Opinion ID: 1968704
Heading Depth: 1
Heading Rank: 5

Heading: Duty to Defend and Breach

Text: It is commonalmost universalfor liability insurance policies to give the insurer both the right to control the defense of any claim covered by the policy and the duty to provide that defense. See 14 COUCH ON INSURANCE 2D § 51.35 at 438 (Rev. ed. 1982 & Supp.1996). These are, essentially, reciprocal or correlative provisions. The right to control the defense, coupled with the corresponding duties of the insured to give prompt notice of any claim and forward relevant papers, to cooperate with the insurer in that defense, to avoid assuming liability, and to refrain from settling the claim or incurring expenses in defense of it without the consent of the insurer, is important to the insurer as a mechanism for protecting and minimizing its duty of indemnification. If it is to be liable for any judgment rendered against the insured, it has a right to make certain that a proper defense is made to the claim and that unwarranted, overstated, and collusive claims are exposed and defeated. See 7C APPLEMAN INSURANCE LAW AND PRACTICE § 4681 at 2-4 (Berdal ed. 1979 & Supp.1996-97). The duty to defend is primarily, of course, for the benefit of the insured. As we observed in Brohawn v. Transamerica Ins. Co., 276 Md. 396, 409-10, 347 A.2d 842, 851 (1975), the promise to defend is in the nature of litigation insurance, protecting the insured from the expense of defending suits brought against him. Not infrequently, that expense may approximate or even exceed the amount of any judgment rendered in the action. Although the issue does not appear to have been litigated, it would seem clear that the right to control the defense necessarily attaches as soon as there is something to defend. The correlative duty of the insured to notify the insurer promptly of an occurrence or a claim is obviously in aid, and assumes the right, of immediate control by the insurer. As a practical matter, of course, that right cannot be effectively exercised until the insurer is, in fact, informed of the occurrence or claim, but it would hardly be sound to conclude that the right does not exist or does not arise until the notice is given, for if that were the case, the right of control vested in the insurer would effectively be within the control of the insured. The same principles would seem to be applicable with respect to the duty to defend, although the courts have not generally applied, or apparently even considered, that kind of analysis. The duty to defend, rationally, should attach at the same moment the correlative right to control attaches, i.e., when the claim is made or, if the policy so provides, when an insured occurrence happens. If that is when the insurer has a right to exercise control, that is also when its duty to do so should arise. The courts and commentators are not in agreement on that approach, however. A number of courts, including the Court of Special Appeals, have stated that the duty to defend does not arise until the insurer is notified of the claim and asked to undertake the defense. See, for example, Washington v. Federal Kemper Ins., 60 Md.App. 288, 297, 482 A.2d 503, 507 (1984), cert. denied, 302 Md. 289, 487 A.2d 292 (1985); Oweiss v. Erie Ins. Exchange, 67 Md.App. 712, 718-19, 509 A.2d 711, 714-15 (1986); Mount Vernon Ins. v. Scottsdale Ins., 99 Md.App. 545, 564, 638 A.2d 1196, 1205 (1994), aff'd in part and rev'd in part, Chantel Associates v. Mt. Vernon, 338 Md. 131, 656 A.2d 779 (1995). See also Scottsdale Ins. v. American Empire Surplus Lines, 791 F.Supp. 1079, 1084-85 (D.Md.1992); Hartford Acc. & Indem. Co. v. Gulf Ins. Co., 776 F.2d 1380, 1383 (7th Cir.1985); Rovira v. LaGoDa, Inc., 551 So.2d 790, 794 (La.Ct.App. 1989), cert. denied, 556 So.2d 36 (La.1990); Am. Mut. Liability Ins. v. Mich. Mut. Liability, 64 Mich.App. 315, 235 N.W.2d 769, 774-75 (1976), leave to appeal denied, Jan. 4, 1976; 14 COUCH ON INSURANCE 2D, supra, § 51.35 at 444; 7C APPLEMAN INSURANCE LAW AND PRACTICE, supra, §§ 4682 at 24 and 4691 at 240. That, as we have indicated, was the principal basis of the Court of Special Appeals decision in this case regarding pre-notice costs and attorneys' fees. Where the duty of notification is regarded as a condition precedent to the insurer's duty to defend, a holding that the duty to defend does not arise until the notice is given is logical; it rests on the very nature of a condition precedent. Where, as in Maryland, however, the duty to notify is merely a covenant that, absent a showing of prejudice, does not excuse the insurer from complying with its duty to defend, the logic of such a holding becomes significantly attenuated, for it creates a time gap between the insurer's right to control the defense and its duty to provide one that has no legal underpinning. [5] The standard policy language places no time delay on the existence of the duty and affords no basis for distinguishing between the right and the duty to defend; as noted, the provision at issue here obligates Hartford to pay those sums Sherwood becomes legally obligated to pay as damages because of advertising injury and vests in Hartford the right and duty to defend any `suit' seeking those damages. Many of the cases articulating the notion that the duty to defend does not arise until notice is given involved situations in which an insurer declined to defend because of a delayed notice and was then sued for breach of contract to recover the cost of defense. See, for example, Towne Realty, Inc. v. Zurich Ins. Co., 201 Wis.2d 260, 548 N.W.2d 64 (1996), recons. denied, 205 Wis.2d 139, 555 N.W.2d 818 (1996); Crist v. Insurance Co. of North America, 529 F.Supp. 601 (D.Utah 1982). At least with respect to post-notification costs, the real issue in those cases was not whether a duty to defend existed, for it was stated in the policy, but whether and when it was breached. A duty to defend is not breached until the insurer is notified of the claim and then, without legal justification, declines to undertake the defense. See TPLC, Inc. v. United Nat. Ins. Co., 44 F.3d 1484 (10th Cir.1995); Paul Holt Drilling, Inc. v. Liberty Mut. Ins. Co., 664 F.2d 252 (10th Cir.1981); Norteck, Inc. v. Liberty Mut. Ins. Co., 858 F.Supp. 1231 (D. R.I. 1994). The duty necessarily preexists; the breach arises from the insurer's conduct following the notice. In this construct, it adds nothing to posit that the duty arises only upon the giving of notice, for it is still the insurer's conduct following the notice that determines the outcome. If the insurer declines to defend on the ground of the delayed notice, the question is whether it suffered sufficient prejudice from the delay; if some other policy defense is asserted, the issue is whether the defense was valid. In either case, the viability of the insurer's action goes to the question of breach, not the existence of the underlying duty. We acknowledge, as we must, the plethora of cases in which courts have based decisions on the notion that the duty to defend does not arise until notice of the claim is provided, or until the suit papers are forwarded, or until a formal request is made. In none of those cases, however, does the court give any reasoned basis for such an approach. In most of them, the court simply cites one or more earlier cases that said the same thing without any analytic support, see, for example, Am. Mut. Liability Ins., supra, 235 N.W.2d at 774-75; in some, the cases cited are not even apposite. [6] We do not find those cases persuasive. They may simply be parroting a conclusion that had a rational basis when the duty to notify was regarded as a condition precedent but that, with the abrogation of that underpinning, no longer is justified. We conclude, instead, that, under the kind of language used in the Hartford policies in this case, the duty to defend arises when an insured claim is filed or insured occurrence happens, but that that duty is not breached, and thus no action will lie for its breach, until the insurer is apprised of the claim or occurrence and thereafter, without legal justification, fails to undertake a defense in accordance with its obligation. Courts that espouse the view that the duty to defend does not arise until notice is given are, of course, prone to conclude that an insurer is not liable for costs and fees incurred by an insured prior to such notice. See, for example, Gully & Associates v. Wausau Ins., 536 So.2d 816, 818 (La.Ct.App.1988) and other Louisiana cases cited therein; Safeguard Scientifics v. Liberty Mut. Ins. Co., 766 F.Supp. 324, 333 (E.D.Pa.1991), aff'd in part, rev'd in part, 961 F.2d 209 (3d Cir.1992) (table); Towne Realty, Inc., supra, 548 N.W.2d at 68; SCSC Corp. v. Allied Mut. Ins. Co., 533 N.W.2d 603, 614-15 (Minn. 1995); Crist, supra, 529 F.Supp. at 604; SL Industries v. American Motorists Ins. Co., 128 N.J. 188, 607 A.2d 1266, 1272-73 (1992); Pitrowski v. Taylor, 55 Wis.2d 615, 201 N.W.2d 52, 56-57 (1972); Sentex Systems, Inc. v. Hartford Acc. & Indem. Co., 882 F.Supp. 930, 946-47 (C.D.Cal.1995), aff'd, 93 F.3d 578 (9th Cir.1996); Aetna Cas. & Sur. Co. v. Chicago Ins. Co., 994 F.2d 1254, 1261 (7th Cir.1993). It follows logically that there would be no obligation to pay for litigation expenses incurred by an insured during a time when the insurer had no duty to defend and therefore no duty to assume litigation expenses. The same result does not necessarily pertain, however, when the issue is one of breach, rather than existence, of the duty to defend. In that setting, the insurer's obligation for pre-notice expenses will depend on the nature of the breach, if any, which merits a more fact-specific inquiry and analysis. Under the approach we takethat the duty to defend arises upon the happening of the insured event but that the duty is not breached until, after notice of the event, the insurer unjustifiably declines to fulfill its obligationsat least three possibilities bearing on the insurer's exposure for pre-notice litigation expenses are presented: (1) following a delayed notice, the insurer undertakes the defense, (2) following a delayed notice, the insurer declines to undertake the defense based on the delayed notice, asserting that the delay constitutes a material breach on the part of the insured, thereby excusing performance by the insurer, or (3) following a delayed notice, the insurer declines to undertake the defense for some other reason that would likely have been asserted without regard to the delayed notice. In each circumstance, the insurer necessarily looks to the insured's covenant not to incur litigation expenses without the consent of the insurer, which complements the covenants to notify the insurer, to forward relevant papers, and to cooperate with the insurer. In the first situation, there is no post-notice breach. The insurer honors the duty that preexisted the notice. Had the notice been given earlier, the insurer would have undertaken the defense at the earlier time and therefore would have incurred all, part, or perhaps even more of the expenses incurred by the insured. The relevant question as to pre-notice expenses, to be tested against the covenant not to incur unconsented to expenses, is whether the insurer has been prejudiced within the meaning of § 482: was it reasonable, under the circumstances, for the insured to have incurred the expense; was the expense reasonable; did the expense materially exceed that which the insurer would likely have incurred in any event had the notice been given earlier? [7] That approach necessarily follows from the nature of the issue. Although there is no post-notice breach because the insurer has, prospectively, assumed the defense, there is the prospect of a breach if the insurer refuses to reimburse the insured for pre-notice expenses. The refusal would be based solely on the delayed notice and the concomitant covenant not to incur expenses without the insurer's consent, and, as to that issue, § 482 would apply and control. In that regard, we reject Hartford's suggestion that § 482 has no application to pre-notice expenses; there is no warrant for such a view in either the language of the statute or in the legislative intent behind it. In the second and third situations, the insurer's liability for pre-notice expenses depends on the validity of its reason for declining coverage. The issue in the second situation is prejudice, within the meaning of § 482. If the insurer succeeds in persuading a court that it was, indeed, prejudiced by the delayed notice, there would be no breach of the duty to defend and therefore, ordinarily, no liability for any of the costs incurred by the insured, whether pre-notice or post-notice. If, however, the insurer loses on that defense, it would be in no better position, with respect to pre-notice expenses, than the insurer who, in the first situation, undertakes the defense. Subject to the caveat we noted in footnote 8, ante, it would be liable for those expenses. The third situation, which is what we have before us, is the most clear cut. If the insurer declines to defend solely because, in its view, the claim is not even potentially within the policy coverage and the court ultimately agrees with that view, there is no obligation to reimburse the insured for any litigation expenses, whether incurred before or after the notice was given. The timing of the notice has no bearing on the issue. If, on the other hand, as occurred here, the court concludes that the claim was potentially within the policy coverage and that, as a result, the insurer did breach its duty to defend, the insurer is liable for all damages incurred by the insured as a result of that breach. Bankers & Shippers. Ins. v. Electro Enter., 287 Md. 641, 648-49, 415 A.2d 278, 282-83 (1980); Brohawn v. Transamerica Ins. Co., supra, 276 Md. at 409-10, 347 A.2d at 851. In that setting as well, the timing of the notice is ordinarily irrelevant. If the delay in giving notice is not a factor in the insurer's decision not to defendif it would have declined the defense in any event based on its mistaken conclusion that there was no potential coveragethe insurer should not later be allowed to use the delay as a bar to reimbursing the insured for the reasonable expenses incurred in defending the covered claim. [8] Upon this analysis, we hold that Hartford is liable for the pre-notice fees and expenses incurred by Sherwood, which the jury found to be reasonable. Because all other issues initially raised in this litigation have been settled by the parties, we shall vacate the judgment of the Court of Special Appeals and direct that the case be remanded to the circuit court for further proceedings in conformance with this Opinion and the parties' agreement. JUDGMENT OF COURT OF SPECIAL APPEALS VACATED; CASE REMANDED TO THAT COURT WITH INSTRUCTIONS TO VACATE THE JUDGMENT OF THE CIRCUIT COURT FOR MONTGOMERY COUNTY AND REMAND TO THAT COURT FOR FURTHER PROCEEDINGS CONSISTENT WITH THIS OPINION AND WITH THE SETTLEMENT AGREEMENT OF THE PARTIES; COSTS IN THIS COURT AND IN COURT OF SPECIAL APPEALS TO BE PAID BY RESPONDENTS.