Liability Insurer’s Duty To Defend
Steven E. Leder
Insurance Covers Everything Except What Happens — Miller’s Law
Tony Stewart, the NASCAR Champion, was sued by the Estate of Kevin Ward, who was struck and killed when he walked onto the course during a Sprint Cup race on August 9, 2014. Stewarts’ commercial general liability (“CGL”), auto and excess insurers denied a duty to defend Stewart in the lawsuit. As counsel for Tony Stewart, how do you advise your client?
The duty to defend forms the backbone of the insurance defense industry but what do we know about it? How do we measure the duty? What is the scope of the duty to defend? What are the consequences of failing to defend? When does the duty terminate? What if, after the jury verdict, there was no duty to defend?
An insurer must defend and indemnify its insured if it is sued by a third party because of an act covered by the policy. The duty to defend is a contractual, not common law, duty usually found in the insuring clause. However, the courts’ decisions on this simple duty fill volumes.
A. Standard for Measuring the Duty to Defend
An insurer’s duty to defend is measured by two tests: (1) the potentiality rule; and (2) the comparison test. The Maryland Court of Appeals first articulated the potentiality rule in Brohawn v. Transamerica Insurance Company:
The Court further explained how to determine whether there is a potentiality of coverage in St. Paul Fire & Marine Insurance Co. v. Pryseski, where the Court adopted the comparison test, also known as the “four corners rule” or the “exclusive pleading rule”:
The comparison test compares the allegations of the complaint with the policy coverage. The court must accept the allegations as true no matter how “attenuated, frivolous, or illogical that allegation may be.” 3
B. The Exclusive Pleading Rule Unchained
The comparison test normally restricts the evidence used to determine the duty to defend to the complaint and the policy language. An insured, however, may rely on extrinsic evidence outside of the complaint to establish a duty to defend where the complaint “neither conclusively establishes nor negates a potentiality of coverage.” 4 The extrinsic evidence must
Any uncertainty as to whether there is a duty to defend is resolved in favor of the insured.6 Moreover, an ambiguous allegation may also trigger a duty to defend; for example, where the allegations in the complaint do not specifically allege that the loss occurred during the policy period, there is a duty to defend.7
Insurers, on the other hand, may not rely upon extrinsic evidence to deny coverage.8 This includes whether the putative insured qualifies as an insured.9 There is an exception to this rule permitting an insurer to contest coverage with extrinsic evidence where there is uncontroverted evidence that clearly establishes that there is no potentiality for coverage.10 A court need not “turn a blind eye where, as here, it is firmly established by judicial decree that an insured tortfeasor is excluded from coverage under particular terms of the insurance policy.” 11
C. Ambiguous Policies + Extrinsic Evidence = A Duty to Defend
D. Mixed Actions
In some states, the insurer may recoup the cost of defense if it turns out the defended counts were not covered.17 This issue has not been addressed by the Maryland appellate courts. However, the Fourth Circuit, applying Maryland law, has predicted that there is no right to recoupment.18
E. Every Story Has a Beginning and an End
The duty to notify is not a condition precedent but a mere covenant due to Maryland’s notice-prejudice statute.21 The duty to defend is not breached until after the insurer receives notice of the event and the insurer unjustifiably declines to fulfill its obligations.22 Tender need not be by the insured, but may be made by another on the insured’s behalf to trigger a duty to defend.23
The duty to defend is a continuing one that extends to an appeal as long as reasonable grounds to appeal exist.24 The duty to defend terminates when the claimant’s “claim may be confined to non-covered allegations.” 25 The duty to defend also terminates when the policy limits are exhausted.26 If there is no duty to defend, there is no duty to indemnify.27
F. Better Late Than Never—Insurer’s Liability For Pre-Tender Defense Costs
Maryland, unlike virtually every other state, requires insurers to reimburse insureds for pre-notice defense costs unless it can show prejudice as a result of the delay.28 The Court of Appeals set forth several factors for determining whether the insurer was prejudiced by the delay; i.e.: (1) was it reasonable for the insured to have incurred the expense; (2) was the expense reasonable; and (3) did the expense materially exceed what the insurer would likely have incurred had the notice been given earlier?29 For example, a rate may be reasonable yet materially in excess of a rate a specific insurer has negotiated with competent counsel.30 Each of these factors goes to the amount of defense costs, not liability for defense costs.
G. Court Actions, Administrative Actions, Judicially Created Trusts -What Type of Proceedings Must be Defended?
The Maryland Court of Appeals has not addressed directly the type of proceeding a liability insurer must defend. It appears that the duty may encompass administrative and some non-traditional proceedings, such as claims filed in judicially created trusts.31
H. Allocation of the Duty to Defend Among Multiple Insurers
Trouble shared is trouble halved. — Sayers, Dorothy L.
I. Reservations of Rights and the Right to Independent Counsel
A reservation of rights letter is the insurer’s first impression of the coverage issues that may arise between it and its insured. The letter informs an insured that a defense is provided subject to certain specified issues. The scope of coverage is not expanded by failure to include them in a reservation of rights letter.34 However, conditions subsequent, such as late notice or failure to cooperate, may be waived.35 Nonetheless, a reservation of rights letter should include all policy language and facts that may serve as the basis for a denial of coverage.
There is a right to independent counsel when there is a conflict of interest in the defense of the action. Maryland follows the dual client approach, where counsel represents both the insured and the insurer.36 This dual representation presents problems where there is a conflict of interest. Where there is a conflict of interest in the defense of the case, such as where the facts to be adjudicated in the lawsuit will also determine coverage, the insured has the right to independent counsel.37
Where the claimant alleges both covered and non-covered counts, the insured and the insurer have diametrically opposed interests. The insurer’s interest is to establish non-coverage and the insured’s interest is to establish coverage. This is a type of conflict of interest where the insurer must allow the insured to choose independent counsel. The seminal case on this point in Maryland is Brohawn v. Transamerica Insurance Company,38 where the complaint alleged negligence and assault (an intentional tort) in the alternative.The insured had previously pled guilty to assault charges. The Court reasoned that the insurer’s selected counsel could defend on the basis that the guilty plea was an admission that the injuries were caused by an intentional act. This could result in a verdict against the insured on the non-covered intentional injury count and a dismissal of the negligence count. The Brohawn Court recognized that the rights of an insured could be adequately protected by the duties imposed upon the attorney by the Cannons of Professional Responsibility. However, the Court held
Two federal district court judges applying Maryland law have found the requirement of independent counsel was fulfilled where the insurer-appointed panel counsel: (1) was instructed by the insurer to represent only the interests of the insured; (2) was at no time also representing the insurer in the case; and (3) had an ethical responsibility to work only on behalf of his client, and no conflict of interest was created.40
A conflict as to how the case should be defended strategically does not give rise to a right to independent counsel,41 nor does a claim in excess of the policy limits.42 Further, an insurer’s rejection of an offer to settle within the policy limits does not automatically create a conflict.43
The insurer must assume the reasonable costs of defense by an independent counsel where required due to a conflict between the insurer and the insured.44 The courts applying Maryland law have not examined what constitutes reasonable attorneys’ fees.
J. Insurer’s Risk in Failing to Defend.
Where an insurer breaches its obligation to defend, it is liable for the damages, including attorneys’ fees, incurred by the insured as a result of the breach.45 These attorneys’ fees may be incurred in defending against the underlying tort claim or in a declaratory judgment action to determine coverage.46
An insurer that mistakenly refuses to defend is not estopped from denying its duty to indemnify.47 If it is found to cover the loss it is bound by the judgment.48 Moreover, it does not give rise to a tort action for bad faith.49
Steven E. Leder is a partner with Leder & Hale PC. He focusing his practice on insurance coverage, toxic torts and recreational boating litigation.
1276 Md. 396, 407-08, 347 A.2d 842, 850 (1975) (internal citations omitted) (emphasis added).
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