Liability insurance coverage should always be an initial consideration when any business faces a claim or lawsuit. Do we have coverage for that? Ideally, the answer is an unqualified “yes.” In reality, the answer from an insurer is typically something less. A common response from the insurer is a “reservation of rights,” often in the form of a multipage letter filled with policy language and legal jargon. In the end, the insurer agrees to “defend” but subject to a reservation of multiple rights, including the right to withdraw the defense and/or deny any indemnity obligation. This article begins to address the practical impact of such a letter by exploring the difference between an insurer’s defense and indemnity obligations under Mississippi law.
The duties to defend and indemnify are two primary obligations owed by a liability insurer after a policyholder makes a claim. These obligations arise from and will be controlled by the insurance contract (the policy) at issue. For example, a commercial general liability policy might include language in the first few pages that reads:
We will pay those sums that the insured becomes legally obligated to pay as damages to which this insurance applies. We will have the right and duty to defend the insured against any “suit” seeking those damages. However, we will have no duty to defend the insured against any “suit” seeking damages for “bodily injury” or “property damage” to which this insurance does not apply.
That language establishes two benefits to the policyholder. First, if the policyholder faces a claim of liability within the scope of the insurance policy, then the insurance company will hire a lawyer to represent the policyholder and will pay the fees, costs, and expenses related to the investigation and defense (“the duty to defend”). In most liability policies, payments made by the insurer to defend do not reduce the available policy limits. Second, if the policyholder faces a judgment after the defense, then the insurance company will pay the judgment subject to the terms and limits of the policy (“the duty to indemnify”). Thus, when an insurer reserves its rights, it may later attempt to withdraw from the duty to defend or deny any indemnity obligation.
On a practical level, and for several reasons, the duty to defend often plays a much larger role than the duty to indemnify. More than 90% of lawsuits settle before trial, so the threat of a judgment for which indemnity would be needed is eliminated. Those settlements are often driven by the defendant’s desire to avoid the ongoing cost of litigation, including attorneys’ fees. Further, the funds used to settle may consist of reallocated future defense reserves. However, if the case goes to trial, the defense may become prohibitively expensive. Uninsured costs of litigation can drive companies into the ground, even if there is no merit to the allegations made by the plaintiff.
For all of these reasons, getting an insurer on board to provide a defense may be essential. So, how does that happen? Mississippi recognizes a number of established rules in this context, and each requires application to the particular facts at hand. Nevertheless, the rules provide a foundation for almost any dispute over an insurer’s obligation to defend.
First, the duty to defend is broader than the duty to indemnify. An insurer may be obligated to hire counsel to defend a lawsuit even if the lawsuit contains some allegations that, if proven true, would not be covered under the policy. For example, a lawsuit may allege that an employee either negligently (accidentally) or intentionally caused harm to the plaintiff. Even though intentional misconduct might not be covered by the policy, the insurer should provide a defense if negligence is alleged. Of course, if there is no duty to defend, then there typically will not be any duty to indemnify.
Second, the duty to defend should be determined by reference to the “allegations of the complaint” rule (sometimes known as the “eight corners” rule). The rule states that two documents—the policy and the complaint—should be considered in making a determination. Even if the allegations bear no relation to the truth, they should be accepted as true when undertaking coverage analysis. There is an exception to the rule when an insurer knows of true facts that would trigger coverage, even if those facts are not alleged. In that instance, the insurer should still provide a defense.
Third, if a lawsuit makes allegations that are even arguably within the scope of coverage, then the duty to defend arises. This rule becomes important when faced with vague or ambiguous allegations or policy terms. If there is any room for debate, Mississippi law requires that the insurer provide a defense unless and until it becomes clear that all claims are beyond the scope of coverage.
There are a number of other rules that apply, but these three provide the critical starting point. They may also be the most important rules for policyholders seeking coverage to keep in mind, particularly if an insurer forgets them.
The takeaway is to be aware of and sensitive to the unique nature of the duty to defend. Unless an insurer provides the rare unequivocal “yes” to a request for liability coverage, a policyholder may need to understand and use Mississippi’s law to enhance the chances of facing the lawsuit with some coverage. Perhaps most important, a denial letter from an insurer may need to be viewed as merely the first step in negotiations that will result in full or partial coverage for a lawsuit.