Civil Code §2860 provides significant protection to insurers that qualify by satisfying each of three prerequisites: “If [A] the provisions of a policy of insurance impose a duty to defend upon an insurer and [B] a conflict of interest arises which creates a duty on the part of the insurer to provide independent counsel to the insured, [then C] the insurer shall provide independent counsel to represent the insured.” However, “in the absence of a stipulation or unconditional agreement between the insurer and insured, unless and until there has been a judicial determination of an insurer’s duty to defend and the existence of a conflict of interest, the provisions of Civil Code section 2860 are inapplicable.” Thus, in order for an insurer to enjoy any of these protections, it must irrevocably agree that a duty to defend exists, a disqualifying conflict of interest exists, and it must faithfully discharge its duty to defend by paying independent counsel.
DUTY TO DEFEND IMMEDIATELY AND ENTIRELY
“[T]he 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.” A liability “insurer must defend immediately. To defend immediately, it must defend entirely.” “[T]he insurer has a prophylactic duty to defend the entire ‘mixed’ claim.” On a motion for summary adjudication, “[t]o prevail, 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.” “If the coverage provisions in any policy of insurance are unclear or the exclusions are ambiguous, so that a reasonable purchaser of the policy would not realize that the risk is excluded and thus would reasonably expect the insurer to furnish a defense, a defense is required.” This broad duty to defend is intended to “give the insured the peace of mind and security which the insured has every right to expect.” “The insurers’ obligations are . . . rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public’s interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements.”
This stringent “immediately and entirely” standard is bourne out in insurance regulations. Every submission of a defense cost invoice to a liability insurer charging for legal services performed by independent counsel constitutes a first party claim on behalf of the policyholder to the insurer for a policy benefit – the insurer’s express promise to defend. Insurance is a regulated industry subject to statutory and regulatory standards of conduct. To faithfully fulfill the duty to defend immediately, an insurer must pay counsel’s invoices as a claim for policy benefits within 30 days. “Upon acceptance of the claim in whole or in part . . . every insurer . . . shall immediately, but in no event more than thirty (30) calendar days later, tender payment.” If a liability insurer denies any portion of defense counsel’s invoice it “shall immediately, but in no event more than forty (40) calendar days later, accept or deny the claim [and] clearly documented in the claim file. . . . Where an insurer denies [a claim], it shall do so in writing and shall provide to the claimant a statement listing all bases for such rejection or denial and the factual and legal bases for each reason given for such rejection or denial which is then within the insurer’s knowledge.” “Every insurer shall conduct and diligently pursue a thorough, fair and objective investigation”, including each invoice for defense costs. Nothing in Civil Code §2860 limits this common law and regulatory obligation to pay.
FAILURE TO PAY CONSTITUTES A BREACH OF CONTRACT
Lip service does not satisfy the duty to defend. Reservation of rights letters alone are “only an expression of [the insurer]’s future intent to comply with its duty to defend, and not an actual acceptance or agreement to provide a defense or to appoint plaintiffs’ chosen counsel as Cumis counsel. [The insurer]’s payment of defense fees at the end of the litigation [was] the equivalent of a defense denial. [Any other rule] would encourage insurers to reject their Cumis obligations for as long as they chose.” The insurer’s duty requires it “to provide counsel with adequate funds to conduct the defense of the suit.” An insurer that wrongfully fails to defend loses all control of its policyholder’s defense, which in turn frees the policyholder to protect its own interests, without regard to the wishes or consent of the defaulting insurer, such as settling the liability suit. Civil Code §2860 provides no protection to a defaulting insurer.
COMMON LAW MEASURE OF DAMAGE
The correct measure of damage for a defaulting insurer is all costs of defense incurred by the policyholder, plus interest at the rate of 10%. An insurer that wrongfully fails to defend is conclusively bound to pay the sums which the policyholder incurred for defense in good faith. “An indemnity against . . . liability, expressly, or in other equivalent terms, embraces the costs of defense against such . . . liability incurred in good faith, and in the exercise of a reasonable discretion.” “If, after request, the [insurer] neglects to defend the [policyholder], a recovery against the [policyholder] suffered by him in good faith, is conclusive in his favor against the [insurer].”
An insurer that breaches its duty to defend immediately and entirely also owes interest on sums due at the rate of 10% per annum. “A person who is entitled to recover damages . . . is entitled also to recover interest thereon.” “[T]he obligation shall bear interest at a rate of 10 percent per annum after a breach.”
The California Supreme Court is clear that a defaulting insurer “is liable for all costs and attorneys’ fees expended by [the policyholder] for this purpose.” “‘An insurer contracts to pay the entire cost of defending . . . claim[s]’ that are at least potentially covered.’” “[T]he law is well settled that, where one is bound either by law or agreement to protect another from liability, he is bound by the result of a litigation to which such other is a party, provided he had notice of the suit and an opportunity to control and manage it.” “[T]he insurer having breached its contract to defend should be charged with a heavy burden of proof of even partial freedom from liability for harm to the insured which ostensibly flowed from the breach.” Where “the insurer has breached its duty to defend [defense costs] are then presumed to be reasonable and necessary.” An insurer which breaches its duty to defend is “presumptively liable” for the costs of defense. “[W]here the insured is thus compelled to conduct his own defense, it is uniformly held that he may recover the expenses of litigation, including costs and attorneys’ fees, from the insurer.” “Having defaulted such agreement the company is manifestly bound to reimburse its insured for the full amount of any obligation reasonably incurred by him. It will not be allowed to defeat or whittle down its obligation. . . . Sustaining such a theory would not only tend to discourage busy attorneys from rendering adequate services for needy clients but would tend also to encourage insurance companies to similar disavowals of responsibility with everything to gain and nothing to lose. If there be uncertainty as to the nature or extent of the services reasonably to be rendered by counsel engaged by the insured, that uncertainty must be resolved against defendant insurer. . . . ‘[The] wrongdoer shall bear the risk of the uncertainty which his own wrong has created.’” “[T]he courts have held that, by its refusal to participate, the recalcitrant [insurer] waives the right to challenge the reasonableness of defense costs.”
A DEFAULTING INSURER FORFEITS CONTROL OF THE CONDUCT AND COST OF DEFENSE
“An insurance company may not wrongfully refuse to defend its insured and thus force the insured into the position of having to engage outside counsel, and then, because the defense was not handled in a manner to the liking of the company, refuse to hold the insured harmless against payment of fees for all services reasonably performed in such defense. Surely the insurance company will not favorably be heard to urge that plaintiff’s counsel acted improperly when he, knowing his clients’ financial position, nevertheless refused to put himself ‘in the position of leaving these clients in the lurch’ and ‘went right on through with the defense of the action.’”
California Courts of Appeal have pronounced a bright line rule to discourage insurers from wrongfully refusing to fund a full defense and provide the policyholder with defense counsel. “Breach of duty to defend also results in the insurer’s forfeiture of the right to control defense of the action or settlement, including the ability to take advantage of the protections and limitations set forth in section 2860.” “‘[I]f the insurer wrongfully refuses to defend, leaving the insured to his own resources to provide a defense, then the insurer forfeits the right to control settlement and defense.” “The Court concludes that if [the policyholder] is able to establish a breach of the duty to defend, its damages are not limited by California Civil Code §2860. . . . “To take advantage of the provisions of §2860, an insurer must meet its duty to defend and accept tender of the insured’s defense, subject to a reservation of rights.” [Because the insurer did not defend], the Court concludes defendant cannot avail itself of the protections and limitations set forth in §2860.”
“When an insurer wrongfully refuses to defend, the insured is relieved of his or her obligation to allow the insurer to manage the litigation and may proceed in whatever manner is deemed appropriate.” “When [the insurer] refused plaintiffs’ tender . . . , it breached the contract. Once [the insurer] wrongfully denied a defense, it gave up the right to control the litigation. . . . Before an insurer rejects a tender, it must make an adequate investigation of the facts. Failure to do so bars the insurer from denying the tendered defense, and subjects it to liability for the insureds’ full attorney’s fees and costs incurred thereafter with other counsel.” “[A]n acceptance of [the insurer’s] position – that ‘insurers always can take advantage of [section] 2860 despite immediately failing to meet their burden to defend’ – would encourage insurers to reject their Cumis obligations for as long as they chose because they knew they could invoke the limitations and remedies of section 2860 at any time.” By its coverage “denial, the insurer has lost its right to control the litigation.”
Federal courts are in accord. “If an insurer breaches its contractual duty to defend, it is ‘liable for attorneys’ fees as provided in the policy, or as “incurred in good faith, and in the exercise of a reasonable discretion” in defending the action.’ Zurich Ins. Co. v. Killer Music, Inc., 998 F.2d 674, 680 (9th Cir.1993), quoting Cal.Civil Code §2778. An insurer may not ‘dispute litigation strategies undertaken by the defense in an action which it refused to cover.’ Foxfire, Inc. v. New Hampshire Ins. Co., Nos. C-91-2940, C-91-4364, 1994 WL 361815, at *2 (N.D.Cal. July 1, 1994).”
TACTICAL DENIAL OF COVERAGE
Some liability insurers take a calculated risk to, deny coverage or to agree to defend but fail to faithfully discharge their duty to defend, especially in construction defect and business litigation. These risks may take many forms. Some insurers deny all coverage in the hope some other insurer will agree to defend instead or waiting to see whether and how the policyholder may respond to a coverage denial. Other insurers may agree to defend under a broad reservation of rights but refuse to pay for independent counsel often enough or at proper rates. Others agree to pay independent counsel, but simply do not pay, seeking to exert control
When an insurer wrongfully denies coverage or fails to faithfully discharge its duty to defend, the policyholder may consider approaching the plaintiff to seek cooperation to promptly resolve the liability dispute since the insurer has forfeited the power to control settlement and before the insurer attempts to cure its default. When an insurer wrongfully refuses to pay for independent counsel, the policyholder may challenge the ethics of dependent counsel, seek the cooperation of the plaintiff, request that a court rule upon the issue of the existence of the disqualifying conflict of interest, and negotiate settlement of the liability dispute.
When an insurer agrees to defend through independent counsel, but fails to pay independent counsel’s invoices within 30 days, policyholders may seek to develop admissible evidence that may support a series of important legal determinations. The policyholder may consider sending a letter requesting clarification whether the insurer concedes that both a duty to defend and a disqualifying conflict of interest exist. If the insurer denies either, it may not qualify for the protection of Civil Code §2860 whereupon independent counsel may insist that the insurer pay full rates. An insurer that fails to pay independent counsel properly may qualify as a defaulting insurer, freeing the plaintiff to negotiate a settlement of the liability dispute without the insurer’s consent. Ultimately the policyholder may need to implement one of many procedural options to seek a court order finally determining whether: 1) the insurer has a duty to defend; 2) the insurer’s reservation of rights creates a disqualifying conflict of interest for dependent counsel; 3) the insurer has a duty to pay independent counsel with what frequency and in what sums; 4) fee disputes may be resolved by mandatory arbitration; and 5) Civil Code §2860 applies retroactively.
 Handy v. First Interstate Bank (1993) 13 Cal.App.4th 917, 926 (emphasis added).
 Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076, 1081.
 Buss v. Superior Court (1997) 16 Cal.4th 35, 48 (Buss).
 Aerojet-General Corp. v. Transport Indemnity Co. (1997) 17 Cal.4th 38, 60 (Aerojet).
 Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 300.
 B & E Convalescent Ctr. v. State Comp. Ins. Fund (1992) 8 Cal.App.4th 78, 99-100.
 California Ins. Guar. Ass’n v. Wood (1990) 217 Cal.App.3d 944, 948.
 Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d 809, 820.
 See, Article: How Often Must an Insurer Pay Independent Counsel?
 Cal. Code of Reg. §2695.7(h).
 Cal. Code of Reg. §2695.7(b).
 Cal. Code of Reg. §2695.7(d).
 Housing Group v. PMA Capital Ins. Co. (2011) 193 Cal.App.4th 1150, 1156-1157 (Housing Group) (emphasis added; citations, quotation marks and ellipses omitted).
 Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 882.
 See, Pruyn v. Agricultural Ins. Co. (1995) 36 Cal.App.4th 500, 515-16; Isaacson v. California Ins. Guarantee Assn. (1988) 44 Cal.3d 775.
 Civil Code §2778(3).
 Civil Code §2778(5).
 Civil Code §3287(a).
 Civil Code §3289(b).
 Hogan v. Midland National Ins. Co. (1970) 3 Cal.3d 553, 558 (emphasis added).
 Aerojet, supra, 17 Cal.4th at 59; see also, Buss, supra, 16 Cal.4th at 47 (emphasis added).
 Kershaw v. Maryland Casualty Co. (1959) 172 Cal.App.2d 248, 257.
 Buss, supra, 16 Cal.4th at 55.
 Aerojet, supra, 17 Cal.4th at 64.
 Arenson v. National Auto. & Cas. Ins. Co. (1957) 48 Cal.2d 528, 537 (Arenson).
 Arenson, supra, 48 Cal.2d at 539; see also, Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825, 839.
 Safeco Ins. Co. of America v. Superior Court (2006) 140 Cal. App. 4th 874, 878-79.
 Arenson, supra, 48 Cal.2d at 538.
 Intergulf Development LLC v. Superior Court (2010)183 Cal.App.4th 16, 20 (emphasis added); see also, Janopaul K Block Cos., LLC v. Superior Court (2011) 200 Cal.App.4th 1239, 1249.
 Fuller-Austin Insulation Co. v. Highlands Ins. Co. (2006) 135 Cal.App.4th 958, 984 (emphasis added).
 Atmel Corp. v. St. Paul Fire & Marine Ins. Co. (N.D.Cal. 2005) 426 F.Supp.2d 1039, 1047.
 Eigner v. Worthington (1997) 57 Cal.App.4th 188, 196.
 Stalberg v. Western Title Ins. Co. (1991) 230 Cal.App.3d 1223, 1233 (emphasis added).
 Housing Group, supra, 193 Cal.App.4th at 1157.
 Hinton v. Beck (2009) 176 Cal.App.4th 1378, 1384 (emphasis added).
 Sentex Systems, Inc. v. Hartford Accident & Indemnity Co. (1995, C.D.Cal.) 882 F.Supp. 930, 946.
 See, Article: How Often Must an Insurer Pay Independent Counsel?
 See, Article: Favorable Evidentiary Presumptions from Settlement.
 See, Practice Pointer: Procedural Alternatives to Determine Disqualifying Conflicts.