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June 17, 2004


Focus Column Insurance Law

By Kirk Pasich
It has long been said that an insurer's duty to defend is broader than its duty to indemnify, and that all that is required to trigger the duty to defend is a "potential" for coverage. However, what do these phrases really mean? And how does one determine exactly how broad the duty to defend is and when there is a potential for coverage? The landmark decision on the duty to defend is Gray v. Zurich Insurance Co., 65 Cal. 2d 263 (1966). The Gray court held that an insurance carrier "must defend a suit which potentially seeks damages within the coverage of the policy." The court explained that this duty arises when the carrier "is informed of [an] accident and learns of even the potential for liability under its policy." Since then, many courts have addressed the duty to defend. For example, in Horace Mann Insurance Co. v. Barbara B., 4 Cal. 4th 1076 (1993), the court ruled that the duty to defend may be deemed to exist based on the allegations in a complaint or on facts extrinsic to the complaint that "reveal a possibility that the claim may be covered by the policy." The court also held: "We look not to whether noncovered acts predominate in the third party's action [against the insured], but rather to whether there is any potential for liability under the policy. ... [A]n insurer has a duty to defend the entire third party action if any claim encompassed within it potentially may be covered ... ." In Montrose Chemical Corp. v. Superior Court, 6 Cal. 4th 287 (1993), the court emphasized the importance of the duty to defend, saying 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 ... . Imposition of an immediate duty to defend is necessary to afford the insured what it is entitled to: the full protection of a defense on its behalf."

The court then held that "facts known to the insurer and extrinsic to the third party complaint can generate a duty to defend, even though the face of the complaint does not reflect a potential for liability under the policy." This is because "current pleading rules liberally allow amendment," and a "third party plaintiff cannot be the arbiter of coverage." The court then summarized the governing principles as follows: "[T]he insured is entitled to a defense if the underlying complaint alleges the insured's liability for damages potentially covered under the policy, or if the complaint might be amended to give rise to a liability that would be covered under the policy. [Our] holding in Gray establishes the rule that the insurer must defend in some lawsuits where liability under the policy ultimately fails to materialize; this is one reason why it is often said that the duty to defend is broader than the duty to indemnify. Any doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured's favor ... ." Indeed, in [Gray] we said that "the insurer need not defend if the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage." The quoted language cannot reasonably be understood to refer to anything beyond a bare "potential" or "possibility" of coverage as the trigger of a defense duty. California courts also have confirmed that an insurance carrier must defend its insured against groundless, false and fraudulent claims. As the court observed in Gray, an insured reasonably would "expect defense of any suit regardless of merit or cause." As the court further explained in Horace Mann: "An insured buys liability insurance in large part to secure a defense against all claims potentially within policy coverage, even frivolous claims unjustly brought ... If [the claimant's] claims were indeed so insubstantial as not to warrant any damages, [the insurance carrier] should have raised that defense in the underlying action for [the insured's] benefit, rather than in this declaratory relief action to his detriment." In fact, a carrier must defend even if the coverage-triggering events may have occurred outside of the carrier's policy period. For example, in County of San Bernardino v. Pacific Indemnity Co., 56 Cal. App. 4th 666 (1997), an insurance carrier attempted to avoid its duty to defend by arguing that there had been no "occurrence" when its policy was in effect. The court rejected this argument, ruling that the carrier could not properly avoid its duty to defend by relying upon a coverage defense related to a critical issue in the underlying lawsuits, to wit, that there was no "occurrence" during the policy period. As another Court of Appeal explained: "[A]n insurer cannot avoid the duty to defend merely by concluding, based on its own investigation, that the insured has done no wrong. The duty to defend does not evaporate simply because the insurer has decided that the insured will ultimately be exonerated (or because evidence supporting that conclusion has been introduced in a declaratory relief action over coverage)."

A-H Plating Inc. v. Am. Nat'l Fire Ins. Co., 57 Cal. App. 4th 427, 442 (1997). See also Reese v. Travelers Ins. Co., 129 F.3d 1056, 1061 (9th Cir. 1997). ("The question is not whether the allegations of the underlying complaint are meritorious, but whether [the insurer's] policy terms require it to provide a defense against such claims ... .") The 9th Circuit applied these various principles in Pension Trust Fund for Operating Engineers v. Federal Insurance Co., 307 F.3d 944 (9th Cir. 2002). In Pension Trust, the insured was an employee benefit trust that invested in a country club development. After the development failed, the purchaser filed suit, claiming that the trust breached its duties. When the trust sought coverage, the insurance carrier argued that the purchaser had alleged no claims that implicated its duty to defend under a fiduciary responsibility policy. The 9th Circuit rejected the carrier's argument. It stated: "A liability insurer's duty to defend its insured is broad. It arises whenever a claim may potentially lead to indemnity. This duty is necessarily broader than the duty to indemnify because of 'the difficulty in determining whether the third party suit falls within the indemnification coverage before the suit is resolved.'" The 9th Circuit noted that the allegations of the complaint and facts extrinsic to the complaint should be compared to the policy terms to see if they "'reveal a possibility that the claim may be covered by the policy.'" The court emphasized that "the insurer must defend an action against its insured even though it has independent knowledge of facts not in the pleadings that establish that the claim is not covered." The court then explained as follows: "The duty to defend does not usually turn on whether facts supporting a covered claim predominate or generate the claim. Instead, California courts have repeatedly found that remote facts buried within causes of action that may potentially give rise to coverage are sufficient to invoke the defense duty. Thus, California law does not require that the insured's conduct proximately cause the third party claim in order to trigger the defense duty." The court cited with approval and discussed CNA Casualty v. Seaboard Surety Co., 176 Cal. App. 3d 598 (1986). In CNA, the insured was named as a defendant in an underlying antitrust action. The court held that the carriers owed a duty to defend, even though none of the policies covered antitrust actions, because the underlying allegations were arguably within the policy's coverage and were used to support the antitrust claim. The Pension Trust court summarized CNA as follows: "The CNA court cited approvingly to Ruder & Finn v. Seaboard Sur., 52 N.Y.2d 663, 439 N.Y.S.2d 858, 422 N.E.2d 518 (1981), wherein a New York court determined that an insurance company had a duty to defend its insured against an antitrust action that included an allegation of 'false disparagement.' See CNA, 176 Cal. App. 3d at 611-12." The court rejected the insurer's argument that "two solitary, unsubstantiated words" buried within a "completely unrelated federal antitrust cause of action, which was, itself, undisputably not covered" could not trigger the duty to defend ... The test for the New York court was whether the claim, "liberally construed, ... [was] within the embrace of

the policy." The defense duty, it held, is triggered even if an element of a covered action is omitted. Thus, the duty to defend is extremely broad. It may exist in circumstances where not even a single cause of action in a complaint is covered, at least as long as there are some potentially covered allegations even if "two solitary, unsubstantiated words" are buried within an indisputably "not covered" cause of action.

Kirk Pasich is a partner in the Los Angeles office of the DC-based firm of Dickstein Shapiro Morin & Oshinsky LLP. He represents insureds in coverage matters.