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Countersuits May Be Lined with Silver

By: James H. Vorhis
08/15/07

Your business sues a debtor to recover money owed to you. A few months later, your attorney calls and tells that the debtor has filed a cross-complaint. Amazingly, this news may have a silver lining! [1]

If you have an insurance policy with a duty to defend clause, the presence of the countersuit may require the insurance company to reimburse the legal expenses of proving your complaint, as well as the expenses of defending the cross-complaint, fees that would not otherwise be covered by your insurance policy. In this e-alert, we provide two real world examples of this situation, and also flag a couple potential downsides.

First Step - Analyze Your Insurance Policies

Any time you are served with a complaint or cross-complaint, a critical early step you should take is to analyze your insurance policies for possible coverage. Liability policies typically obligate the insurer to both indemnify the policyholder for any judgment and also to defend potentially covered claims.

If there is a duty to defend clause, under California law the insurance company must defend its insured against any lawsuit (complaint or cross-complaint) that potentially seeks damages within the coverage of the policy. (Aerojet-General Corp. v. Transport Indemnity Co. (1997) 17 Cal.4th 38, 57-58; Gray v. Zurich Ins. Co. (1966) 65 Cal.2d 263). This duty is far broader than the duty to indemnify, and requires insurers to defend claims that would be covered if true, even if the claim itself is groundless, false or fraudulent. (Horace Mann Ins. Co. v. Barbara B. (1993) 4 Cal.4th 1076.)

In practical effect, if the policy obligates the insurer to provide a defense, it must pay all fees and costs that are reasonable and necessary to defend the lawsuit. This standard applies to complaints and cross-complaints.

The "Blame the Other Guy" Defense

In many cases, a cross-complaint raises the facts and issues that largely overlap with matters already put in issue by the complaint. Frequently, the best defense to the cross-complaint is to prove that the entire situation is the defendant’s fault, viz, proving the facts alleged in the complaint. Usually, the activities and expenses undertaken to defend the cross-complaint are largely the same as those needed to prove plaintiffs’ affirmative case.

In that situation, being sued can be a wonderful thing.

Practical Examples

In our first example, a group of municipal water companies sued a munitions manufacturer to recover the remediation costs of cleaning up water supply wells, which had been contaminated with the manufacturer’s chemicals. Ordinarily, the water companies would not have insurance to pay for the litigation and expert expenses of proving the manufacturer’s misconduct, causation and damages.

But, what happens when the manufacturer decides to cross-complain, alleging that actions of the water companies caused or contributed to the contamination? Under the policies in our case, that cross-complaint was potentially covered by the water companies’ general liability insurance policies, so the insurer was obligated to fund the defense to the cross-complaint.

The best defense for defeating the cross-complaint strategically was for the water companies to prove that, in fact, defendant’s actions caused the contamination. Because the complaint raised this precise issue, most of the fees, costs and expert expense that plaintiffs incurred to prove the complaint were also "reasonable and necessary" to defend against the cross-complaint. Because of that overlap, plaintiffs were reimbursed a portion of the fees it spent to prosecute the complaint.

The second scenario arises from a landslide on a residential hillside. The landsides damaged a number of homes, and one home owner sued all of the other affected property owners alleging that the landslide was their fault. Each property owner then cross-complained against all of the other property owners with essentially the same allegations. Thus, the filing of the cross-complaints triggered the duty to defend. As a result, the property owners’ insurance companies paid for litigation expenses and costs that, absent the cross-complaints, would not be covered.

Other Issues

Of the issues that may arise whenever you tender a claim to an insurance carrier, there are two to watch for in these cross-complaint scenarios.

  • If you tender the defense of the cross-complaint, the insurer may deny coverage and instead respond with a declaratory relief lawsuit. All of a sudden, the plaintiff-policyholder is fighting a two-front battle -- the initial lawsuit and cross-complaint, plus the insurance coverage action.

This may not be a battle you want to fight while the underlying lawsuit is ongoing. But there are three things to keep in mind. First, insurance coverage lawsuits can very frequently be stayed until resolution of the underlying lawsuit – so, if nothing else you can minimize your costs in the insurance coverage lawsuit while fighting your main battle. You can stay that lawsuit in its entirety, or you can litigate just the duty to defend and stay indemnity issues—this latter option is often the best approach for the policyholder. (See Montrose Chemical Corp. v. Superior Court (1993) 6 Cal.4th 287, 301.) Second, where an insurer wrongfully refuses to defend a third party suit against its insured, and the insured is also compelled to pay its own defense costs, the insured is entitled to interest on such defense costs from the date it paid the obligation. (Oil Base, Inc. v. Transport Indem. Co. (1957) 148 Cal.App.2d 490, 492.). Thus, if you prevail on the coverage lawsuit you will recover interest in addition to the underlying defense fees and costs accrued in the main litigation. Third, if the insurance company has acted unreasonably in denying your defense you may be able to recover the fees you incur in the lawsuit to procure the defense (Brandt v. Superior Court (1985) 37 Cal.3d 813.)

  • A second, often significant issue focuses on the hourly rate the insurer is willing to pay legal counsel to defend the cross-complaint. When an insurance company agrees to defend, Civil Code section 2860 works to limit the hourly rates the insurance company is required to reimburse to the same rates which "are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar actions in the community where the claim arose or is being defended." This can also lead to further dispute, but, under the statute, such disputes about rates must be arbitrated, not litigated. In the cross-complaint scenario, where the policyholder already has counsel in place, it may need to negotiate an arrangement by which the insurer agrees to pay a portion of the attorney’s actual fees, with the insured paying the remainder.

Conclusion

No one likes to be sued, but it is not always a bad thing if it is in the form of a cross-complaint. If one of your defenses to the cross-complaint was that the defendant did it, you may find an insurance company paying you for the same fees you would have needed to spend anyway.


[1] "Look for the silver lining, When e’er a cloud appears in the blue…" by B. G. DeSylva

Thomas D. Long is a member of Nossaman’s Litigation Department with over 23 years of experience. Tom represents policyholders in insurance coverage litigation involving environmental, construction defect and other claims. He can be reached at tlong@nossaman.com. James H. Vorhis is an Associate in the Insurance Coverage Practice Group and can be reached at jvorhis@nossaman.com.

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