Julian D. Ehrlich

The duty to defend can be triggered by insurance policies and contractual indemnity provisions.

It is a well-known axiom that the duty to defend is broader than the duty to indemnify under an insurance policy. However, less well known is that the duty to defend is typically no broader than the duty to indemnify for contractual obligations. Moreover, many cases resolve before the duty to indemnify is ever established. Accordingly, the duty to defend presents earlier and more often than the duty to indemnify.

This discussion will examine the nature and nuances of the duty to defend.

Coverage Duties

The majority rule, and long the rule in New York, is that determination of the duty to defend under an insurance policy depends on a comparison of the wording in the coverage grant and the allegations in the complaint. Continental Cas. Co. v. Rapid-American Corp., 80 N.Y.2d 640, 648 (1993).

The current version of the Insurance Services Organization (ISO) Commercial General Liability (CGL) policy, the CG 00 01 04 13, states in part: “[w]e will pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage … .’”

Accordingly, an immediate defense obligation should be triggered whenever a claimant makes allegations of damages because of personal injury or property damages.

Moreover, the New York rule has long been that known extrinsic facts, disputed and undisputed, beyond the pleadings can expand but not restrict an insurers’ duty to defend. Fitzpatrick v. American Honda Motor Co., 78 N.Y.2d 61, 66 (1991).

Jurisdictions’ case law is mixed on whether there is a concurrent duty to investigate facts bearing on coverage, but such an investigation should be part of best practices claim handling.

In addition, insurers’ duties generally apply across liability policy lines and to named insureds as well as additional insureds. BP A.C. Corp. v. One Beacon Ins. Group, 8 N.Y.3d 708, 714 (2007).

Duties Contrasted

In contrast to insurers’ duty to defend, which is often triggered when the complaint is served or when the claim is tendered to an insurer, the insurers’ duty to indemnify is not triggered until the insured’s negligence is established.

Accordingly, the duty to indemnify may not be determined until years into the life of a claim.

Moreover, many cases settle, often with insurers paying toward settlement, before any duty to indemnify is ever established.

Where an insurer recognizes a duty to defend but takes the position that a determination of the duty to indemnify is premature, it will typically issue a reservation of rights letter to the insured and other stakeholders.

Scope

While the insurer’s duty to defend is broader than the duty to indemnify, the duty to defend is not unlimited.

For example, it has been held that “[t]he duty to defend is not triggered, where it may be concluded as a matter of law, that there is no possible factual or legal basis upon which the insurer might eventually be held to be obligated to indemnify the claimant under any provision of the insurance policy…” or where “the allegations of the complaint cast that pleading solely and entirely within a policy exclusion.” Bruckner Realty v. County Oil Co., 40 A.D.3d 898 at 900 (2d Dept. 2007).

Moreover, an insurer which breaches its duty to defend, can subsequently still rely on exclusions to “escape” its duty to indemnify. K2 Inv. Group v. American Guar. & Liab. Ins. Co., 22 N.Y.3d 578 (2014).

However, the majority rule, again also true in New York, is that an insurer may have a duty to defend even when it ultimately has no obligation to indemnify, either because no damages are awarded in the underlying action against the insured, or because the actual judgment is for damages not covered under the policy. Paramount Ins. Co. v. Federal Ins. Co., 2019 NY Slip Op. 05755 (1st Dept. 2019); Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131 at 137 (2006).

This line of cases greatly favors policyholders in the emerging area of insurers’ rights to recoup attorney fees in the event there is an eventual finding of no indemnity obligation.

Similarly, this line of cases may explain why recoupment wording in reservations of rights is far more common than insurers’ attempts to get defense costs back from their insured customers at the end of a case.

Reconciling Standards

The notion of a broad but defined scope of the duty to defend can be harmonized by taking a closer look into the how allegations are typically pleaded and the nature of the obligation.

Pleadings are often vaguely worded and missing important information. For example, in property damage claims, dates of loss may be missing or only refer to the dates damage was discovered and not dates the damage occurred.

Reasons for this imprecision may include: notice-based rather fact-based pleading requirements; deliberately naming as many defendants as possible to maximize the number of settlement funding sources; or, that the claimant may just not know the all the facts.

However, there is also good reason for plaintiffs to broadly word allegations to trigger defendants’ insurance.

In addition, courts have described the duty to defend not just as broad but as “exceedingly broad” and considered to be “litigation insurance.” Automobile Ins. Co. of Hartford, 7 N.Y.3d at 137.

Liability insurance policies are sold to respond to claims with and without merit. Moreover, a broad interpretation of the duty to defend is consistent with the courts’ generally favoring the use of insurance to resolve claims.

Contractual Indemnity Compared

Many contracts, including leases between owners and commercial tenants and construction agreements, contain both indemnity and insurance procurement obligations.

While these dual tracks of risk transfer are not mutually exclusive, the duty to defend is different under contractual indemnity than under insurance.

For contractual indemnity, the duty to defend is no broader than the duty to indemnify.

The reason for this distinction is rooted in the different targets of risk transfer. Contractual indemnity obligations run to parties who are not insurers. Brooklyn View v. PRP, 159 A.D.3d 865 (2d Dept. 2018).

As a result, there may be a delay obtaining defense from a party through contractual indemnity pending a liability determination.

However, case law suggests parties can draft contracts to require a duty to defend provided such an obligation is clearly conveyed. See Sellitti v. TJX Cos., 127 A.D.3d 724 (2d Dept. 2015); Alfaro v. 65 W. 13th Acquisition, 74 A.D.3d 1255 (2d Dept. 2010).

To that end, some contractual indemnity provisions include wording which, for example, requires a party to “defend even if the allegations are groundless, false or meritless.”

Of course, contractual indemnity provisions must always be compliant with New York’s anti-indemnity statutes codified in the General Obligations Law which prevents contracting away negligence in various settings.

Conclusion

It is not unusual for defense costs exceeds liability exposure in complicated but defensible claims.

Moreover, often it is in the interest of insureds and insurers to avoid the risk a liability finding by settling claims after the duty to defend has been acknowledged but before any indemnity obligation has been established.

Ultimately, the specific wording of each complaint and the extrinsic facts of each claim will have to be scrutinized to determine whether the duty to defend applies.

However, as the above discussion highlights, understanding the parameters of the duty to defend is core to planning and executing effective risk transfer and resolving claims optimally.

Julian D. Ehrlich is Senior Vice President Claims of Aon’s Construction Services Group in New York.