On September 22, 2011, an appellate court in California issued aruling that is troublesome, but instructive. Both the Court and theinsurer seriously confused the interrelationship of threecompatible provisions in the insurer's Commercial General Liability policy, but in different ways.These are the duty to defend as provided for in the insuring agreement; theapplication of the deductible to defense expenses, as explained inan endorsement; and the inclusion of defense expenses in theSupplementary Payments provision in the policy.

|

To carry the metaphor further, apples and oranges are bothfruit, and like apples and oranges these policy provisions arerelated, but distinct. The duty to defend is related to andcompatible with, but distinct from the application of a deductibleto defense expenses. And defense expenses are supplementarypayments.

|

In Zurich Specialties London, LTD v. Century SuretyCompany, 2011 Cal. App. Unpub. LEXIS 7192 (Cal. App.4^th Dist. Sept. 22, 2011), Zurich sued Century forequitable contribution for the defense and indemnity it provided totheir mutual insured, a sheet metal contractor, in six constructiondefect lawsuits involving the contractor's work at a number ofhousing projects in the 1990's.

|

Zurich had paid about $133,000 to defend the lawsuits.Both Century and Zurich had two policies each in play.

|

Any claims professional who handles construction defect andother types of long-term exposure, or continuous damage/injuryclaims, regularly confronts disagreements over allocation ofdefense and indemnity among carriers. It is not surprising giventhe number of variables encountered, like the differences amongjurisdictions, different criteria applicable to the duty to defendand the duty to indemnify, i.e. potential vs. actual coverage, thetrigger of coverage, number of occurrences, allocation theories orprinciples, the application of deductibles that can vary among thecarriers and even among policies with the same carrier, etc.

|

In this case, Century argued that it had no duty to defend thesheet metal contractor in any of the lawsuits because itsdeductible of $5,000 per claim applied to supplementary paymentswhich included defense expenses:[1]

|

Century … argued it had no obligation to participate in Star'sdefense because the defense costs did not exceed Century'sdeductible. According to Century, its $5,000 per claim deductibleapplied to each home included in a lawsuit. For example, one of theunderlying lawsuits involved 26 homes and therefore Century arguedits deductible for that lawsuit was $130,000-that is, $5,000 perclaim multiplied by 26 claims.

|

The deductible endorsement in Century's policy stated:

|

“Our obligation under the Bodily Injury Liability and PropertyDamage Liability Coverages to pay damages on your behalf appliesonly to the amount of damages in excess of any deductible amountsstated in the Schedule above as applicable to such coverages”… “Theterms of this insurance, including those with respect to: a.Our right and duty to defend any 'suits' seeking those damages… apply irrespective of the application of the deductibleamount.” (Emphasis added.)

|

The Court correctly pointed out that the endorsement did notlimit Century's duty to defend; that, in fact, Century had a duty(and right) to defend as provided for in the Insuring Agreement,“irrespective of the application of the deductible amount.” Simply,Century should have defended and then worried about the deductibleafter the payments were made.

|

So far, so good.

|

But then the Court went further … not so good because it mixedthe apples and oranges and concluded that SupplementaryPayments:

|

…are all expenses Century agreed to pay in addition to attorneyfees and other ordinary costs associated with providing a defense.In other words, these expenses are not covered by Century's duty todefend provision. The “Supplementary Payments” coverage thereforesupplements the duty to defend; it does not define or limit theduty to defend. Indeed, the “Supplementary Payments” coverage isset forth in a different section of Century's policy, separate andapart from the “Bodily Injury and Property Damage Liability”coverage that creates the duty to defend.

|

The Duty to Defend Irrespective of theDeductible

|

The right and duty to defend applies irrespective of thedeductible, meaning that the insurer has the duty to defend fromthe get-go when there is a potential for coverage. The courtbetrayed its fundamental misunderstanding of what supplementarypayments includes by confusing the duty to defend with theapplication of the deductible to the defense expenses:

|

Under the “supplementary payments” coverage, Century agrees to“pay, with respect to any claim or 'suit' we defend:” (1) allexpense it incurs … These items are all expenses Century agreed topay in addition to attorney fees and other ordinary costsassociated with providing a defense…In other words, these expensesare not covered by Century's duty to defend provision. The“supplementary payments” coverage therefore supplements the duty todefend; it does not define or limit the duty to defend. Indeed, the“supplementary payments” coverage is set forth in a differentsection of Century's policy, separate and apart from the “BodilyInjury and Property Damage Liability” coverage that creates theduty to defend. Zurich 13-14

|

Using the “supplementary payments” coverage to apply thedeductible to Century's duty to defend ignores the clear statementin the “Deductible Liability Insurance” endorsement that Century'sduty to defend “appl[ies] irrespective of the application of thedeductible amount.” …

|

Our interpretation of Century's policy is consistent with thegenerally accepted rule that deductibles apply to an insurer's dutyto indemnify, not its duty to defend: “A 'deductible' is a portionof an insured loss for which the insured is responsible. Itgenerally is 'a specific sum that the insured must pay before theinsurer owes its duty to indemnify the insured for a covered loss.'A deductible relates only to the 'damages for which the insured isindemnified, not to defense costs. The insurer is fullyresponsible for defense costs regardless of the amount of thedeductible so long as there is a potential for coverage under thepolicy.' Century argues that no statute, regulation, or otherauthority prevents an insurance policy from applying a deductibleto the duty to defend. That argument, however, ignores the morepertinent point that Century's policy did not apply the deductibleto the duty to defend. We therefore need not resolve the abstractquestion whether a policy can apply its deductible to the duty todefend because Century's policy simply failed to do so.

|

Contrary to the Court's assertion, an insurance policy can, ofcourse, include defense expenses in the deductible.

|

The immediate duty to defend does not supplant the applicationof the deductible to the expenses incurred in the defense. Theseare distinct issues. As mentioned previously, if there is apotential for coverage under the policy the insurer has animmediate duty to defend, irrespective of the deductible. In otherwords, the insurer must defend regardless of whether the deductibleis or will be satisfied. So to argue that the duty to defend iscontingent on, or begins at the time of, the satisfaction of thedeductible contravenes the Insuring Agreement in the policy and thelanguage in the liability deductible endorsement.

|

Furthermore, supplementary payments clearly and unambiguouslyincludes defense expenses. “All expenses we incur”, the firstcategory of supplementary payments, is about as clear as one canget:

|

Both the Coverage A and the Coverage B insuring agreements ofthe CGL policy specify that, beyond the damages the insured islegally obligated to pay, “no other obligation or liability to paysums or perform acts or services is covered unless explicitlyprovided for under supplementary payments-coverages A and B .” Thesupplementary payments section of the policy lists specifically thesums the insurer will pay in addition to the amount of the judgmentassessed against the insured for covered injury or damage. The mostimportant of these sums is the cost to defend the insured when adecision is made to contest the claim rather than pay it.Supplementary payments—attorney's fees, court costs, and otherexpenses—are paid “outside” the policy's limits. They do not reduceor exhaust those limits.

|

…

|

In the first category of supplementary payments, the insureragrees to pay all expenses incurred by it with respect to any claimor suit investigated and settled or defended by the insurer. Thiswould encompass all necessary costs incurred by the insurer, suchas legal fees, private investigator fees, expert witness fees,court costs, and the like.[2] The insurer improperly denied a defenseobligation based on the amount and application of its deductible.The Court, however, while correcting the insurer, failed tounderstand the interrelationship among the policy provisions. Theyare not in conflict with each other. Rather, they arecomplementary. The Insuring Agreement obligates the insurer todefend. The deductible endorsement specifies that supplementarypayments are subject to the deductible but that the duty to defendis activated regardless of the amount of the deductible, or whetherthe deductible is satisfied. And, finally, supplementary paymentsinclude these defense expenses.

|

[1] Century also argued at the trial level that its policieswere excess over Zurich's because of the other insurance conditionin the Century policies. Century abandoned that argument onappeal.

|

[2] http://www.irmi.com/online/cli/ch005/1l05g000.aspx

The information contained in this article is intended to beused for informational purposes only. Any views expressed do notnecessarily represent the views of the Admiral Insurance Company orany of its affiliates. The information contained herein is notintended to constitute and should not be considered legal advice,nor should it be considered a substitute for obtaining legaladvice.