Pre-Tender Defense Costs: Who Pays?

Standard CGL Policy Language Regarding Notice of a Claim and Voluntary Payments

The commercial general liability (CGL) policy Conditions section of the standard Insurance Services Office, Inc. (ISO), policy form, in describing the insured's responsibilities in the event of an "occurrence, offense, claim or suit," contains the following provisions:

2. Duties in the Event of Occurrence, Offense, Claim or Suit.

• You must see to it that we are notified as soon as practicable of an "occurrence" or an offense which may result in a claim.
• ***
• If a claim is made or "suit" is brought against any insured, you must:
• ***
• (2) Notify us as soon as practicable.
• You must see to it that we receive written notice of the claim or "suit" as soon as practicable.
• You and any other involved insured must:
• (1) Immediately send us copies of any demands, notices, summonses or legal papers received in connection with the claim or "suit";
• ***
• No insureds will, except at their own cost, voluntarily make a payment, assume any obligation, or incur an expense, other than for first aid, without our consent.

Insured Pays

Jurisdictions finding that an insurer has no responsibility for defense costs incurred by the insured before the insured tenders the defense rely on the policy language and the notion that an insurer cannot incur responsibility or liability for defense costs before being notified of a claim.

In Elan Pharm. Research Corp. v. Employers Ins. of Wausau, 144 F.3d 1372 (11th Cir. 1998), the Eleventh Circuit, applying Georgia law, held as a matter of law that an insurer was not responsible for pre-tender defense costs incurred by the insured. Elan sought reimbursement for 2 months of defense costs it incurred before it forwarded the suit papers to the insurer. The court relied on the language of the conditions provisions of the CGL policy that required notice "as soon as practicable" and that suit papers be forwarded "immediately."

The court explained that requiring the insurer to pay costs incurred before tender would render the "contractual terms necessary to trigger ... [the insurer's] performance under the policy meaningless." Elan at 1381 (citation omitted). Ultimately, the court explained that the insurer's duty to defend was not triggered until the insured notified the insurer and "as a result, [the insurer] is not liable for the litigation expenses ... incurred before that date." Id.

Similarly, the Supreme Court of Wisconsin explained that "a tender of defense is a condition precedent to the creation of a duty to defend" so that an insurer has no liability for pre-tender defense costs. Towne Realty, Inc. v. Zurich Ins. Co., 548 N.W.2d 64, 68 (Wis. 1996). The court explained that the insurer "can only be liable for damages which 'naturally flow' from its breach of a contractual duty"; no such duty exists until the insured puts the insurer on notice of a claim. Towne at 68 (citation omitted, emphasis in original).

While the Towne court found that Zurich ultimately breached its duty to defend the insured, Zurich's breach of the duty to defend did not render it liable for pre-tender defense costs because the policy did not specifically allow this type of cost. The court cited the voluntary payments provision as support for its determination that the only costs or expenses allowable without consent are those for first aid. See e.g., Ethchell v. Royal Ins. Co., 165 F.R.D. 523 (N.D. Cal. 1995) (relying on the voluntary payments provision); see also LaFarge Corp. v. Hartford Cas. Ins. Co., 61 F.3d 389 (5th Cir. 1995) (relying on the voluntary payments provision and concurring that, because there is no duty placed on the insurer until notice, pre-tender defense costs are per se unrecoverable against the insurer even absent a showing of prejudice).

Jurisdictions that allow recovery of pre-tender defense costs link responsibility for pre-tender defense costs to the policy's notice provisions and the case law interpreting that rather than to the policy's provisions regarding the duty to defend. Some of these jurisdictions take the position that "the right to control the defense necessarily attaches as soon as there is something to defend. ... [and that the duty to defend] should attach at the same moment." Sherwood Brands, Inc. v. Hartford Acc. and Indem. Co., 698 A.2d 1078, 1083 (Md. 1997). Moreover, if a jurisdiction treats notice as "merely a covenant that, absent a showing of prejudice, does not excuse the insurer from complying with its duty to defend," the responsibility for pre-tender defense costs becomes a question of the scope of that duty, and not whether the duty exists for pre-tender defense costs in the first instance. Id. at 1085.

Sherwood envisioned three scenarios following delayed notice in which the question of responsibility for pre-tender expenses might arise: (1) the insurer undertakes the defense; (2) the insurer declines the defense, citing the insured's breach of the notice provisions of the policy; and (3) the insurer declines to defend for reasons which it would have asserted regardless of the timing of the notice. See id., at 1085-6. The second scenario turns upon the question of prejudice to the insurer. Id. at 1086. See also Liberty Mut. Ins. Co. v. Black & Decker Corp., 383 F. Supp. 2d 200 (D. Mass. 2004) (adopting the Sherwood reasoning and rationale).

The Sherwood court found the third scenario the easiest to analyze because, if the court ultimately agrees with the insurer's position, "there is no obligation to reimburse the insured for any litigation expenses" and "the timing of the notice has no bearing on the issue." Sherwood at 1086. If, however, the court disagrees, then the insurer is liable for breaching the duty to defend and the damages include responsibility for the insured's defense costs. Similarly, under the first scenario, if the insurer accepts the defense, then the insurer has not breached the duty to defend. Without citation to authority, Sherwood stated that "there is the prospect of a breach if the insurer refuses to reimburse the insured for pre-notice expenses" and, because the insurer would be basing its refusal to pay the pre-notice expenses on the policy's notice provision, the same prejudice analysis of the second scenario would determine responsibility for those expenses. Id. at 1086.

In Smith & Nephew, Inc. v. Federal Ins. Co., 2005 WL 3434819 (W.D. Tenn. 2005), a federal district court applying Tennessee law recognized that no state court had addressed the issue of pre-tender defense costs. However, the court explained that the Tennessee Supreme Court recently "adopted the modern trend and held that in order for forfeiture of an insurance policy to result from an insured's breach of a notice provision, prejudice to the insurer must be shown." Smith & Nephew at 1. See also, BellSouth Telecomm., Inc. v. Church & Tower of Florida, Inc., 2006 WL 626071 (Fla. 3rd DCA 2006) (the insured's violation of a notice requirement does not relieve the insurer's contractual obligation to defend absent prejudice). Relying on the fact that Tennessee no longer treats notice as a condition precedent to coverage, the district court concluded that "a prejudice analysis should apply to both the existence of a duty to defend after late notice, as well as to whether that duty includes pre-notice costs." Smith & Nephew at 2 (internal citation omitted). See also, TPLC, Inc. v. United Nat. Ins. Co., 44 F.3d 1484 (10th Cir. 1995) (applying Pennsylvania law to the question of notice and finding that the insurer cannot avoid paying pre-tender defense costs absent a showing of prejudice).

These two lines of cases provide guidance in determining responsibility for pre-tender defense costs for a jurisdiction that hasn't addressed the question. However, predicting what an undecided jurisdiction might do may not prove as straightforward as these lines of cases might suggest.

Florida, for example, has not considered the issue of responsibility for pre-tender defense costs. Florida allows the insured to recover the cost of defense when the insurer breaches its duty to defend. Florida requires a showing of prejudice to preclude coverage under the policy if the insured breached the policy's notice provisions. See BellSouth, supra.

Application of coverage defenses based on untimely notices falls within Florida's Claims Administration Statute which contains requirements insurers must follow to disclaim coverage based on certain types of coverage defenses under the policy. The Supreme Court of Florida has defined "coverage defense" to mean "a defense to coverage which otherwise exists." AIU Ins. Co. v. Block Marina Inv., Inc., 544 So. 2d 998, 1000 (Fla. 1989). Failure to comply with the statute will prevent an insurer from disclaiming coverage for a breach of the policy conditions (i.e., notice) but will not "bar an insurer from disclaiming liability where a policy or endorsement has expired or where the coverage sought is expressly excluded or otherwise unavailable under the policy or under existing law." Id.

Florida thus draws a distinction between situations where the insured forfeits coverage to which it is otherwise entitled by failing to comply with policy conditions and situations where the coverage sought is not provided by the policy in the first instance. As recognized by the court in LaFarge, supra, "prejudice is only a factor when the insurer is seeking to avoid all coverage for failure to comply with the notice provisions of the policy." LaFarge at 400, n.19.

Sherwood appears to create an illusory distinction between exercising the right to control the defense and the existence of the duty to defend, recognizing that "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 also observing that the right, and correspondingly the duty, arises "as soon as there is something to defend." Sherwood at 1083. Finding that the need for a defense arises at the moment that circumstances exist which give rise to liability, however, fails to recognize that the duty to defend is purely contractual. See Allstate Ins. Co. v. RJT Enterprises, Inc., 692 So. 2d 142 (Fla. 1997) (clarifying that the duty to defend is purely contractual).

The application of Sherwood under Florida law would impermissibly rewrite the contract and impose duties and obligations upon the insurer not contemplated by the contract. This would effectively do away with the insurer's right to control the defense by allowing the insured control until it chose to involve the insurer. Florida recognizes that the right to control the defense is "a valuable one in that it reserves to the insurer the right to protect itself against unwarranted liability claims and is essential in protecting its financial interest in the outcome of litigation." Travelers Indem. Co. of Illinois v. Royal Oak Enter., Inc., 344 F. Supp. 2d 1358, 1374 (M.D. Fla. 2004). Arguably, Florida courts should recognize that disclaiming responsibility for pre-tender defense costs based on the plain meaning of the voluntary payments provision of the policy differs from seeking to avoid coverage by virtue of the insured's failure to promptly notify the insurer of the claim.

Conclusion

Assigning responsibility for pre-tender defense costs based on the notice provisions of the policy mixes apples with oranges. Applying principles that regulate an insurer's ability to entirely disclaim coverage based on late notice to questions of an insurer's responsibility for defense costs voluntarily incurred by the insured before it notified the insurer of the claim divests the insurer of its contractual right to control the defense and ignores the plain language of the policy.