Courts typically determine an insurer's duty to defend its insured under a liability policy in one of two ways.
In some jurisdictions, an insurer's duty to defend depends solely on a comparison of the allegations of the complaint to the policy language. See, e.g., Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 13 (Tex. 2007). An insurer has a duty to defend if the face of the complaint alleges something covered and does not allege an exclusion to coverage. Extrinsic facts not alleged in the complaint do not affect the insurer's duty to defend in these jurisdictions. See Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 908 A.2d 888, 896–7 (Pa. 2006). Courts refer to this approach as the four-corners, or sometimes the eight-corners, rule. 1GuideOne Elite Ins. Co. v. Fielder Rd. Baptist Church, 197 S.W.3d 305, 307 (Tex. 2006).
Other jurisdictions do not rely solely on a comparison of the allegations of the complaint to the policy language. These jurisdictions also require that, where the complaint does not trigger the duty to defend, an insurer must conduct a reasonable investigation of the surrounding facts to determine whether it has an obligation to defend. If the insurer determines that facts exist that would trigger the duty to defend despite the absence of such allegations in the complaint, the insurer has a duty to defend. See e.g., Mortgage Exp., Inc. v. Tudor Ins. Co., 771 N.W.2d 137, 147 (Neb. 2009) ("In determining its duty to defend, an insurer must not only look to the petition or complaint filed against its insured, but must also investigate and ascertain the relevant facts from all available sources.").
However, even in a four-corners jurisdiction, the actual facts (as opposed to the alleged facts) may still play an important role in determining an insurer's defense obligation, particularly when the insurer knows about such facts.
Under the four-corners rule, an insurer has a duty to defend its insured complaint states a claim that is potentially covered by the policy. National Union Fire Ins. Co. v. Lenox Liquors, Inc., 358 So. 2d 533 (Fla. 1978). The court may not read facts into the pleadings, look outside the pleadings, or imagine factual scenarios that might trigger coverage. National Union Fire Ins. Co. of Pittsburgh, Pa. v. Merchs. Fast Motor Lines, Inc., 939 S.W.2d 139, 141 (Tex. 1997). The insurer's duty to indemnify, however, is governed by the actual facts establishing the insured's liability in the underlying litigation. Trinity Universal Ins. Co. v. Cowan, 945 S.W.2d 819, 821 (Tex. 1997).
In four-corners jurisdictions, "the allegations of the complaint are controlling and, if ambiguous, must be construed most favorably to the insured to establish the duty to defend." Baron Oil Co. v. Nationwide Mut. Fire Ins. Co., 470 So. 2d 810 (Fla. App. 1985); accord Merchs. Fast Motor Lines, Inc., supra, at 141 (resolving all doubts regarding the duty to defend in favor of the insured). Thus, if the complaint is ambiguous, the insurer generally has an obligation to defend and may be able to institute a declaratory judgment action to determine the actual facts. See Baron Oil, supra. However, in some states:
if it is not clear from the face of the complaint that the policy provides coverage, but coverage could exist, the insurer must investigate and give the insured the benefit of the doubt that the insurer has a duty to defend.
Campbell v. Ticor Title Ins. Co., 209 P.3d 859, 861 (Wash. 2009).
Two kinds of facts may impact an insurer's obligation to defend in four-corners jurisdictions: (1) unpleaded but known facts that would negate coverage and (2) unpleaded but known facts that would trigger the insurer's duty to defend.
[I]f the allegations in the complaint conflict with facts known to or readily ascertainable by the insurer, or if the allegations are ambiguous or inadequate, facts outside the complaint may be considered.
Woo v. Fireman's Fund Ins. Co., 164 P.3d 454, 459 (Wash. 2007). The insurer may not rely on facts extrinsic to the complaint to deny the duty to defend, and may do so only to trigger the duty.
Despite Woo's pronouncement that facts extrinsic to the complaint in a four-corners jurisdiction can never permit an insurer to deny the duty to defend, courts widely accept some situations as exceptions to the four-corners rule. One such exception is "the creation of the basic insurer-insured relationship" in the complaint. In Nateman v. Hartford Cas. Ins. Co., 544 So. 2d 1026, 1027 (Fla. Dist. Ct. App. 1989), the underlying defamation complaint against Dr. Nateman alleged that he was acting in his capacity as an employee of the hospital when he made allegedly libelous statements. Dr. Nateman sought a defense from Hartford, the hospital's insurer, as an additional insured because the Hartford policy made employees additional insureds.
The court relied on Dr. Nateman's actual status as an independent contractor in holding that Hartford had no duty to defend merely because the plaintiff alleged that the defendant was an insured or alleged facts which, if true, would make the defendant an insured. The Nateman court explained that:
The insurer is not obligated to provide a defense for a stranger ... it would be imprudent and illogical to confer such a duty upon an insurer as to a party who is not an insured ... and the ensuing duty to defend cannot be left to the imagination of the drafter of a complaint.
Id. (citing Navajo Freight Lines, Inc. v. Liberty Mut. Ins. Co., 471 P.2d 309, 315–6 (Ariz. 1970)). "[A]s to who is an insured, the facts as they actually exist must be determinative." Id. (emphasis in original).
When an insured admits facts to the insurer which negate coverage and a claimant subsequently files a complaint against the insured that does not allege these facts, the insurer may have no duty to defend. In Nationwide Mut. Fire Ins. Co. v. Keen, 658 So. 2d 1101 (Fla. Dist. Ct. App. 1995), before suit was filed, the insured admitted to the insurer that he operated a boat with an engine that generated 40 horsepower and thus excluded under the policy (the policy excluded coverage for boats with certain horsepower engines). The complaint made no mention of the horsepower of the engine but the fact of the actual horsepower previously admitted by the insured clearly placed the boat outside the coverage afforded by the policy. Accordingly, the insurer had no duty to defend. Accord Burns v. Underwriters Adjusting Co., 765 P.2d 712 (Mont. 1988) (insurer had no duty to defend insured against complaint alleging negligence where insured admitted to intentionally striking claimant in interview with insurer). When:
uncontroverted evidence places the claim outside of coverage, and the claimant makes no attempt to plead the fact creating coverage or suggest the existence of evidence establishing coverage, ... the insurer is relieved of defending.
Keen at 1103.
While many situations exist in which an insurer might know of actual unpleaded facts that would, if pleaded, trigger the duty to defend, an issue has arisen causing trouble for insurers recently where a complaint against a general contractor is silent about the use of subcontractors against whom a plaintiff either cannot or does not allege liability. The following cases illustrate this situation.
In Revelation Ind. Inc. v. St. Paul Fire & Marine Ins., 206 P.3d 919 (Mont. 2009), Revelation entered into a contract with Phillips Environmental Products, Inc., to design and develop a disposable sanitary bag for use with Phillips's portable environmental toilets. Revelation subcontracted with Manchester Packaging to produce the bags in accordance with Phillips's specifications. The bags provided by Manchester did not contain cornstarch as required by Phillips and, not knowing of the nonconformity, Revelation provided the bags to Phillips. Phillips promptly claimed the bags failed to meet its specifications and terminated its relationship with Revelation.
Revelation attempted to meet with Phillips to salvage the relationship, to no avail. Eventually Phillips claimed to have suffered significant damages and Revelation notified St. Paul of the claim by telephone. St. Paul memorialized the conversation in a letter reciting the facts described above. Phillips subsequently demanded compensation from Revelation, and Revelation forwarded the demand letter to St. Paul. The demand letter did not mention Manchester. St. Paul denied Revelation's request for a defense and indemnity to Phillips's claim. Phillips subsequently sued Revelation in a complaint, which again failed to mention Manchester, and St. Paul declined coverage. Revelation defended itself and filed a third-party complaint against Manchester.
Revelation also sued St. Paul, claiming it breached the insurance contract, and St. Paul counterclaimed for a declaratory judgment that it was not obligated to defend Revelation. Ruling on each party's motion for summary judgment, the lower court concluded that the policy "provided coverage for a defective product manufactured by a subcontractor" but the complaint, by omitting any reference to Manchester, did not trigger St. Paul's duty to defend or indemnify Revelation.
The Supreme Court of Montana reviewed Montana case law addressing situations in which courts "looked beyond the allegations [of the complaint] to the facts known by the insurer or to the actual acts giving rise to the underlying claims" to determine the insurer had no duty to defend, the Supreme Court of Montana concluded that:
this same analysis should be utilized when the complaint does not present a claim which on its face is covered by the policy, but the insurer nonetheless has information that could give rise to a duty to defend and indemnify.
Revelation at 925‑6.
The Supreme Court of Montana clarified that looking beyond the allegations of the complaint to the actual facts where the allegations in the complaint:
were either incomplete or inaccurate ... does not require an insurer to seek out such information—as we have previously held, insurers that look at facts beyond the allegations in the complaint do so at their own risk as they will be required to defend and/or indemnify based on the information discovered.
Id. (citation omitted).
The court found that St. Paul had knowledge of the true, undisputed facts giving rise to coverage when the complaint was filed, could not ignore those facts, and thus, had a duty to defend. The Supreme Court of Montana did not address whether St. Paul acted in bad faith by disclaiming its defense obligation and it does not appear the issue was raised in that suit.
In a similar case in Connecticut where the insurer withdrew a defense provided for many years after the operative pleading was amended, the insured sued alleging its insurer acted in bad faith in withdrawing its defense. Despite noting that "the exclusive pleading rule has never been used in Connecticut to defeat an insurer's duty to defend," the court further explained that "[a]n insurer's reasonable interpretation of unsettled law does not amount to bad faith." Fortin v. Hartford Underwriters Ins. Co., 2009 WL 659210, 10 (Conn. Super. 2009) (citation omitted).
However, in a case with facts analogous to Revelation, the Northern District of Illinois found that the insurer acted in bad faith in refusing to defend its insured where the insurer had undisputed knowledge "of true but unpled facts" which triggered the insurer's duty to defend. Edward Gray Corp. v. National Union Fire Ins. Co. of Pittsburgh, Pa., 1997 WL 102542, 5 (N.D. Ill. 1997) (citation omitted).
In that case, Edward Gray contracted to perform work at an electrical utility plant in Indiana. Edward Gray subcontracted with Correct Construction Company to perform piping and plumbing work at the site. Under the subcontract, Correct was required to provide insurance coverage for its work both during its operations and after its operations were completed. Edward Gray was named as an additional insured under the general liability insurance policies issued to Correct by National Union.
Subsequent to the completion of Correct's work, the utility plant suffered a collapse of soil above two underground intake and discharge circulating water pipes. The utility's insurers paid the $47 million in repair costs and subsequently sued various contractors who performed work at the site, including Edward Gray. Edward Gray sought a defense from National Union and National Union refused. Edward Gray defended itself, won summary judgment, and then filed this declaratory judgment action seeking a determination that National Union breached the insurance contract and Edward Gray was entitled to attorney's fees and costs.
As an additional insured under Correct's policy, "the underlying complaint must have alleged that property damage occurred as a result of work which was performed by or for Correct" to trigger National Union's obligation to defend Edward Gray. The court found the underlying complaint to be "completely devoid" of any information relating to Correct and, in fact, "there is no mention of Correct or any other subcontractors in the complaint." Id. Accordingly, the complaint did not trigger National Union's duty to defend Edward Gray.
However, after several exchanges of correspondence in which Edward Gray requested a defense and National Union declined to provide it, Edward Gray tendered two binders of information to National Union and met with National Union representatives to discuss the possibility of a defense. The court reviewed the materials provided and determined that "it should have become apparent to National" that "a possibility of coverage existed." Further, National Union's "own notes on this case reflect the fact that the possibility of coverage existed." Id. at 6. Thus, because "all questions of coverage must be resolved in favor of the insured," the court found National Union's knowledge of the possibility that its duty to defend was triggered "did in fact trigger National's duty" and its refusal to defend was in error.
Important to the court's determination that National Union's "denial was vexatious and unreasonable" and therefore in bad faith, were the following facts: National Union repeatedly denied the insured's requests for a defense instead of defending under a reservation of rights or seeking a declaratory judgment and National Union did not seek the opinion of an insurance coverage attorney, despite Edward Gray's requests, instead responding that it did not need one. The court found that the record supported "the fact that National did not attempt to resolve the question of coverage but merely kept denying that coverage existed" which is not proper practice in Illinois and "such denials were unreasonable under the circumstances." Id.
Although four-corners jurisdictions do not require an investigation into the facts to determine an insurer's duty to defend, courts in those jurisdictions generally liberally construe the allegations of the complaint and resolve any doubt in favor of a defense for the insured. In this context, extrinsic facts known by the insurer can create a defense obligation even where the complaint is silent as to those facts.
As the Supreme Court of Montana explained,
An insurer cannot ignore knowledge of facts that may give rise to coverage under the policy simply because the complaint—which is, after all, drafted by a claimant over whose draftsmanship the insured has no control—does not allege these facts of which the insurer has knowledge. Under such circumstances, the insurer must defend. It may commence a defense under a reservation of rights while conducting an investigation, and it may commence a declaratory action ... It may not, however, ignore information in its possession that may give rise to coverage simply because the complaint fails to recite it, and thereupon refuse to defend.
Revelation at 928.
While facts extrinsic to the allegations of the complaint clearly negating coverage can allow the insurer to deny coverage, particularly where the insured acknowledges such facts, an insurer's failure to defend based on known unpleaded facts that potentially trigger coverage under the policy can lead to extracontractual exposure for the insurer.
Contributing author Rebecca C. Appelbaum is a senior associate practicing in the area of third-party coverage at the firm of Butler Pappas Weihmuller Katz Craig, LLP.
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