Duty to Defend

Study guide: Exam 6C

The Duty to Defend is the liability insurer's obligation to provide and pay for the defence of a claim against its insured. It is broader than the duty to indemnify: it is triggered by the allegations in the pleadings, not by what is ultimately proven, so an insurer must defend a claim it may never have to pay.

\text{Duty to defend} \supset \text{Duty to indemnify}

• The pleadings rule. A court reads the statement of claim and asks whether any allegation, if proven, would fall within coverage. If so, the insurer must defend the entire action — including the uncovered allegations bundled with it. Ambiguity is resolved in favour of the duty.
• Reservation of rights. Where coverage is uncertain, the insurer defends while expressly reserving its right to deny indemnity later. Defending without reserving rights can waive the coverage defence; refusing to defend and being found wrong exposes the insurer to the insured's own defence costs and to a bad faith claim.
• Conflict of interest. When the defence could be conducted so as to steer the outcome toward an uncovered allegation, the insured is entitled to independent counsel at the insurer's expense — a significant and often-underestimated cost exposure.
• Defence costs and the limit. Whether defence costs erode the limit ("wasting" or "defence within limits" policies, common in professional liability) or sit outside it changes the insurer's total exposure materially and must be reflected in reserving.
• Actuarial significance. Defence cost is ALAE and, on liability lines with a broad duty to defend, can rival indemnity in size. Because it accrues steadily through litigation while indemnity lands at settlement, it develops on a different pattern — the reason a combined loss-and-ALAE triangle can mislead.
• The duty ends when the limit is exhausted by payment, or when it becomes clear no covered allegation remains — but not merely because the insurer believes the claim is meritless.

Mixed Allegations A contractor is sued for \$2 million. The claim alleges (a) negligent construction causing water damage, which the CGL policy covers, and (b) intentional misrepresentation in the contract, which the policy expressly excludes. The insurer's counsel believes allegation (a) is weak and (b) is the plaintiff's real case.

Must the insurer defend?

Answer Yes — the whole action. The pleadings contain an allegation (negligent construction) that would fall within coverage if proven. That triggers the duty regardless of how weak the insurer thinks it is, and the duty extends to the entire defence because the covered and uncovered allegations arise from the same facts and cannot be defended separately.

What the insurer should do:

1. Defend under a reservation of rights, specifying that the misrepresentation allegation is excluded and that indemnity for it is denied.
2. Consider independent counsel. There is a live conflict: insurer-appointed counsel could conduct the defence so that any liability found is characterised as intentional rather than negligent — an outcome good for the insurer and disastrous for the insured. Where that conflict exists, the insured chooses counsel and the insurer pays.
3. Reserve for defence cost regardless of indemnity. Even if the insured is ultimately found liable only for misrepresentation and the insurer pays no indemnity, the defence cost — plausibly several hundred thousand dollars — is a real and certain loss.

What the insurer may not do is decline to defend because it expects to win on coverage. If it is wrong, it pays the insured's defence costs, loses control of the defence, and faces a bad-faith claim on top.