Court Addresses When Duty to Defend Ends

Margo Meta and Anthony Miscioscia | White and Williams

There are certain generally held principles regarding an insurer’s duty to defend. One of these principles is that an insurer has a duty to defend its insured if the complaint states a claim that potentially falls within the policy’s coverage. However, there is a lack of consistency regarding the point at which the insurers’ duty to defend ends. When the only potentially covered claim has been dismissed, must the insurer continue to defend?

Certain jurisdictions, such as Hawaii and Minnesota, have held that an insurer’s duty to defend continues through an appeals process, or until a final judgment has been entered, disposing of the entire case. Commerce & Industry Insurance Company v. Bank of Hawaii, 832 P.2d 733 (Haw. 1992); Meadowbrook, Inc. v. Tower Insurance Company, 559 N.W. 2d 411 (Minn. 1997).

Earlier this week, the U.S. District Court for the Eastern District of Pennsylvania took a different approach to this question in Westminster American Insurance Company v. Spruce 1530, No. 19-539, 2020 U.S. Dist. LEXIS 106534 (E.D. Pa. June 17, 2020) – holding that the trial court’s dismissal of the only potentially covered claim was sufficient to terminate Westminster’s duty to defend.

Spruce 1530 arose out of a property line dispute. In 2015, Spruce 1530 and Touraine, L.P., a neighboring landowner, filed lawsuits against each other alleging that the other had extended its building over the property line. At trial, it was determined that Spruce 1530 had improperly encroached on Touraine’s property. Touraine then filed a second lawsuit against Spruce 1530, alleging that during the 2015 actions, Spruce 1530 had “pursued frivolous claims and engaged in abusive practices” in order to increase Touraine’s litigation costs in an attempt to coerce Touraine to give up the rightful ownership of its property.

Touraine brought two counts against Spruce 1530; Count I was for wrongful use of civil proceedings under the Dragonetti Act, and Count II was for common-law abuse of process. Ultimately, the underlying court dismissed Count I, without opinion.

Westminster conceded that Count I would have been covered under its policy; however, it maintained that because Westminster was not notified of the action until after Count I had been dismissed, it has no duty to defend Spruce 1530 in the action. On dueling motions for summary judgment, the court addressed whether Westminster had an ongoing duty to defend Spruce 1530 in the action, following the dismissal of Count I.

Westminster asserted that it had no duty to defend Spruce 1530 in the action, as any obligation to defend was dismissed along with Count I. Spruce 1530, relying on Bank of Hawaii and Meadowbrook, argued that Westminster could not prove that the action would not result in a judgment covered by its policy, because dismissal of Count I was not by a final, non-appealable order and, as a result, could be modified, vacated, or reversed, and could continue to remain a factor in settlement negotiations.

The court noted that Pennsylvania courts have not yet addressed whether dismissal of a claim terminates an insurer’s duty to defend. Relying on Pennsylvania’s general rule that an insurer’s duty to defend continues until the insurer can show that the lawsuit consists of only non-covered claims, the court determined that the dismissal of the only potentially covered claim was sufficient to terminate Westchester’s duty to defend. The court concluded that although the dismissal was not procedurally “final”, the dismissal of the claim was meant to “constitute a conclusive rejection” of recovery on that claim.

An Insurer’s Duty to Defend does not Extend to a Construction Claim that Falls Clearly Within a Policy Exclusion

Amandeep Kahlon and Alex Purvis | Build Smart

On May 14, 2020, in James G. Davis Constr. Corp. v. FTJ, Inc., the Virginia Supreme Court upheld a judgment on an unjust enrichment claim in favor of FTJ, a drywall supplier on a condominium project, against Davis, the general contractor. Notably, FTJ did not have a purchase order with Davis, but FTJ was able to rely on the existence of a joint check agreement and Davis’s multiple assurances regarding payment and the resulting inducement for FTJ to continue performance to succeed on its theory of unjust enrichment.

Davis subcontracted with a drywall company to complete the drywall and metal framing for the building. The subcontractor hired FTJ to supply the drywall materials for the project. According to the court, to ensure the smooth operation of the project, Davis, its subcontractor, and FTJ executed a joint check agreement for Davis to make any and all checks out to both the subcontractor and its supplier. When the subcontractor fell behind on invoices for drywall, FTJ repeatedly contacted Davis about these past due payments, and each time, Davis assured FTJ that a check had been written or would be written for the materials at issue. As a result, FTJ continued to ship materials that it would have typically withheld on a past due account. During these interactions, Davis learned that its subcontractor was having trouble meeting payment obligations and worried that it would be unable to pay FTJ for materials.

When the subcontractor defaulted, Davis requested that FTJ not ship further materials and, again, assured FTJ that there were funds available to pay FTJ on past due amounts. FTJ did not file a lien, in part, because of its confidence that Davis would satisfy its subcontractor’s debts. However, after terminating the subcontractor, Davis incurred additional costs to complete the subcontractor’s work and informed FTJ that Davis could only pay a fraction of the past due invoices. FTJ filed suit, and, after finding the joint check agreement void for lack of consideration, the trial court ruled in FTJ’s favor on its claim for unjust enrichment.

On appeal, Davis argued the trial court decision should be overturned based on the following:

  1. The joint check agreement was valid, and the existence of a contract covering the subject matter of a dispute precluded recovery for unjust enrichment.
  2. The unjust enrichment claim should be barred because it forced Davis to pay for the same goods twice, first, under the subcontract and, again, under the court’s judgment.
  3. Because the joint check agreement required Davis to make payments only when Davis actually owed money to the subcontractor, and no such payments were actually owed, FTJ failed to satisfy one of the key elements of an unjust enrichment claim — that a defendant must reasonably have expected to repay the plaintiff for the benefit conferred.

The Virginia Supreme Court rejected each of these arguments finding:

  1. The existence of the joint check agreement, even if valid, did not foreclose recovery under a theory of unjust enrichment, where the benefit conferred was outside the scope of that agreement. The court concluded the joint check agreement governed the parties’ interactions only as to the form of payment, and, thus, FTJ’s claim regarding nonpayment of delivered materials fell outside the plain terms of the joint check agreement. The court also reasoned that Davis’ repeated assurances that it would pay FTJ for materials after the subcontractor fell behind on payment created separate expectations regarding payment outside the confines of the joint check agreement.
  2. Davis was not being asked to pay twice for the same goods because the dispute with FTJ involved payment for specific supplies and not the overall cost of the project. The evidence established that Davis did not pay for the delivered materials, Davis used the materials, and, absent those materials, Davis would have had to procure replacement supplies elsewhere, so, the court reasoned, Davis was only being required to pay once for those materials.
  3. The language in the joint check agreement limiting Davis’s obligation to payment for amounts actually owed to the subcontractor was undone by Davis’s course of conduct in repeatedly assuring FTJ of payment to induce further delivery of materials. Based on that course of conduct, the trial court could plausibly conclude that Davis expected to pay for the drywall delivered by FTJ.

In upholding the trial court’s decision, the Virginia Supreme Court emphasized the narrowness of its holding as to the specific facts at issue. The court appeared particularly troubled by Davis’s intrusion into the subcontract-supplier relationship by providing repeated promises of payment to encourage FTJ’s continued performance. The opinion also includes a lengthy dissent criticizing a number of legal positions staked out by the majority.

What lessons can be learned from this decision?

Under these circumstances, any broad takeaways or lessons from the court’s ruling are limited. The decision creates as many questions as it answers.  For example, progress billings often do not itemize expenditures from individual suppliers, but the court’s decision suggests a contractor will not be able to rely on progress payments to demonstrate payment of suppliers whose work should have been incorporated into the work during the applicable pay period.  How, then, can a contractor be expected to avoid double payment for work when sub-subcontractor raises a claim for unjust enrichment?

Regardless, contractors should be mindful of the court’s approach in Davis. Strong legal arguments will not always be enough to overcome certain factual scenarios, and the reverse may also be true. The dispute in Davis was only over $160,000, and after extensive and expensive litigation, the court found the contractor responsible for the full amount. To avoid unfortunate and unpredictable results like the decision in Davis, it is important to spend time evaluating claims on the front end and exploring reasonable commercial resolutions to any dispute.

No Duty to Defend If No Fortuity and No Occurrence

Larry P. Schiffer | Insurance and Reinsurance Disputes Blog

So after just blogging about how tough it is to avoid the duty to defend, the Seventh Circuit issues an opinion concluding that where the underlying allegations lack fortuity and there is no occurrence, there is no obligation for the insurance company to defend.

In Lexington Insurance Co. v. Chicago Flameproof & Wood Specialties Corp., No. 19-1062 (7th Cir. Feb. 27, 2020), a lumber supplier was sued by a commercial contractor that ordered fire retardant and treated lumber (FRT lumber) required by the projects’ architects for several construction projects. The FRT lumber was required to meet the standards of the International Building Code (IBC). The allegations in the underlying suit are that the supplier purposely substituted uncertified lumber that did not meet the IBC standards, was not properly labeled, even though the purchase order was for a specific brand that met the IBC standards.

The supplier’s insurance company brought this action for a declaratory judgment that it had no duty to defend the underlying suits. The district court granted summary judgment to the insurance company holding that the insurance company had no duty to defend. The Seventh Circuit affirmed.

In affirming, the circuit court described the well-known provisions of a commercial general liability policy requiring the insurer to pay sums that the insured becomes legally obligated to pay as damages because of property damage caused by an occurrence, and defining an “occurrence” as “an accident.” The court held that the underlying complaints did not trigger the duty to defend because they did not allege an occurrence. Quoting from several Illinois cases, the court noted that if an injury is the rational and probable consequence of the act or the natural and ordinary consequence of the act, then the act is not an accident. In analyzing the underlying complaints, the court concluded that the allegations were inconsistent with shoddy workmanship or that the lumber shipped had a hidden defect resulting in damage that could not have been reasonably expected. Rather, said the court, the underlying complaints alleged that the supplier “deliberately shipped uncertified lumber despite knowing the consequences of doing so.”

The court essentially disregarded the negligent misrepresentation count in one of the complaints, stating that the label “negligent” is given little weight by courts and that courts focus on the actual allegations. Here, said the court, there was no unforeseen, sudden or unexpected event. There was no allegation that the supplier was negligent or failed to exercise reasonable care when it made its unilateral decision to ship uncertified lumber. Rather, the court found, the underlying complaints allege that the supplier did not exercise reasonable care by representing that it had the specific certified lumber requested by the contractor available for purchase, and by failing to notify the contractor that it supplied uncertified lumber. The court concluded that the alleged injury stemmed from the supplier’s unilateral decision to supply the uncertified lumber and its concealment of having done so.

Thus, the court affirmed the district court’s summary judgment in favor of the insurer finding that there was no duty to defend because the damage alleged was the natural and ordinary result of the supplier’s deliberate decision to supply, and conceal that it supplied, uncertified lumber.

In a footnote, the court mentioned that the supplier had not even addressed the insurance company’s argument that the policy’s business risk exclusions precluded coverage. Because the court determined that there was no “occurrence,” the court did not need to rely on the exclusion to resolve the appeal.

It Is Tough to Avoid the Duty to Defend

Larry P. Schiffer | Squire Patton Boggs

Most states view the duty to defend more broadly than the duty to indemnify. Some people call the duty to defend “litigation insurance” because it often applies even where the allegations are slim, conclusory and ultimately untrue. A recent Fifth Circuit case reemphasizes how many courts address the duty to defend.

In Allied World Specialty Insurance Co. v. McCathern, P.L.L.C., No. 17-10615 (5th Cir. Feb. 26, 2020) (Not Precedent), a lawyers’ professional liability insurer brought a declaratory judgment action against a law firm seeking to avoid both the duty to defend and indemnify the law firm from an underlying legal malpractice case. The malpractice case arose after the lawyer allegedly was late in accepting a Stowers demand for the remaining policy limits of the underlying insured’s policy. In the underlying case, the court rejected the law firm’s arguments that the demand had been accepted, dismissed the affirmative defense of settlement, and a jury found against the underlying insured for an amount well over the policy limit.

A legal malpractice case was brought (actually two), with the allegations brought by the underlying insured going beyond the failure to timely accept the Stowers demand and including the law firm’s failure to monitor the file, failure to work the file, failure to timely communicate and failure to properly research all issues of fact and law. The malpractice complaint included the allegation that “[a]ll of these acts of negligence, among others, taken together and separately, proximately caused” the excess judgment.

The professional liability insurer defended under a reservation of rights and then brought this declaratory judgment action. The insurer contended that it did not have to defend or indemnify because of a Prior Knowledge Condition in the policy, which precluded coverage for wrongful acts that occurred before the policy’s inception date that the insured should have been aware could result in potential liability. The law firm moved to dismiss the case and the district court granted the law firm’s motion on the duty to defend, holding that a ruling on the duty to indemnify would be premature. Partial judgment was entered and the professional liability carrier appealed.

The Fifth Circuit affirmed, holding that the insurance company had failed to show that none of the allegations in the underlying actions were potentially covered by the policy or that the underlying pleadings only alleged facts excluded by the policy. The court concluded that some of the alleged wrongful acts occurred during the policy period, which required the insurance company to defend the law firm.

While it was not clear from the vague pleadings when some of the alleged wrongful acts occurred, some of the alleged wrongful acts, held the court, seemingly would apply throughout the underlying personal injury suit. Holding that the pleadings should be liberally construed in favor of the duty to defend even if the timing of these acts were indeterminable, the court affirmed the partial judgment.

The court found that the insurance company’s challenge to the non-Stowers allegations was based on specificity and truthfulness. The court stated that “at the duty-to-defend stage it is not for us to say whether [the underlying insured] will be able to prove that [the law firm] was negligent in failing to monitor the personal injury suit or in failing to research legal issues.” The court noted that under Texas law, even vague allegations may give rise to a duty to defend. The court also noted that Texas law has long applied a tiebreaker in the case of doubt as to whether the allegations compel the insurer to defend. That tiebreaker, unsurprisingly, is in favor of the insured, not the insurance company.

Based on these principles, the court affirmed the judgment on the duty to defend because the district court correctly concluded that at least some of the malpractice allegations potentially implicated the professional liability policy.

Do Putative Class Members’ Claims Trigger the Duty to Defend?

Ryan Vanderford | Policyholder Pulse

Must an insurer consider the possibility that putative class members (i.e., potential class members not named in the complaint) other than the proposed class representatives (i.e., the plaintiffs named in the complaint to represent the proposed class) have claims within the proscribed policy period in determining whether its duty to defend has been triggered? Many insurers answer “no,” arguing putative class members’ claims—many of which would otherwise be barred by the applicable statute of limitations—are too speculative to trigger coverage. But courts across the country have disagreed, repeatedly answering the question in the affirmative. Last year, the Northern District of Indiana was the latest court to decide this issue in favor of policyholders.

In Liberty Mutual Ins. Co. v. Dometic Corp., the insured (Dometic) purchased four consecutive insurance policies from Liberty Mutual, covering a period from 2001 to 2005. The policies provided commercial general liability coverage for “property damage” caused by an “occurrence” during a policy period. The policies required Liberty Mutual to provide Dometic with a defense “against any ‘suit’ seeking [damages because of property damage].”

Dometic tendered three putative class complaints to Liberty Mutual seeking a defense under the policies. Liberty Mutual denied coverage because the property damage claims of the proposed class representatives in the three underlying complaints all occurred in years after the policies had expired. Dometic argued that Liberty Mutual still owed a defense because the complaints contained allegations of property damage sufficient to trigger the duty to defend, including broad allegations of thousands of fires that caused millions of dollars in property damage. Dometic maintained that, although the proposed class representatives’ claims fell outside of the coverage periods, the putative class’ claims—which fell within the policy periods—had to be considered. In response, Liberty Mutual contended the putative class claims were too speculative to trigger coverage.

In deciding whether to consider the putative class’ claims, the court looked to see how courts around the country addressed the issue. The court cited a number of opinions, including decisions from the Eleventh Circuit and several other district courts. Notably, every opinion cited held putative class claims should be considered in determining whether an insurer’s duty to defend was triggered. The court noted that the Liberty Mutual did not “point the court to any cases directly addressing the issue that disagree with this persuasive authority.” Accordingly, the court held it would consider the putative class’ claims in deciding whether Liberty Mutual owed Dometic a defense on the underlying class actions, following Indiana law providing that coverage is triggered when the claims raised in an underlying complaint “potentially” fall within the coverage provided by the relevant policies.

Holdings like that in Dometic Corp. continue to amass, which is good news for policyholders. Any potential funding of a class action defense is critical to a class defendant’s continued business success, and in many cases, its viability going forward. And insurers should now think long and hard before denying a defense on a putative class action because the proposed class representatives’ claims do not fall within the proscribed policy periods. Those insurers that fail to also consider putative class members’ claims run the risk of liability for bad faith, as it is becoming increasingly clear how courts across the country will come out on this issue—especially in jurisdictions where an insurer’s duty to defend is triggered whenever a claim is potentially covered under a policy.