June 5, 2013
Doubts about coverage pose a dilemma for liability insurers. When an insured requests a defense in a case the insurer believes does not seek covered damages, an outright denial of coverage can have severe consequences if the insurer is wrong. Not only may the insurer lose opportunity to contest the factual basis for the insured’s liability, but it may face tort liability for insurance bad faith as well. In order to avoid these consequences, insurers often will agree to defend their insureds subject to a reservation of rights to contest coverage and, in some cases, seek reimbursement of defense costs.
The Idaho Supreme Court’s recent decision in Employers Mutual Casualty Co. v. Donnelly, __ P.3d __, 2013 WL 1693661 (Idaho Apr. 19, 2013), illustrates that an insurer’s decision to honor its obligation to defend despite harboring doubts about coverage itself poses risks for insurers. In Donnelly, the Idaho high court interpreted the supplementary payments provision in a contractor’s commercial general liability (CGL) policy to obligate the insurer to indemnify against the contractor’s liability for a claimant’s attorney fees and costs in a lawsuit even though the insurer had no duty to indemnify against the claimant’s damages.
After a fire, David and Kathy Donnelly hired Rimar Construction Company (“RCI or” the insured”) to repair and remodel their home. The Donnellys later sued RCI for faulty workmanship, breach of contract, and breach of warranties seeking damages for property damage, bodily injury, and loss of use. RCI’s liability insurer, Employers Mutual Casualty Company, agreed to defend the Donnelly’s lawsuit subject to a reservation of rights.
The construction defect action proceeded to trial where a jury awarded the Donnellys $126,611.55 in contract damages for breach of the warranty of workmanship. In addition, the court awarded the Donnellys $296,933.89 in attorney fees and costs.
The Declaratory Relief Action
Employers Mutual’s policy’s supplementary payments provision provided coverage for “[a]ll costs taxed against the insured” in “any ‘suit’ against the insured we defend.” The central issue in the ensuing coverage action was whether the supplementary payment provision in Employers Mutual’s policy covered the contractor’s liability for the Donnellys’ attorney fees despite absence of covered damages.
Employers Mutual argued that its reservation of rights letter protected it against liability for costs related to noncovered claims. The Idaho Supreme Court disagreed, pointing out that a reservation of rights preserves only rights that existed. Nowhere did Employers Mutual’s policy condition coverage for costs taxed to the insured on the existence of covered damages. The court concluded that the duty to pay supplemental coverages emanated from the duty to defend, and Employers Mutual’s own reservation of rights letter acknowledged its obligation to defend.
One justice wrote a separate concurring opinion in order to respond to the lone dissenting justice’s opinion. He specifically criticized the dissent’s position that the policy should not apply because “‘an insured could not reasonably expect the insurer to pay all costs awarded against the insured in a suit in which there was no coverage for any of the claims.’” The concurring justice stressed that under Idaho law the reasonable expectation of the insured does not trump the plain language of the policy.
The dissenting opinion focused on how the majority’s decision placed the insurer “squarely between a rock and a hard place.” As the dissent put it,
On the one hand, if it denied coverage while the complaint continued to allege potentially covered damages, if it were eventually determined there were such damages, EMC would subject itself to claims of breach of contract, bad faith, and punitive damages. (citations omitted). By continuing with the defense, however, it ended up subjecting itself to claims for costs and attorney’s fees by reason of the supplemental payments provision of its insurance policy, or so at least the majority holds.
The concurring justice’s response to the dissenting justice’s concern for the insurer was simple and straightforward: “It is not up to us to rewrite EMC’s policy to say what it now wishes it would have.”