Whether an insurance carrier has a duty to defend its insured in an underlying lawsuit is perhaps the most critical coverage determination of a coverage investigation and can be a highly contested issue. A carrier’s wrongful denial of this duty can have substantial ramifications, including bad faith exposure and forfeiture of policy-based coverage defenses that would otherwise apply to limit or preclude indemnity coverage. But a carrier’s decision to assume the defense of its insured can be very costly, and it can be difficult for a carrier to extricate itself from this decision. Accordingly, when Connecticut law governs the interpretation of a liability policy, a carrier would be wise to consider the impact of a recent Supreme Court of Connecticut decision, Nash Street, LLC v. Main Street America Assurance Co.,1 before reaching a decision regarding its duty to defend.
By way of brief background, a carrier has the right and duty to defend its insured under a commercial general liability (CGL) policy in a lawsuit seeking damages because of bodily injury or property damage to which the policy applies. In determining a carrier’s duty to defend, Connecticut, like many other jurisdictions, follows the “four corners” rule. The four corners rule holds that a liability carrier’s duty to defend depends on the allegations asserted in the underlying complaint, and, with limited exceptions, a carrier is prohibited from relying on evidence extrinsic to the four corners of the complaint to deny coverage. Accordingly, where the allegations of the complaint in the underlying lawsuit create some factual uncertainty and there is a reasonable possibility that indemnity coverage may ultimately be available to the insured, the carrier has a duty to defend the lawsuit.
However, where there is no factual uncertainty and a dispute arises between an insured and a carrier over the meaning and/or application of a policy provision, the carrier’s duty to defend turns on a legal question. In such a circumstance, to the extent there is no contrary controlling appellate authority, the carrier can (potentially rightfully) decline to defend based on its interpretation of the policy provision. This, however, is no longer permitted in Connecticut under certain circumstances when a carrier relies on a policy exclusion to disclaim coverage. On September 9, 2020, the Supreme Court of Connecticut decided Nash Street, wherein the court expanded a liability carrier’s duty to defend to situations where the allegations of an underlying complaint do not create any factual uncertainty but do create legal uncertainty.
Nash Street: Case Background
In Nash Street, a homeowner retained the insured, a contractor, to perform repairs to the homeowner’s house after it sustained serious damage from Hurricanes Sandy and Irene. The repairs included site grading and foundation work that required the house to be lifted and temporarily placed on cribbing. The insured hired a subcontractor to lift the house, place it on the cribbing, and perform the foundation work. While lifting the house in advance of the foundation work, the house “shifted off the supporting cribbing and collapsed,” resulting in extensive damage to the house.2
The homeowner filed suit against the insured, seeking to recover damages for property damage to the house due to the collapse. In the underlying complaint, the homeowner alleged that the insured and its subcontractor negligently constructed or assembled the cribbing and failed to ensure that the cribbing properly supported the house, thereby causing its collapse. The insured tendered the underlying complaint to its CGL insurance carrier, which determined it had no duty to defend. The underlying litigation proceeded, and the homeowner secured a default judgment against the insured and then filed a direct action against the carrier as a judgment creditor pursuant to Connecticut General Statutes section 38a-321.3
In the ensuing direct action, the homeowner stood in the shoes of the insured contractor with the same rights, protections, and obligations under the CGL policy. The homeowner and the carrier filed cross-motions for summary judgment. The carrier maintained there was no genuine issue of fact that the policy’s so-called business risk exclusions entirely barred coverage. Business risk exclusions are standard exclusions in CGL coverage forms and primarily preclude coverage for faulty workmanship. The business risk exclusions provided, in pertinent part, that the policy did not apply to property damage to “[t]hat particular part of real property on which you or any contractor or subcontractor working directly or indirectly on your behalf is performing operations, if the ‘property damage’ arises out of those operations” and “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.”4
The carrier argued that these exclusions precluded coverage for property damage to the house because “that particular part” referred to the whole house, which was being lifted when the collapse occurred. The homeowner argued that these exclusions did not apply to preclude coverage because “that particular part” referred to the site grading and foundation work being performed under the house, but not the house itself. The homeowner further contended that irrespective of whether the business risk exclusions were ultimately determined to bar coverage for the underlying lawsuit, when the insured tendered the lawsuit to its CGL carrier, legal uncertainty concerning the application of the business risk exclusions under Connecticut law existed, creating a possibility of coverage that triggered the carrier’s duty to defend.5
Holding from Nash Street: Legal Uncertainty Triggers Duty to Defend
The Supreme Court of Connecticut agreed and followed a line of cases that at their core stand for the following proposition: to trigger a carrier’s duty to defend, all that is required is the possibility of indemnity coverage; and where “legal uncertainty” exists regarding whether a court will side with the carrier’s interpretation that an exclusion precludes coverage, it is possible that the carrier may owe indemnity. This is an expansion of a carrier’s duty to defend as recognized in the majority of jurisdictions.
The Nash Street court held that legal uncertainty concerning how it may interpret and apply an exclusion to a given situation, in addition to factual uncertainty, may give rise to the possibility of coverage and thereby trigger a carrier’s duty to defend. According to the court, legal uncertainty exists if, at the time the insured tendered the underlying lawsuit to the carrier, (1) there was no controlling Connecticut appellate authority regarding the meaning or application of the subject policy exclusion, and (2) there was a significant split of authority regarding the interpretation of the exclusion in other jurisdictions such that if presented to the court, the court could adopt a principle of law that creates a reasonable possibility of coverage.6
In announcing this new rule of law, the court principally relied on two decisions: Hugo Boss Fashions, Inc. v. Federal Insurance Co.7 and American Best Food, Inc. v. Alea London, Ltd.8 The court, however, did not set forth an identical standard, and it articulated additional parameters in an effort to define what constitutes “legal uncertainty,” though the contours of this doctrine will be decided in future litigation.
Hugo Boss. In Hugo Boss, the U.S. Court of Appeals for the Second Circuit took a curious position, purporting to expand a carrier’s duty to defend under New York law. The primary issue before a Second Circuit panel in Hugo Boss was whether the subject policy’s intellectual property exclusion precluded coverage for a trademark infringement lawsuit against the fashion designer Hugo Boss, thereby absolving the carrier of any duty to defend or indemnify.9
The litigants disputed whether the term “BOSS,” emblazoned on the fashion house’s products at issue, qualified as a “trademarked slogan,” as that phrase was used in the exception to the intellectual property exclusion, and was thus potentially covered.10 The panel unanimously concluded that the meaning of the phrase “trademarked slogan” was sufficiently well-established in federal trademark case law that the phrase, as employed in the policy, was unambiguous. The court further held that the intellectual property exclusion barred any indemnity coverage as the term “BOSS” did not constitute a trademarked slogan, and consequently the underlying lawsuit did not fall within the exception to the exclusion.11
Notwithstanding the panel’s determination that the disputed phrase was unambiguous and that the exclusion applied, when the panel examined the carrier’s duty to defend the underlying lawsuit, the majority concluded that the carrier had a defense obligation.12 The majority, like the court in Nash Street, began with the premise that if there is a possibility of indemnity coverage for a lawsuit, the carrier’s duty to defend is triggered under New York law.13 The majority then, without citing any New York authority for the proposition, extended this notion to any possibility of indemnity coverage, even due to legal uncertainty, e.g., uncertainty about how a court might interpret and apply the exclusion.14 Despite the majority’s conclusion that the phrase “trademarked slogan” was unambiguous because it was “sufficiently well-established [in federal trademark jurisprudence] that it has been taken as a given by the vast majority of federal courts,” the existence of a single contrary district court decision created legal uncertainty, according to the majority, that triggered the carrier’s duty to defend.15
Judge Sotomayor, now Associate Justice Sotomayor of the Supreme Court of the United States, dissented from this part of the majority’s opinion. Sotomayor criticized the majority’s decision for multiple reasons. First, it was not grounded in New York law: “The majority’s attempt to establish a two-tiered standard for legal clarity—requiring ‘unambiguous’ legal terms to disclaim the duty to indemnify, but requiring unambiguous legal terms that courts will recognize with certainty to disclaim the duty to defend—finds no basis in New York law.”16 Second, it was unworkable. The majority invited a carrier to take up the difficult task of predicting when it was “certain” whether a court applying New York law “will recognize an unambiguous policy provision for what it is.”17 Third, adequate incentives were already in place for carriers to ensure clarity in their policy language and to permit carriers to determine whether a policy term is unambiguous in the first instance—determinations that are then subject to judicial review and even extracontractual liability.18
Alea. In addition to Hugo Boss, the Supreme Court of Connecticut relied on the Supreme Court of Washington’s decision in Alea. In Alea, a carrier declined to defend its insured in an underlying lawsuit based on the policy’s assault and battery exclusion.19
The Supreme Court of Washington began its analysis with the same premise: “[t]he duty to defend is triggered if the insurance policy conceivably covers allegations in the complaint.”20 The court’s interpretation of “conceivably covers” was not limited to the facts alleged in the underlying operative complaint and included colorable legal arguments about the meaning and application of policy terms. “The insurer is entitled to investigate the facts and dispute the insured’s interpretation of the law, but if there is any reasonable interpretation of the facts or the law that could result in coverage, the insurer must defend.”21 Accordingly, where an insured challenged a carrier’s disclaimer, advancing a reasonable interpretation of disputed policy terms and/or applicable law, the carrier had a duty to defend and then had the option to seek a declaration of no coverage in a separate declaratory judgment action.
The court relied on several policy underpinnings to support its expansion of a carrier’s duty to defend. The court noted that under Washington law, the duty to defend is broader than the duty to indemnify. It observed that a carrier cannot put its interests before the interests of its insured; rather, a carrier is required to give its insured, and not itself, the benefit of the doubt when determining whether a claim may be covered.22
The Supreme Court of Washington concluded that the carrier’s duty to defend was triggered because there was no controlling appellate authority directly on point with the factual scenario presented; and other jurisdictions’ recognition of a distinction between pre-assault negligence, to which the exclusion applied, and post-assault negligence, to which it did not, created legal uncertainty that triggered the carrier’s duty to defend.23 The court counseled that a carrier could defend under a reservation of rights so as not to breach its duty to defend or become vulnerable to waiver or estoppel arguments while it sought a definitive ruling with respect to its obligations, if any, in a declaratory judgment action.24
Application of Hugo Boss and Alea to business risk exclusions. Chiefly relying on these cases, the Supreme Court of Connecticut in Nash Street applied this new legal principle to the policy’s business risk exclusions, inquiring whether a legal uncertainty existed that created the possibility of indemnity coverage.25 The court concluded that a legal uncertainty did exist when the insured tendered the underlying lawsuit because there was no controlling Connecticut appellate authority interpreting the meaning and applicability of the exclusions and the court could follow a construction adopted in other jurisdictions that would create a reasonable possibility of coverage for the underlying lawsuit.26
According to the court, other jurisdictions interpret the phrase “that particular part” in these business risk exclusions in one of three ways: (1) as precluding coverage for damage to all of the insured’s work product resulting from the insured’s defective work, even damage to that part of the work product that exceeds the scope of the defective component; (2) as precluding coverage only for damage to the defective component of the insured’s work but not damage to other nondefective parts of the insured’s work; or (3) by considering the exclusions ambiguous and finding in favor of the insured’s reasonable contrary interpretation.27
The court observed that if it were asked to decide the meaning and applicability of the exclusions, it could—consistent with Connecticut’s precedent holding that carriers bear the burden to prove the application of an exclusion and that exclusions are to be interpreted narrowly with any ambiguity resolved in favor of the insured—follow a minority of other jurisdictions in adopting the narrower construction of the exclusions or deem them ambiguous.28 Thus, when the insured tendered the lawsuit, a legal uncertainty existed with respect to whether the Connecticut highest court would agree that the business risk exclusions operated as a complete bar to coverage for the lawsuit. The court held that this legal uncertainty created a possibility of coverage that triggered the carrier’s defense obligation.29
The court succinctly stated its holding as follows:
In sum, we conclude that the trial court incorrectly determined that [the business risk exclusions] relieved the defendant of its duty to defend [its insured] New Beginnings in the underlying action that the plaintiff brought against New Beginnings. At the time New Beginnings tendered defense of the underlying action to the defendant, there was a possibility that the damages the plaintiff alleged were covered by the policy. This possibility existed because of legal uncertainty as to the meaning and applicability of [the business risk exclusions], which arose from a combination of the following factors: Connecticut law favors a narrow construction of exclusions and requires that ambiguous provisions be construed in favor of the insured, multiple state supreme court and federal court of appeals decisions have interpreted exclusions identical to those in the present case in a manner favorable to the insured, and no Connecticut appellate authority has interpreted [these exclusions].30
Contours of “Legal Uncertainty”
Although the Nash Street court followed other courts in expanding a carrier’s duty to defend to situations involving disputes over the meaning of policy terms, it seems to try to articulate a definition of “legal uncertainty” that requires more than was demanded by Hugo Boss and Alea. Notably, the Nash Street court expressly stated that the absence of controlling authority in and of itself does not constitute legal uncertainty.31 Moreover, although the court did not address whether a single contrary decision constitutes legal uncertainty as it did in Hugo Boss,32 by emphasizing the extensive litigation over the meaning of the business risk exclusions and characterizing the split of authority as “significant,” with “multiple state supreme court and federal court of appeals decisions hav[ing] interpreted exclusions identical to those in the present case in a manner favorable to the insured,” the court indicated that it may not conclude that a single contrary case gives rise to legal uncertainty. The court also suggested that it may limit the reach of its holding in Nash Street in a future case.
Despite the court’s attempt at providing further guidance to stakeholders—lower courts, litigants, and their respective counsel—concerning what constitutes legal uncertainty, the doctrine’s contours are yet to be determined. In fact, Nash Street leaves several important questions open for what may be a host of future litigation. For example, does the doctrine apply only to a policy’s exclusions or to its insuring agreement and conditions as well? What constitutes a lack of appellate authority? In other words, how legally and factually similar must appellate authority be to be considered “controlling”? The court also leaves open the question of what constitutes a sufficient split of authority in other jurisdictions on the meaning and interpretation of a policy provision. The only data points provided by the court relating to these questions are its describing the split of authority regarding the meaning of the business risk exclusions as “significant,” signaling that a single contrary decision may be inadequate, and language concerning the breadth of the duty to defend.
Legal Uncertainty: Viewpoints of Other Jurisdictions
Although the Connecticut Supreme Court cited to numerous cases that it contended supported the notion that a carrier’s defense obligation arose not from just factual uncertainty but also legal uncertainty, this does not appear to be the law in most jurisdictions. For instance, neither the majority nor Justice Sotomayor could find any New York decision, let alone one from New York’s highest court, that explicitly adopted the rule of law in Hugo Boss. It has been nearly 20 years since Hugo Boss was decided, and it does not appear that any New York courts have followed this decision.
The California Supreme Court rejected a similar argument in Waller v. Truck Insurance Exchange, Inc.33 In Truck Insurance, the policyholder argued that the carrier had a defense obligation with respect to the underlying lawsuit because of a lack of any published decisions at the time of tender holding that a claim for emotional and mental distress arising from alleged intangible economic loss was not covered. As in Nash Street, Hugo Boss, and Alea, the policyholder asserted that “uncertainty of policy interpretation compels a duty to defend in this case.”34 The California Supreme Court began its analysis with the same premise: a carrier has a duty to defend if any potential liability from facts available to it, including those extrinsic to the underlying complaint, is covered by the policy.35 However, the court in Truck Insurance rejected the insured’s assertion that legal uncertainty triggers a defense obligation, holding that it is not the law of California that a carrier must defend an insured, absent a published judicial opinion construing the particular provision upon which the carrier relies, until the extent of the policy’s coverage is determined with certainty.36
Effects of Nash Street Decision
Significant legal and practical consequences will flow from Nash Street, and navigating what constitutes legal uncertainty will pose considerable challenges to carriers and counsel. As Justice Sotomayor observed in dissent in Hugo Boss, the Connecticut Supreme Court has invited carriers to embark on the unenviable journey of predicting whether the enforcement of a policy exclusion will be deemed a legal uncertainty. “[A] decision that the policy term is ‘unambiguous’ does not prospectively clarify what had been unclear, but merely retrospectively ascertains that the law was unambiguous at the time that the policy was signed.”37
With Nash Street, unless a disclaimer is unquestionably sound, the court has at a minimum required carriers to incur additional costs to perform legal research with respect to the interpretation and application of any exclusion relied upon to disclaim coverage in order to evaluate (1) whether any arguably controlling Connecticut appellate authority exists; and (2) whether and to what extent other jurisdictions have interpreted the same or a substantially similar exclusion and, if so, whether there is a significant split of authority from which the court might reasonably determine that a possibility of coverage for the underlying lawsuit exists consistent with Connecticut law.
In addition to announcing this expansion in a carrier’s duty to defend, the court reminded carriers that the stakes for properly determining their defense obligations are exceedingly high in Connecticut. Notably, the court reaffirmed that in Connecticut a carrier that is held to have wrongfully breached its duty to defend forfeits its policy-based coverage defenses as to indemnity.38 Thus, where a carrier determines that a policy exclusion is unambiguous and entirely eliminates any reasonable possibility of coverage for claims made in the underlying lawsuit despite the lack of appellate authority interpreting the exclusion and conflicting authority from other jurisdictions, it runs the risk that if its position is subsequently challenged and rejected by a court pursuant to Nash Street, it may have also forfeited policy-based coverage defenses as to indemnity.
Although Nash Street expanded a carrier’s duty to defend and imposed additional burdens on liability carriers, when there may be legal uncertainty regarding the application of an exclusion, the court instructed the prudent carrier to defend the insured under a reservation of rights and commence a separate declaratory judgment action to definitively ascertain its defense and indemnity obligations under the policy.39 The cautious carrier will do well to heed this advice given the undeveloped scope of the Nash Street decision and the substantial downside risk of a wrongful denial should the carrier’s position be challenged and a court determine that legal uncertainty existed with respect to Connecticut’s treatment of the subject exclusion at the time of initial tender. Significantly, however, Connecticut law provides a small comfort to those prudent carriers in that it permits a carrier that has defended an insured under a reservation of rights and prevailed in securing a judicial determination that it has no duty to defend to seek recoupment of defense costs in the interest of preventing unjust enrichment and a windfall for the insured.40
1. No. SC 20389, 2020 Conn. LEXIS 197 (Sept. 9, 2020).
2. Id. at *3.
3. Id. at *3–4.
4. Id. at *4–5.
5. Id. at *2.
6. Id. at *29–30.
7. 252 F.3d 608 (2d Cir. 2001).
8. 229 P.3d 693 (Wash. 2010).
9. 252 F.3d at 615.
10. Id. at 616.
11. Id. at 618–20.
12. Id. at 623.
13. Id. at 620.
14. Id. at 620; see also id. at 626 (Sotomayor, J., dissenting). It must also be noted that I have not found any New York courts following this part of the court’s decision.
15. Id. at 618–19, 620 n.11 (majority opinion) (emphasis added).
16. Id. at 626 (Sotomayor, J., dissenting).
17. Id. at 629.
18. Id. at 628–29.
19. Am. Best Food, Inc. v. Alea, 229 P.3d 693, 695 (Wash. 2010).
20. Id. at 696.
22. Id. at 700.
23. Id. at 697–98. “Because any uncertainty works in favor of providing a defense to an insured,” the carrier was obligated to defend its insured from the date of the initial tender. Id.
24. Id. at 696, 701.
25. Nash St., LLC v. Main St. Am. Assurance Co., No. SC 20389, 2020 Conn. LEXIS 197, at *19 (Sept. 9, 2020).
26. Id. at *24.
27. Id. at *20–21.
28. Id. at *22–24.
29. Id. at *30.
30. Id. at *29–30.
31. Id. at *14 n.4.
32. Id. at *15 n.5.
33. 900 P.2d 619 (Cal. 1995).
34. Id. at 632.
36. Id. “This has never been the law.” Id. (citing McLaughlin v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 23 Cal. App. 4th 1132, 1152 (1994) (“duty to defend depends on facts in complaint; where only potential for liability turns on resolution of legal question, there is no duty to defend”)).
37. Hugo Boss Fashions, Inc. v. Fed. Ins. Co., 252 F.3d 608, 628 (2d Cir. 2001) (Sotomayor, J., dissenting).
38. Nash St., LLC v. Main St. Am. Assurance Co., No. SC 20389, 2020 Conn. LEXIS 197, at *18 n.6 (Sept. 9, 2020) (noting that it is “well established . . . that an insurer that breaches its duty to defend cannot then use the contract to escape its indemnity obligations” (citing Capstone Bldg. Corp. v. Am. Motorists Ins. Co., 67 A.3d 961, 997 n.58 (Conn. 2013))).
39. Id. at *24.
40. Sec. Ins. Co. of Hartford v. Lumbermens Mut. Cas. Co., 826 A.2d 107, 125 (Conn. 2003).