The Basics on Liability Policies - ABA YLD 101 Practice Series

By Christine Spinella Davis

In today's day and age, coverage under liability policies, such as comprehensive general liability policies, directors' and officers' policies, and errors and omissions policies, is a necessity for all major corporations. In fact, coverage disputes involving liability policies represent a significant portion of commercial litigation. If you're a commercial litigator, there is a good chance that at some point you will be asked to work on an insurance dispute. Even if you never work on a coverage case, it is a good idea to gain an understanding of the basic principles of insurance law. You may defend a client one day in an underlying lawsuit where the client is seeking reimbursement from its insurer for the expenses related to the lawsuit. Your actions as defense counsel could have ramifications for the client's ability to recoup insurance proceeds.

Provided below is an overview of key terminology and concepts of insurance law for liability policies.

Interpretation and Construction of Insurance Policies
All insurance policies, including liability policies, are contracts between two parties - a policyholder ( aka "insured") and an insurance company ( aka "insurer" or "carrier"), and thus interpretation and construction of policies generally are based on standard contract principles. There is one important difference between interpretation of general commercial contracts and that of insurance policies, however. Most jurisdictions follow the doctrine of contra proferentum ("against the author or proffer") for coverage disputes. Under this doctrine, if policy language is determined to be ambiguous, and could reasonably be interpreted as both the insured and insurer claim, then the language will be applied liberally in favor of the insured. Thus, an insured can prove coverage as long as it can show that its interpretation of ambiguous policy language is reasonable.

First-Party Insurance versus Third-Party Insurance
Insurance policies are viewed as either first-party insurance or third-party insurance. First-party insurance policies, such as homeowner's policies, protect the insured from its own loss or harm. Third-party policies are essentially liability insurance. They protect the insured from loss arising from liability to a third party. For example, a manufacturer or other corporate entity purchases a comprehensive general liability policy to protect itself against civil suits filed by customers. Individuals typically have liability coverage as well. For example, portions of an automobile policy covering suits by other drivers provide liability coverage.

The Different Levels of Insurance
There are often several layers of insurance purchased by an insured, particularly when the insured is a corporation. The first and main level of insurance is called the primary policy. Should the policyholder have an insurance claim, the primary policy will be the first policy to apply. The primary insurer will be responsible for the insurance until the policyholder's expenses reach the limit of the primary policy. Reaching the limit of a primary policy is referred to as "exhausting" the policy.

Once the primary coverage has been exhausted, the "excess" or "umbrella" policy (collectively referred to as "excess policy") will be triggered, requiring the excess insurers to step up to the plate and provide coverage. The excess policy sits on top of the primary coverage. The excess policy typically "follows form" to the primary policy, meaning it adopts most of the primary policy's terms and conditions. Say a policyholder had $1 million in primary coverage, and $10 million in excess coverage above that. If the insured were sued for $3 million, which fell under the terms of the primary policy, the insured would recoup the first $1 million from the primary insurer and then turn to the excess carrier for the remaining $2 million. Many large corporations even purchase additional layers of excess policies to protect themselves against future liability. Excess policies are meant for when an insured faces a catastrophic loss.

What Triggers Coverage under a Policy?
To "trigger" a policy, an event specified in the policy - such as property damage, bodily injury, or the filing of a lawsuit - must take place during the period of the policy. If the policy is triggered, then the insurer's obligations under the terms of the policy kick in. The triggering event for each policy is very much dependent on how the policy is written.

Generally, liability policies are written so that the triggering event is one of two things - either the occurrence that leads to the lawsuit, or the filing of the lawsuit itself. Under "occurrence-based policies," the policy is triggered if the underlying harm took place during the stated policy period, regardless of when the lawsuit was actually filed. "Claims-based policies," on the other hand, are triggered if the third-party claim is alleged during the defined policy period. For example, say an alleged securities violation occurred in December 1999, but the particular allegations did not arise until December 2001. These circumstances would trigger a claims-made policy with a period encompassing December 2001 - the date of the allegation. The same circumstances would trigger an occurrence-based policy with a period encompassing December 1999 - the date of the underlying harm.

The Insurer's Duties to Defend and to Indemnify the Insured
First, a liability insurer has a duty to indemnify an insured for awards to a third party if the liability falls within the terms of coverage. This determination requires a close analysis of the language of the policy, including the insuring agreement itself, as well as the definitions, conditions, and exclusions laid out in the policy.

In addition to the duty to indemnify, liability policies generally obligate an insurer to defend the insured against the third-party claims (either a duty to actively defend the insured or a duty to reimburse the insured for the defense costs, depending on the wording of the policy). The insurer's obligation to provide a defense (or reimburse for defense costs) is much broader than its duty to indemnify. It is a well-settled principle that an insurer must defend an insured if there is even a "potential" for coverage under the policy. And an insured is responsible for all reasonable defense costs.

The Insured's Duties to Notify the Insurer of a Claim and Cooperate with the Insurer
An insured also has duties under a policy, which, if it fails to meet, can deprive the insured of its coverage. The first duty of an insured is to notify its insurer(s) of a claim "as soon as practicable." In other words, it must do so in a reasonable time or face possible ramifications. In some states, failure to provide notice in a timely manner is a complete bar to coverage, or at least a bar to expenses incurred prior to the notice. In other states, failure to provide timely notice will only prevent coverage if the insured was prejudiced by the late notice. Either way, it is in the insured's best interest to put the insurer on notice of a claim as soon as possible.

Insureds also have a duty to cooperate with an insurer that is defending a claim on its behalf. This means that the insured must keep the insurer informed of all major case developments, must respond to all of the insurer's reasonable inquiries and requests, and should notify the insurer and attempt to obtain its consent before settling the underlying lawsuit. The failure to do so could result, in an extreme case, in the loss of its right to indemnity.

The above information represents some of the main concepts in insurance law and details common coverage disputes between the parties. Knowing these core principles will make it that much easier to jump onto a coverage case as a new attorney or research and analyze a coverage issue along the way.

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About the Author

Christine Spinella Davis, Esq., is a senior associate in the Washington, D.C. office of Howrey LLP and is Chair of the YLD Tort, Trial & Insurance Practice Committee. She can be reached at daviscs@howrey.com.

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