Most business owners and executives know the basics of liability insurance coverage, such as giving timely notice of a claim. But insurance law can be a complex maze of twisted policy language and myriad regulations. Here are 20 common—and a few not so common—questions companies may want to discuss with their insurance coverage counsel when faced with potential liability for a business tort or related dispute. The answers, of course, will depend on the particular policy language and will vary from jurisdiction to jurisdiction, but knowing what questions to ask up front will make a business a more informed policyholder.
Defense Cost Questions
1. Can an insured choose who it wants as defense counsel? Some policies expressly permit the insured to select its own attorney, but such provisions often need to be explicitly negotiated into the policy. Otherwise, an insurer with a duty to defend can typically appoint defense counsel, which is often a law firm beholden to the insurer. In most jurisdictions, if the insurer has a duty to defend and the interests of the insurer and insured potentially conflict, the insured has a right to select independent counsel of its choosing, whose fees will be reimbursed by the insurer. Conflicts of interest often arise when the insurer—or the law firm it hires and pays—has an incentive to steer the evidence or the case toward a result that will result in no indemnification obligation for the insurer.
2. Can the insurer allocate defense costs? In many jurisdictions, if a complaint alleges a single cause of action that triggers coverage, the insurer must defend against the entire complaint, including uncovered claims. In some jurisdictions, however, the insurer is only required to pay for the defense of covered claims, and it can demand that defense counsel allocate fees between covered and uncovered work.
3. If the insurer accepts coverage and then changes its mind, what happens? In many jurisdictions, the answer may depend on the insurer’s conduct. For example, if the insurer did not defend under a reservation of rights or seek a declaration from the court regarding its rights, the insurer may be estopped from asserting certain policy defenses. If the insurer misrepresents the coverage, traditional estoppel rules may also prevent the insurer from backing out of coverage.
4. Can the insurance company recover defense costs if it is later determined that there is no coverage? Often an insurer will agree to defend but reserve its rights to deny coverage. When the insurer later denies coverage, it may seek to recover the defense costs it already paid. Some states permit this on the theory that to hold otherwise would unjustly enrich the insured. Other states only permit this if the policy expressly provides the insurer with this right, and others preclude the insurer from seeking reimbursement altogether. See, e.g., General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 215 Ill.2d 146, 828 N.E.2d 1092 (2005) (insurer cannot seek reimbursement of defense costs where policy does not provide for reimbursement); Buss v. Superior Court, 16 Cal.4th 35, 939 P.2d 766 (1997) (insurer that reserves right to seek reimbursement can recover defense costs later determined not covered by policy).
5. Will amounts the insurance company pays for attorney fees reduce the policy limits?This depends on the coverage and the language of the policy. Under some policies, defense costs are outside the limits, meaning that the policy limits available for any judgment or settlement are not reduced by the payment of attorneys’ fees. Other policies have wasting or eroding limits, meaning that each dollar spent on defense costs is one less dollar available to indemnify the insured for any judgment or settlement.
6. If the insurer is obligated to defend a lawsuit, does it also have to indemnify the insured for any settlement or judgment? The duty to defend is broader than the duty to indemnify. The duty to defend is triggered by the potential for insurance coverage. Whether the duty to indemnify exists will depend on what grounds the insured is ultimately obligated to pay any settlement or judgment.
7. Can policy limits from multiple years be combined? This is often referred to as stacking limits. Suppose a claim implicates coverage spanning five years and five separate policies each with a $1 million limit. Does the insured have $1 million for the loss, or $5 million? The answer may depend on both the policy language and the applicable law, which can differ from state to state.
8. If multiple policy periods each with primary and excess carriers are implicated, which pays first? The answer to this question can be complex and varies from jurisdiction to jurisdiction. It can involve questions concerning the triggering of coverage, which determines whether one or multiple policy periods apply, and if so, which one(s). This often depends on the nature of the alleged loss. The answer can also involve questions of vertical versus horizontal exhaustion, which determine whether the limits of all primary policies need to be used up before any excess coverage is implicated.
9. Is the insurance company required to settle within policy limits? Just because a party is willing to settle for an amount that is within the policy limits does not obligate the insurer to pay the settlement. That said, an excess insurer that refuses a demand to settle for an amount at or below the policy limits can sometimes be held responsible for any judgment that exceeds the policy limits.
10. Is the insurer required to pay for the entire settlement or judgment up to its policy limits? Unlike many jurisdictions in which an insurer cannot allocate defense costs to uncovered claims (see question 2), the insurer is typically only required to pay for the covered portion of any settlement of judgment. Disputes in regard to what portion is covered often arise. This is particularly true of settlements, which resolve both covered and uncovered claims. Insured parties and their defense counsel should keep these issues in mind at the outset of any settlement discussions.
Policy Language Considerations
11. If the insured negotiated certain policy language, does the ambiguity rule still apply?In virtually every (if not every) jurisdiction, ambiguities in an insurance policy are interpreted in favor of the insured and against the insurer. This is because the insurer typically drafts the policy and is in the best position to avoid ambiguities. However, when the insured (or its broker) had a role in drafting the policy, certain jurisdictions may not apply the typical ambiguity rule.
12. What if an endorsement conflicts with the form language of the policy? Typically endorsements will control over an inconsistency with the form policy language. If there are two endorsements that contradict one another (which are not uncommon), usually the most recent endorsement will control. If both endorsements are issued at the same time, there may be a mistake or the policy may be ambiguous.
13. What happens if there is a mistake in the policy language or an endorsement? An insurance policy is a contract—albeit a contract with special regulations and rules of interpretation. In the event of a mistake, traditional contract rules typically will apply. Usually, when an insurer seeks to reform a policy based on a mistake, a court will require clear and convincing evidence of a mutual mistake (i.e., a mistake by both the insurer and insured). A unilateral mistake may be grounds for reforming a policy in certain instances, such as when there is evidence of bad faith or fraud.
14. What happens if a renewal policy changes the existing coverage? Many states have regulations that require the insurer to provide advance notice of any material changes to the policy. If a new endorsement was added to the policy that precludes coverage, an insured should ensure the insurance company provided any required notice. If it did not, the insured may be able to extend the prior coverage to apply to an otherwise excluded loss.
15. Does the insurer have a right to access privileged communications between the insured and its defense counsel? Most policies require the insured to cooperate with the insurer. The Illinois Supreme Court has taken this requirement to an extreme. Even where the insurer has denied coverage, it has a right to access privileged attorney-client communications regarding the underlying claim and use them against the insured in a coverage dispute. Waste Mmgmt., Inc. v. Int’l Surplus Lines Ins. Co., 144 Ill. 2d 178, 190-91, 579 N.E.2d 322, 326-27 (1991). Fortunately, at least for policyholders outside the state, Illinois is an outlier in this area. Keep in mind that privileged communications regarding coverage issues themselves should not be discoverable by the insurer.
16. When must an insured give umbrella or excess carriers notice of a claim? Like the answer to many coverage questions, it depends on the policy language. Typically, however, an insured does not need to notify these carriers until it becomes reasonably likely that any loss will implicate the excess coverage. In certain jurisdictions, to prevail on a late-notice defense, insurers need to show that the late notice prejudiced the insurer.
17. If the insurer denies coverage, can the insurance claim be assigned to a third party? Most policies state that the coverage cannot be assigned. This makes sense because when the insurer underwrites the coverage, it is assessing the risk profile of a particular insured. Allowing another insured to substitute in the original insured’s place would change that risk. Often, however, an insured may assign a particular claim for coverage without violating an anti-assignment clause. Thus, suppose a plaintiff is willing to take a million-dollar settlement and execute that settlement only against the insurer. The defendant insured may assign its claim to the underlying plaintiff who can then pursue the coverage. This does not always make sense to the plaintiff, but it may be an attractive alternative when the insured has limited ability to satisfy a judgment and the insurer has denied a claim that appears to be covered.
18. What state’s law will govern the policy? Insurance policies typically do not have choice of law provisions. What law governs will depend on the particular state’s rules. Most states have specific choice of law rules applicable to insurance policies and other contracts. For example, many states will apply the law of the place where the policy was negotiated and delivered. Other factors may include where the risk insured was located and which state has the most interest in addressing the particular dispute.
19. Can the insurance company cancel coverage? An insurer is not required to renew coverage once the policy period expires. Similarly an insurer can often cancel the coverage before the end of the policy period. Many states, however, have regulations requiring notice of any cancellation or non-renewal. If the insurer fails to comply with those regulations, the insured may be able to extend the coverage.
20. Is there any basis for recovering attorney fees in a lawsuit with the insurer?Insurance policies typically do not have fee-shifting. Some state statutes allow a prevailing insured to recover attorney fees when the insurer denies coverage. Usually, however, this requires a showing of bad faith or other misconduct by the insurer.
An insurance policy is a valuable asset. The more policyholders know about how their coverage works, the better decisions they can make when it comes time to call on an insurer to respond to a claim. There will often be other questions to ask, but the foregoing is a good start.
Keywords: litigation, business torts, copyright, fair use, smartphones, video games, in-app purchases, infringement