Parties to a contract have a duty to exercise good faith and fair dealing to not do anything to injure the rights of the other to receive the benefits of the agreement. This duty applies to parties to insurance policies that provide for an insurer’s obligation to defend the insured.
Duty to defend
If an insured is involved in an accident with a third party or causes some type of harm to the third party, the third party may bring an action against the insured to recover damages. If the insured has an insurance policy providing third-party or liability coverage, he may seek indemnity from his insurer for the third-party claim. In addition to requiring the insurer to indemnify the insured for third-party claims covered by the policy, the typical liability insurance policy requires the insurer to defend any suit against the insured subject to its right to settle the suit.
When the insurer must defend
Whether an insurer must defend an insured depends upon the language of the policy and the language of the third-party complaint. Its duty typically arises when a third-party action against the insured alleges facts that fall within the scope of coverage under the policy, even if the claim is false, groundless, or fraudulent. When there is no potential of liability under a policy exclusion, the insurer has no duty to defend. When there is doubt as to whether the facts pleaded fall within the scope of the policy coverage, the insurer must accept the defense of the claim. In certain jurisdictions, the duty to defend may extend beyond the face of the complaint as pleaded and may be imposed when there is the potential for liability if the pleading were amended. Most courts also require the insurer to defend if it knows of facts that are not included in the complaint that would bring the cause of action within the policy coverage. Some courts even impose on the insurer a duty to investigate to determine whether a claim that appears on its face to be outside the coverage of the policy may potentially be covered.
An insurer’s duty to defend may not arise because of an exclusionary clause in the insured’s policy. Such a clause normally excludes coverage for intentional acts of the insured. However, the insurer may be obligated to defend if it knows of a complete defense for the insured’s acts. Furthermore, the fact that the third party’s complaint alleges that the insured acted intentionally does not in itself mean that the claim is excluded under the intentional acts provision. If a business pursuit exclusion applies to an activity conducted on the insured premises, courts generally will not reason that a specific act of negligence causing injury in the course of the activity brings that injury within the policy coverage. An exclusion for bodily injury to any employee of the insured may also excuse the insurer from any duty to defend a suit.
Scope of the duty to defend
When some of the allegations of the third party’s complaint are covered by the indemnification provisions of the policy, the insurer generally must defend the entire action.
Timing of defense
The duty to defend arises when the insurer receives notice of the third party’s claim. Delayed notice of the claim relieves the insurer of the duty if it proves that it suffered prejudice due to the delay.
Excess insurer’s duty to defend
Generally, if the primary insurer undertakes the defense of the insured in an action claiming an amount in excess of the policy limits, any excess insurer is discharged from its duty to defend. If, however, the primary insurer declines to defend a third-party action, the excess insurer must assume the insured’s defense. An excess insurer may be required under certain circumstances to assist the primary insurer in defending the insured.
Conflict of interest
A conflict of interest may arise if the insured’s counsel, appointed by the insurer, becomes tempted to put forth a defense that would limit the insurer’s liability. When such a conflict arises, some courts allow the insurer to be discharged from its duty to defend, while other courts find that its duty is not entirely discharged.
Consequences of breach of duty
An insurer’s refusal to defend may constitute a waiver of its right to control the insured’s defense and settlement negotiations. Such refusal may also estop the insurer from denying coverage under the indemnification provisions of the policy. The breach of duty is generally considered to give rise to an action in contract.
If the insurer’s refusal to defend was in bad faith, it may also be subject to an action in tort, particularly if it failed to investigate facts indicating potential coverage or refused to defend without any factual basis. Even if the insurer assumed the defense, it may be liable if it failed to inform the insured of the progress of the litigation in order to maintain the ability to pass up settlement opportunities.
Under contract law, an insurer that breaches its duty to defend may be liable for:
- Attorney fees and other costs incurred by the insured in defending the third-party action
- Any judgment, up to the policy limits, within the policy coverage rendered against the insured who unsuccessfully defended the suit or for any settlement reached between the insured and the third party
- The judgment entered in the third-party action
- Interest accrued on the judgment in the third-party action
- Attorney fees and other costs incurred by the insured in bringing an action to establish the insurer’s duty to defend
- Emotional distress caused by the insurer’s breach of its contractual duty to defend
The tort approach to recovery of damages is generally less restrictive than that taken by contract law. Therefore, in jurisdictions