By Dominic S. Nesbitt and Gary Osborne
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Exactly fifty years ago, the California Supreme Court laid down the standard
for determining whether a liability insurer owes a duty to defend a third-party
lawsuit filed against its insured. The Court held that an insurer “must
defend a suit which
potentially seeks damages within the coverage of the policy[.]”
Gray v. Zurich Ins. Co., 65 Cal.2d 263, 275 (1966).
Over the years since
Gray, the California Supreme Court has repeatedly affirmed the “potential
for coverage” standard, making clear that an insurer will only be
relieved of a duty to defend if the third-party complaint can “by
no conceivable theory” raise a “single issue” which
would bring it within the policy coverage.
Montrose Chem. Corp. v. Superior Ct., 6 Cal.4th 287, 300 (1993). Moreover, insofar as what an insurer must
consider in evaluating whether there exists a “potential for coverage,”
the California Supreme Court has made clear that an insurer must consider
all known facts, including facts
extrinsic to the third-party complaint.
See Scottsdale Ins. Co. v. MV Transp., 36 Cal.4th 643, 655 (2005).
Despite this black-letter law, certain liability insurers in California
continue to disclaim defense obligations based on arguments that run afoul
of the potential for coverage standard. Five of these arguments are described below.
1.
The Covered “Cause of Action” Argument
Liability insurers will sometimes deny a defense obligation on the ground
that the third-party complaint filed against the insured does not allege
a “cause of action” covered by their policy. For example,
even where a complaint includes factual allegations of slander or libel
(an offense typically covered by a standard CGL policy), an insurer may
deny it owes a defense if no formal cause of action labeled “libel,”
“slander,” or “defamation” has been pled.
Such a denial may well be wrongful. California law is clear that the duty
to defend turns on the
facts pled, or otherwise known to the insurer, and not on which formal causes
of action the plaintiff’s attorney has chosen to plead in the complaint.
See Scottsdale, supra, 36 Cal.4th at 654 (“[T]hat 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.”).
2.
The “All Elements” Of A Covered Claim Argument
Another related argument made by certain liability insurers is that they
owe no duty to defend unless the third-party complaint alleges “all
essential elements” of a covered claim. However, there is no such
requirement under California law.
See Barnett v. Fireman’s Fund Ins. Co., 90 Cal.App.4th 500, 510 (2001) (rejecting the insurer’s argument
that a plaintiff must allege “all of the elements” of a covered
cause of action in order to trigger the duty to defend).
3.
The “Gravamen” of the Complaint Argument
Insurers will sometimes take the position that no defense is owed where the
gravamen of the third-party complaint involves uncovered injuries and claims. Such
an argument, however, cannot be squared with the California Supreme Court’s
affirmation in
Montrose, supra, that an insurer will be relieved of its duty to defend only if the complaint
can by no conceivable theory raise a “single issue” within
the policy coverage.
Courts that have considered the gravamen argument made by insurers have
soundly and consistently rejected it.
See
Horace Mann Ins. Co. v. Barbara B., 4 Cal.4th 1076, 1084 (1993) (rejecting insurer’s argument that
certain alleged misconduct “could not possibly give rise to liability”
because other non-covered misconduct was the “dominant factor”
in the case);see also Pension Trust Fund for Operating Engineers v. Federal Ins. Co., 307 F.3d 944, 951 (9th Cir. 2002) (“California courts have repeatedly
found that remote facts buried within causes of action that may potentially
give to coverage are sufficient to invoke the defense duty.”).
4.
The “Insured Is Not Liable” Argument
Some insurers will argue that where the insured has a cast-iron defense (e.g., a statute of limitations defense) against the third-party complaint,
it follows that the insured faces no potential for covered liability,
and therefore no duty to defend is owed. This argument turns the entire
concept of the duty to defend on its head and has been rejected by courts
and leading commentators.
Simply stated, an insured purchases and expects insurance protection against
both valid
and invalid claims.
See Horace Mann, supra, 4 Cal.4th at 1086 (“An insured buys liability insurance in large
part to secure a defense against
all claims potentially within policy coverage, even frivolous claims unjustly
brought.”);
see also Croskey
et al., Cal. Practice Guide:Insurance Litigation (The Rutter Group 2015), ¶ 7:522 (“The insured does not have
to prove the claim against it is valid in order to obtain a defense!”).
5.
An “Exclusion” Precludes a Duty to Defend Argument
Insurers will sometimes rely upon an unproven and disputed allegation made
in an underlying complaint to invoke a policy exclusion. California law,
however, imposes a very high burden on insurers that seek to evade a defense
obligation based upon a policy exclusion. This heavy burden was described
by Justice H. Walter Croskey in
Atlantic Mutual Ins. Co. v. J. Lamb, Inc., 100 Cal.App.4th 1017, 1039 (2002), as follows:
[A]n insurer that wishes to rely on an exclusion has the burden of proving,
through conclusive evidence, that the exclusion applies in all possible worlds.
Therefore, at the duty to defend stage, an insurer may not rely upon
unproven allegations to establish an exclusion’s application. If there exists
any “potential” that the exclusion ultimately may not apply
to a judgment in the underlying action, a duty to defend is owed.
See Gray, supra, 65 Cal.2d at 277 (intentional act exclusion did not negate defense against
allegations of assault because the insured might prove at trial he engaged
only in non-intentional tortious conduct.).
Two federal district courts in California recently applied a number of
the rules discussed in this article.See KM Strategic Management, LLC v. American Cas. Co. of Reading, PA, 2015 U.S. Dist. LEXIS 171435 (C.D. Cal. Dec. 21, 2015), and
MedeAnalytics, Inc. v. Federal Ins. Co., 2016 U.S. Dist. LEXIS 21377 (N.D. Cal. Feb. 19, 2016). In both cases,
the district courts held that the CGL-insurer defendants breached a duty
to defend underlying third-party lawsuits that included allegations of
defamation, despite the fact that no cause of action for libel or slander
had been pled. The courts also found that the insurers wrongfully relied
upon an exclusion in their policies for claims arising from a “breach
of contract.” The courts held that to invoke this exclusion, the
insurers required conclusive evidence that their insureds had
actually – not just
allegedly – breached a contract. Because neither of the insurers had such
evidence, they were found liable for breaching the duty to defend.
As reflected in these recent decisions, the potential-for-coverage standard
laid down in
Gray v. Zurich, supra, remains as valid today as it did fifty years ago.