Liability Coverage and the Duty to Defend

Like most types of liability insurance, the standard ISO general liability policy imposes two obligations on the insurer. First, the insurer must indemnify you (or pay on your behalf) the cost of damages or settlements that result from a claim or suit covered by the policy. Secondly, the insurer must defend you against a covered lawsuit.

What Does "Duty to Defend" Mean?

The term duty to defend refers to the insurer's obligation to defend you (or provide a defense) for a claim you file under your policy. The insurer may either enlist a member of its legal staff to defend you or hire an attorney at an outside law firm to provide a defense.

The ISO liability policy includes two coverages that impose a duty to defend on the insurer. Coverage A, Bodily Injury and Property Damage Liability, affords the insurer both the right and the duty to defend you (or any other insured) against any suit seeking damages for bodily injury or property damage caused by an occurrence. Coverage B, Personal and Advertising Injury Liability, gives the insurer the right and the duty to defend you against any suit seeking damages for personal and advertising injury.

Both Coverages A and B relieve the insurer of any duty to defend claims seeking damages for injury or damage not covered by the policy. For example, let's say Company ABC begins manufacturing and selling a product identical to one sold by Company XYZ. XYZ holds a patent on its product and sues ABC for patent infringement. If ABC sends the lawsuit to its general liability insurer, the insurer will decline to provide a defense. Patent infringement doesn't meet the definition of bodily injury, property damage, or personal and advertising injury in the policy.

What Does Duty to Indemnify Mean?

Duty to indemnify refers to the insurer's obligation to pay a judgment awarded to the plaintiff or a settlement the plaintiff has accepted in lieu of a judgment. Under Coverage A, the insurer has a duty to pay damages awarded or a settlement negotiated with the claimant because of bodily injury or property damage caused by an occurrence. Under Coverage B, the insurer has a duty to pay damages or a settlement to a claimant because of personal and advertising injury caused by an offense committed by an insured.

Insurer's Separate Duties

The insurer's obligation to defend you is separate from its duty to indemnify. The insurer has a duty to pay damages that result from a covered claim whether or not a defense is required. The reverse is also true. The insurer may be obligated to defend you even if it has no duty to pay damages. For instance, your insurer would have a duty to defend you against a claim by a customer who faked an injury. Your insurer would need to provide a defense until it proved the claim was false and that no damages were warranted.

An insurer's duty to defend is broader than its duty to indemnify. Generally, your insurer must provide a defense if the allegations in the complaint are potentially covered by the policy. This is true even if the insurer believes the claim isn't covered due to an exclusion or some other policy provision. It must continue to defend you until it can demonstrate that the claim isn't covered.

For example, suppose a worker of yours (Sandy) is injured on the job and sues your firm for $25,000. Your insurer believes that Sandy is your employee and that their claim is excluded via the employer's liability exclusion in your policy. You contend that Sandy is an independent contractor so the exclusion doesn't apply. Because Sandy's claim might be covered, your insurer must defend you until the matter of Sandy's status has been resolved.

Insurer's Right to Control Your Defense

Because a general liability insurer has the right to defend you, it maintains control over your defense. It determines which attorney is assigned to your case and whether to offer the claimant a settlement or proceed with a trial.

Suppose your business is insured under the standard liability policy and has been sued for property damage by a customer. If your brother is a hotshot litigator, can you hire him to handle your defense and then bill the insurer for his services? No! Your insurer will not relinquish control of your defense or pay an attorney you've hired.

If your insurer opts to settle a suit rather than contesting it in court, you can't prevent the settlement even if you disagree with the insurer's decision. Your insurer has the right to settle a claim without your consent.

Are Defense Costs Subject to Limits?

The standard general liability policy covers expenses the insurer incurs to defend you under Supplementary Payments. These expenses will not reduce your policy limits. However, some insurers sell proprietary liability policies that cover defense costs within the policy limits. When buying general liability insurance, make sure the policy covers defense outside the limits.

Declaratory Judgment or Reservation of Rights

If you and your insurer disagree about some aspect of your insurance policy, such as your insurer's obligation to defend you, either party may request a declaratory judgment. A declaratory judgment is a decision by a court regarding the matter of dispute. The court's decision is binding on you and the insurer.

An alternative to a declaratory judgment is a reservation of rights letter, which is sent by the insurer to the policyholder. A reservation of rights typically states that the insurer will defend a claim but that it reserves its right to deny coverage for all or part of the claim at a later date. If you receive a reservation of rights letter, a declination letter may soon follow.