Given the cost of insurance premiums and litigation, you should strive to obtain the full benefit of your insurance coverage. To do so, you should know what is required of your insurance carrier when a claim is made; actively engage with your carrier and work closely with the attorney retained by your insurance carrier to defend you during the litigation of a claim; and be aware of your duties, rights and exposures.
The commercial general liability (CGL) policy available to contractors is a standard policy developed by the insurance industry organization Insurance Services Office, Jersey City, N.J. The insuring agreement in the standard CGL policy says your insurance carrier has the right and duty to defend you against a suit seeking bodily injury or property damage and to pay those sums you become legally obligated to pay as damages because of "bodily injury" or "property damage." Your insurance carrier may, at its discretion, investigate any "occurrence" and settle any resulting claim or suit.
Although policy language may be identical, carriers' obligations and insureds' rights vary substantially from state to state. The legal principles and judicial rulings governing insurance coverage disputes and insurers' obligations are a function of state law and state court decisions interpreting specific provisions in insurance policies. As with other contract types, courts examine insurance policies to determine parties' rights and obligations. If unambiguous, a provision is given effect as written. Because insurance policies are written and prescribed by insurance carriers, ambiguities are construed in the insured's favor.
Duties to defend and indemnify
Although identical policies may be and have been interpreted in different ways by courts in different states, there is agreement insurance carriers have two distinct and separate duties under a standard CGL policy: a duty to defend the insured against allegations made against it if the allegations are within the policy's coverage and a duty to indemnify the insured by paying a covered claim.
The duty to defend arises at the outset of litigation when the insured requests the insurer to provide a defense to an alleged liability; the duty to indemnify arises at the conclusion of litigation either through settlement or a judgment against the insured.
Questions sometimes arise as to when an insurer's duty to defend begins. The policy's insuring agreement states the insurance carrier has the right and duty to defend the insured against any "suit" seeking property damages or bodily injury.
In recent years, the standard CGL policy text has been revised so a suit includes an arbitration proceeding (seeking recovery for bodily injury or property damage) in which the insured contractor is bound to participate or to which the insurance carrier has consented. Similarly, the current CGL standard policy provides a suit includes any other alternative dispute resolution proceeding to which the insured submits with the insurance carrier's consent.
Although an insurer's duty to defend usually will not arise until a suit has begun, the standard CGL policy calls on the insured to provide notice to the carrier "as soon as practicable of an ‘occurrence' or an offense which may result in a claim."
The policy defines occurrence as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions." You should provide written notice to your insurance carrier promptly upon learning of an incident resulting in property damage or bodily injury and whenever a suit or arbitration demand is brought against you in which covered damages may be sought.
Rather than waiting until a suit is filed, you and your insurance carrier can save thousands of dollars by becoming actively engaged in investigating and managing a claim as soon as one arises. By the time a lawsuit is filed, the opportunity to examine the site, gather evidence, mitigate damages and control expenses will be lost, and the litigation process is likely to take on a life of its own.
In the June 2013 decision of Capstone Building Corporation v. American Motorists Insurance Company, the Connecticut Supreme Court ruled the insurer's duty to defend may arise before a suit is initiated, stating "[i]n the context of pre-suit demands by an insured, the insurer's duty is triggered when the demand is 'sufficiently detailed for the defendant to discern whether the allegations … [are] within the scope of the plaintiff's insurance coverage.'"
Breadth of duty
Just as there is agreement insurance carriers have separate duties to defend and indemnify, all states recognize insurance carriers' duty to defend is broader than the duty to indemnify. This means insurance carriers have a duty to provide a defense to insureds even if the claims are devoid of merit as long as there is an allegation that could potentially come within the policy's scope.
For instance, there might be two Best Roofing companies, and the wrong Best Roofing, which had nothing to do with the project in dispute, is sued. Although the suit against the "wrong" Best Roofing is meritless and its insurance company would have no obligation to pay the claim, the "wrong" Best Roofing's insurance carrier still would be obligated to provide a defense and cause the suit to be dismissed. A liability insurer has a duty to defend its insured in a pending lawsuit if the pleadings allege a covered occurrence even though extrinsic facts would indicate the claim may be meritless or not covered.
Four corners rule
To determine whether an insurance carrier has a duty to defend, some courts take an approach commonly referred to as the four corners rule. Following this approach, a court will look solely to what is included within the four corners of the complaint lodged against the insured and compare the allegations against the insurance policy's terms. If an allegation possibly invokes insurance coverage, the insurer has a duty to defend. A complaint that is unclear will be construed so the insurer has an initial duty to defend until doubts regarding the insurer's duty to defend are resolved.
State courts differ as to whether an insurer's duty to defend is based solely on the allegations in a complaint or whether extrinsic information also can be considered to determine whether an insurer has a duty to defend. In situations where a complaint does not indicate a lack of coverage but the insurer possesses extrinsic information obtained through its own investigation that the claims are covered, the insurance carrier will have a duty to defend.
Although courts in some states, including Florida, Pennsylvania and Texas, explain an insurer's duty to defend is determined solely by a complaint's allegations, the more prevalent view is factual information beyond what is alleged in the complaint can and should be considered to determine whether the insurer should provide a defense. However, an insurer's duty to defend does not depend on facts obtained during the insurer's investigation when the complaint against the insured contractor appears to be within the policy coverage.
In this situation, it is irrelevant if the insurer has information indicating the claim is not covered. Although extrinsic evidence may be considered when establishing a duty to defend in a situation where the complaint is unclear, extrinsic evidence is not to be considered if allegations of the complaint indicate there is coverage.
These principles might be applied to a typical construction defect case against you where a complaint alleges a defective roof caused unspecified damages and requires replacement. If the alleged property damages arose from an allegedly defective roof, your insurance carrier would have an unambiguous duty to defend the suit. But if the complaint does not specify damages, the insurer may hesitate or decline to provide a defense because a lawsuit for repair or replacement of only the roof is not covered by standard CGL insurance policies.
If you knew there was property damage to other parts of the building (such as ceiling tiles, carpets, drywall and floors) or damage to personal property within the building, you should inform the insurer when requesting a defense.
If coverage applies to a portion of the claim, the insurance carrier is likely to proceed with providing a defense coupled with the insurer reserving its right to subsequently decline coverage. If there is doubt concerning coverage, the insurance carrier or you can initiate a declaratory judgment requesting the court to rule on whether there is insurance coverage applicable to the underlying claim.
If the insurance carrier declines to provide a defense, forcing you to provide your own defense, and it subsequently is determined there was a duty to defend, you can recover the defense costs from the carrier in addition to payment of the covered claim up to the policy limits.
Covered or not?
Roofing contractors commonly face a situation where some claims and damages alleged in a lawsuit may be covered but others are not. Court decisions are clear an insurer's duty to defend arises when there is a possibility that at least some of the claims made in the complaint are covered by the insurance policy. A court only needs to find one claim or allegation in the complaint is covered by the insurance policy to establish the insurer's duty to defend. If an allegation falls even possibly within the coverage, the insurer must provide a defense.
When there are covered and noncovered claims in the same lawsuit, the insurer is obligated to provide a defense to the entire suit. In addition, the insurance carrier must provide whatever defense is necessary for the noncovered claims while it is defending the covered claims.
Consider again a typical case alleging a defective roof caused property damage. Although the insurer's duty to indemnify is limited to the property damage resulting from roof leaks, because repair or replacement of the work is not covered by standard CGL policies, the duty to defend encompasses the entire claim.
The rule requiring insurers to defend suits in which there are claims and damages that are covered and others that are not covered is supported by strong practical considerations where, as is usually the case, the covered and noncovered claims arise out of the same incident. Defense of intertwined claims is to be conducted by a single counsel.
Right to control defense
The standard CGL policy offered to contractors affords insurance carriers the right to select counsel and decide how the defense will be conducted. Typically, insurance carriers have well-established relationships with law firms who regularly represent them and their insureds. An increasing number of insurance carriers, including CNA, Chicago, directly employ attorneys, referred to as staff counsel, to represent their insureds.
Insurance law principles and professional rules governing attorney conduct recognize the client is the insured and the attorney's defense obligation is owed to the insured, not the insurance carrier.
If you find yourself represented by an insurance carrier's counsel, communicate with him or her in the same manner as if the defense attorney had been retained by you. Retaining a well-qualified expert to examine job-site conditions and testify about the issues in the case, including the problem's cause and your performance, are essential to defending a construction defect claim.
In addition, though the counsel's obligation is owed to the insured contractor, consider retaining your own counsel experienced in construction cases to monitor the defense being provided by the insurer whenever a suit includes noncovered claims or damages. The time to ensure an effective defense is being provided is at the beginning and during the course of the litigation, not as the case is nearing an end and you are informed you face a large liability exposure for an uncovered claim.
The insurer's right to control the defense carries with it the duty to not prejudice the insured's rights and exercise diligence and utmost good faith to protect the insured's interests. The attorney retained by the insurance carrier to defend the insured is not to be involved in insurance coverage issues. If the attorney receives instructions from a claims adjuster or insurer representative to improperly advance the insurer's interests at the insured's expense or detriment, the carrier would have breached its duty to defend the insured and the attorney may well have violated ethical requirements.
As long as the insured's and insurer's interests are aligned, there is no potential conflict of interest facing the insurance defense attorney. However, if there are coverage issues and the insurance carrier has issued a letter reserving its right to withdraw its defense, a potential conflict of interest exists.
Reservation of rights
In situations where there is doubt whether an insurance carrier has a duty to defend or whether claims or damages are covered, insurance carriers routinely issue reservation of rights letters. The purpose of such letters is for an insurance carrier to notify an insured there may not be insurance coverage applicable to all or some of the claims or damages alleged and the insurance carrier reserves its rights to withdraw coverage at a later date.
The typical reservation of rights letter quotes extensively from the CGL policy text, focusing on the standard business risk exclusions pertaining to the contractor's work so the contractor is made aware the insurance policy does not cover repair or replacement of his or her work.
When an insurance carrier issues a reservation of rights letter and chooses to defend a case subject to a reservation of rights, depending on state law, the insurance carrier relinquishes to some extent its previously unfettered right to exercise exclusive control over handling the defense. The issuance of a reservation of rights letter creates a potential conflict of interest between the insurer and insured.
This issue was considered by the Supreme Court of Alabama in L & S Supply Company v. St. Paul Fire & Marine Insurance Company. The Alabama Supreme Court was asked to determine whether an attorney who had been retained by an insurance carrier, which chose to defend its insured subject to a reservation of rights, had a conflict of interest that justified the insured contractor in engaging counsel of its choice and controlling the defense.
The dispute between the insured, L & S Roofing Supply Co. Inc., Birmingham, Ala., and its insurer, St. Paul Fire & Marine Insurance Co., St. Paul, Minn., arose out of a suit brought against L & S Roofing Supply and TAMKO Building Products Inc., Joplin, Mo., concerning the quality of roofing materials manufactured by TAMKO Building Products and purchased by a construction company from L & S Roofing Supply. The complaint included four counts and compensatory and punitive damages against L & S Roofing Supply. Some allegations and damages were covered by the CGL insurance, and others were not.
After L & S Roofing Supply called upon St. Paul Fire & Marine Insurance to provide a defense, St. Paul Fire & Marine Insurance sent a reservation of rights letter stating it was reserving its rights to disclaim coverage to certain claims and damages alleged in the complaint.
The reservation of rights letter said defense of the claim was being referred to the law firm Balch & Bingham, Montgomery, Ala., "who will protect your interests" per the policy. Balch & Bingham had a continuing relationship with St. Paul Fire & Marine Insurance and regularly represented its insureds and interests in litigation.
Upon receiving the letter, L & S Roofing Supply demanded St. Paul Fire & Marine Insurance allow L & S Roofing Supply to retain, at St. Paul Fire & Marine Insurance's expense, independent counsel to control the litigation. St. Paul Fire & Marine Insurance agreed to allow counsel retained by L & S Roofing Supply to participate in the defense but at L & S Roofing Supply's expense. St. Paul Fire & Marine Insurance maintained overall control.
L & S Roofing Supply then filed a declaratory judgment suit against the insurance company, alleging there was conflict of interest for St. Paul Fire & Marine Insurance's attorneys to continue to control the litigation because the lawyers were retained by St. Paul Fire & Marine Insurance and it had a direct pecuniary interest in having the litigation resolved in a manner that would relieve it of financial responsibility.
L & S Roofing Supply alleged it would be in St. Paul Fire & Marine Insurance's interests to have the underlying claim resolved on claims outside the policy coverage, while L & S Roofing Supply would want the suit resolved based on claims that were covered in the policy. Because of this conflict, L & S Roofing Supply contended it should be able to retain independent counsel at St. Paul Fire & Marine Insurance's expense to defend the underlying litigation.
Quoting extensively from a case decided by the Washington Supreme Court, the Alabama Supreme Court declined to follow the cases cited by L & S Roofing Supply, which stated when an insurer issues a reservation of rights letter, regardless of actual circumstances, the insured is entitled to defense counsel of its choice to be paid by the insurer. The court said those cases went too far.
Instead, the Alabama Supreme Court held that when defending an insured subject to a reservation of rights, the insurer cannot pursue a course of action that is advantageous to itself while disadvantageous to its policyholder and owed "an enhanced obligation of good faith" to its insured, which required:
Whenever a claim is being defended by an insurance carrier and particularly if a reservation of rights letter has been issued, the insured contractor should see the principles listed are being scrupulously followed by the insurer and insurance defense counsel.
Consistent with a portion of the Alabama Supreme Court's decision, in 2010, the U.S. District Court for the Southern District of New York recognized in Executive Risk Indemnity Inc. v. Icon Title Agency LLC that an insurer's reservation of rights letter does not automatically entitle the insured to representation of its choice at the insurer's expense.
However, the New York court went on to state: "Instead, the insured's right to independent counsel is only triggered when the reservation of rights creates a potential conflict of interest for the counsel provided by the insurer, and in particular, where the defense attorney's duty to the insured would be to defeat liability on any ground but his duty to the insurer would be to defeat liability on only those grounds for which the insurer might be liable."
According to the New York decision, when a complaint includes a claim based on fraud that is not covered by insurance, there is a potential conflict of interest sufficient to trigger a right to independent counsel at the insurer's expense.
You need to be careful if you receive a reservation of rights letter that states the insurance carrier will defend the suit but reserves the right to obtain reimbursement from you for the defense costs if it subsequently is determined there is no coverage or if the suit includes noncovered claims. Ignoring this admonition in the reservations of rights letter can be perilous.
Courts have reached conflicting rulings regarding whether an insurance carrier can recover some or all the attorneys' fees. Some courts have ruled that unless there is a provision in the insurance policy authorizing the insurer to obtain reimbursement, the insured is not liable for reimbursement because a reservation of rights letter cannot alter policy terms. However, other courts have permitted insurance carriers to obtain reimbursement when the carrier had no duty to defend the claim and the insured would be receiving a windfall if the insured did not pay defense costs for uninsured claims.
If you receive a reservation of rights letter stating your insurance carrier reserves its right to seek reimbursement, first confirm the applicable policy does not contain such a provision and, assuming a standard CGL policy without that provision applies to the claim, notify the carrier you object. The insurance carrier can choose to file a declaratory judgment, defend the suit or deny the claim.
Getting your insurance carrier to defend a claim brought against you does not mean you can go about your business and take a passive approach. Most construction defect suits include covered and noncovered claims and damages. To minimize your liability, actively ensure the case is well-defended and your interests are well-protected.
Your insurance premium dollars entitle you to call upon your insurance carrier to defend a suit that potentially includes claims and damages covered by your insurance policy even when there are other claims and damages not covered. The insurer's duty to defend provides you with valuable rights and benefits you should be sure are given full effect.
Stephen M. Phillips is a partner with Atlanta-based law firm Hendricks, Phillips, Salzman & Flatt.