Considering the Duty to Defend

In his new chapter (Chapter 11, “Considering the Duty to Defend” in the New Appleman Insurance Law Practice Guide), J. Robert Hall explores the wide array of considerations implicated by one a liability insurers’ main contractual obligations ─ the duty to defend. He is quick to point out, however that the duty to defend also includes the right to defend. “Taken together, the right and duty to defend provide the insurer with the right and duty to control litigation in which the insurer may have a duty to indemnify the insured.” Many factors come into play and some involve unresolved issues. For instance, disputes often arise as to whether an insured can recover from an insurer “pre-tender” defense costs that it incurs before the insurer becomes involved in the defense, and jurisdictions are divided on this issue. Another example is that in many jurisdictions an insurer can obtain recoupment of some or all of its defense costs from the insured when it defends subject to a reservation of the right to recoup defense costs, and no duty to defend ultimately is held to exist. Arguments supporting a right of recoupment can be contractual, equitable, or based on public policy, and the issue remains undecided in many jurisdictions.
 
In fact, there are so many diverse factors to consider in this area that it may well be instructive to present the chapter’s “Master Checklist” – a succinct cataloging of pertinent concerns for both policyholder and insurer counsel to bear in mind. References to sections in Chapter 11A are provided where each factor is discussed in more detail:
 
      
Consider whether the liability policy at issue contains a duty to defend provision and, if it does not, consider whether the applicable law will imply a duty to defend.

Discussion: § 11A.04
 
Understand that the duty to defend includes a right to defend, what the right and duty entail, and what their purposes are.

Discussion: §§ 11A.05-11A.06
 
Know that the duty to defend generally is owed only to insureds, and understand how to determine whether a person or entity qualifies as an insured.

Discussion: § 11A.07
 
Know that, in order for the insurer to have a duty to defend, the policy usually must have a duty to defend provision, and understand the differences among primary, excess, and umbrella policies in terms of their defense obligations and when they arise.

Discussion: § 11A.08[1]
 
Understand that, in order for the insurer to have a duty to defend, a potentially covered ''suit'' typically must be instituted against the insured, and know that in addition to lawsuits, some claims, demands, and alternative dispute resolution proceedings may qualify as ''suits.''

Discussion: § 11A.08[2]
 
Evaluate when any duty to defend arises under the applicable law, whether it is at the time the insured tenders its defense to the insurer, the time the insured first has notice of the suit, or when the complaint is filed, irrespective of the insurer's knowledge of it.

Discussion: §§ 11A.09[1], 11A.09[2]
 
To the extent the insured incurred defense costs prior to notice or tender to the insurer, consider whether those ''pre-notice'' or ''pre-tender'' defense costs may be recovered from the insurer, and under what circumstances.

Discussion: § 11A.10
 
Understand the concept of a ''targeted tender,'' permitted in a small minority of jurisdictions, the purpose behind it, and its effect.

Discussion: § 11A.11
 
Determine whether a duty to defend exists -- whether there is a potential for coverage -- by comparing the allegations of the complaint against the insured to the policy terms, taking care to analyze the complaint as a whole, with a focus on the factual allegations, and be sure to consider any amended complaints.

Discussion: §§ 11A.12, 11A.14
 
Understand that many jurisdictions permit or require an insurer to consider facts extrinsic to the complaint, in addition to the complaint allegations, in evaluating its duty to defend. Know that whether and to what extent extrinsic evidence may be considered often depends on whether it is used to create or preclude a duty to defend.

Discussion: §§ 11A.13[1], 11A.13[2]
 
Realize that, even in ''four corners'' jurisdictions that generally do not allow consideration of extrinsic evidence, evidence that the putative insured is not really an insured (and certain other types of evidence) usually still can be considered.

Discussion: § 11A.13[3]
 
Insurers should be aware that, at least in certain circumstances, a minority of jurisdictions impose a duty to investigate on insurers before they decline to defend.

Discussion: § 11A.13[4]
 
Understand that, in determining whether a duty to defend exists, doubts and ambiguities usually are resolved in the insured's favor.

Discussion: § 11A.15
 
Know that even if only some claims or counts are potentially covered, most courts require the insurer to defend the entire action. A small minority of states permit an insurer to defend only the potentially covered claims or counts.

Discussion: § 11A.16
 
Realize that the duty to defend often extends to groundless, false, or fraudulent claims, particularly under older policies.

Discussion: § 11A.17
 
Realize that insurers often defend subject to a reservation of rights because it enables them later to assert coverage defenses which otherwise might be barred by operation of the doctrines of waiver and estoppel.

Discussion: §§ 11A.18[1], 11A.18[2]
 
Understand that a defense provided subject to a reservation of rights is not a breach of the duty to defend, although a minority of courts hold that an insured has a right to reject the defense and retain its own counsel.

Discussion: § 11A.18[3]
 
Evaluate the effectiveness of any reservation of rights letter, both in terms of the insurer's rights reserved as well as the timeliness of the letter. Consider whether any of the insurer's rights reserved gives rise to a conflict of interest, such that the insured may be entitled to independent counsel under applicable law.

Discussion: §§ 11A.18[4], 11A.18[5]
 
Know that the insurer's defense obligation typically does not extend to the prosecution of the insured's affirmative claims.

Discussion: § 11A.19
 
Know whether an allocation or sharing of defense costs among other parties is permitted under the policy language or applicable law.

Discussion: §§ 11A.20, 11A.21
 
To the extent defense cost allocation is permitted, know the various allocation methodologies that may apply and how they operate, including whether defense costs may be allocated to the insured for uninsured or self-insured periods, and whether an insurer may provide a partial defense.

Discussion: §§ 11A.22, 11A.23, 11A.24
 
Understand when the duty to defend may terminate, including when all potentially covered claims have been dismissed or deleted from the operative complaint.

Discussion: § 11A.25
 
Consider whether facts extrinsic to the complaint have come to light, through discovery or otherwise, which negate the potential for coverage.

Discussion: § 11A.26
 
Understand that the insurer's payment of its policy limits in satisfaction of a judgment or settlement that does not resolve the case nonetheless probably will terminate the duty to defend, although payment of the policy limits into court or to the insured prior to judgment or settlement likely will not.

Discussion: § 11A.27
 
Know that the duty to defend may include, at least under certain circumstances, a duty to appeal an adverse judgment against the insured.

Discussion: § 11A.28
 
Understand that, absent bad faith on the part of the insurer, the damages awarded for breach of the duty to defend typically are limited to the insured's reasonable and necessary defense costs, and possibly prejudgment interest, although some courts have suggested other damages may be awarded in very limited circumstances.

Discussion: §§ 11A.29, 11A.30
 
Be aware that, absent unusual circumstances, a judgment against the insured is not a consequential damage of a breach of the duty to defend, although in a small minority of states an insurer's breach of the duty to defend will estop it to raise any coverage defenses.

Discussion: §§ 11A.31, 11A.32
 
Know that another consequence of an insurer's breach of the duty to defend may be that the insured may be able to enter into a reasonable, good faith, non-collusive settlement with the plaintiff without the insurer's consent.

Discussion: § 11A.33
 
To the extent a default judgment is entered against the insured following the insurer's breach of the duty to defend, consider whether the insured had a duty to mitigate the damages flowing from the insurer's breach.

Discussion: § 11A.34
 
Know that an insurer's failure to provide independent counsel in a conflict of interest situation may, in some jurisdictions, be viewed as a breach of the duty to defend, although any negligence of defense counsel likely will not be imputed to the insurer.

Discussion: §§ 11A.35[1], 11A.35[2]
 
Understand that, under certain circumstances, an insurer that provides a defense for suits that contain both noncovered and potentially covered claims, or for suits that are entirely noncovered, may be able to recoup some or all of its defense costs from the insured.

Discussion: §§ 11A.36[1], 11A.36[2]
 
Know that an insurer typically may obtain defense cost recoupment if it defends the insured subject to a reservation of the right of recoupment and no duty to defend is ultimately held to exist, or if it defends pursuant to a court order that a defense obligation exists, which order is later reversed.

Discussion: §§ 11A.37[1], 11A.37[2]
 
Understand the arguments in favor of defense cost recoupment and against it, and realize that many courts have not yet addressed the issue.

Discussion: § 11A.38
 
Taking just this last item, let’s see how Mr. Hall develops this issue:
 
Arguments with respect to defense cost recoupment focus on the rights of the insurer in light of equity, contract, and public policy principles.

Insurer's Perspective: 
In terms of equitable principles, insurers argue that they are entitled to recoupment to prevent an unjust enrichment of the insured: it would be unjust for the insured to retain the benefit of the defense without paying for it, because it would be contrary to the parties' intentions under the insurance contract. The insured paid a premium to receive a defense for covered or potentially covered claims; it did not pay any premium for a defense of claims which are not even potentially covered. Courts have held that an insured's receipt of a defense of noncovered claims under these circumstances constitutes unjust enrichment [see, e.g., Buss v. Superior Court, 939 P.2d 766 (Cal. 1997) ; Colony Ins. Co. v. G & E Tires & Service, Inc., 777 So. 2d 1034 (Fla. Dist. Ct. App. 2000) ].

Insured's Perspective: 
Insureds, on the other hand, argue that the doctrine of unjust enrichment does not apply. They argue that, generally speaking, a party cannot recover in equity if it has entered into an express contract concerning the same subject matter, and the insurance contract was intended to delineate all of the parties' rights and obligations in connection with the insurer's defense of the insured. Accordingly, insureds reason, the insurer cannot effectively ''re-write'' the contract by bringing an equitable claim for unjust enrichment [ General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005) ; Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d 510, 513-14 (Wyo. 2000) ].

Insurer's Perspective: 
Insurers also maintain they are entitled to recoupment of defense costs under contract principles. Many courts have held that a new contract is formed by the insured's express or implied acceptance of the terms and conditions of an insurer's reservation of rights letter, including the insurer's reservation of its right of recoupment [see United Nat'l Ins. Co. v. SST Fitness Corp., 309 F.3d 914, 919 (6th Cir. 2002) ; Jim Black & Assocs., Inc. v. Transcont'l Ins. Co., 932 So. 2d 516, 516-18 (Fla. Dist. Ct. App. 2006) ].

Insured's Perspective: 
To counter this, insureds often argue there was no acceptance of the offer, and that their own ''mere silence'' does not qualify as acceptance of the terms of a ''unilateral'' reservation of rights letter [ General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1099 (Ill. 2005) ; Shoshone First Bank, 2 P.3d at 513-14 ].
 
A number of courts have rejected this counter-argument, however, and hold that an insured need not expressly agree to the insurer's offer to defend the insured subject to a right of recoupment [ Jim Black, 932 So. 2d at 516-18 ]. These courts instead reason that an insured manifests its acceptance through its conduct in accepting a defense under the terms offered [id.; see also Robert H. Jerry, The Insurer's Right to Reimbursement of Defense Costs, 42 Ariz. L. Rev. 13, 56-57 (2000)].
 
Insurers also claim that recognition of a right of recoupment is supported by public policy principles for three reasons:
1. It provides an incentive for insurers to defend their insureds under a reservation of rights when coverage is uncertain;
 
2. It results in a decrease in litigation; and
 
3. It results in fairly priced liability insurance premiums, by not requiring insurers to pay for the defense of noncovered claims.

Insurer Perspective: 
Insurers argue that recognition of a defense cost recoupment right provides a strong incentive for the insurer, particularly in close cases, to provide a defense under a reservation of rights rather than deny coverage [see United Nat'l Ins. Co. v. SST Fitness Corp., 309 F.3d 914, 922 (6th Cir. 2002) (applying Ohio law); Scottsdale Ins. Co. v. MV Transp., 115 P.3d 460, 464 (Cal. 2005) ; Buss, 939 P.2d at 778 ]. One court explained that by recognizing a right of recoupment, courts created an incentive for insurers to defend by subsequently allowing them to seek reimbursement and ''attempted to create a remedy for insurers that provided defenses to insureds when coverage ultimately did not exist'' [ Cotter Corp. v. Am. Empire Surplus Lines Ins. Co., 90 P.3d 814, 828 (Colo. 2004) ].

Insured Perspective: 
Insureds often counter that public policy considerations should not frustrate the parties' freedom of contract, and that insurers can add express recoupment provisions to their policies if they wish to do so [ General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1099 (Ill. 2005) ].
 
Given the absence of controlling authority in many jurisdictions, the law as to defense cost recoupment will continue to develop and evolve in the years to come.