terminating the duty to defend: evaluating when the insurer can extinguish the...

Terminating the Duty to Defend: Evaluating

When the Insurer Can Extinguish the Duty Advocating the Defense Obligation from Insurer and Policyholder Perspectives

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WEDNESDAY, JUNE 3, 2015

Presenting a live 90-minute webinar with interactive Q&A

Duana J. Grage, Partner, Hinshaw & Culbertson, Minneapolis

Eric Jesse, Esq., Lowenstein Sandler, New York

Suzanne L. Jones, Esq., Hinshaw & Culbertson, Minneapolis

Christopher C. Loeber, Partner, Lowenstein Sandler, New York

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Strafford Webinar 2015

Terminating the Duty to Defend:

Evaluating When the Insurer Can

Extinguish the Duty

Christopher C. Loeber

Eric Jesse

LOWENSTEIN SANDLER LLP

Duana J. Grage

Suzanne L. Jones

HINSHAW & CULBERTSON LLP

The Duty to Defend, Generally

What establishes the duty to defend?

• Policy defense agreement – Insurer has the right and duty to

defend.

• Applies to groundless, false, or fraudulent claims.

Duty to defend broader than duty to indemnify. First

Bank of Turley v. Fidelity and Deposit Ins. Co., 928 P.2d

298 (Okla. 1996).

• What does this mean?


How to determine if a defense is owed?

• 4 corners/8 corners rule (4 corners of complaint, and 4 corners of

the policy). See, e.g., Guideone Elite Ins. Co. v. Fielder Road

Baptist Church, 197 S.W.3d 305 (Tex. 2011).

• If complaint against insured alleges facts within or potentially

within the scope of the policy coverage, a defense is owed. City

of College Station, Tex. v. Star Ins. Co., 735 F.3d 332 (5th Cir.

2013)

• Duty to defend is triggered when the allegations of a complaint,

liberally construed, suggest a reasonable possibility of

coverage.


What about facts outside the complaint?

Who may rely on extrinsic evidence – insurer or insured?

Later use of extrinsic evidence to terminate the duty to defend. Polarome

Int’l, Inc. v. Greenwich Ins. Co., 961 A.2d 29 (N.J. App. Div. 2008)

Insurers’ duty to discover reasonably attainable facts vs. Insureds’

responsibility to inform the Insurer of relevant facts.

The insurer has actual knowledge of facts establishing a reasonable

possibility of coverage. Bruckner Realty, LLC v. County Oil Co., Inc.,

838 N.Y.S.2d 87 (2d Dep’t 2007); SL Indus. v. Am. Motorists Ins.

Co., 607 A.2d 1266 (N.J. 1992); Boston Symphony Orchestra Inc. v.

Commercial Union Ins. Co., 545 N.E.2d 1156 (Mass. 1989).

Facts reasonably apparent to the insurer. Esicorp, Inc. v. Liberty Mut.

Ins. Co., 193 F.3d 966 (8th Cir. 1999).


When is the duty to defend not triggered?

• Where the insurer establishes as a matter of law that there is no

possible factual or legal basis upon which it might ultimately be

obligated to indemnify under any policy provision, the insurer is

relieved of such duty. Great Northern Ins. Co. v. Kobrand Corp.,

837 N.Y.S.2d 41 (1st Dep’t 2007).


If the underlying factual basis of the complaint, even if

true, would not result in coverage under the policy, then

no duty to defend.

Look at the factual allegations alleged, or the causes of

action?

• Example, facts relating to defamation contained in the complaint,

but no cause of action for defamation.

• Intentional conduct cannot be done negligently. Erie Ins.

Exchange v. Fidler, 808 A.2d 587 (Pa. 2002).

• Intentional pollution over time is not sudden and accidental.

Guaranty Nat. Ins. Co. v. Vic Mfg. Co., 143 F.3d 192 (5th Cir.

1998).


Whether the claimant is seeking damages based on a

reason covered by the policy, not whether the claimant

could have sought damages based on a reason covered

by the policy.

• Duty to defend cannot be based on speculation as to claims that

could have been brought. Storek v. Fidelity & Guar. Ins.

Underwriters, Inc., 504 F. Supp. 2d 803 (N.D. Cal. 2007).

• But when the coverage question cannot be decided from the face

of the complaint, the insurer must provide a defense until all

potentially covered claims are resolved. See Flomerfelt v.

Cardiello, 997 A.2d 991 (N.J. 2010).

The Duty to Defend: Mixed Claims

Insurer efforts to limit the duty to defend when a claim

includes covered and uncovered components.

• Duty to defend all claims when only one is potentially covered, or

only the covered claims?

• Allocation / Recoupment of defense costs for uncovered claims.

Insured can recover defense costs that simultaneously benefit

covered and uncovered claims; insurer can only withhold defense

costs solely relating to uncovered portion of the claim. See Buss v.

Superior Court, 16 Cal. 4th 35, 50 (1997).

Insurer has no right to recoupment of defense costs for uncovered

claims in the absence of express agreement. See Shoshone First

Bank v. Pacific Employers Ins. Co., 2 P.3d 510 (Wyo. 2000).


Conflict of interest between the Policyholder and Insurer.

• Theory: insurer’s defense of a complaint with covered and

uncovered claims divides the loyalty of counsel selected and paid

for by the insurer, creating concern that defense counsel would

skew the defense in favor of the insurer. See Nowacki v.

Federated Realty Group, 36 F. Supp. 2d 1099, 1109 (E.D. Wis.

1999).

• Duty to defend transformed into a duty to pay defense costs.

• Insurer loses the right to select defense counsel and control the

policyholder’s defense.

For whose benefit is defense counsel appointed?


Delaying the Duty to Defend – An Outlier.

• When an insurer asserts a defense to coverage that depends on

facts that will not be decided in the underlying case, the duty to

defend is transformed into a duty to reimburse. See Burd v.

Sussex Mut. Ins. Co., 267 A.2d 7 (N.J. 1970)

• But that rule was recently eroded in Flomerfelt v. Cardiello, 997

A.2d 991 (N.J. 2010): “[I]n circumstances in which the underlying

coverage question cannot be decided from the face of the

complaint, the insurer is obligated to provide a defense until all

potentially covered claims are resolved” in the underlying action

or a DJ action between insured and insurer.

The Duty to Defend: Are there

Sufficient Protections for the Insured?

Burden of proof.

Policy wording ambiguities.

Any doubt as to what is alleged.

Covered and uncovered claims.

Frivolous claims.

Breach of the Duty to Defend

What happens if the insurer breaches the duty to

defend?

• Extra-contractual (bad faith) damages?

• Attorney’s Fees? Brown v. State Auto. and Cas. Underwriters,

293 N.W.2d 822 (Minn. 1980)

• Waive other provisions of the policy?

Exhaustion of limits – withdrawing

from the defense

Defense is a separate contractual right from

indemnity

Withdrawing from the defense is an issue only

where defense is supplementary to an insurer's

indemnity obligation

Notice that the insurer may withdraw from the

defense should be given to the insured in a

reservation of rights


from the defense

Policy language controls

• Pre-1966 – No language in policies regarding

withdrawing from the defense

• Post-1966 – Language added to policies allowing

insurers to withdraw from the defense if their limit of

liability has exhausted by payment of settlements or

judgments

• Policy language differs greatly from policy to policy


from the defense

Examples

• Once our limit of liability applicable to the claim is exhausted, we

will no longer pay legal expenses for that claim.

•


from the defense

Withdrawal allowed

• "Exhausted" – American States Ins. Co. of Tex. v.

Arnold, 930 S.W.2d 196 (Tex. App. 1996)

• "Offering, tendering or paying" – Thompson v. Arbella

Mut. Ins. Co., 1999 WL 1325975 (Mass. Super. Ct.

1999)

• "Limit of liability has been offered or paid" – Novak v.

Am. Fam. Mut. Ins. Co., 515 N.W.2d 504 (Wis. Ct.

App. 1994)


from the defense

Withdrawal not allowed

• Meaning of "paid" – Am. Standard Ins. Co. v.

Basbagill, 775 N.E.2d 255 (Ill. Ct. App. 2002)

• Interplead remaining policy limits after excess verdict

– Jenkins v. Ins. Co. of N. Am., 220 Cal. App. 3d 1481

(Cal. App. Ct. 1990)

• Interplead limits before insured's liability has been

determined by judgment – Exchange Mut. Ins. Co. v.

Geiser, 498 N.Y.S.2d 291 (NY. Sup. Ct. 1986)


from the defense

Loy release

• When excess insurance applies, primary settles in exchange for

covenant not to hold insured liable for primary amounts to force

excess to assume the defense. Loy v. Bunderson, 320 N.W.2d

175 (Wis. 1982); Teigen v. Jelco of Wisc. Inc., 367 N.W.2d 806

(Wis. 1985)

Drake v. Ryan

• Primary settled for below its limit and plaintiff agreed to be

responsible for the gap. Drake v. Ryan, 514 N.W. 2d 785 (Minn.

1994)

Covered claims resolved –


Meadowbrook Inc. v. Tower Ins. Co., 559

N.W.2d 411 (Minn. 1997) (insurer has right to

settle covered claims directly with plaintiff and

withdraw from defense when those claims have

been dismissed with finality)

Cagle v. Home Ins. Co., 483 P.2d 592 (Ariz. Ct.

App. 1971)

Allstate Ins. Co. v. Mende, 575 N.Y.S.2d 520

(N.Y. App. Div. 1991)

Covered claims resolved –


Finality

Don't prejudice the insured

Act in good faith

Too many claimants, not enough

limits

No national bright-line rule

3 general approaches

• First-come, first-served

• Pro-rata

• Interpleader


limits

First-come, first-served

• In re Sept. 11 Litig., 723 F.Supp.2d 534, 542 (S.D.N.Y. 2010)

(insurer has discretion to settle multiple claims on a first-come,

first-served basis as long as it acts in good faith)

• U.S. Fire Ins. Co. v. Worcester Ins. Co., 821 N.E.2d 91, 94

(Mass. App. Ct. 2005) (an insurer may settle with less than all

claimants even if it results in an exhaustion of the policy

proceeds)

• Aetna Cas. & Sur. Co. v. Sullivan, 597 N.E.2d 62, 64 (Mass. App.

Ct. 1992) (insurer is discharged from any further duty to defend if

it pays policy limits – either to settle a claim against the insured,

or in total or partial satisfaction of a judgment against the insured

– upon conclusion of the litigation)


limits

Pro-rata

• Christleib v. Luten, 633 S.W.2d 139 (Mo. Ct. App. 1982) (pro-rata

approach is warranted)

• Underwriters for Lloyds of London v. Jones, 261 S.W.2d 686 (Ky.

1953) (insurance proceeds distributed on a pro-rata basis

following adjudication of multiple claims)

• Farinas v. Florida Farm Bureau General Ins. Co., 850 So.2d 555,

560-561 (Fla. Dist. Ct. App. 2003) (where multiple claims arise

out of one accident, insurer may exercise discretion in how to

settle claims and may choose to settle certain claims to the

exclusion of others provided that the decision is reasonable and

"in keeping with its good faith duty." )


limits

Interpleader

• Boris v. Flaherty, 672 N.Y.S.2d 177, 180 (N.Y. Sup. Ct. 1998)

("[i]nterpleader actions, while not required in situations such as this, are

to be encouraged as part of the duty of good faith of an insurer.")

• Club Exch. Corp. v. Searing, 567 P.2d 1353, 1356 (Kan. 1977) (insurer

can take three alternative courses of action when faced with competing

claims in excess of policy limits)

• McReynolds v. Am. Commerce Ins. Co., 235 P.3d 278, 282 (Ariz. Ct.

App. 2010) (where available coverage is not adequate to resolve all

claims, insurer can find a "safe harbor")

Even if an insurer files an interpleader and deposits its limits into court, the

insurer should not withdraw the defense unless it has clear policy language

which would permit a withdrawal.

Too many insureds, not enough

limits

Strauss v. Farmers Ins. Exchange, 31 Cal. Rptr.

2d 811 (Cal. App. Ct. 1994) (insurer not

obligated to pay demand for policy limits if it

does not resolve liability for all its insureds)

Pride Transp. V. Continental Cas. Co., 804

F.Supp.2d 520 (N.D. Tex. 2011) (insurer allowed

to accept claimant's demand for policy limits to

the exclusion of other insureds)

What Does It All Mean?

Should an insurer be penalized for breaching the duty to

defend, and how?

Current repercussions:

• Bad faith/extra-contractual damages.

• Attorney’s fees in coverage action.

• Limited ability to contest settlement.

• Waiver of policy provisions.

Practice Pointers

Check your policy language and your jurisdiction before withdrawing

from the defense.

Explain the problem of potential excess exposure to the insured

early on and in writing.

Identify claimants and potential claimants.

Conduct meaningful investigations and evaluations of various

claims.

Keep the insured advised as claims are settled and limits are

exhausted.

Notify all excess insurers and keep them apprised of the

investigation and settlement efforts.

Practice Pointers

Consider immediately filing an interpleader action if the jurisdiction

allows it. Deposit the money into court and continue defending until

those funds are disbursed to claimants. In some states, an insurer

must file an interpleader to avoid a claim for bad faith. Other courts

do not allow an interpleader action in these circumstances.

Develop and attempt to implement a strategy to resolve all the

claims.

Never artificially inflate the value of any claims, particularly the first

claims that are made. Do not overpay a claim with the intention of

exhausting the limit as soon as possible to justify withdrawing from

the defense.

Practice Pointers

Pay the limits to claimants to resolve claims and obtain

releases of liability for the insured; do not pay the limits

to the insured in an attempt to "buy out" the coverage or

the defense obligation.

Practice Pointers

Don’t waive coverage (timely notice, etc.).

Even if defense is rejected, keep insurer apprised of the

litigation.

Advise insurer of settlement possibility, and ask that it

contribute.

Be mindful of costs of defense – reasonableness and

relatedness issues.

Enlist coverage counsel.

Questions?

Christopher C. Loeber

[email protected]

Eric Jesse

[email protected]

LOWENSTEIN SANDLER LLP

Duana J. Grage

[email protected]

Suzanne L. Jones

[email protected]

HINSHAW & CULBERTSON LLP

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