Reed Smith LLP on the “Four Corners” Rule and the Duty to Pay Defense Costs – A Potent Tool for Policyholders Under D&O Insurance Policies

Reed Smith LLP on the “Four Corners” Rule and the Duty to Pay Defense Costs – A Potent Tool for Policyholders Under D&O Insurance Policies

   By John B. Berringer and Jill N. Averett, Reed Smith LLP

Officers, directors and their corporations routinely are denied the full benefits of the D&O Insurance Policies they purchased at great cost when lawsuits naming them as defendants include allegations of intentional wrongdoing which arguably trigger policy exclusions.  Even though such exclusions routinely provide that coverage will not be forfeited until it can be shown that the wrongdoing triggering the exclusion has "in fact" occurred, insurance companies will often refuse to honor their contractual promise to pay defense costs based upon their unilateral conclusion that the allegations of misconduct are well-founded.  Courts around the country, however, have refused to allow insurance companies to walk away from their defense obligations based upon the insurance company's unilateral conclusion that the allegation misconduct triggering an exclusion has "in fact" taken place.

The decision by these courts is firmly rooted in traditional black-letter law in many states concerning the defense obligations of liability insurers.  In fact, it is black-letter law in jurisdictions around the country, once an insurance company's duty to defend has been triggered by allegations of a covered claim, the insurer will not be relieved of its duty even if some of the claims in the underlying action are not covered or are excluded.  Neither can an insurer argue that the "four corners" rule does not apply, or should be applied in a different fashion, because D&O policies generally impose a duty to pay defense costs, as opposed to a duty to defend, in connection with the underlying claims.  As noted by one court, the "effective difference between [these] two defense obligations is who chooses and pays the defense attorney, not whether a defense obligation lies with the insurer."  Accordingly, both an insurer's duty to defend and to pay defense costs must be construed broadly in favor of the policyholder.

Thus, where the allegations of a complaint in an underlying action fall squarely within the terms of a D&O Policy, and the insurer's duty to advance defense costs thereby is triggered, courts have consistently held that an insurer cannot walk away from that obligation with impunity merely because of unproven allegations of wrongdoing.  Indeed, authority nationwide squarely rejects any rule that would permit an insurer to unilaterally relieve itself of its defense obligation to its policyholder.

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John B. Berringer is a partner and Jill N. Averett is an associate in the New York office of Reed Smith LLP.  Mr. Berringer and Ms. Averett are both members of Reed Smith's Insurance Recovery practice group.

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