage, to the potential detriment of the insured.
On the one hand, defense counsel has a duty of loyalty and allegiance to his or her client, the insured. On the other hand, that attorney has received and counts on receiving many assignments from the insurer to defend its other policyholders in other cases. The retained attorney has a vested interest in a good relationship with the insurer. Just how is a “good relationship” with the insurer maintained? Ideally, that good relationship is maintained simply by the attorney competently and loyally defending his or her client, the insured.
But it certainly is not difficult to understand the trepidations of an insured, facing potentially uncovered claims, having its defense handled by an attorney, hired by the insurer, who wants more business from that insurer. It is possible that a misguided attorney who wants more work, and perhaps because of overt or covert pressure from an unscrupulous insurer, may act in ways that places the insurer's interests above the insured's. (Maniloff, 124)
The attorney who is hired to defend the insured may find him/herself in a “conflict-of-interest purgatory.” (Gary L. Johnson, 2012) If the interests of the insurer and insured coincide, the attorney can proceed confidently knowing that the interests of both are being protected, “But where…the interests are adverse to one another, then the attorneys may not ‘assist the lost traveler along the road and at the same time prepare a trap into which he will ultimately fall.’” (Johnson)
Whether any coverage issues create a conflict of interest such that independent counsel must be paid for by the insurer depends on the jurisdiction. Probably the best known treatment of conflicts of interest created by an insurer's reservation of rights while defending its insured can be found in California's “Cumis” law. Codified in California Civil Code §2860, popularly known as “Cumis” after a case that preceded the code, the law provides that in the event of a conflict of interest “…the insurer shall provide independent counsel to represent the insured unless, at the time the insured is informed that a possible conflict may arise or does exist, the insured expressly waives, in writing, the right to independent counsel.”
The code goes on to state that the insurer can incorporate into its policy a method for the selection of the independent counsel. Furthermore, the code makes clear that not all conflicts create a conflict of interest such that the insured has a right to independent counsel: “…when an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist. No conflict of interest shall be deemed to exist as to allegations of punitive damages or be deemed to exist solely because an insured is sued for an amount in excess of the insurance policy limits.”
In California, then, not every reservation of rights triggers a conflict of interest situation. Some states recognize a conflict of interest if the insurer reserves its rights for any reason, while others recognize no reservations that create a conflict.
If a conflict of interest arises when the insurer reserves its rights, it may be prudent to withdraw the reservations that create the conflict, to avoid the obligation to pay for independent counsel. Of course, such a decision requires thoughtful deliberation, carefully weighing the pros and cons of affirmatively waiving any rights.
In February 2013, Dr. Jerry Buss, long-time owner of pro basketball's Los Angeles Lakers and hall of famer, died at the age of 80. Aside from a legacy of world championships, he also left one for the insurance industry in the form of a California Supreme Court case decided in 1997, Buss v. Superior Court, 16 Cal. 4th 35 (Cal. 1997), probably the leading case supporting the right of an insurer to seek reimbursement for expenses incurred in the defense of causes of action against the insured that are not potentially covered under the policy.
If the defense of an insured is conducted under a reservation of rights due to coverage issues, the reservations may include the right to seek reimbursement for defense expenses paid. Because the duty to defend is very broad, and because the insurer must defend the entire action, some jurisdictions provide for the right to reimbursement of defense expenses specific (solely) to causes of action that are not potentially covered.
In the underlying case against Buss and others, H&H Sports had contracted with Buss to provide advertising and other services. A dispute between the parties evolved into a lawsuit in which 27 causes of action were asserted, including count 23 for defamation. Buss’ insurer defended the entire lawsuit on the premise that only the defamation count was potentially covered. The Supreme Court ruled that the insurer had the right to reimbursement of expenses in the defense of specific causes of action that are not potentially covered.
While California is a bellwether state in many instances, not every jurisdiction always follows its lead. In 2010, the Supreme Court of Pennsylvania ruled in Am. & Foreign Ins. Co. v. Jerry's Sport Ctr., Inc., 606 Pa. 584 (Pa. 2010) that the right of reimbursement should be included in the insurance policy if the insurer wishes to preserve this right, as opposed to creating a new contractual obligation by way of an unilateral reservation of rights letter within which the insurer attempts to preserve its right to reimbursement and where the insured accepts the defense. Thus in Pennsylvania, an insurer's right to recoupment of expenses incurred in the defense of a claim or cause of action that is not potentially covered must be provided for in the insurance policy, and cannot be preserved in a simple, unilateral reservation of rights letter extrinsic to the policy.
The content of this article is intended to provide general information and as a guide to the subject matter only. Please contact an Advise & Consult, Inc. expert for advice on your specific circumstances.