It's not much of a stretch to say that an insurer's duty todefend has been litigated over the years at a cost of hundreds ofmillions of dollars. There are three issues that have accounted fora substantial amount of that litigation.

Anomalies

It is well-established that the duty to defend is broader thanthe duty to indemnify. Often touted as being “axiomatic,” if thereis a potential for coverage under the CGL policy, there is a dutyto defend a suit. The duty to indemnify, on the other hand, isnarrower because it depends on the insured proving that a loss isactually covered.

Is it possible to have a duty to indemnify but not acorresponding duty to defend? Is the duty to indemnify without acorresponding duty to defend an anomaly, or at least a bitillogical? Or is it perfectly logical in the context of an“eight-corners” state like Texas?

The analysis of the duty to defend begins with an examination ofthe facts and the policy. It is necessary to determine, however,what facts an insurer must or can review when determining itsdefense obligation in a particular jurisdiction. Is the examinationof the facts limited to those stated in the lawsuit or caninformation extrinsic to the lawsuit be consulted?

While it is universally accepted that the duty to defend isbroader than the duty to indemnify, jurisdictions differ as to whatinformation can be used to determine that duty. For instance, in an“eight-corners” state, the decision to defend must be based on areview of the policy and the lawsuit. Use of information outside ofthe complaint is generally not permitted. In other states,information extrinsic to the complaint must be considered. In somecases, this information can be used to defeat coverage as well asafford it. In other cases, the information can be used only toafford coverage.

So, while it appears that the defense duty is broad because onlya potential for coverage need be established, an eight-cornersstate restricts the amount of information that can be examined.Does this restriction detract from the axiom that the duty todefend is broader than the duty to indemnify when only limitedinformation can be used?

Common rationale for rejecting the eight-corners rule can bepersuasive. First, the denial of a defense based on informationrestricted to the lawsuit would appear to be contrary to the broadduty to defend, which is universally recognized; and, second, thedecision to defend, or not, would be based on the pleadings, whichcould be limited in its recitation of the facts and be subject to“the pleading strategies, whims, and vagaries of third-partyclaimants to control the rights of parties to an insurancecontract.” (Maniloff and Stempel, 2011.)

On March 21, 2013, a federal district court in Texas ruled thatthe duty to defend and duty to indemnify are distinct duties underTexas law and that one can exist without the other. (ColonyIns. Co. v. Price, 2013)

Citing the Supreme Court of Texas in D.R. Horton-Tex., Ltd.v. Markel Inter'l Ins. Co, 300 S.W.3d 740, 743, theColony court stated that “although the duty to defend is'strictly circumscribed by the eight-corners doctrine, it is wellsettled that the facts actually established in the underlying suitcontrol the duty to indemnify.'”

Is the duty to defend truly broader than the duty to indemnifyif determination of the duty to defend is “strictly circumscribedby the eight-corners doctrine?” To answer this question, it ishelpful to distinguish the “potential v. actual” criterion fordetermining duties from any constraints on the information to whichthis criterion can be applied.

When the duty to defend must be determined from the lawsuit onlyand not from extrinsic information, it is possible that no duty todefend exists given the way the lawsuit is drafted. On the otherhand, there may be a duty to indemnify because it can be determinedbased on information outside of the complaint.

In D.R. Horton-Texas, Ltd., the Court ruled that thedefense and indemnity duties are independent of each other and thatan indemnity duty can exist without a defense duty: “We hold thateven if Markel has no duty to defend D.R. Horton, it may still havea duty to indemnify… That determination hinges on the factsestablished and the terms and conditions of the CGL policy.”

Hence, the anomaly…the duty to defend is broader than the dutyto indemnify, but in an eight-corners jurisdiction, the informationused to determine the duty to defend is limited. And while the dutyto indemnify is narrower, the information used to determine thatduty is broad. Since the duties exist independent of each other, itis possible to have a duty to indemnify without a duty todefend.

Crowds

Two's company and sometimes three's a crowd in the “tripartiterelationship,” that frequently complicated and contentiousrelationship among the insurer, the defense attorney hired by theinsurer to defend its insured, and the insured.

The Insuring Agreement in the CGL form provides that the insurer“…will have the right and duty to defend the insured against any'suit' seeking those damages.” (Commercial General Liability Form)The right to defend includes the right to select defense counsel.Whether that right can be exercised depends on whether a conflictof interest arises when the insurer hires an attorney to defend itsinsured, but also reserves its rights to deny coverage. In suchcircumstances, the potential for conflict in the “tripartiterelationship” among the insured, insurer, and defense counsel hiredby the insurer can play havoc with the insurer's right to selectcounsel.

When the insurer has an obligation to defend, it will retain anattorney to defend its insured and frequently the attorney isselected from the insurer's “panel.” If the defense is conductedsubject to reservations, however, the insurer must determinewhether and under what conditions the insured is entitled toindependent counsel at the insurer's expense. When an insurerreserves its rights while defending, warning that there may be nocoverage for indemnity, a potential conflict of interest may ariseas to the attorney retained by the insurer to defend the insuredand that attorney's ability to impact insurance coverage, to thepotential detriment of the insured.

On the one hand, defense counsel has a duty of loyalty andallegiance to his or her client, the insured. On the other hand,that attorney has received and counts on receiving many assignmentsfrom the insurer to defend its other policyholders in other cases.The retained attorney has a vested interest in a good relationshipwith the insurer. Just how is a “good relationship” with theinsurer maintained? Ideally, that good relationship is maintainedsimply by the attorney competently and loyally defending his or herclient, the insured.

But it certainly is not difficult to understand the trepidationsof an insured, facing potentially uncovered claims, having itsdefense handled by an attorney, hired by the insurer, who wantsmore business from that insurer. It is possible that a misguidedattorney who wants more work, and perhaps because of overt orcovert pressure from an unscrupulous insurer, may act in ways thatplaces the insurer's interests above the insured's. (Maniloff,124)

The attorney who is hired to defend the insured may findhim/herself in a “conflict-of-interest purgatory.” (Gary L.Johnson, 2012) If the interests of the insurer and insuredcoincide, the attorney can proceed confidently knowing that theinterests of both are being protected, “But where…the interests areadverse to one another, then the attorneys may not 'assist the losttraveler along the road and at the same time prepare a trap intowhich he will ultimately fall.'” (Johnson)

Whether any coverage issues create a conflict of interest suchthat independent counsel must be paid for by the insurer depends onthe jurisdiction. Probably the best known treatment of conflicts ofinterest created by an insurer's reservation of rights whiledefending its insured can be found in California's “Cumis” law.Codified in California Civil Code §2860, popularly known as “Cumis”after a case that preceded the code, the law provides that in theevent of a conflict of interest “…the insurer shall provideindependent counsel to represent the insured unless, at the timethe insured is informed that a possible conflict may arise or doesexist, the insured expressly waives, in writing, the right toindependent counsel.”

The code goes on to state that the insurer can incorporate intoits policy a method for the selection of the independent counsel.Furthermore, the code makes clear that not all conflicts create aconflict of interest such that the insured has a right toindependent counsel: “…when an insurer reserves its rights on agiven issue and the outcome of that coverage issue can becontrolled by counsel first retained by the insurer for the defenseof the claim, a conflict of interest may exist. No conflict ofinterest shall be deemed to exist as to allegations of punitivedamages or be deemed to exist solely because an insured is sued foran amount in excess of the insurance policy limits.”

In California, then, not every reservation of rights triggers aconflict of interest situation. Some states recognize a conflict ofinterest if the insurer reserves its rights for any reason, whileothers recognize no reservations that create a conflict.

If a conflict of interest arises when the insurer reserves itsrights, it may be prudent to withdraw the reservations that createthe conflict, to avoid the obligation to pay for independentcounsel. Of course, such a decision requires thoughtfuldeliberation, carefully weighing the pros and cons of affirmativelywaiving any rights.

Basketball

In February 2013, Dr. Jerry Buss, long-time owner of probasketball's Los Angeles Lakers and hall of famer, died at the ageof 80. Aside from a legacy of world championships, he also left onefor the insurance industry in the form of a California SupremeCourt case decided in 1997, Buss v. Superior Court, 16Cal. 4th 35 (Cal. 1997), probably the leading case supporting theright of an insurer to seek reimbursement for expenses incurred inthe defense of causes of action against the insured that are notpotentially covered under the policy.

If the defense of an insured is conducted under a reservation ofrights due to coverage issues, the reservations may include theright to seek reimbursement for defense expenses paid. Because theduty to defend is very broad, and because the insurer must defendthe entire action, some jurisdictions provide for the right toreimbursement of defense expenses specific (solely) to causes ofaction that are not potentially covered.

In the underlying case against Buss and others, H&H Sportshad contracted with Buss to provide advertising and other services.A dispute between the parties evolved into a lawsuit in which 27causes of action were asserted, including count 23 for defamation.Buss' insurer defended the entire lawsuit on the premise that onlythe defamation count was potentially covered. The Supreme Courtruled that the insurer had the right to reimbursement of expensesin the defense of specific causes of action that are notpotentially covered.

While California is a bellwether state in many instances, notevery jurisdiction always follows its lead. In 2010, the SupremeCourt of Pennsylvania ruled in Am. & Foreign Ins. Co. v.Jerry's Sport Ctr., Inc., 606 Pa. 584 (Pa. 2010) that theright of reimbursement should be included in the insurance policyif the insurer wishes to preserve this right, as opposed tocreating a new contractual obligation by way of an unilateralreservation of rights letter within which the insurer attempts topreserve its right to reimbursement and where the insured acceptsthe defense. Thus in Pennsylvania, an insurer's right to recoupmentof expenses incurred in the defense of a claim or cause of actionthat is not potentially covered must be provided for in theinsurance policy, and cannot be preserved in a simple, unilateralreservation of rights letter extrinsic to the policy.