The Duty to Defend in the Contractor’s CGL Insurance Policy
The CGL carrier’s duty to defend an insured contractor for a claim for defective construction can be a huge cost savings tool. But, contractors should be mindful of the benefits and hazards of tendering a defense to its carrier before doing so.
What is the duty to defend?
Commercial general liability (“CGL”) insurance carriers generally owe two separate and distinct obligations to their insureds. The first is the duty to indemnify for covered losses or claims. This is the duty that typically comes to mind in the context of insurance coverage — if the insured suffers a covered loss, the carrier will compensate or reimburse the insured for some or all of that loss (practically speaking, the carrier pays the claimant directly). In doing so, the carrier satisfies its duty to indemnify.
The second obligation is the duty to defend. The International Risk Management Institute defines the duty to defend as “an insurer’s obligation to provide an insured with defense to claims made under a liability insurance policy.” This means that the insurance company has to pay the contractor’s defense costs and attorneys fees in the event of a claim or lawsuit alleging defective construction.
Since this obligation is separate and distinct, carriers may owe a defense to the insured regardless of whether the alleged defect is ultimately found to be covered under the policy’s duty to indemnify. This nuance is important, because losses that are covered under a typical CGL policy are subject to an ever-growing number of exclusions that are set forth in the language of the policy. So, the duty to indemnify covers a very narrow range of losses, but the duty to defend is much broader. While policy exclusions may impact a carrier’s duty to indemnify, they usually won’t impact the duty to defend so long as the potential for coverage is present.
So, when a contractor is sued and the duty to defend is triggered, the insured contractor gets a legal defense it doesn’t have to pay for. But, turning a claim into an insurance carrier isn’t without potential risks.
What are the downsides to turning in a claim?
While this provides an obvious potential for cost savings for the insured, there are a few potential downsides. The first and most obvious concern for any insured is the impact the claim may have on future premiums. This will vary by carrier and on a case-by-case basis. The impact on premiums will depend not only on the costs of defense incurred by the carrier, but also the amount ultimately paid by the carrier to resolve the claim (whether paid toward a judgment in the event of a trial, or toward an out-of-court pre-trial settlement). Thus, contractors should consult with their insurance agent to discuss the potential premium impact before turning in a claim.
Insurance carriers will almost always honor the duty to defend under what is known as a reservation of rights. When the claim is tendered to the carrier and the duty to defend is triggered, the carrier will send the insured a reservation of rights letter informing the insured of some or all of the following: (1) that the carrier has the right to choose the attorney(s) who will defend the suit; (2) that the carrier may withdraw the defense if it determines there is no potential basis for coverage; (3) that the insured may need to retain its own counsel; and (4) that the carrier may ultimately contest coverage as to any damages assessed against the insured at trial.
A recent South Carolina Supreme Court case involved the adequacy of reservation of rights letters, and what carriers must include in these letters in order for them to be effective. In its opinion (found here), the Court determined that a reservation of rights letter failed to adequately articulate the grounds on which the carrier may later contest coverage. As a result, the carrier failed to reserve that right and was liable for the entirety of a jury verdict against the insured contractor, even though many of the damages awarded to the plaintiff owner by the jury were likely excluded from coverage by the language of the contractor’s policy. Because of this case, all carriers will exercise extreme care in drafting reservation of rights letters in the future.
In addition, carriers honoring the duty to defend will exercise some level of decision-making authority as to how the case is ultimately resolved. This means the carrier may ultimately decide to settle the case and pay the claimant in an out-of-court settlement. This settlement amount may be (and often is) more than what the insured believes the claimant’s case is worth, and the amount paid by the carrier could become a factor that affects the insured’s premiums.