Introduction

California law describing a liability insurer’s duty to defend is well developed and substantially settled.[1] The nature of the duty to defend arises from the language of a liability policy, many of which use standardized forms.[2] The duty to defend arises from contract and statute. The duty to defend is distinct from and broader than the promise to indemnify and arises whenever there is a mere possibility that the insurer may be obligated to indemnify its policyholder.

Contractual Promise to Defend

A standard CGL policy provides: “We will have the right and the duty to defend the insured against any ‘suit’ seeking those damages.” (Emphasis added.) The phrase “those damages” typically refers to defined terms: “bodily injury”, “property damage”, and/or “personal injury”, “advertising injury”. The word “seeking” clarifies that the duty to defend is triggered by allegations of potentially covered liability. The promise to defend is not affected by whether or not plaintiff wins the suit. However, “[a]n insurer may assume a duty to reimburse for defense costs without assuming a duty to defend.”[3]

Statutory Duty to Defend

Insurance is a “contract whereby one undertakes to indemnify another against . . . liability.”[4] The meaning of indemnity contracts is illuminated by the Civil Code. “[S]ection 2778, unchanged since 1872, sets forth general rules for the interpretation of indemnity contracts, ‘unless a contrary intention appears.’ If not forbidden by other, more specific, statutes, the obligations set forth in section 2778 thus are deemed included in every indemnity agreement unless the parties indicate otherwise. Several subdivisions of this statute touch specifically on the indemnitor’s obligations with respect to the indemnitee’s defense against third party claims.”[5]

Civil Code § 2778 recognizes that a liability insurer must pay for the defense of its policyholder, which the policyholder may control, and that if the insurer fails to do so, it is responsible to pay for a judgment or settlement. “An indemnity against . . . liability . . . embraces the costs of defense against such . . . liability incurred in good faith, and in the exercise of reasonable discretion.[6] The [insurer] is bound, on request of the [insured], to defend actions . . . brought against the [insured] in respect to the matters embraced by the indemnity, but the [insured] has the right to conduct such defenses, if he chooses to do so.[7] If, after request, the [insurer] neglects to defend the [insured], a recovery against the [insured] suffered by him in good faith, is conclusive in his favor against the [insurer].”[8] The Insurance Code is silent regarding the affirmative duty to defend.[9]

Notice Requirement

All liability policies require the policyholder to notify the insurer of a claim. A standard CGL policy states: “If a claim is made or ‘suit’ is brought against any insured, you must: (2) Notify us as soon as practicable.” “[T]he law will charge a party with notice of all those facts which he might have ascertained had he diligently pursued the requisite inquiry. In short, the duty to defend, ordinarily arising after receipt of actual notice to do so, arose here upon receipt of constructive notice.”[10]

The Duty to Defend Is a Primary Obligation

The duty to defend is a primary obligation of a liability insurer.[11] “[S]o far as the insured is concerned, the duty to defend may be as important as the duty to indemnify.”[12] To satisfy the promise to defend, the insurer must defend immediately and entirely.[13] “Implicit in this understanding of the duty to defend [a policyholder] . . . is that the duty arises immediately upon a proper tender of defense by [the policyholder], and thus before the litigation to be defended has determined whether indemnity is actually owed. This duty, as described in the statute, therefore cannot depend on the outcome of that litigation.”[14]

“The insured’s desire to secure the right to call on the insurer’s superior resources for the defense of third party claims is, in all likelihood, typically as significant a motive for the purchase of insurance as is the wish to obtain indemnity for possible liability. As a consequence, California courts have been consistently solicitous of insureds’ expectations on this score.”[15]

The Test Is: “Potential” Indemnity Coverage

A liability policy typically makes two primary promises: to defend and to indemnify. The coverage provided by the promise to defend is different from the coverage encompassed by the promise to indemnify. “[A] liability insurer owes a broad duty to defend its insured against claims that create a potential for indemnity. [T]he carrier must defend a suit which potentially seeks damages within the coverage of the policy. Implicit in this rule is the principle that the duty to defend is broader than the duty to indemnify; an insurer may owe a duty to defend its insured in an action in which no damages ultimately are awarded.”[16]

The Duty to Defend Is Determined by a Comparison of the Policy to the Complaint

“The determination whether the insurer owes a duty to defend usually is made in the first instance by comparing the allegations of the complaint with the terms of the policy. Facts extrinsic to the complaint also give rise to a duty to defend when they reveal a possibility that the claim may be covered by the policy. For an insurer, the existence of a duty to defend turns not upon the ultimate adjudication of coverage under its policy of insurance, but upon those facts known by the insurer at the inception of a third party lawsuit. Hence, the duty may exist even where coverage is in doubt and ultimately does not develop.”[17]

Extrinsic Facts May Trigger the Duty to Defend

“[F]acts known to the insurer and extrinsic to the third party complaint can generate a duty to defend, even though the face of the complaint does not reflect a potential for liability under the policy. This is so because current pleading rules liberally allow amendment; the third party plaintiff cannot be the arbiter of coverage.”[18]

The Duration of the Duty to Defend

“The defense duty is a continuing one, arising on tender of defense and lasting until the underlying lawsuit is concluded, or until it has been shown that there is no potential for coverage.”[19]

An Amended Complaint May Trigger the Duty to Defend

“[T]he insured is entitled to a defense if the underlying complaint alleges the insured’s liability for damages potentially covered under the policy, or if the complaint might be amended to give rise to a liability that would be covered under the policy.”[20]

The Duties to Defend and Indemnify Are Independent

“[T]he rule [is] that the insurer must defend in some lawsuits where liability under the policy ultimately fails to materialize; this is one reason why it is often said that the duty to defend is broader than the duty to indemnify.”[21]

Doubt as to the Duty to Defend Must Be Resolved for a Defense

“Any doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured’s favor.”[22] Significant public policy considerations are served by encouraging “insurers to defend and settle cases for which insurance coverage is uncertain. In so doing, it transfers from the injured party to the insurer the risk that the insured may not be financially able to pay the injured party’s damages.”[23]

Only Undisputed Facts Eliminate “Potential” Indemnity Coverage

“[W]here extrinsic evidence establishes that the ultimate question of coverage can be determined as a matter of law on undisputed facts, we see no reason to prevent an insurer from seeking summary adjudication that no potential for liability exists and thus that it has no duty to defend. We see the critical distinction as not whether extrinsic evidence may be considered, but whether such evidence presents undisputed facts which conclusively eliminate a potential for liability.”[24]

“[T]he insurer need not defend if the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage. The quoted language cannot reasonably be understood to refer to anything beyond a bare potential or possibility of coverage as the trigger of a defense duty.[25] California courts have used the terms possibility and potential interchangeably, and we see no difference between them.”[26]

“[T]he insurer’s duty to indemnify the insured for ‘all sums that the insured becomes legally obligated to pay as damages’ is limited to money ordered by a court. . . . [T]he duty does not extend to any expenses required by an administrative agency pursuant to an environmental statute.”[27]

Burden of Proof

“To prevail [on a motion for summary adjudication], the insured must prove the existence of a potential for coverage, while the insurer must establish the absence of any such potential. In other words, the insured need only show that the underlying claim may fall within policy coverage; the insurer must prove it cannot. Facts merely tending to show that the claim is not covered, or may not be covered, but are insufficient to eliminate the possibility that resultant damages (or the nature of the action) will fall within the scope of coverage, therefore add no weight to the scales. Any seeming disparity in the respective burdens merely reflects the substantive law.”[28]

Risk of Abuse Does not Excuse the Duty to Defend

“[The insurer] raises the specter of intransigent insureds being empowered to block summary judgment, to which insurers are otherwise entitled, with mere assertions that coverage may exist. The prospect is apparent rather than real. This is because, as in summary judgment proceedings generally, an insured cannot manufacture a dispute on summary judgment, ipse dixit, by refusing to concede the truth of a fact without adducing some evidentiary support for its position.”[29]

The Duty to Defend Is Prophylactic – No Hindsight Rule

Liability insurers have a duty to investigate which precludes them from denying a claim without making a thorough investigation.[30] “The inquiry narrows to whether an insurance company can, without having all of the facts before it, refuse to defend an insured in a lawsuit brought against the insured. . . . We believe that public policy alone mandates a negative answer to the question; otherwise an insurance carrier could refuse to defend its insured on the slightest provocation and then resort to hindsight for the justification. Furthermore, a contrary holding would force the insured to finance his own investigation and the defense of the lawsuit, and then to seek reimbursement in a second lawsuit against the insurance company. This, in turn, could not only impose an undue financial burden on persons who have purchased insurance protection, but it could deprive them of the expertise and resources available to insurance carriers in making prompt and competent investigations as to the merits of lawsuits filed against their insureds.”[31] “We evaluate the reasonableness of the insurer’s actions and decision to deny benefits as of the time they were made rather than with the benefit of hindsight.”[32]

Each of Multiple Insurer Must Defend

“[W]here more than one insurer owes a duty to defend, a defense by one constitutes no excuse of the failure of any other insurer to perform.”[33] An insurer may not delay or deny a claim on grounds that responsibility for payment should be assumed by others.[34]

The Duty to Defend May Continue After Payment of Policy Limits

An insurer may not terminate it duty to defend by paying its policy limit which leaves its policyholder still exposed to liability. The insurer’s duty to defend may continue “despite payment of the policy limits or, even in the absence of full payment, despite a legal bar to indemnification. Thus, the absence of an insurer’s potential liability does not necessarily eliminate an insurer’s duty to defend. Rather, the policy must be construed “according to the layman’s reasonable expectations.”[35]

Breach of the Duty to Defend Alone May Yield Tort Damages

While several California cases award tort damages where an insurer both 1) wrongfully fails to defend and 2) rejects a settlement offer, tort damages are also available for a breach of the duty to defend alone.

In Campbell v. Superior Court (1996) 44 Cal.App.4th 1308 (Campbell), the court found that “it is undeniable that insurance is purchased to provide the peace of mind and security. [O]ne of the primary benefits is that the insurer [will] defend against third party claims. [I]f an insurer unreasonably fails to defend, it has breached the implied covenant of good faith and fair dealing. An anomalous situation would be created if an insured is denied tort recovery if the insurer simply refuses to defend [without also refusing to settle. Any other rule] could have the effect of encouraging an insurer to stonewall by simply refusing to defend [whereupon] the insurer would be in no worse position financially than if it had accepted the case, defended, and then settled. [A]n insurer would have a strong financial incentive to [refuse] to defend. In order to prevent that situation, [we adopt] the rule that a refusal to defend can give rise to tort liability [because] contract damages would not even begin to compensate for the financial and emotional losses. Only a rule that recognizes the potentially tortious nature of a bad faith refusal to defend can assure that all insureds, rich and poor alike, will have the opportunity to recover all of their losses.”[36]

In Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825 (Amato II), an insurer wrongfully refused to defend on grounds that the insurer later established that it had no duty to indemnify. Notwithstanding a subsequent finding of no coverage, the court held “that where an insurer tortiously breaches the duty to defend, the insurer is liable for the judgment, which is a proximate result of its wrongful refusal to defend. We also conclude the insured is not required, in these circumstances, to conduct a “trial [of the underlying case] within a trial,” in order to recover the amount of the judgment from the insurer who wrongfully refused to defend.”[37] “Breach of an insurer’s duty to defend violates a contractual obligation and, where unreasonable, also violates the covenant of good faith and fair dealing, for which tort remedies are appropriate. We hold [the insurer] is liable for the judgment, which is a proximate result of its wrongful refusal to defend. [T]he insurer must defend in some lawsuits where liability under the policy ultimately fails to materialize. In purchasing his insurance the insured would reasonably expect that he would stand a better chance of vindication if supported by the resources and expertise of his insurer than if compelled to handle and finance the presentation of his case. He would, moreover, expect to be able to avoid the time, uncertainty and capital outlay in finding and retaining an attorney of his own. The insured’s desire to secure the right to call on the insurer’s superior resources for the defense of third party claims is, in all likelihood, typically as significant a motive for the purchase of insurance as is the wish to obtain indemnity for possible liability.[38]

Attorney’s Fee Claims Do Not Trigger a Duty to Defend

California courts have “rejected the idea that because the plaintiffs in the underlying action had a substantive claim for attorney fees, there was any possibility of indemnity for damages. Just because the underlying plaintiffs could collect attorney fees as part of the underlying action did not mean those attorney fees were potentially covered damages implicating the duty to defend. [A]ttorney fees are ‘inconsistent with the concept of ‘damages.’”[39]

Supreme Court’s Statement of Familiar Principles

“We summarize familiar principles pertaining to an insurer’s duty of defense. An insurer must defend its insured against claims that create a potential for indemnity under the policy. The duty to defend is broader than the duty to indemnify, and it may apply even in an action where no damages are ultimately awarded. Determination of the duty to defend depends, in the first instance, on a comparison between the allegations of the complaint and the terms of the policy. But the duty also exists where extrinsic facts known to the insurer suggest that the claim may be covered. Moreover, that the precise causes of action pled by the third party complaint may fall outside policy coverage does not excuse the duty to defend where, under the facts alleged, reasonably inferable, or otherwise known, the complaint could fairly be amended to state a covered liability. The defense duty arises upon tender of a potentially covered claim and lasts until the underlying lawsuit is concluded, or until it has been shown that there is no potential for coverage. If any facts stated or fairly inferable in the complaint, or otherwise known or discovered by the insurer, suggest a claim potentially covered by the policy, the insurer’s duty to defend arises and is not extinguished until the insurer negates all facts suggesting potential coverage.”[40]