Liability Insurance Coverage: Basic Principles
Liability Insurance Coverage: Basic Principles

There are certain core principles that must be applied in analyzing coverage under a liability insurance policy.

This two-part article sets out those principles. It also explores some counter-intuitive situations in which such coverage may come into play.


Insurance Liability

  • Hidden opportunities to obtain coverage in liability cases
  • Sometimes counter-intuitive
  • Often obscured by jargon and complexity
  • What strategies will assist in uncovering these opportunities?

The 8 Key Points

1. Law Tilted in Favor of Policyholders

Liability insurance provides protection (i.e., indemnity) in respect to a claim, but also funding for the insured’s defense to litigation. It also imposes a duty on the insurer to settle the case for its insured. The law heavily favors policyholders. In this regard, grants of coverage are construed broadly, whereas exclusions are construed narrowly. In addition, an insurer must give as much consideration to its insured as its own interests.

Where the policy provides a duty to defend, there are three important features: (1) the duty to defend is extremely broad; (2) where there is a duty to defend, the carrier is obligated to defend both covered and uncovered claims; and (3) a carrier that breaches the duty to defend may face huge penalties for doing so. California courts have repeatedly found that remote facts buried within causes of action that may potentially give rise to coverage are sufficient to invoke the defense duty. Thus, California law does not require that the insured’s conduct proximately cause the third-party claim in order to trigger the defense duty.

2. The specific causes of action in a complaint do not define or limit the scope of coverage.

The duty to defend is not limited by the causes of action that are pled by the plaintiff. “…That the precise causes of action pled by the third party complaint may fall outside policy coverage does not excuse the duty to defend where, under the facts alleged, reasonably inferable or otherwise known, the complaint could be fairly amended to state a covered liability.” Scottsdale Ins. Co. vs. MV Transportation, 36 Cal.App.4th 643, 654 (2005); Hartford Casualty vs. Swift Distribution, 59 Cal.4th 277 (2014).

3. The duty to defend has surprising breadth.

Under California Civil Code § 2778(4), the duty to defend is in all liability insurance contracts unless the policy clearly and unambiguously excludes such a duty. One of the most basic cornerstones of modern insurance law is that the duty to defend is broader than the duty to indemnify. An insurer must provide a complete defense to its insured even where some causes of action may be outside coverage. Thus, if any claims in a third party complaint against a party insured under a CGL policy are even potentially covered by the policy, the insurer must provide its insured with a defense to all claims.

4. An insurer may be obligated to fund the prosecution of affirmative claims

Insurer responsibility for funding the prosecution of affirmative claims of an insured usually arises in the context of cross-complaints initiated in response to the underlying liability claim. Thus, in some instances, an insurer may be obligated to fund the prosecution of an insured’s counterclaim for affirmative relief where the request for that affirmative relief is inextricably intertwined with the defense of the covered action.

5. Opportunities for securing coverage are enhanced by the penalties flowing from an insurer’s wrongful failure to defend.

Consequences of an Insurer’s Wrongful Failure to Defend:

Waiver of Exclusions to Coverage. Where the carrier wrongfully fails to defend, it will be deemed to have waived any exclusions to coverage under the policy that it otherwise would have had with respect to its obligation to indemnify. If a carrier denies the insured a defense and it is ultimately determined that a defense was owed, the carrier can be subjected to a claim of bad faith and may ultimately be required to provide indemnity even where no duty to indemnify exists

Waiver of Right to Reimbursement for Defense of Uncovered Claims. An insurer that breaches its duty to defend is liable for the costs incurred in the insured’s defense and is precluded from pursuing a reimbursement claim or otherwise allocating between covered and non-covered fees and costs.

Waiver of Right to Insist on “Panel” Rates. An insurer that breaches the duty to defend is precluded from arguing that Civil Code § 2860 should limit its insured’s recoverable fees. "If [a] plaintiff is able to establish breach of the duty to defend, its damages are not limited by California Civil Code § 2860." Atmel Corp. v. St. Paul Fire & Marine, 426 F. Supp. 2d 1039, 1047 (N.D. Cal. 2005).

Unreasonable Delay By Carrier In Paying Defense Costs Can Constitute Breach Of The Duty To Defend As Subjecting Carrier To Claim For Bad Faith

In Travelers lndem. Co. of Connecticut v. Centex Homes, 2015 WL 58369 47, at *4 (N.D. Cal. 2015), the court held that "[a] failure to provide counsel or to guarantee the payment of legal fees immediately after an insurer's duty to defend has been triggered constitutes a breach of the duty to defend, even if the insurer later reimburses the insured." Id. at *5. In Okada the court found that the specific language in the policy required the insurer "must make contemporaneous payments for legal defense on claims covered by the policy." Okada v. MGIC lndem. Corp., 283 (9th Cir. 1986).

Public Policy Reasons Supporting The Imposition Of Penalties on Insurers That Breach The Duty to Defend

These seemingly harsh results advance the policy of incentivizing insurers to vigorously search the underlying claim for the purpose of finding a duty to defend. “If the insured elects to proceed in tort, recovery is possible for not only all unpaid policy benefits and other contract damages, but also extra-contractual damages such as those for emotional distress, punitive damages and attorney fees”. Archdale v. American International Specialty Lines Ins. Co., 154 Cal. App. 4th 449, 467-68, n. 19 (2007).

Recent Developments in Bad Faith Liability

Recent case authority suggests that an insurer may be liable for bad faith even if it offers up its full policy limits to settle a third party liability claim. In that case the Court held that notwithstanding its offer of full policy limits, the insurer was unreasonable in refusing to agree to the inclusion of language in the settlement agreement which would have preserved the insured’s right, without offset, to court-ordered restitution from the tortfeasor. In those circumstances, the court allowed the insured’s bad faith case to proceed.

6. The “leverage” created by the duty to settle.

Once the duty to defend attaches, the insurer also has an obligation to settle the claim within policy limits. If the carrier rejects a reasonable settlement offer from the claimant that is within policy limits, it may be liable for any judgment that is in excess of the policy limits. Importantly, in rejecting such a settlement offer, the carrier may not take into account or consider any defenses it may have to coverage for the claim. In order to establish a claim for bad faith, the insured must demonstrate that the policy obligated the insurer to indemnify the insured for the underlying loss. Liability carrier has affirmative duty to negotiate toward a settlement on behalf of its insured, even in the absence of an offer or demand by the claimant.

7. Amounts ostensibly paid as restitution for “ill gotten gains” may in fact represent covered “damages”.

Whether amounts paid by policyholders to fund settlements are covered under an insurer’s duty to indemnify is often a contested issue. See, e.g., TIAA-CREF Individual & Institutional Services, LLC, et al. v. Illinois National Insurance Company, et al., Case No. N14C-05-178 JRJ (Delaware Superior Court, October 20, 2016) (finding that settlement amounts paid to settle class actions alleging unfair business practices did not represent uninsurable disgorgement). See also U.S. Bank v. Indian Harbor Insurance Company, 2014 WL 3012969 (D. Minn. 2014) (bank was entitled to coverage under its professional liability insurance for restitutionary amounts it paid in settlement of an overdraft fee overcharge class action).

8. Unexpected coverage opportunities in IP and commercial disputes

Utilizing coverage for “personal injury” or “advertising injury” in business disputes. In lawsuits involving claims of infringement, misappropriation or the violation of the right of privacy, the key portion of a CGL policy is the “personal injury” or “advertising injury” coverage found in Coverage B. That coverage section will typically contain language providing as follows:

1. We will pay those sums that the insured becomes legally obligated to pay as damages because of “personal and advertising injury” to which this insurance applies. We will have the right and duty to defend any “suit” seeking those damages…

2. This insurance applies to “personal and advertising injury” caused by an offense arising out of your business but only if the offense was committed in the “coverage territory” during the policy period.

“Accidental” conduct is not required for coverage for personal or advertising injury. Coverage for personal or advertising injury does not depend on the existence of an “occurrence,” which typically is defined in terms of “accidental” conduct. Thus, coverage for personal and advertising injury is not limited to negligence and may even cover intentional torts.

This is Part One of a two part series by Peter Selvin, Partner and Chair of ECJ’s Insurance Coverage and Recovery Department.

Disclaimer: The views and opinions expressed in this presentation are not necessarily the views of Ervin Cohen & Jessup LLP or any of its clients. © 2020 Ervin Cohen & Jessup LLP

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