Corporate litigation is expensive. The expenses come in multiple forms, often the highest of which is lawyers’ fees. Insurance can be a critical resource to defray those fees. In fact, general liability insurance often is termed “litigation insurance” because it provides financial assistance when companies hire lawyers and other professionals to respond to lawsuits against them.
Defense fee coverage contained in those policies is crucial because it pays even if the claim against the company has no merit—the policy pays for the company to hire lawyers to avoid liability for unsupported claims. Thus, the benefit of defense fee coverage never should be overlooked. However, the extent of that coverage is not always understood.
1. The “potentiality standard”. Most general liability policies include a “duty to defend”—when a policyholder is sued an insurer must hire and pay for a lawyer to defend the policyholder. Policyholders and their insurers generally agree that under the “duty to defend,” if the complaint alleges the merest potential for coverage for the claims at issue, the insurer’s duty is immediately triggered. However, some policies (such as directors & officers and errors & omissions policies) do not include a “duty to defend,” but, instead, a “duty to pay” defense costs. Pursuant that duty, the insurer need not hire a lawyer for its policyholder. Instead, the policyholder hires its own lawyer and the insurer “reimburses” the legal fees incurred.
Policyholders and insurers often debate about whether the broad “potentiality” standard applies to the “duty to pay.” Insurers sometimes claim that it does not, and that they need only “reimburse” defense fees if coverage actually exists. In other words, even if the complaint includes a potential for coverage, the insurer will argue that until the underlying claim resolves and the existence of coverage is determined, it need not pay the policyholder’s legal fees.
Policyholders should not accept that approach. Plenty of courts have ruled that even under a “duty to pay” policy, the defense duty is triggered by the potential for coverage. Thus, if the merest potential for coverage exists, and the policy does not include language regarding the timing of payment, the insurer must reimburse defense fees as they are incurred.
2. “Allegations” not “causes of action” govern. When determining whether a policy triggers defense coverage, companies should look beyond the causes of action alleged in the complaint. “Allegations,” not “causes of action” should determine an insurer’s defense duty. Even just a few words buried within an otherwise uncovered cause of action can trigger the defense duty.
For example, a policyholder’s insurance may not cover patent infringement lawsuits, but does cover “disparagement.” A complaint might include only patent infringement causes of action. However, one of those causes of action alleges product disparagement. Those facts could trigger a defense duty, even if the majority of the complaint addresses allegedly uncovered conduct.
3. “Uncovered parties or claims”. In most states, if a complaint includes a covered claim, the insurer must pay for the policyholder’s entire defense, which may include the defense of uncovered claims. Insurers often argue that if they can prove that defense expenditures have been incurred solely to address an uncovered claim or party, the insurer can avoid paying those expenditures. Policyholders should reject that approach.
Often, defense fees incurred solely to address an uncovered claim or party is covered if they “benefitted” a covered claim or party. For example, a company and its consultant might be sued for alleged misstatements in public documents. The company’s insurance does not cover the consultant. However, it might help the company to reduce its exposure in the litigation to hire counsel for the consultant or, otherwise, coordinate its defense with the consultant’s defense. In that circumstance, the money spent by the company with respect to the consultant’s defense could be covered under the company’s policy.
4. The claimed “right of reimbursement”. Insurers often will agree to defend their policyholders pursuant to a “reservation of rights” to obtain reimbursement of defense fees paid for claims that a court later concludes are not covered. Simply because the insurer reserves its alleged reimbursement right, it does not necessarily have that right. Many courts have ruled that unless the policy allows the insurer to “claw back” defense expenditures paid before a court rules regarding the duty to defend, the insurer cannot create a reimbursement right through a reservation of rights letter. Insureds should be careful to object to “reservation of rights” letters that includes a “right of reimbursement,” and be aware that in many states, policyholders can fight insurer reimbursement efforts.
5. Defense fee coverage extends to “intentional conduct claims”. A common misconception is that if a complaint alleges “intentional conduct,” there is no coverage. At the very least, policyholders should fight insurer efforts to avoid paying defense fees for such claims—policyholders are entitled to coverage for legal fees expended to defend against intentional conduct claims. And, under many policies that preclude coverage for fraud, the defense fee coverage should continue until a final judgment is entered establishing that the policyholder committed fraud—the insurer should pay even for all appeals until the fraud question is finally resolved.
To increase available defense fee coverage when sued, a company should carefully study the complaint, its policy(ies), applicable law and, if necessary consult with the right professionals to ensure that it is pursuing all available bases to support maximum coverage.