Pre-Tender Defense Costs: Who Pays?
July 2006
Usually the insured pays pre-tender defense
costs. Many jurisdictions find that an insurer cannot be responsible as a matter
of law for defense costs incurred by the insured before the insured tenders
the claim to the insurer.
by R. Steven
Rawls and Rebecca Appelbaum
Butler Pappas
Weihmuller Katz Craig, LLP
In some jurisdictions, however, courts may require an insurer to pay for
pre-tender defense costs, regardless of the timeliness of the tender. Some of
these courts have required that an insurer pay for pre-tender costs when an
insurer is not prejudiced.
Standard CGL Policy Language Regarding Notice of a Claim and Voluntary Payments
The commercial general liability (CGL) policy Conditions section of the standard
Insurance Services Office, Inc. (ISO), policy form, in describing the insured's
responsibilities in the event of an "occurrence, offense, claim or suit," contains
the following provisions:
- 2. Duties in the Event of Occurrence, Offense,
Claim or Suit.
- You must see to it that we are notified as
soon as practicable of an "occurrence" or an offense which may result
in a claim.
***
- If a claim is made or "suit" is brought against
any insured, you must:
***
(2) Notify us as soon as practicable.
You must see to it that we receive written notice of the claim or "suit" as
soon as practicable.
- You and any other involved insured must:
(1) Immediately send us copies of any demands, notices, summonses or legal
papers received in connection with the claim or "suit";
***
- No insureds will, except at their own cost,
voluntarily make a payment, assume any obligation, or incur an expense,
other than for first aid, without our consent.
Insured Pays
Jurisdictions finding that an insurer has no responsibility for defense costs
incurred by the insured before the insured tenders the defense rely on the policy
language and the notion that an insurer cannot incur responsibility or liability
for defense costs before being notified of a claim.
In Elan Pharm. Research Corp. v. Employers Ins. of
Wausau, 144 F.3d 1372 (11th Cir. 1998), the Eleventh Circuit, applying
Georgia law, held as a matter of law that an insurer was not responsible for
pre-tender defense costs incurred by the insured. Elan sought reimbursement
for 2 months of defense costs it incurred before it forwarded the suit papers
to the insurer. The court relied on the language of the conditions provisions
of the CGL policy that required notice "as soon as practicable" and that suit
papers be forwarded "immediately."
The court explained that requiring the insurer to pay costs incurred before
tender would render the "contractual terms necessary to trigger ... [the insurer's]
performance under the policy meaningless." Elan at 1381 (citation omitted). Ultimately, the court explained that the insurer's
duty to defend was not triggered until the insured notified the insurer and
"as a result, [the insurer] is not liable for the litigation expenses ... incurred
before that date." Id.
Similarly, the Supreme Court of Wisconsin explained that "a tender of defense
is a condition precedent to the creation of a duty to defend" so that an insurer
has no liability for pre-tender defense costs. Towne
Realty, Inc. v. Zurich Ins. Co., 548 N.W.2d 64, 68 (Wis. 1996). The court
explained that the insurer "can only be liable for damages which 'naturally
flow' from its breach of a contractual duty";
no such duty exists until the insured puts the insurer on notice of a claim. Towne at 68 (citation omitted, emphasis in original).
While the Towne court found that Zurich ultimately
breached its duty to defend the insured, Zurich's breach of the duty to defend
did not render it liable for pre-tender defense costs because the policy did
not specifically allow this type of cost. The court cited the voluntary payments
provision as support for its determination that the only costs or expenses allowable
without consent are those for first aid. See e.g., Ethchell v. Royal Ins. Co., 165 F.R.D. 523 (N.D.
Cal. 1995) (relying on the voluntary payments provision); see also LaFarge
Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389 (5th Cir. 1995) (relying
on the voluntary payments provision and concurring that, because there is no
duty placed on the insurer until notice, pre-tender defense costs are per se
unrecoverable against the insurer even absent a showing of prejudice).
Insurer Pays
Jurisdictions that allow recovery of pre-tender defense costs link responsibility
for pre-tender defense costs to the policy's notice provisions and the caselaw
interpreting that rather than to the policy's provisions regarding the duty
to defend. Some of these jurisdictions take the position that "the right to
control the defense necessarily attaches as soon as there is something to defend.
... [and that the duty to defend] should attach at the same moment." Sherwood Brands, Inc. v. Hartford Acc. and Indem. Co.,
698 A.2d 1078, 1083 (Md. 1997). Moreover, if a jurisdiction treats notice as
"merely a covenant that, absent a showing of prejudice, does not excuse the
insurer from complying with its duty to defend," the responsibility for pre-tender
defense costs becomes a question of the scope of that duty, and not whether
the duty exists for pre-tender defense costs in the first instance. Id. at 1085.
Sherwood envisioned three scenarios following
delayed notice in which the question of responsibility for pre-tender expenses
might arise: (1) the insurer undertakes the defense; (2) the insurer declines
the defense, citing the insured's breach of the notice provisions of the policy;
and (3) the insurer declines to defend for reasons which it would have asserted
regardless of the timing of the notice. See id.,
at 1085-6. The second scenario turns upon the question of prejudice to the insurer.
Id. at 1086. See alsoLiberty
Mut. Ins. Co. v. Black & Decker Corp., 383 F. Supp. 2d 200 (D. Mass.
2004) (adopting the Sherwood reasoning and rationale).
The Sherwood court found the third scenario
the easiest to analyze because, if the court ultimately agrees with the insurer's
position, "there is no obligation to reimburse the insured for any litigation
expenses" and "the timing of the notice has no bearing on the issue." Sherwood at 1086. If, however, the court disagrees,
then the insurer is liable for breaching the duty to defend and the damages
include responsibility for the insured's defense costs. Similarly, under the
first scenario, if the insurer accepts the defense, then the insurer has not
breached the duty to defend. Without citation to authority, Sherwood stated that "there is the prospect of
a breach if the insurer refuses to reimburse the insured for pre-notice expenses"
and, because the insurer would be basing its refusal to pay the pre-notice expenses
on the policy's notice provision, the same prejudice analysis of the second
scenario would determine responsibility for those expenses. Id. at 1086.
In Smith & Nephew, Inc. v. Federal Ins. Co.,
2005 WL 3434819 (W.D. Tenn. 2005), a federal district court applying Tennessee
law recognized that no state court had addressed the issue of pre-tender defense
costs. However, the court explained that the Tennessee Supreme Court recently
"adopted the modern trend and held that in order for forfeiture of an insurance
policy to result from an insured's breach of a notice provision, prejudice to
the insurer must be shown." Smith & Nephew at
1. See also, BellSouth
Telecomm., Inc. v. Church & Tower of Florida, Inc., 2006 WL 626071 (Fla.
3rd DCA 2006) (the insured's violation of a notice requirement does not relieve
the insurer's contractual obligation to defend absent prejudice). Relying on
the fact that Tennessee no longer treats notice as a condition precedent to
coverage, the district court concluded that "a prejudice analysis should apply
to both the existence of a duty to defend after late notice, as well as to whether
that duty includes pre-notice costs." Smith & Nephew at 2 (internal citation omitted). See also, TPLC, Inc. v. United Nat. Ins. Co., 44 F.3d 1484
(10th Cir. 1995) (applying Pennsylvania law to the question of notice and finding
that the insurer cannot avoid paying pre-tender defense costs absent a showing
of prejudice).
Application: Florida
These two lines of cases provide guidance in determining responsibility for
pre-tender defense costs for a jurisdiction that hasn't addressed the question.
However, predicting what an undecided jurisdiction might do may not prove as
straightforward as these lines of cases might suggest.
Florida, for example, has not considered the issue of responsibility for
pre-tender defense costs. Florida allows the insured to recover the cost of
defense when the insurer breaches its duty to defend. Florida requires a showing
of prejudice to preclude coverage under the policy if the insured breached the
policy's notice provisions. SeeBellSouth, supra.
Application of coverage defenses based on untimely notices falls within Florida's
Claims Administration Statute which contains requirements insurers must follow
to disclaim coverage based on certain types of coverage defenses under the policy.
The Supreme Court of Florida has defined "coverage defense" to mean "a defense
to coverage which otherwise exists." AIU Ins. Co. v.
Block Marina Inv., Inc., 544 So. 2d 998, 1000 (Fla. 1989). Failure to
comply with the statute will prevent an insurer from disclaiming coverage for
a breach of the policy conditions (i.e., notice) but will not "bar an insurer
from disclaiming liability where a policy or endorsement has expired or where
the coverage sought is expressly excluded or otherwise unavailable under the
policy or under existing law." Id.
Florida thus draws a distinction between situations where the insured forfeits
coverage to which it is otherwise entitled by failing to comply with policy
conditions and situations where the coverage sought is not provided by the policy
in the first instance. As recognized by the court in LaFarge, supra, "prejudice is only
a factor when the insurer is seeking to avoid all coverage for failure to comply
with the notice provisions of the policy." LaFarge at 400, n.19.
Sherwood appears to create an illusory distinction
between exercising the right to control the defense and the existence of the
duty to defend, recognizing that "as a practical matter, of course, that right
cannot be effectively exercised until the insurer is, in fact, informed of the
occurrence or claim" but also observing that the right, and correspondingly
the duty, arises "as soon as there is something to defend." Sherwood at 1083. Finding that the need for a
defense arises at the moment that circumstances exist which give rise to liability,
however, fails to recognize that the duty to defend is purely contractual. SeeAllstate Ins.
Co. v. RJT Enterprises, Inc., 692 So. 2d 142 (Fla. 1997) (clarifying
that the duty to defend is purely contractual).
The application of Sherwood under Florida
law would impermissibly rewrite the contract and impose duties and obligations
upon the insurer not contemplated by the contract. This would effectively do
away with the insurer's right to control the defense by allowing the insured
control until it chose to involve the insurer.
Florida recognizes that the right to control the defense is "a valuable one
in that it reserves to the insurer the right to protect itself against unwarranted
liability claims and is essential in protecting its financial interest in the
outcome of litigation." Travelers Indem. Co. of Illinois
v. Royal Oak Enter., Inc., 344 F. Supp. 2d 1358, 1374 (M.D. Fla. 2004).
Arguably, Florida courts should recognize that disclaiming responsibility for
pre-tender defense costs based on the plain meaning of the voluntary payments
provision of the policy differs from seeking to avoid coverage by virtue of
the insured's failure to promptly notify the insurer of the claim.
Conclusion
Assigning responsibility for pre-tender defense costs based on the notice
provisions of the policy mixes apples with oranges. Applying principles that
regulate an insurer's ability to entirely disclaim coverage based on late notice
to questions of an insurer's responsibility for defense costs voluntarily incurred by the insured before it notified the insurer of the claim
divests the insurer of its contractual right to control the defense and ignores
the plain language of the policy.
Contributing author
Rebecca C. Appelbaum is a senior associate
with Butler Pappas Weihmuller Katz Craig, LLP, practicing in the area of third-party
coverage.
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