What Is a “Duty to Defend” Policy Form?
Generally speaking, when a policy is written on a duty to defend basis, the insurer must defend the entire claim even if it is only partially covered under the policy. The duty to defend provision has been interpreted broadly and courts will uphold it even if there is only a potential for coverage and the claim is without merit. Courts will also look past the titles of the causes of action to examine the underlying facts when determining whether the duty is triggered. Going a bit further, while courts will generally employ the “eight corners test” looking to the four corners of the complaint and the four corners of the insurance policy, they may also consider extrinsic evidence. The general standard is that “[a]ny doubt as to whether the facts give rise to a duty to defend is resolved in the insured’s favor.”1
In situations where there are covered and uncovered matters or allegations, the insurer has a duty to defend the entire claim, as long as the covered allegations remain open. For example, if a D&O claim includes allegations of breaches of fiduciary duty, but also allegations of breach of contract, the insurer’s duty to defend remains until the claim is resolved of either by settlement or judgment or until the covered breach of fiduciary duty allegation is dismissed. Similarly, if there are covered and uncovered parties in the litigation, so long as the covered parties remain as defendants in the case, the insurer’s duty to defend remains - if the covered defendants are dismissed by motion practice, the duty to defend ends. At the end of the claim, the insurer may have the right to “true up” on the defense costs, allocating between covered and uncovered matters.2 The ability to true up depends upon the policy wording; if there is a policy provision stating that 100% of defense costs will be deemed to be covered, the ability to “true up” defenses costs will not be an option.
The trade-off for duty to defend policies is that the insurer makes the selection and retains counsel for the insured, typically from a panel of defense firms that the insurer maintains. This panel generally provides access to prominent law firms, available at preferred rates, due to the established working relationship between the firm and the insurer, resulting in a higher volume of cases. This benefits the insurer with a slower erosion of self-insured retentions, but also benefits the insured with a slower erosion of policy limits. Panel counsel defense firms are also accustomed to the insurer’s required billing practices and reimbursement provisions, thereby minimizing the insurer’s invoice auditing and adjustment processes and likely resulting in a higher percentage of invoiced defense costs being paid on a timely basis. While coverage is always subject to “reasonable and necessary” defense costs, the parties’ working relationship and familiarity leads to fewer disputes as to what is “reasonable and necessary.”
There are some common misconceptions and other hurdles with a duty to defend form. Some insureds are concerned that because the insurer selects defense counsel, then the attorney-client privilege may be destroyed with the three-party relationship. Privilege in claims handling is a complicated subject warranting its own lengthy article.3 However, to oversimplify the issue for purposes of this article, the majority of states recognize the tripartite dynamic and apply dual client status for the insured and insurer. In other scenarios, courts have applied the “common interest” or “joint defense” doctrines as an exception to waiver of the attorney-client privilege and the attorney work product doctrine.
Some insureds may be concerned that the insurer selects counsel when there may be a conflict of interest, specifically when the manner of defense dictates how coverage applies under the policy (i.e. fraud). Insureds also are concerned that the defense counsel’s stronger loyalty will be to the insurer rather than the insured involved in the litigation. Again, to oversimplify a complicated topic, in cases where there is an actual conflict of interest between the counsel’s representation and the insured’s interests, most states recognize that the insured has the right to independent counsel (also paid by the insurer).4
Lastly, some insureds are concerned that a duty to defend allows the insurer to settle a claim that the insured wouldn’t otherwise wish to settle. It is important to review the insurance policy wording regarding consent to settle. However, most management liability policies contain a clause which provides that the insurer cannot settle a claim without the insured’s consent (and vice versa).
What is a “Non-Duty to Defend” or “Reimbursement” Policy?
A non-duty to defend or “reimbursement” policy form is the other side of the coin. It obligates the insured to provide its own defense, subject to the consent of the insurer. No matter the policy form, counsel must always abide by the insurer’s billing practices. However, for a non-duty to defend form, the process for reimbursement is more involved and takes more time because the insurer will conduct a more thorough audit and adjustment of defense invoices according to its litigation management guidelines. This may result in reductions in incurred defense costs, meaning either that the defense firm reduces its invoices to reconcile with what the insurer recognizes as “reasonable and necessary” fees and costs in its litigation management guidelines, or the insured pays the difference between the amount billed and the fees and costs approved by the insurer. This could result in the insured spending amounts above its self-insured retention.
Moreover, in situations where covered and uncovered allegations and/or parties exist, the insurer allocates defense costs coverage from the onset of the claim. Some insureds find this challenging because it may seem that the two parties are pitted against each other while defending a matter in which they have a common interest in resolving, not to mention a distraction to resolving the underlying matter.
However, selection of counsel is considered critical by some insureds who believe that the flexibility is worth the trade-off. The key is knowing whether or not your company, its legal department, and/or executives view that control on counsel selection as critical in order to select the appropriate policy form before a claim is made.
How to Decide?
Most public company D&O policies are written on a non-duty to defend/reimbursement basis. However, many other management liability policies provide choices for insureds. There is no wrong answer. It depends on your balance sheet, staffing, and expectations. Size also guides decisions — larger, sophisticated companies tend to choose non-duty to defend/reimbursement policy form, while small to middle market companies tend to opt for duty to defend policy forms. Below are some questions to consider when choosing a policy form:
- Do you want to retain a particular law firm or counsel in a claim? If so, is that counsel on the insurer’s panel listing? How does your preferred counsel compare to the law firms, attorneys, and rates of panel counsel?
- Are you able and willing to take a more active role in managing counsel expenses and the overall litigation process? Do you have in-house counsel to assist in the process? Have you had experience in prior claims that allowed you to become familiar with the claims process?
- Is your balance sheet able to sustain additional costs associated with either the allocation of uncovered matters/parties or the insurer’s adjustment of invoices? To the extent that the adjustment process takes time to complete and payment isn’t made by the insurer to defense counsel on your behalf, do you have the cash flow to wait for reimbursement of expenses?
While there is not a wrong answer, it is an important discussion to have in advance of a claim so that your expectations are met in the event a claim does arise. As always, Gallagher professionals are available to assist.
1. Horace Mann Ins. Co. v. Barbara B., 846 P.2d 792, 796 (Cal. 1993).
2. See Buss v. Superior Court, 939 P.2d 766, 778 (Cal. 1997).
3. See, e.g., http://apps.americanbar.org/litigation/committees/insurance/articles/ marapr2012-confidentiality-privilege.html.
4. See https://www.americanbar.org/content/dam/aba/administrative/litigation/ materials/2014_inscle_materials/written_materials/p3_2_independent_defense_ counsel_50_state.authcheckdam.pdf.