Chapter Five

• Jurisdiction: New York

Chapter Five

The Duty to Defend

Sanjeev Devabhakthuni, Esq.*

* Thomas J. Drury, Esq. authored previous editions of this chapter.

I. Introduction

The benefits of an insurance policy are twofold: (1) indemnification through payment when a covered loss occurs and (2) legal representation furnished at the expense of the carrier in the event of a lawsuit. This chapter addresses the latter obligation, the insurer’s duty to defend its insured. First, this chapter discusses the scope of this duty and in what circumstances the duty to defend is triggered. It then reviews those instances where there is no duty to defend, followed by the ramifications of an insurer’s failure to defend its insured when it is required to do so. Finally, how the duty to defend is affected when a conflict arises between the insurer and insured is addressed.

II. When the Duty to Defend Arises

A. Scope of the Duty to Defend

A basic and well established proposition in insurance law is that an insurance carrier’s duty to defend its insured is much broader than its duty to indemnify.⁷³⁰ In fact, whether an insured might ultimately be found liable is not an issue for an insurer to consider when presented with a claim against its insured.⁷³¹ “As frequently observed, the duty to defend arises not from the probability of recovery, but from its possibility, no matter how remote.”⁷³² An insurer cannot decline to defend the policyholder against a claim based merely upon the insurer’s subjective assessment that the liability asserted is meritless, or outside the scope of coverage; even a “demonstrably groundless, false, or fraudulent” claim may trigger the duty to defend.⁷³³ Accordingly, an insurer’s obligation to defend and the obligation to indemnify are separate and distinct.⁷³⁴

The scope of an insurer’s duty to defend is so broad that courts resolve any doubts regarding the existence of a duty to defend in favor of the insured.⁷³⁵ For example, a court concluded that an insurer had a duty to defend its insured when faced with conflicting evidence regarding whether the insured intentionally struck two pedestrians.⁷³⁶

B. What Triggers the Duty to Defend

In order to determine if an insurer owes its insured a defense, the allegations contained in the complaint must be compared to the terms of the insurance.⁷³⁷ When the “four corners of the complaint” contain facts that suggest a reasonable possibility of coverage, the duty to defend is triggered.⁷³⁸ If the complaint does not allege a covered occurrence, but the insurer has knowledge of facts outside the complaint that possibly establish coverage, the duty to defend is still triggered.⁷³⁹ Consequently, if an insurer has knowledge of such facts, it cannot rely on an inadequately pled complaint to avoid providing a defense to its insured.⁷⁴⁰ An insurer’s knowledge of facts establishing coverage can come from various sources, such as correspondence between the insurer and insured,⁷⁴¹ the plaintiff’s bill of particulars⁷⁴² or deposition testimony.⁷⁴³

While facts beyond the four corners of the complaint can trigger an insurer’s duty to defend, an insurer cannot rely on external facts to demonstrate that the allegations contained in the complaint are not covered or are false or meritless.⁷⁴⁴ An insurer must provide a defense “no matter how groundless, false or baseless the suit may be.”⁷⁴⁵ Additionally, if the theory of liability against the insured cannot be determined from the facts alleged in the complaint, a defense must be provided.⁷⁴⁶ Likewise, if the complaint contains grounds outside coverage but other grounds within coverage, then the duty to defend is triggered.⁷⁴⁷

C. The Duty to Defend When Multiple Insurers and/or Excess Carriers Are Involved

In some instances, an insured may have more than one policy that could potentially cover a claim. When this occurs, each insurer involved must provide that insured with a defense.⁷⁴⁸ As stated by the Court of Appeals in Continental Casualty Co. v. Rapid-American Corp., “the insured should not be denied initial recourse to a carrier merely because another carrier may also be responsible.”⁷⁴⁹ This approach also has been taken when multiple policies covering the same risk each purport to be excess insurance; each insurer owes a defense to the insured regardless of how the loss is potentially divided.⁷⁵⁰ A pro rata sharing of the insured’s defense costs can be ordered by a court, or one insurer can subsequently obtain contribution from the other insurers involved.⁷⁵¹ Where two coincidental primary policies exist, one excess to the other by reason of competing “other insurance” provisions, and where the excess carrier has voluntarily assumed the insured’s defense, an allocation of defense costs based on primary policy limits is appropriate.⁷⁵²

III. When There is No Duty to Defend

A. The Insurer Bears the Burden to Prove Absence of Duty

The duty to defend, though broad, is not absolute. An insurer can establish that it has no duty to defend by proving “as a matter of law that there is no possible factual or legal basis on which it might eventually be obligated to indemnify its insured under any policy provision.”⁷⁵³

In some circumstances, an insurer may justify its refusal to defend its insured when the allegations in the complaint essentially amount to a claim for which no coverage is afforded. For example, in Parkset Plumbing & Heating Corp. v. Reliance Insurance Co., the underlying complaint contained allegations of breach of contract and negligent performance of plumbing work.⁷⁵⁴ Reliance was correct in contending that it owed no defense to its insured, said the court, as the complaint was “clearly one sounding in contract and not in negligence and [the] mere use of the word ‘negligent’ alone cannot turn [the] complaint into [a] cause of action for negligence.”⁷⁵⁵ This issue also has risen in the context of underlying actions involving sexual assault or sexual harassment.⁷⁵⁶

Insurance carriers also may refuse to provide their insureds with a defense where the claim falls within a policy exclusion. In such situations, “if the insurer is to be relieved of a duty to defend it is obligated to demonstrate that the allegations of the complaint cast that pleading solely and entirely within the policy exclusions, and, further, that the allegations, in toto, are subject to no other interpretation.”⁷⁵⁷

A refusal to defend also is justified if an insured breaches a condition precedent to coverage, such as providing the insurer with late notice of a claim⁷⁵⁸ or if the insured fails to cooperate by concealing and misrepresenting material facts.⁷⁵⁹ Similarly, if the insurance policy was properly cancelled prior to the subject loss, the insurer has no obligation to defend the insured.⁷⁶⁰

B. Assumption of Insured’s Defense When No Coverage Exists

If an insurer assumes the defense of its insured when there is no coverage, and the insurer fails to reserve its right to disclaim coverage, the principle of equitable estoppel is implicated⁷⁶¹ and the insurer will be estopped from denying coverage.⁷⁶² To invoke equitable estoppel, an insured must establish that it sustained prejudice; however, “proof of prejudice may be implied where the insurer has complete control of the defense.”⁷⁶³

IV. Effect of an Insurer’s Wrongful Failure to Defend

If an insurer unjustifiably fails to defend its insured, the repercussions vary depending upon the outcome of the underlying action. If, for example, an insured enters into a settlement with the plaintiff in the underlying suit, the insurer must reimburse its insured for the settlement or compromise if the amount is reasonable, together with the attorney fees incurred by the insured.⁷⁶⁴ The insured is entitled to be indemnified for reasonable sums paid in settlement, even though the policy contains language that attempts to avoid liability for settlements made without the insurer’s consent.⁷⁶⁵ However, “an insurer’s breach of duty to defend does not create coverage and . . . even in cases of negotiated settlements, there can be no duty to indemnify unless there is first a covered loss.”⁷⁶⁶

It should be noted that New York is one of several jurisdictions that have held that an insurer that breaches its duty to defend its insured is not barred from later relying on policy exclusions in defending against an action for indemnification.⁷⁶⁷ An insurer may rely on policy exclusions that do not depend on facts established in the underlying litigation.⁷⁶⁸

When the underlying action proceeds to judgment the insurer is bound by that judgment.⁷⁶⁹ Consequently, the insurer “cannot thereafter collaterally attack [the] judgment or raise defenses with respect to its merits.”⁷⁷⁰ In such circumstances, the insurer is liable for the portion of the underlying judgment that is within the limits of the policy it issued to its insured, as well as the defense costs incurred by the insured.⁷⁷¹ If the underlying judgment exceeds the policy limits, the insured can only recoup the excess portion if the insured can successfully establish bad faith on the part of the insurer.⁷⁷²

The foregoing principles apply equally in situations involving an underlying default judgment taken against the insured.⁷⁷³ Accordingly, an insurer that wrongfully refuses to...