General liability policies commonly give the insurer the right and duty to defend the insured against claims that are potentially covered by the policy.
In Texas and many other states, the duty to defend is determined under the "eight-corners rule" or similar analysis, without considering any evidence other than the third-party complaint and the policy. If the complaint states at least one claim that could potentially be covered, the insurer has a duty to defend the entire lawsuit. Many lawyers, risk managers, and adjusters take these rules for granted and assume they apply to all commercial general liability (CGL) policies.
Texas Trailer v. National Union
A recent case in the Northern District of Texas highlights important differences, however, between a duty to defend and a duty to pay defense costs. In Texas Trailer Corp. v. National Union Fire Ins. Co., 2016 U.S. Dist. LEXIS 33670 (N.D. Tex. Mar. 16, 2016), Texas Trailer purchased a CGL policy from National Union, under which the insurer had the right, but not a duty, to defend. Texas Trailer was sued for allegedly destroying a specialized shipping container while testing it to obtain a certification for hauling sand. National Union was notified of the suit, denied coverage, and did not provide a defense.
Texas Trailer successfully defended itself in the lawsuit and sued National Union to recover its defense costs.
In the coverage suit, both parties filed motions for summary judgment without submitting evidence other than the underlying complaint and the policy, relying on the eight-corners rule. The trial court, however, disagreed and denied both motions. The court held the eight-corners rule was not "an immutable rule of law," but "merely a means of enforcing a contractual bargain" concerning defense of lawsuits against the insured.
Under the terms of this policy (which apportioned costs based on the outcome), the amount of defense costs payable by the insurer could not be determined until the "actual facts" were determined in the underlying lawsuit. Consequently, the court held extrinsic evidence was required. It therefore granted both parties leave to refile their motions, attaching evidence of the underlying case to support their positions.
Basic Energy v. Liberty Mutual
In the Western District of Texas, another district court reached a different conclusion and applied the eight-corners rule to determine an insurer's duty to reimburse defense costs under a CGL policy that disclaimed a duty to defend in Basic Energy Servs. v. Liberty Mut. Ins. Co., 655 F. Supp. 2d 666 (W.D. Tex. 2009). The Texas Trailer court distinguished Basic Energy as based on different policy language.
Although provisions requiring insurers to advance or reimburse costs rather than defend are unusual in CGL policies, they are common in directors and officers (D&O) liability and other claims-made policies. The Fifth Circuit refused to apply the eight-corners rule to an insurer's duty to advance defense costs under a D&O policy. See Pendergest-Holt v. Certain Underwriters at Lloyd's of London, 600 F.3d 562 (5th Cir. Tex. 2010) (the policy required the insurer to pay costs "until it is determined that the alleged act or acts did in fact occur").
Liberty Mutual v. Pella Corp.
Courts in other jurisdictions have held that a duty to defend and a duty to advance or reimburse defense costs are "different but similar in result" and generally subject to a version of the eight-corners rule. One example is Liberty Mut. Ins. Co. v. Pella Corp., 650 F.3d 1161, 1170 (8th Cir. Iowa 2011) (quotation omitted) (construing Iowa law). Pella involved a CGL policy in which Liberty had a duty to pay defense costs but no duty to defend. Liberty argued its duty to pay costs did not arise until a covered "occurrence" was established.
The Eighth Circuit Court of Appeals affirmed the district court's ruling that Liberty had a "contemporaneous duty" to reimburse defense costs as long as the underlying complaints "contain allegations that potentially bring the action within the policy coverage." (Id. at 1167, 1170.) The court also observed that other jurisdictions "generally have viewed an insurer's duty to advance defense costs as an obligation congruent to the insurer's duty to defend, concluding that the duty arises if the allegations in the complaint could, if proven, give rise to a duty to indemnify." (Id. at 1170 (quotation omitted) (citing cases from California, Delaware, and Ohio).)
New York Federal Courts
Federal courts in New York have likewise held "there is no relevant difference between the allegations that trigger an insurer's duty to defend and the allegations that trigger an insurer's obligations to pay defense expenses." Lowy v. Travelers Prop. & Cas. Co., 2000 U.S. Dist. LEXIS 5672, (S.D.N.Y. May 1, 2000) (citing cases); see also Julio & Sons Co. v. Travelers Cas. & Sur. Co. of Am., 591 F. Supp. 2d 651 (S.D.N.Y. 2008) (predicting the same result under Texas law). The district court in Julio & Sons noted it had "found no decisions by the Texas courts concerning a different standard for a duty to advance defense costs, and the reasons for applying the eight-corners rule to duty to defend disputes appear to apply equally to the duty to advance."
Whether Texas Trailer is an anomaly based on unusual policy language or a departure from conventional wisdom, it behooves policyholders and their counsel to pay attention to the defense provisions of their policies. Policyholders generally prefer a defense by the insurer, although they sometimes chafe at relinquishing control of defense and settlement decisions to the insurer. A duty to advance defense costs, as under most D&O policies, generally involves a level of "approval" by the insurer, but if policy language suggests the duty depends on "actual facts" rather than third-party allegations, the insured risks having to bear more of the costs of defending itself. And a policy requiring the insurer to reimburse the insured's defense costs increases that risk, particularly where the policy has language similar to that in Texas Trailer. The court in Basic Energy noted that delaying reimbursement until the third-party lawsuit is concluded "could completely nullify any such obligation if the insured were not adjudicated responsible for the underlying occurrence" (655 F. Supp. 2d 673).
Even in duty-to-defend policies, insurers sometimes seek reimbursement from the insured for the cost of defending noncovered claims with varying degrees of success in different jurisdictions—a subject for another day. As a practical matter, however, it is more difficult for an insurer to recoup costs already paid than it is to withhold payment of costs it does not want to bear and has not yet paid. The moral for policyholders, as always, is to read the policy.
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