Coverage Analysis
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DUTY TO DEFEND

An insurer's duty to defend is broader than its duty to indemnify.  Gray v. Zurich Ins. Co., 65 Cal.2d 263, 275, 419 P.2d 168, 177 (1966).  California takes an expansive view of the duty to defend, requiring that an insurer take into account facts known or readily available to it as well as the allegations contained in the suit against the insured.  Horace Mann Ins. Co. v. Barbara B., 4 Cal. 4th 1076, 846 P.2d 792 (1993).  However, there is no duty to defend if there is no possibility of any duty to indemnify.   Fire Ins. Exchange v. Abbott, 294 Cal. App.3d 1012, 1026, 251 Cal. Rptr. 620, 629 (1988), rev. den. (Cal. 1988). 

The determination of whether the insurer owes a duty to defend usually is made in the first instance by comparing the allegations of the complaint with the terms of the policy.  Waller v. Truck Ins. Exchange, Inc., 11 Cal 4th 1, 18 (1995).  Facts extrinsic to the complaint may also give rise to a duty to defend, however, when they reveal a possibility that a claim may be covered by the policy. Extrinsic facts may eliminate a potential for coverage, even where the bare allegations in a complaint suggest potential liability, if they indisputably establish the absence of any basis for the policy being triggered.  “This is because the duty to defend, although broad, is not unlimited; it is measured by the nature and kinds of risks covered by the policy.”  Id. at 18-19. 

An insurer has no obligation to investigate claims that present no possibility of coverage.  Continental Casualty Company v. Richmond, 763 F.2d 1076, 1083 (9th Cir. 1985)(California law).

“Where there is a duty to defend, there may be a duty to indemnify; but where there is no duty to defend there cannot be a duty to indemnify.”  Certain Underwriters of Lloyd’s, London v. Superior Court, 21 Cal.4th 545 (Cal. 2001).

The duty to defend is contractual in nature and extends to all claims that are potentially covered based on facts alleged or otherwise disclosed.  Montrose Chemical Corp. v. Superior Court, 6 Cal. 4th at 295.  It arises at the date of tender.  Id.  It continues until the case ends or the insurer is able to show that there is no possibility of any claim being covered.  In that event, however, the extinction is prospective only and does not eliminate the insurer's retroactive responsibility for defense costs incurred up to that point.  Buss v. Superior Court, 16 Cal.4th 35, 65 Cal. Rptr.2d 366, 939 P.2d 766 (1997).

An insurer has no duty to reimburse pre-tender defense costs.  Montrose, supra and Palmer v. Truck Ins. Exchange, 66 Cal. App.4th 916 (1998).

Even where the underlying allegations are clearly outside the scope of coverage, the insurer may be compelled to provide a defense if there is any possibility, based upon the actual facts, that there will be a judgment based upon non-intentional conduct.  Gray v. Zurich, 65 Cal. 2d 263, 276, 54 Cal. Rptr. 104, 419 P.2d 168 and Horace Mann, 46 P.2d 792, 798.  The fact that the claims against the insured are so insubstantial as not to warrant any damages is a defense that the insurer may interpose on its policyholder's behalf in the underlying action, not a basis for denying a defense in the first instance.  Horace Mann, 846 P.2d 792, 798. 

Horace Mann left open the issue of whether insurers could similarly look to extrinsic facts to defend a duty to defend that might otherwise exist.  This question was answered by the Supreme Court in Montrose Chemical Corporation v. Canadian Universal Ins. Co., 6 Cal. 4th 287, 861 P.2d 1153 (1993).  The Supreme Court ruled that liability insurers must defend any law suit in which there is a possibility of coverage, even if the complaint itself is silent, unless their own investigation conclusively determines that there is, in fact, no possibility of coverage.  The court noted that "the defense duty is a continuing one, arising on tender of defense and lasting until the underlying lawsuit is concluded or until it has been shown that there is no potential for coverage."   6 Cal.4th at 295. 

In assessing the duty to defend under California law, the proper focus is on the facts alleged, rather than the theories of recovery.  Michaelian v.  State Compensation Ins.  Fund, 50 Cal.  App.  4th 1093 (1996).  A duty to defend may not be manufactured by the  insured’s speculation about unpled third-party claims.  Id. at 1106.

As noted by the California Supreme Court in its seminal ruling in Gray v.  Zurich Ins.  Co., 65 Cal.  2d at 274, the “groundless, false or fraudulent clause does not extend the obligation to defend without limits; it includes only defense to those actions of the nature and kind covered by the policy.”  See also Quan v.  Truck Ins.  Exchange,  67 Cal. App.4th 583, 79 Cal. Rptr.2d 134 (2nd Dist.1998)(insured’s assertion that he did not commit crime does not create coverage for intentional criminal act).

The Ninth Circuit ruled in Friedland v. Liberty Mutual Ins. Co., 15 F.3d 1084 (9th Cir. 1994) that a duty to defend should only arise under California law if the insured had a "reasonable basis for believing at the time of time of tender that a covered cause of action has accrued."  Similarly, in Gunderson v. Fire Ins. Exchange, 37 Cal. App.4th 1106, 44 Cal. Rptr.2d 272 (1995), the court ruled that the mere possibility that a suit might later be amended to state a covered claim did not give rise to a present duty to defend.  In Gunderson, the Court of Appeal further ruled that insurers did not have a continuing duty to investigate the possibility of coverage after a good faith denial.  Under such circumstances, if new facts appear supporting their claim, the insureds have the duty to re-tender the claim for coverage.

The California Court of Appeal has ruled that an insurer cannot avoid a duty to defend merely because it does not believe the facts communicated by its insured.  In Amato v. Mercury Cas. Co., 18 Cal. App.4th 1784, 23 Cal. Rptr.2d 73 (1993), the court suggested that an insurer might refuse to defend if its own investigation had produced information that conclusively refuted the insured's extrinsic facts.  However, an insurer may not do so merely based upon an "uncorroborated belief" that the information is fabricated.  Under such circumstances, the court found insurers may either (1) defend under a reservation of rights; (2) bring a DJ; (3) file a cross-complaint in the liability case; (4) agree to reimburse the insured for defense costs if subsequent investigation confirms that defense is owed or (5) take a chance that it will be held liable for bad faith if a court subsequently finds that there was a duty to defend.

Nor may an insurer refuse to defend on the basis that the coverage-triggering allegations in the underlying suit are without legal support.  See Travelers Indemnity Co. of Illinois v. INA, 94-0317 (S.D. Cal. May 10, 1995)(allegations of emotional distress triggered coverage as a "bodily injury" even though such damages may not be awarded in an action for damage to property).

An insurer’s duty to defend must be analyzed on the basis of the sources and evidence actually available to it at the time of the tender of  defense.  CNA Casualty of California v. Seaboard Surety Company, 176 Cal. App. 3rd 598, 605 (1986). 

The Ninth Circuit has declared in Envirotech Industries, Inc. v. United Capitol Ins. Assoc., 1998 U.S. App. LEXIS 6175 (9th Cir. March 26, 1998)(unpublished) that an insurer need not obtain an adjudication that there is no coverage before withdrawing from the defense of an action where its investigation has confirmed that no factual basis for coverage exists and the insured has not furnished it with any information to support a claim for coverage.  However, the insurer does so as its own peril and may later be found to have acted in bad faith if later developments establish that there was, in fact, coverage.

A federal court has also ruled that an insurer had a duty to defend under its "personal injury" provisions, despite the fact that the plaintiff had told the insurer's investigator during its coverage investigation that he was not seeking damages for libel or slander.  Dobrin v. Allstate Ins. Co., 897 F.Supp. 442 (C.D. Cal. 1995).

A federal court has ruled in Crystal Peak Water Co. v. American Motorist Ins. Co., No. 94-1531 (N.D. Cal. June 22, 1995)  that an insurer's duty to defend terminated when the single covered claim was dismissed from the underlying litigation, rejecting the insured's contention that the possibility of a successful appeal or amendment of pleadings created a "potential" for coverage requiring a continued defense under the California Supreme Court's ruling in Montrose I.  Similarly, a federal district court has ruled that liability insurers had no continuing duty to defend once the plaintiff’s cross-claim for damages against the insured was dismissed.  Walsh v. Northbrook Property & Cas. Co., 1999 U.S. Dist. LEXIS 8126 (N.D. Cal. May 26, 1999)(even though dismissal was without prejudice, court refused to allow plaintiff to introduce any evidence beyond what could be asserted in support of its affirmative defenses).

Affirmative defenses set forth by defendant in response to a lawsuit by the insured did not give rise to a duty to defend as the defenses did not present any potential that the insured would be obligated to pay damages for which coverage would be afforded under the policy.  3250 Wilshire Boulevard Building v. Employers Insurance of Wausau, 39 Cal. App. 4th 1277, 46 Cal. Rptr. 2nd 399 (2nd Dist. 1995) (neither the prosecution of the insured's suit nor the defeat of the defendant's defenses thereto can be considered the defense of a "suit seeking damages").  Similarly,  Judge Breyer ruled in Larkin v. ITT Hartford, 1999 U.S. Dist. LEXIS 9960 (N.D. Cal. July 1, 1999) that Hartford had no duty to fund the insured’s pursuit of cross-claims against other responsible parties in a pollution case.

Where a professional malpractice policy provided that the insurer was entitled to its attorney’s fees and costs if it was compelled to sue an insured for  reimbursement of the policy deductible, the California Supreme Court has ruled that the insurer was not prohibited from recovering attorney’s fees by reason of the fact that it utilized in-house counsel.  In  rejecting the defendant’s contention that such fees were not “incurred” for purposes of   Section 1717 of the California Civil Code because there was no evidence that the insurer had actually paid them, the Supreme Court ruled in PLCM Group, Inc. v. Drexler,  72 Cal. App.4th 693, 84 Cal. Rptr.2d 905 (1999), aff’d, S080201 (Cal. May 8, 2000)  that the amount of the fees should be computed in accordance with reasonable market rates for outside counsel.    Even though parties who appear pro se are not entitled to recover fees, no similar reason excludes for discriminating against in-house counsel as they are not representing their personal interests and are not seeking remuneration simply for lost opportunity costs.

The duty to defend exists until the insurer's policy limits are fully exhausted. An insurer may not terminate its defense obligation by simply tendering its policy limits.  Chubb/Pacific Indemnity Group v.  INA, 188 Cal. App. 3d 691, 233 Cal. Rptr. 539 (1987); and Hartford Accident & Indemnity Co. v. Continental National American Ins. Co., 861 F.2d 118 (9th Cir. 1988) and Jenkins v. INA, 272 Cal. Rptr. 7, 220 Cal. App.3d. 1481 (4th Dist. 1990).

In Jenkins, the Court of Appeal ruled that an insurer could not terminate its defense duty by tendering its limits after an excess verdict against its insured, finding that the duty continued until the judgment became final and that the insurer therefore had a duty to take all reasonable steps to protect its insured's interests in the interim, including paying for an appeal. Accord, Cathay Mortuary v. United Pacific Ins. Co.,  582 F.Supp. 650 (N.D. Cal. 1984).   However, this rule only applies if reasonable grounds exist for such an appeal.  INA v. National American Ins. Co. of California, 37 Cal. App. 4th 195, 43 Cal. Rptr.2d 518 (4th Dist. 1995). 

The Fourth District ruled in Prichard v. Liberty Mutual Ins. Co., G021825 (Cal. App. November 8, 2000) that a liability insurer’s defense obligations with respect to a “mixed claim” that sets forth both covered and non-covered causes of action extend to the conclusion of the litigation, including the duty to pay for an appeal, even though the evidence produced at trial failed to provide factual support for the allegations that triggered the insured’s defense obligation. 

In general, although there is little case law, it does not appear that California courts would require pre-1966 insurers to defend even after exhaustion.  Such claims were rejected by Judge Munter in Kaiser Coverage Dispute Cases, Coordinated Judicial Counsel Proceeding No. 7212 (Cal. Super. October 8, 1996).

The payment of the applicable policy limit in settlement of the underlying claims against one insured may not terminate the duty to defend another insured in the same litigation.  Shell Oil Co. v. National Union Fire Ins. Co. of Pittsburgh, 44 Cal. App. 4th 1633, 52 Cal. Rptr.2d 580 (2d Dist. 1996)(holding that insured had a duty of good faith and fair dealing to all of its policyholders and was not relieved of its obligations to the others by settling the claims against a single policyholder).  Subsequently, a federal district court ruled in  Wallace v. Allstate Insurance Company, 1999 WL 51822 (N.D. Cal. 1999) that an insurer should accept a policy limit settlement on behalf of one of its insureds if it had tried but failed to obtain a release of all of the claims against all of its policyholders.  The court ruled that, in such circumstances, an insurer does not act in bad faith if the settlement offer does not extend to all of its insured.  The rule, therefore, is that an insurer may not discriminate on behalf of one group of insured or another and must endeavor to obtain the broadest release possible but is not prohibited from effecting a partial settlement if that is the best that can be done.

Liability insurers had no continuing duty to defend once the plaintiff’s cross-claim for damages against the insured was dismissed.  In Walsh v. Northbrook Property & Cas. Co., 1999 U.S. Dist. LEXIS 8126 (N.D. Cal. May 26, 1999), Judge Illston declared that even though the dismissal had been without prejudice, the practical effect of the ruling had been to prevent the plaintiff from presenting any evidence beyond that called for by its affirmative defenses.  Finally, even though the dismissal had been negotiated by the defense counsel retained by the insurers, the court refused to find any basis for a claim of bad faith or unfair practices.

Even though an insurer must defend unless and until it can demonstrate that there is no potential for coverage, the insurer may reject a tender of defense or withdraw from defending a claim once it is able to demonstrate, by reference to undisputed facts, that the claim cannot be covered.  Montrose, 6 Cal. 4th at 295, 297 and Saylin v. California Insurance Guaranty Association, 179 Cal. App. 3rd at 263-264.  While it may be prudent for an insurer to only withdraw after obtaining a declaration that it does not owe coverage, it is not required to do so.  Ringler Associates, Inc. v. Maryland Casualty Company, A082472 (Cal. App. May 23, 2000).

The measure of damages for breaching the duty to defend “is that amount which will compensate the insured for the harm or loss caused by the breach of the duty to defend, i.e., the cost incurred in defense of the underlying suit.”  Amato v. Mercury Casualty Company, 18 Cal. App. 4th 1784, 1794 (1993). 

The California Supreme Court ruled in Signal Companies v. Harbor Ins. Co., 27 Cal.3d 359, 612 P.2d 889 (1980(en banc) that excess insurers have no obligation to share defense costs with primary carriers even if the loss is ultimately settled for more than the primary limits.  In Associated Int. Ins. Co. v. St. Paul Fire & Marine Ins. Co., 220 Cal. App.3d 692, 269 Cal. Rptr. 485 (6th Dist. 1990), the Court of Appeal ruled, however, that an excess carrier could not require an insured to trigger primary policies in other years before it became obligated to share defense costs for a continuing injury claim (silicosis).
 
A primary policy containing a self-insured retention including defense costs transformed the primary policy into an excess policy and thereby eliminated any duty to defend until such time as the SIR was exhausted.  General Star Indemnity Co. v. Hard Rock Café, 35 Cal. Rptr. 2d 322 (2d Dist. 1996). 

In Buss v. Superior Court, 16 Cal.4th 35, 65 Cal.Rptr.2d 366, 939 P.2d 766 (1997) the Supreme Court overruled numerous previous Court of Appeals decisions that had discussed an insurer's right to recoup defense costs.  The court made clear that no right of recoupment exists under the policy.  Accordingly, if costs are incurred in the defense of a potentially covered claim, the insurer has not right to obtain reimbursement after the fact.  However, the insurer has a right of reimbursement that is implied in law and is quasi-contractual under the law of restitution so as to prevent the insured from being unjustly enriched by having obtained the benefit of services relating to the defense of non-covered claims to which it was not otherwise entitled.  The court pointed out in Buss that insurers must be permitted this remedy as they would otherwise be tempted to refuse to defend any part of the lawsuit even though some of the claims were potentially covered.
 

"To defend meaningfully, the insurer must defend immediately... to defend immediately, it must defend entirely. It cannot parse the claims, dividing those that are at least potentially covered from those that are not. To do so would be time-consuming. It might also be futile; the 'plasticity of modern pleading' ...also the transformation of claims that are at least potentially covered in the claims that are not, and vice versa."

In one of the few post-Buss rulings, the Ninth Circuit has declared in Envirotech Industries, Inc. v. United Capitol Ins. Assoc., 1998 U.S. App. LEXIS 6175 (9th Cir. March 26, 1998)(unpublished) that an insurer was entitled to full repayment of the costs of defense that it incurred on behalf of its insured up until the point that its investigation confirmed that there was, in fact, no basis for coverage.

Earlier federal court rulings had recognized an insurer's right to recover defense costs if it has reserved its rights to do so.   Omaha Ind. Co. v. Cardon Oil Co.. 687 F.Supp. 502 (N.D. Cal. 1988) and Walbrook Ins. Co., Ltd. v. Gosbgarina, 726 F.Supp. 777 (C.D. Cal. 1989)(recognizing right even where insured did not consent to reservation).  But see Ins. Co. of the West v. Haralambos Beverage Co., 195 Cal. App.3d 1308, 241 Cal. Rptr. 427 (1987)(no right unless specifically communicated to insured).  The Supreme Court briefly accepted this issue in Gossard v. Ohio Cas. Group of Ins. Cos., 35 Cal. App.4th 190 (1994), review granted, 888 P.2d 236, 37 Cal. Rptr.2d 842 (1995) but subsequently dismissed the appeal and remanded it for further findings.

Under California law, mere claim letters, however adversarial or coercive, are not a “suit.”   In Foster-Gardner, Inc.  v.  National Union & Fire Ins.  Co.  of Pittsburgh,  18 Cal. App.4th 857, 959 P.2d 265, 77 Cal. Rptr.2d 107 (1998), the court declared that a “suit” is a civil proceeding in a court of law that is initiated by the filing of a complaint.  Accordingly, the court reversed the Court of Appeal’s ruling, which had declared that so-called “PRP letters” from governmental agencies are so adversarial as to be the “functional equivalent” of a lawsuit.  The court declared that the term “suit” was not ambiguous nor was it reasonable for a policyholder to assume that a CGL policy contractually obligated an insurer to defend “the substantial equivalent” of a suit.   Moreover, the court noted that such an expansive interpretation of “suit” as the insured had proposed would confound other rules that the court had adopted over the years, such as the necessity of examining the allegations in a complaint to determine whether a duty to defend existed and the requirement that a declaratory judgment action be stayed insofar as it would result in factual findings that are inconsistent with the underlying suit against the insured.  Further, the court noted the difficulty of applying a “hybrid” approach given the slippery nature of what constitutes a sufficiently adversarial or coercive demand letter as to become the equivalent of a “suit.”  Three dissenting justices disagreed, arguing that the term “suit” was ambiguous and that a typical layperson would understand the administrative process initiated by a PRP letter as being more in the nature of a “suit.”  See also  Samson v. Allstate Ins. Co., 1996 U.S. Dist. LEXIS 17057 (N.D. Cal. November 12, 1996)( a mere claim letter from an attorney in a civil matter was not deemed to be a "suit" ).
 
An Illinois appellate court has since ruled that Foster-Gardner should be presumed to have retroactive effect.  W.C. Richards Co. v. Continental Ins. Co., 1999 Ill. App. LEXIS 956 (Ill. App. December 30, 1999). 

The Supreme Court’s ruling in Foster-Gardner is particularly important for insurers as the court has taken a very broad view of what constitutes a  cost of defense in such cases. In Aerojet Chemical Corp. v. Transport Ind. Co., 17 Cal. 4th 38, 70 Cal. Rptr.2d 118, 948 P.2d 909 (1997), the Supreme Court rejected any suggestion that the cost of carrying out site studies and the RI/FS should be presumed to be indemnity, the court held that such costs could be part of the defense obligation if the costs (1) are incurred after the date of tender but before liability is adjudicated ; (2) are reasonably and necessary in amount and (3) reasonably related to diminishing (as opposed to satisfying) the insured's liability.   Such costs will now not be covered in cases where the insured has not yet been sued.

Judge Bea ruled in Tosco Corp.  v.  Hartford Accident & Indemnity Co., San Francisco No.  952681 (Cal.  Super.  March 1, 1999) that whether site investigation expenses are defense costs must be determined objectively with the policyholder bearing the burden of proving, by a preponderance of the evidence, the existence, amount, reasonableness and necessity of the site investigation expenses claimed as defense costs.  The insured’s burden is effected by whether the insurer wrongfully denied any responsibility to defend. If the insurer has wrongfully refused to defend, it has the burden of proving unreasonableness.

The Supreme Court noted in its 1997 ruling in Aerojet that insurers are only obligated to pay defense costs incurred after the date of tender.  Pre-suit costs were held to be covered in Stein v. International Ins. Co., 217 Cal. App.3d 609, 266 Cal. Rptr. 72 (1990) if they were incurred after notice of a claim had been given to an insurer.  The Court of Appeal also ruled in Fiorito v. State Farm Fire & Cas. Co., 226 Cal. App.3d 433, 277 Cal. Rptr. 27 (1990) that there was a question of fact as to whether pre-tender costs were "voluntary" so as to be in breach of the "cooperation clause."  Some courts have limited Fiorito to situations in which the insured was unaware that a policy existed. Faust v. The Travelers, 55 F.3d 471 (9th Cir. 1995); Crystal Peak Water Co. v. American Motorist Ins. Co., No. 94-1531 (N.D. Cal. June 22, 1995); Fidelity & Deposit Co. v. First Commercial Bank, No. C92-2252 (N.D. Cal. April 17, 1993); Northern Ins. Co. v. Allied Mutual Ins. Co., 955 F.2d 1353 (9th Cir. 1992) and Xebec Development Partners, Inc. v. National Union Fire Ins. Co., 12 Cal. App.4th 501, 15 Cal. Rptr.2d 726 (1993).  Where the insured only later learns that the insurer's coverage exists, it may not be barred from demanding reimbursement.  Meritplan Ins. Co. v. Universal Underwriters Ins. Co., 247 Ca. App.2d 451, 55 Cal. Rptr. 561 (1966).  The Court of Appeal took a broad view of Fiorito in Shell Oil Co. v. National Union Fire Ins. Co. of Pittsburgh, 44 Cal. App. 4th 1633, 52 Cal. Rptr.2d 580 (2d Dist. 1996), holding that the "voluntary payment" prohibition in the cooperation clause does not apply to defense costs, particularly where these costs were necessitated by the exigencies of the litigation and thus were not "voluntarily paid."  See also Gribaldo, Jacobs, Jones & Associates v. Agrippina Versicherunges, A.G., 3 Cal. App.3d 434, 476 P.2d 406, 91 Cal. Rptr. 6 (1970)(no coverage where policy required insurer's assent to defense costs).

Under Civil Code Section 2778, Subdivision (4), a defense obligation is implied in all indemnity agreements unless a contrary intention appears.  Accordingly, California courts have ruled that an insured may reasonably expect to have a defense provided unless its policy expressly excludes such an obligation.  Maryland Casualty Co. v. Nationwide Ins. Co., 65 Cal. App.4th 21, 76 Cal. Rptr.2d 113 (4th Dist. 1998).

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