United States: Duty To Defend On Collision Course

A coverage issue yet to be decided in New Jersey is whether a commercial general liability (CGL) policy, which provides the insurer with the duty and right to defend its insured against third-party claims, also authorizes the insurer to be reimbursed for defense costs that are later determined to be beyond the policy grant of coverage.¹

Since the California Supreme Court decided Buss v. Superior Court² in 1997, and held that an insurer has the right to reimbursement of defense costs for non-covered claims based on a reservation of rights letter, courts nationwide have split over this issue. The growing minority view, however, has uniformly concluded an insurer has no right to reimbursement of defense costs absent an express provision in the written insurance contract authorizing the reimbursement.³ The Pennsylvania Supreme Court, in American and Foreign Insurance Company v. Jerry's Sports Center, Inc.,⁴ recently joined this growing minority view. The Pennsylvania high court rejected the carrier's contention that it was entitled to reimbursement of defense costs for a claim the lower court had determined was not covered and, thus, there was no duty to defend. The Court's rationale was predicated on Pennsylvania's broad duty to defend, and the plain language of the insured's CGL policy, which was devoid of any language suggesting the carrier had a right to reimbursement.⁵

The Pennsylvania Supreme Court's recent decision in Jerry's Sports Center, Inc. may be the better-reasoned approach to this issue, since it is more consistent with New Jersey's duty to defend common law, as well as the standard duty to defend language found in CGL policies. Accordingly, when the issue is squarely addressed by New Jersey courts, New Jersey may align itself with the growing minority view that holds an insurer is not entitled to reimbursement of defense costs based on an 'after the fact' drafted reservation of rights letter issued by the insurer.

This article will initially explain the basic principles governing New Jersey's duty to defend, and briefly discuss the Buss holding and those court decisions that have followed its lead. The article will then address those courts that have taken a contrary view to the Buss decision, and will conclude with a discussion of why the authors believe New Jersey should also reject the Buss holding and follow those courts that have found the plain language of the CGL policy does not allow reimbursement of defense costs.

Duty to Defend

Generally, an insurer's duty to defend is broader than its duty to indemnify.⁶ This is a distinct obligation under the CGL policy that is separate and apart from the insurer's duty to provide coverage.

An insurer is contractually obligated to provide the insured with a defense against all actions covered by the CGL policy. Generally, when a complaint is filed against the insured alleging a covered claim, the insurer's duty to defend is triggered. Thus, when the allegations in the complaint fall within a risk that is covered by the CGL policy, the insurer is obligated to defend. Indeed, as long as the allegations in the complaint comprehend a claim or injury that may possibly be covered by the insurance policy, a duty to defend will arise.⁷

The question of whether the third-party claim asserted against an insured is potentially covered under the CGL policy is determined by comparing the allegations in the complaint to the insurance policy's language. The duty to defend arises even if the allegations in the complaint are "poorly developed and almost sure to fail."⁸

That is because the duty to defend is not limited to only meritorious actions. The merit of the claim asserted against the insured is immaterial. The duty to defend does not rely upon whether the claim or cause of action stated in the complaint can be maintained against the insured. In other words, the duty to defend is not defeated simply because the allegations may be "groundless, false, or fraudulent."⁹

As the New Jersey Supreme Court recently pronounced, the "determination of an insurer's duty to defend requires review of the complaint with liberality to ascertain whether the insurer will be obligated to indemnify the insured 'if the allegations are sustained.'"¹⁰

Buss Line of Cases

Buss arose out of an underlying lawsuit in which only one of 27 claims was potentially within the insurance policy's coverage. The underlying action was brought against Jerry Buss, the owner of several sports teams, including the Los Angeles Lakers, who was alleged to have, among other things, breached a contractual obligation with a third party. The underlying complaint alleged 27 causes of action, including one count for defamation, which turned out to be the only potentially covered claim. The insurer provided a defense for all 27 counts pursuant to a reservation of rights letter, which included a right to seek reimbursement of all defense costs.

The coverage action eventually came before the California Supreme Court, which held that because the insurer's duty to defend extended to claims at least potentially covered, the insurer was not entitled to seek reimbursement of defense costs for the one potentially covered defamation claim. The Court held, however, that the insurer could seek reimbursement of all the defense costs related to the 26 claims that were not potentially covered.¹¹

In support of its conclusion that the insurer was entitled to reimbursement of the non-covered claims, the California Court observed that the insurer had not been paid premiums by the insured with regard to those non-covered claims, nor did the insurer bargain to bear the costs of defending claims that were not potentially covered under the insurance policy. According to the Court, the insurer had a right to seek reimbursement that is "implied in law as quasi-contractual, whether or not it has one that is implied in fact in the policy as contractual."¹²

The Court also reasoned that the insurer had the right to seek reimbursement since the insured would be "unjustly enriched" if the insurer had to incur unbargained-for defense costs, which the Court found to be unjust.¹³ In short, while the insurer had no right to seek reimbursement of the potentially covered claim, the insurer did have a right to seek reimbursement for claims that were not potentially covered. Following Buss, insurers have routinely issued reservation of rights letters seeking reimbursement of defense costs.

Many courts following Buss found in favor of the insurer, usually based on contractual and/or equitable principles. For example, several courts viewed the insurance policy as being inapplicable because reimbursement was sought for defense costs incurred for claims that were not covered, and the reservation of rights letter was an offer to create a 'new contract' regarding those non-covered claims. These courts viewed the insured as having accepted that reservation of rights letter by virtue of having accepted the insurer's payment of defense costs pursuant to that reservation.¹⁴

Besides this contractual viewpoint, other courts following Buss apply the equitable theory of unjust enrichment and the remedy of restitution in quantum meruit. This theory disallows the insured from being unjustly enriched when the insurer paid defense costs for non-covered claims.¹⁵

Although many courts have followed the Buss lead on this issue of reimbursement of non-covered claims, that majority view has eroded over time. There is now a growing minority view, embraced by a number of courts, which has rejected the reasoning of Buss.

The Growing Trend to Get Off the Buss

A growing number of courts have rejected Buss for various reasons. Some courts have concluded that reimbursement is simply inconsistent with the broad duty to defend.¹⁶ Other courts have rejected the notion that reimbursement of defense costs should be allowed based on a reservation of rights letter, pointing out that the insurer voluntarily undertakes the defense in order to protect its own self interest. The Third Circuit Court of Appeals endorsed this reasoning in Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc. several years before Buss was decided.

The court explained:

Faced with uncertainty as to its duty to indemnify, an insurer offers a defense under reservation of rights to avoid the risks that an inept or lackadaisical defense of the underlying action may expose it to if it turns out there is a duty to indemnify. At the same time, the insurer wishes to preserve its right to contest the duty to indemnify if the defense is unsuccessful. Thus, such an offer is made at least as much for the insurer's own benefit as for the insured's. If the insurer could recover defense costs, the insured would be required to pay for the insurer's action in protecting itself against the estoppel to deny coverage that would be implied if it undertook the defense without reservation.¹⁷

Further, several courts have rejected Buss by finding that a unilateral reservation of rights letter from the insurer does not create new contractual rights that were absent in the insurance policy itself.¹⁸ Other courts have rejected Buss by finding that, as a matter of fairness, an insurer should not be able to benefit unfairly by hedging its bets on its defense obligations by reserving its right to reimbursement while potentially controlling the defense and avoiding a bad faith claim.¹⁹

The Pennsylvania Supreme Court recently joined this growing trend of cases that has rejected Buss. In American & Foreign Ins. Co. v. Jerry's Sports Center, Inc., the NAACP filed a civil action against several firearms wholesalers and distributors seeking to hold the firearms industry liable for injury, death and other damages through the negligent creation of a public nuisance for failing to distribute firearms in a reasonable and safe manner. The insured notified its carrier of the action and requested a defense and indemnification, noting that the allegations fell under the 'bodily injury' coverage provided by the CGL policy. The insurer assigned defense counsel to provide a defense and respond to this lawsuit pursuant to a full reservation of rights, which included the right to seek reimbursement for all defense costs for claims ultimately determined not to be covered. The insurer sent the insured several reservation of rights letters emphasizing this right to seek reimbursement. ²⁰

In rejecting Buss, the Pennsylvania Supreme Court concluded that the growing minority view was more consistent with Pennsylvania's broad duty to defend when also viewed in light of the CGL policy's express language.²¹ The Court noted that where the insurance contract is silent about the insurer's right to reimbursement of defense costs, allowing reimbursement for costs that the insurer incurred exercising its right and duty to defend potentially covered claims prior to a court's determination on coverage would be inconsistent with Pennsylvania's broad duty to defend. It would also amount to a "retroactive erosion of the broad duty to defend in Pennsylvania by making the right and duty to defend contingent upon a court's determination that a complaint alleged covered claims, and would therefore narrow Pennsylvania's longstanding view that the duty to defend is broader than the duty to indemnify."²²

The Court accordingly held that the insurer could not employ a reservation of rights letter to reserve a right it did not have under the CGL policy, which the Court found would be "tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract."²³

The Pennsylvania Court also rejected the notion there was any equitable basis upon which to allow the insurer the right of reimbursement. The Court reasoned that an insured is not unjustly enriched by the insurer's payment of defense costs. This is because the insurer not only has the duty to defend, but also the right to defend pursuant to the insurance agreement. This arrangement, the Court observed, assists both parties, since the duty to defend benefits the insured to protect it from the costs of defense, while the right to defend allows the insurer to control the defense to protect itself against potential indemnity exposure.²⁴

Lastly, the Court recognized that if the insurer could seek reimbursement of defense costs beyond the express language of the CGL policy, that would allow the insurer to "design its own right to reimbursement subject only to the insurer's designs."²⁵ The Court was concerned that allowing the insurer to "design" its own right of reimbursement would open the door to unjustified maneuverings by insurance companies at their policyholders' expense.26 Therefore, the Court held that the insurer cannot obtain reimbursement of defense costs for a claim for which a court later determines there was no duty to defend, even where the insurer attempts to claim a right to reimbursement through a reservation of rights letter.²⁷

New Jersey Will Likely Follow the Growing Minority View

As noted at the outset, New Jersey has not yet addressed the coverage issue regarding an insurer's ability to seek reimbursement of defense costs incurred in connection with non-covered claims. Nationwide, the courts now appear to be evenly divided over this issue. The growing trend of authority that rejects Buss, as exemplified by the recent Pennsylvania Supreme Court decision, appears to be the better reasoned approach to this coverage issue for the following reasons.

First and foremost, the plain language of the standard CGL policy does not authorize an insurer to seek reimbursement. The CGL policy provides the insurer with the duty and right to defend its insured against third-party claims. Once the insurer elects to defend its insured, the carrier has no contractual right to unilaterally modify that agreement—an agreement the carrier drafted in the first instance—by trying to create a new agreement through a reservation of rights with different terms that were never agreed to by the insured.²⁸ If the insurer wants to have this right to reimbursement, it can easily be included in the policy language. Presently, that language is absent.²⁹

Moreover, by defending the insured, the carrier also benefits its own selfinterests by controlling the defense to hopefully avoid or minimize its indemnity obligation.³⁰ Buss's duty to reimburse rule is also inconsistent with New Jersey's broad duty to defend.³¹ All potentially covered claims trigger the insurer's duty to defend. There is always the possibility, however, that a court will later determine the claim was not covered. In that instance, there may no longer be a duty for the insurer to indemnify that claim. However, the duty to defend is broader than the duty to indemnify.³² To allow the insurer to be reimbursed for defense costs would place those two contractual rights on the same level—which New Jersey has always considered separate and apart.³³

Further, the concept of 'fairness' has no place in this analysis. Buss espoused that it would be unfair for insurers to be required to defend non-covered claims because the insured never paid a premium for that coverage.³⁴ Buss misses the point. The plain language of the CGL policy provides that very coverage. The insured paid a premium so it would be defended against third-party claims that are potentially covered under the insurance agreement. That was the understanding struck, and it is the insurer that is in the better position to appreciate the risks it is underwriting. Indeed, insurers are in the business of taking risks and determining when claims are covered or not covered.³⁵ Insurers should not be allowed to have it both ways, which is exactly what Buss allows when it sanctions the unilateral abridgement of the insurance contract through a reservation of rights letter.

Because New Jersey law recognizes the insurer has a broad duty to defend its insured, because the plain language of the standard form CGL policy recognizes that duty and does not authorize the insurer to seek reimbursement for claims later determined to be non-covered, and because in defending its insured the insurer receives the benefit of controlling the defense and minimizing its indemnity exposure, the Buss rationale that a carrier can unilaterally alter the CGL policy's duty to defend by the issuance of a reservation of rights letter is inconsistent with New Jersey's broad duty to defend, as well as the plain language of the insurance agreement. For these reasons, it would appear that New Jersey courts will follow the growing trend of authority and, accordingly, exit the Buss.

Footnotes

1. See Hebela v. Healthcare Ins. Co., 370 N.J. Super. 260 (App. Div. 2004) (where the court in discussing allocation of covered and non-covered claims noted, in dicta, that an insurer might be entitled to reimbursement of defense costs when it is determined that an insured was defended for a non-covered claim).

2. Buss v. Superior Court, 939 P.2d 766 (Cal. 1997).

3. See Angela R. Elbert and Stanley C. Nardoni, Buss Stop: A Policy Language Based Analysis, 13 Conn. Ins. L.J. 61, 94 (2006-07) (noting that many courts have overlooked the CGL policy's "supplementary payment" clauses that "promise that the insurer will bear the full costs for cases it defends," which policy language "runs expressly against a right of reimbursement").

4. American and Foreign Insurance Company v. Jerry's Sports Center, Inc., 2 A.3d 526 (Pa. 2010).

5. Id. at 540-46.

6. W9/PHC Real Estate LP v. Farm Family Cas. Ins. Co., 407 N.J. Super. 177, 191 (App. Div. 2009) (noting that "duty to defend is broader than the duty to indemnify"); Polarome Intern., Inc. v. Greenwich Ins. Co., 404 N.J. Super. 241, 273 (App. Div. 2008) (same); Rosario ex rel. Rosario v. Haywood, 351 N.J. Super. 521, 534 (App. Div. 2002) ("The duty to defend, which is itself a meaningful benefit, is broader then [sic] the duty to indemnify."); Horesh v. State Farm Fire & Cas. Co., 265 N.J. Super. 32, 38 (App. Div. 1993) (noting the duty to defend is broader than the duty to pay because the duty to defend is not based on merits of the claim).

7. See Abouzaid v. Mansard Gardens Associates, LLC, 207 N.J. 67, 79-80 (2011) (noting that whenever the allegations in the complaint encompass an injury or claim that is "potentially coverable," the insurer is required to provide a defense); see also Voorhees v. Preferred Mutual Ins. Co., 128 N.J. 165 (1992); Hartford Accident & Indemn. Co. v. Aetna Life & Cas. Ins. Co., 98 N.J. 18, 22 (1984); Danek v. Hommer, 28 N.J. Super. 68, 77 (App. Div. 1953), aff'd o.b., 15 N.J. 573 (1954); L.C.S., Inc. v. Lexington Ins. Co., 371 N.J. Super. 482, 490 (App. Div. 2004).

8. Voorhees v. Preferred Mutual Ins. Co., 128 N.J. 165, 174 (1992).

9. Abouzaid, 207 N.J. at 81.

10. Id. at 79.

11. Buss, 939 P.2d at 775-76.

12. Id. at 776.

13. Id.

14. See, e.g., Valley Forge Ins. Co. v. Health Care Mgmt. Partners, 616 F.3d 1086 (10th Cir. 2010); United Nat'l Ins. Co. v. SST Fitness Corp., 309 F.3d 914, 921 (6th Cir. 2002); Underwriters at Lloyds London v. STD Enters., Inc., 395 F. Supp. 2d 1142, 1150-51 (M.D. Fla. 2005); Travelers Cas. & Surety Co. v. Ribi Immunochem Research, Inc., 108 P.3d 469, 480 (Mont. 2005).

15. See, e.g., Blue Ridge Ins. Co. v. Jacobsen, 22 P.3d 313, 321 (Cal. 2001).

16. See Perdue Farms, Inc. v. Travelers Cas. & Surety Co. of Am., 448 F.3d 252 (4th Cir. 2006); Liberty Mut. Ins. Co. v. FAG Bearings Corp., 153 F.3d 919 (8th Cir. 1998).

17. Terra Nova Ins. Co. Ltd. v. 900 Bar, Inc., 887 F.2d 1213, 1219-20 (3d Cir. 1989) (construing Pennsylvania coverage law); see also General Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092 (Ill. 2005) (similarly rejecting insurer's right to reimbursement if not included in written contract).

18. See, e.g., Excess Underwriters at Lloyds, London v. Franks Casing Crew & Rental Tools, Inc., 246 S.W.3d 42 (Tex. 2008); Shoshone First Bank v. Pacific Employers Ins. Co., 2 P.3d 510 (Wyo. 2000).

19. Shoshone First Bank, 2 P.3d 510.

20. Jerry's Sports Center, Inc., 2 A.3d at 529-30.

21. Id. at 540.

22. Id. at 544.

23. Id. at 544.

24. Id. at 545.

25. Id.

26. Id.

27. Id. at 546.

28. See, e.g., Jerry's Sports Center, Inc., 2 A.3d at 545 ("We are persuaded that permitting reimbursement by reservation of rights, absent an insurance policy provision authorizing the right in the first place, is tantamount to allowing the insurer to extract a unilateral amendment to the insurance contract."). See also Shoshone First Bank, 2 P.3d at 515-16.

29. See, Shoshone First Bank, 2 P.3d at 515-16 ("[The insurer] could have included allocation language in the Policy, but it failed to do so. We look only to the four corners of the policy to determine coverage...In light of the failure of the policy language to provide for allocation, we will not permit the contract to be amended or altered by a reservation of rights letter."

30. See, Jerry's Sports Center, Inc., 2 A.3d at 545.

31. See supra, note 6.

32. Id. See also, Jerry's Sports Center, Inc., 2 A.3d at 540-41 (and cases cited therein).

33. See supra, note 6.

34. See generally, Jerry's Sports Center, Inc., 2 A.3d at 545 ("Nor are we persuaded that there are any equitable bases upon which to grant a right to reimbursement.").

35. See, Shoshone First Bank, 2 P.3d at 516 ("The question as to whether there is a duty to defend an insured is a difficult one, but because that is the business of an insurance carrier, it is the carrier's duty to make that decision.").

Originally published in NEW JERSEY LAWYER | August 2012

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