Opinion ID: 160332
Heading Depth: 2
Heading Rank: 2

Heading: Royal's Duty to Defend

Text: 16 Signature contends that Royal breached its duty to defend Signature under the policy by failing to fully discharge its duties under the policy. Specifically, Signature argues that Royal (1) should have contributed to defense costs and (2) because of its breach of its duty to defend, Royal should have been precluded from relying on its coverage defenses. The district court found that Signature produced no evidence that Royal refused to defend Signature. We shall consider each contention in turn. 17
18 Under Colorado law, an insurer's duty to defend arises when the underlying complaint against the insurer alleges any facts that might fall within the coverage of the policy. Hecla Mining Co. v. New Hampshire Ins. Co., 811 P.2d 1083, 1089 (Colo. 1991) (en banc). The duty to defend is separate from and broader than the duty to indemnify. See id. Furthermore, where the insurer's duty to defend is not clear from the pleadings, but the allegations do state a claim which is potentially or arguably within the policy coverage, the insurer must abide by its duty to defend the claim. Id. 19 As to its duty to defend, Royal's policy stated: We will have the right and duty to defend any `suit' seeking [those sums that the insured becomes legally obligated to pay as damages]. Rec. vol. III at R01053. The allegations in the Wernli and Long litigations were based on Signature's negligence and breach of warranty, which might be occurrences under Royal's policy as defined therein. An occurrence could include negligence and breach of warranty. See id. at R01051. The district court concluded that Signature produced no evidence that Royal refused to defend it. Rec. vol. I, tab 7, at 7-8 (Dist. Ct. Order filed July 22, 1999). 20 Signature contends, however, that Royal did not uphold its duty to defend or to participate in settlement proceedings. First, Signature states that Royal had agreed to split defense costs and yet ignored subsequent written demands for those costs. Colorado law recognizes that primary coverage insurers are duty bound to defend the insured and are required to contribute their pro rata share to the defense costs. National Cas. Co. v. Great S.W. Fire Ins. Co., 833 P.2d 741, 747-48 (Colo. 1992). Signature, relying in part on Lujan v. Gonzales, 501 P.2d 673, 677 (N.M. Ct. App. 1972), also contends that Royal may not rely on the defense provided by Travelers and may not as a result shirk from its defense costs obligations. See id. (holding that insurer's refusal to defend was breach of its duty to defend, notwithstanding the defense rendered by the other insurer). Finally Signature contends that Royal failed to complete a reasonable and prudent investigation of all aspects of the underlying case, as required by Aetna Cas. & Sur. Co. v. Kornbluth, 471 P.2d 609, 612 (Colo. Ct. App. 1970). 21 Royal counters Signature's argument by stressing the relevance of its reservation of rights under Colorado law. Royal does not dispute that its duty to defend was triggered and argues that it agreed to defend Signature as to property damages that occurred while Royal was Signature's carrier. In fact, Royal acknowledged its duty to defend, but undertook the duty subject to a reservation of rights. See Hecla Mining Co., 811 P.2d at 1089 (stating [t]he appropriate course of action for an insurer who believes that it is under no obligation to defend, is to provide a defense to the insured under a reservation of its rights to seek reimbursement should the facts at trial prove that the incident resulting in liability was not covered by the policy). 22 Royal asserts that it upheld its defense obligation: it appointed the law firm of Long & Jaudon, and conducted a thorough and diligent internal investigation as to its duty to indemnify. Royal argues that the record indicates that it was prepared to reimburse Travelers for its defense costs as required under Colorado law. See Rec. vol. 2, tab 11.2 (Depo. of Donalee Pelovsky, Royal claims adjuster supervisor); National Cas. Co., 833 P.2d at 747-48. Royal set up a reserve for the claim and avers it was prepared to contribute its share of defense costs and indemnity payment to the extent Signature's claims fell within the coverage of Royal's policy. Royal contends it paid no bills because Travelers paid defense counsel's bills. Royal received no invoices until they were produced in this litigation. 23 But we agree with Signature that although Royal pursued the above actions, these actions do not amount to an active independent defense of Signature's claims. We disagree with the district court's conclusion, and hold that Royal breached its duty to defend by not fully discharging its duty. Rather than discharging its duty to defend, Royal was non-responsive to settlement overtures, failed to communicate with its insured, and failed to fully cooperate in settlement negotiations. See Kornbluth, 471 P.2d at 612. Although Colorado courts have not specifically addressed the issue, we agree that [t]he fortuitous existence of another insurer who [wa]s willing to meet its own obligations did not excuse Royal from discharging its duty to defend. Aetna Cas. & Sur. Co. v. Coronet Ins. Co., 358 N.E.2d 914, 917 (Ill. Ct. App. 1976); see Lujan, 501 P.2d at 677. Finally, the district court's determination of noncoverage as to Royal's policy might have been a defense to the claims in the underlying action, but the district court's noncoverage ruling did not excuse Royal from fully defending the claims in the first instance. 24
25 Having determined that Royal breached its duty to defend, we turn now to what damages Signature has incurred. As determined above, the presence of another insurer will not protect Royal from breach of its duty to defend. Again we are faced with a issue that Colorado courts have not squarely addressed. Royal reminds us that Signature received a competent defense and it voluntarily entered an apparently favorable and reasonable settlement agreement. See, e.g., Employers' Fire Ins. Co. v. Western Guar. Fund Servs., 924 P.2d 1107, 1113 (Colo. Ct. App. 1996) (holding where insureds were not undefended, alternate insurer's refusal to defend... caused the [insureds] no harm). Signature's acceptance of a portion of Travelers' right to attorneys' fees from Royal is not evidence of damages flowing from Royal's breach. When Signature accepted the assignment, it had already received the reservation of rights, and was aware that Royal might be entitled to reimbursement had Royal paid any fees. 26 However, to hold that Royal is insulated from contributing any defense costs because Royal notified Signature of its reservation of rights to seek reimbursement should we determine that the events were covered by Royal's policy would amount to permitting the insurer to do indirectly what it cannot do directly. See National Cas. Co., 833 P.2d at 747 (stating that to find insurer not responsible for contribution would be to reward insurer for refusing to honor its contractual obligations by failing to defend a lawsuit brought against the insured that falls within the terms of the policy). Hecla Mining Co. demands that an insurer notify the insured of its reservation of rights and requires the insurer to provide a defense. 811 P.2d at 1089; see also State v. Pacific Indem. Co., 63 Cal. App. 4th 1535, 1546-47 (1998) (The insurer must preserve its right to seek reimbursement by undertaking the defense of its insured upon an express reservation of rights, a reservation the insurer may unilaterally impose.) (emphasis added). 27 Signature had a contract right to have actions against it defended by Royal, at Royal's expense, subject to Royal's reservation of its rights. A reservation of rights agreement serves to furnish temporary protection to an insured, even though [as in this case] it may turn out that the insured was not entitled to such protection. 14 Couch on Ins. § 202:38. We have held Royal in breach of that contractual duty because Royal offered little or no protection to its insured. Further, Royal did not seek a declaratory judgment as to its duty after the underlying litigation was resolved. See Hecla Mining Co., 811 P.2d at 1089 (The appropriate course of action for an insurer who believes that it is under no obligation to defend, is to provide a defense to the insured under a reservation of its rights to seek reimbursement should the facts at trial prove that the incident resulting in liability was not covered by the policy, or to file a declaratory judgment action after the underlying case has been adjudicated.). We cannot allow Royal to benefit from its breach, for to do so compels the insured to bear the expense of the litigation, and Signature is actually no better off financially that if it never had the contract right of a defense from Royal. See National Cas. Co., 833 P.2d at 747; cf. Willis Corroon Corp. v. The Home Ins. Co., 203 F.3d 449, 453 (7th Cir. 2000) (en banc) (holding that, under Illinois law, where insurer mishandled a defense which it undertook under a reservation of rights and left [insured] in the lurch to allow insurer to blatant[ly] manipulat[e] the law and file a twelfth-hour declaratory judgment action would encourage the worst possible behavior.). A natural and proximate result of Royal's breach was the participation by Traveler's as the only insurer in the continued litigation and settlement proceedings. Traveler's subsequently assigned its rights to seek contribution from Royal to Signature. We hold that Signature is therefore entitled to receive from Royal a pro rata portion of attorney fees, costs and expenses incurred in reaching settlement in the underlying litigation. See National Cas. Co., 833 P.2d at 747-48.
28 Signature contends that because Royal failed to adequately defend under a reservation of rights, Royal is estopped from challenging coverage under the policy. Colorado subscribes to the majority view that an insurer who believes that it is under no obligation to defend must provide a defense if the allegations in the underlying complaint might fall within coverage of the policy. Hecla Mining Co., 811 P.2d at 1089. 29 As discussed above, an insurer may provide a defense subject to a reservation of rights to seek reimbursement should the facts at trial provide that the incident resulting in liability was not covered by the policy. Id.; see Employers' Fire Ins. Co., 924 P.2d at 1113 (stating that insurer's letter was sufficient to reserve insurer's right to contest insured's claim for payment of defense costs). The duty to defend continues until the insurer can establish that the allegations in the complaint are solely and entirely within the exclusion in the insurance policy. Hecla Mining Co., 811 P.2d at 1090. An insurer is not excused from its duty to defend unless there is no factual or legal basis on which the insurer might eventually be held liable to indemnify the insured. Id. at 1090. 30 Although Colorado courts have stressed the distinction between the duty to defend and the duty to indemnify, they have not specifically addressed whether an insurer who breaches its duty to defend is consequently estopped from challenging the duty to indemnify. Signature contends that we should follow the minority view, and hold that Royal is estopped from challenging coverage See, e.g., Underwriters at Lloyds v. Denali Seafoods, 927 F.2d 459, 462-65 (9th Cir. 1991) (applying Washington law and holding that insurer who breaches duty to defend cannot contest coverage); St. Paul Fire & Marine Ins. Co. v. Vigilant Ins. Co., 919 F.2d 235, 240 (4th Cir. 1990) (same, applying North Carolina law); Flannery v. Allstate Ins. Co., 49 F. Supp.2d 1223, 1227 (D. Colo. 1999) (considering majority and minority viewpoints as to ability of an insurer to contest coverage when it has breached duty to defend). Royal argues that we should adopt the majority view that a breach of the duty to defend is a breach of contract separate and apart from the duty to indemnify. See, e.g., Western Alliance Ins.Co. v. Northern Ins. Co. of N.Y., 176 F.3d 825, 828 (5th Cir. 1999) (applying Texas law, noting that [e]ven if an insurer breaches the broad duty to defend, it is not in all respects estopped from challenging the duty to indemnify and the duty to indemnity may turn on the facts in the underlying lawsuit, not the allegations of the complaint). 31 We consider state court decisions, decisions of other states, federal decisions, and the general weight and trend of authority in anticipating how the Colorado Supreme Court will address an issue. Armijo v. Ex Cam, Inc., 843 F.2d 406, 407 (10th Cir. 1988). Colorado has repeatedly recognized the separate and distinct nature of the duties to defend and indemnify. We are inclined to agree with the District Court of Colorado's analysis and conclusion in Flannery, 49 F. Supp.2d at 227, that Colorado will likely join the majority of jurisdictions in holding that an insurer who breaches its duty to defend may contest coverage. This approach is consistent with the doctrinal distinction between the duty to defend and the separate duty to indemnify. See, e.g., Hecla Mining Co., 811 P.2d at 1086; Flannery, 49 F. Supp.2d at 1228-29 (noting that Colorado law suggests that an insurer does not forfeit its right to contest coverage when it has breached its obligation to defend the insured); Colorado Farm Bureau Mut. Ins. Co. v. Snowbarger, 934 P.2d 909, 911 (Colo. Ct. App. 1997) (Moreover, a liability insurer has no duty either to defend or to indemnify if it can establish that the factual allegations in the underlying complaint that is solely and entirely within the policy's exclusions.). Thus, when an insurer breaches its duty to defend, the insured is entitled to receive compensation for any prejudice the insured may have suffered as a result of the breach. Hamlin, Inc. v. Hartford Accident & Indem. Co., 86 F.3d 93, 94-95 (7th Cir. 1996) (giving example of prejudice suffered by insured and stating If the lack of a defender causes the insured to throw in the towel in the suit against it, the insurer may find itself obligated to pay the entire resulting judgment or settlement even if it can prove lack of coverage.); see Denali Seafoods, Inc., 927 F.2d at 464 (offering instances in which insured might be able to establish prejudice based upon insured's reliance of insurer's defense). 32 Because we hold that Royal may raise coverage defenses where there exists a duty to defend, we next consider the district court's grant of summary judgment to Royal based upon the absence of evidence that any damages occurred during Royal's policy period. 33