A recent Fifth Circuit decision highlights the difference between an insurer’s duty to defend and a duty to indemnify and emphasizes that business owners should fully understand their insurance policies to ensure they will receive the benefits they expect under such policies.
Duty to Defend vs. Duty to Indemnify
An insurer’s duty to defend means that, when you timely report a covered claim against you, the insurer must appoint and pay for defense counsel to defend you against the claim. If you decide to appoint your own counsel, in most jurisdictions the duty to defend requires the insurer to reimburse you for those costs.
Conversely, the insurer’s duty to indemnify means the insurer’s only obligation is to pay the claim by funding a settlement or paying a judgment on behalf of the insured. An insurer’s duty to indemnify is limited to the amount of the policy limit.
Liberty Mutual v. Copart of Connecticut
In Liberty Mutual v. Copart the Fifth Circuit clarified the scope of inquiry to determine whether an insurer has a duty to defend, a duty to indemnify, or both. A group of homeowners sued Copart, a car auction company, alleging that after heavy rains, pollutants from Copart’s lot ran into a nearby stream, causing aesthetic and material damage to their properties.
Copart had insurance policies with Liberty Mutual during this time period. Given certain pollution exclusions in the relevant policies, the parties disputed whether Liberty Mutual had a duty to defend or indemnify Copart in this lawsuit. The District Court found that the pollution exclusion was clear and unambiguous, such that Liberty Mutual had no duty to defend Copart. The lower court reasoned that because Liberty Mutual had no duty to defend Copart, there was also no duty to indemnify. Based on that holding, Copart appealed.
What triggers the duty to defend?
An insurer’s duty to defend is determined by the “eight-corners rule” which states that the court may only look at the four corners of the policy and the four corners of the petition or complaint. Richards v. State Farm Lloyds, 597 S. W. 3d 492, 494 (Tex. 2020). The court may not consider facts ascertained before the suit, developed in litigation, or by the ultimate outcome of the suit. Courts may not consider hypothetical factual scenarios which may trigger coverage. As such, the analysis focuses exclusively on the facts alleged in the pleadings.
On appeal, the Fifth Circuit held that the pollution exclusion covered the claims alleged in the complaint. To trigger the duty to defend, Copart had the burden to identify allegations of harm in the complaint attributable to a covered source (i.e., something other than the pollutants, which were excluded from the policy). Copart argued that it’s possible that flowing storm water alone caused damage to the plaintiff’s properties. However, the “eight-corners rule” bound the court to look only at the allegations in the complaint. Despite the possibility of damages not covered by the pollution exclusions, the court could not consider alternate hypothetical sources of the damage which were not mentioned in the plaintiff’s complaint when determining whether a duty to defend exists.
What triggers the duty to indemnify?
Unlike the duty to defend, whether an insurer has the duty to indemnify cannot be ascertained until the completion of litigation when potential liability is established. The duty to indemnify can exist even where there is no duty to defend. Colony Ins. Co v. Peachtree Const., Ltd., 647 F.3d 248, 253-54 (5th Cir. 2011). Evidence ascertained during trial which shows that the defendant is liable for damages not excluded by the policy may trigger the duty to indemnify.
In Liberty Mutual v. Copart, the district court erred by finding no duty to indemnify at the summary judgment stage. Evidence arising from or related to the underlying suit may later reveal the non-pollutants caused the plaintiff’s damage. The same hypothetical situations that cannot establish the duty to defend may later trigger the duty to indemnify if found to be based in fact at trial.
Key Takeaways for Business Owners
- Duty to Defend: When the complaint alleges harm covered by your insurance policy, the insurance company may have a duty to defend the claim on your behalf or reimburse you for legal costs. If the complaint mentions only harms that are subject to exclusion, the court may not entertain alternate theories about the source of damage that are not mentioned in the complaint.
- Duty to Indemnify: Even when the insurer does not have a duty to defend if underlying facts ascertained at trial establish that your insurance policy covers the incident, the insurer may have the duty to indemnify you for any damages up to your policy limit, regardless of whether a duty to defend exists.
- Understanding Your Policy: It is essential that you fully understand your insurance policies. This includes any exclusions that may allow the insurance company to avoid defending or indemnifying you in the event of a lawsuit. It is also important to know your policy limits and consider an umbrella policy to ensure potential damages don’t exceed the limits within your policy.
- Evaluate your risks: While it is impossible to imagine every situation for which your company may be liable, consider your risks and evaluate them against the coverages and exclusions in your policy.