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To Defend or Not to Defend, That Is the Question

Daily Journal

Two recent cases published in March 2010 examine the rights and obligations of defending insurers under two different circumstances. In one, a defending insurer was entitled to act to protect itself against a "set-up" judgment (where the insured's assignee seemed to be over-reaching). In the other, a defending insurer was still in the hot seat because it ignored its obligations under a higher limits policy hoping to insulate itself by defending under the lower limits policy (where the insurer seemed to be over-reaching). These cases offer a common message: what is fundamentally fair seems to win out.

In Gray v. Begley (2010, Cal. App. Lexis 373), the underlying case involved a traffic accident in which the defendant, Dameon Begley, while driving drunk (and possibly in the course and scope of his employment, driving a car entrusted to him by his employer) hit the car in which the plaintiff Steven Gray was a passenger, seriously injuring Gray. Gray sued Begley and Begley's employer, Granite Construction Co., Granite was insured by CNA (its primary insurer) and Westchester (its excess insurer).

Prior to trial, CNA, Westchester, and Granite settled with the plaintiff whereby CNA paid its remaining limits and Westchester paid a significant sum to settle the claims against Granite only. The release the plaintiff signed expressly did not release Begley (the driver-defendant) nor did it release CNA, but it recited that Gray agreed not to execute on any judgment against Begley. Thereafter the case went to trial against Begley who then moved to vacate the judgment for $4.5 million because it was offset by the earlier settlement (which exceeded that sum).

Before the court heard the motion, Gray and Begley entered into a "private" settlement, which included an agreement not to execute in return for an assignment to Gray of Begley's rights against CNA. Begley then withdrew his motion to vacate, but CNA then sought to intervene to make its own motion to vacate and set off. The trial court initially granted the motion to intervene, but later denied CNA's set-off motion, because supposedly there was not enough time for it to be heard, as the judge had entered a judgment and the time to appeal expired before the hearing date! Not surprisingly, Gray and Begley then brought suit against CNA, asserting the $4.5 million judgment as "evidence" against CNA.

How did CNA get into this pickle in the first place? Initially CNA refused to defend Bagley, asserting he was not driving while drunk in the course and scope of his employment, but thereafter provided him a "courtesy defense." Having defended under a reservation, Gray and his now ally, Begley, argued CNA had no standing to intervene as an "interested party" because it had only a contingent interest dependent on a later determination that there is coverage.

The appellate court disagreed because, in fact, CNA did defend. The court concluded that an insurer that provides a defense under a reservation of rights has sufficient interest in the litigation to intervene, because the key factor as to whether an insurer is bound by a settlement reached without its participation is whether the insurer provided a defense. Further, CNA had a right to a hearing on its motion for set-off as the trial court erroneously entered judgment before the hearing date. The appellate court has remanded the issue of set-off back to the trial court to determine.

In contrast, the court in Risely v. Interinsurance Exchange (2010 Cal. App. Lexis 399), determined that an insurer may be sued for failing to defend or settle under one policy even where it did defend under another, smaller policy and paid out the limits on the smaller policy. The underlying lawsuit involved facts potentially invoking coverage under both an auto and a homeowners policy. The claimant, Lisa Risely, accepted a ride from Sean Turner. Turner drove erratically and refused Risely's repeated demands to let her out. She suffered severe, debilitating injuries in an ensuing car crash. Risley attributed her injuries to false imprisonment, and sued Turner for, inter alia, motor vehicle negligence, negligence per se, and false imprisonment, recovering $434,000 in stipulated judgment.

Turner was insured under two policies issued by the Interinsurance Exchange of the Automobile Club: a $50,000 auto policy and a $300,000 homeowners policy. During the litigation, Risely offered to settle her claims against Turner for the policy limits of the homeowners policy. In response, the Auto Club informed Turner that it declined coverage under the homeowners policy but that it would defend all claims (including false imprisonment) under the auto policy. Thereafter, the Auto Club declined the $300,000 settlement demand as exceeding the auto policy's limits. Turner then brought a combined bad faith suit and Insurance Code Section 11580 action. The Auto Club brought a motion for summary judgment on the basis that there was no judicial determination of liability and that it was not bound by the stipulated judgment, which was entered by the trial court. The trial court granted the summary judgment.

The court of appeal reversed. While an insurer who provides a full defense is not bound by a stipulated judgment and an Insurance Code Section 11580 action can be brought only when there is a final judgment against the insured to meet the "no action" clause requirements of the policy, where the insurer has breached the duty to defend, the rules change. As the court explained, if the insured is not fully protected, and can show damages, even if a defense has been provided, an action against the breaching insurer will lie. The appellate court noted that each separate insurance policy carries with it the duty to defend, and a defense under one policy does not constitute a defense under the other, and an insurer that breached the duty to defend under a policy may be bound by a stipulated judgment agreed to by its insured without its consent, notwithstanding a "no action" clause in the policy.

The appellate court also reviewed the case law where multiple insurers owe a duty to defend which stand for the general proposition that a bad faith case will not lie if the insured is fully protected, notwithstanding a failure to defend where another insurer does protect the insured from any damages. That is so because in that scenario the insured suffered no damages. However, none of those cases abrogate the holding in the seminal case of Windt v. Fidelity & Casualty Co. (1973) 9 Cal. 3d 257,263, where the non-defending insurer's failure to provide a defense potentially increased the insured's exposure to personal liability. Under those facts, the non-defending insurer could be liable for its share of a stipulated judgment. Indeed the California Supreme Court stated "[W]here more than one insurer owes a duty to defend, a defense by one constitutes no excuse of the failure of any other insurer to perform" and "[A] defense by an insurer whose policy has a limit far below the amount claimed cannot be equated to the defense of an insurer who stands to lose 10 times as much as to the insurer who defends."

Although this appellate court noted that "there appears to be no prior case in which a court has considered whether an insured may establish damages based on an insurer's alleged breach of its duty to defend where a single insurer is alleged to owe a duty to defend under more than one policy, Auto Club offers no reason why the law should differ depending on whether the policies in question are issued by a single insurer, or instead, multiple insurers." The court noted that there had not yet been a determination whether the homeowners policy provided indemnity coverage but, assuming it did, Auto Club's choice to defend under the smaller auto policy only exposed Turner to a greater potential for personal liability.

These issues of coverage, duty to defend under the homeowners policy, and whether the settlement demand was reasonable were all remanded back to the trial court. While the holding simply reversed Auto Club's summary judgment because it could not, as a matter of law, show its insured had no damages and/or that it was not bound by the stipulated judgment, the court's review of this substantial body of coverage case law is very instructive.

The opinions in both of these recent cases not only provide a detailed review of prior case law, but they are also instructive on how the law is developing in a logical fashion under varied factual circumstances. Neither the insureds nor their assignees are permitted to over-reach, nor are the insurers permitted to dodge their contractual and legal obligations where doing so may harm their insureds. The consequences of failing to defend potentially covered claims remain harsh, but fundamental fairness will apply, all in keeping with the substantial body of case law that has developed in California. It remains sound practice to consult with knowledgeable insurance coverage attorneys whenever insurance coverage issues arise as this is an important protection against potentially catastrophic loss.

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