There is a host of well established legal principles that govern insurers’ defense obligation under the standard liability insurance policy where the insurer has the duty to defend the insureds. But many professional liability insurance policies are not written on with the duty on the insurer to defend (which is usually described as a “duty to defend” basis). Because many professionals want to control their own defense, liability insurance for these professionals often provides that the insured professionals will defend themselves, with the obligation on the insurer to advance defense expenses as they are incurred, subject to all of the policy’s terms and conditions.

Because the defense obligations under the more traditional duty to defend coverage are well established and are more familiar to many courts, the courts all too often attempt to resolve issues arising under duty to advance policies by referring to principles developed with regard to duty to defend policies.

A recent Central District of California decision in a dispute arising under a legal malpractice policy takes an interesting look at these issues. In an August 21, 2012 opinion (here), Judge James V. Selna, applying California law, rejected the insured’s arguments to have the malpractice insurer’s duty to advance obligations determined under duty to defend principles, and applying the more stringent principles  the court determined to be applicable to the insurer’s duty to advance, the court concluded that the insurer did not have the duty to advance the insured’s defense expenses he incurred in a dispute between the insured and his former law firm.

Background

Between May 2007 and March 2008, Gregory Glenn Petersen was an attorney with and shareholder of the Jackson, DeMarco, Tidius & Peckenpaugh law firm (JDTP). Before, during and after the time Petersen was with JDTP, he represented the San Diego Police Officers’ Association (SPDOA), as well as several individual police officers in litigation related to employment benefits and labor negotiations. The SPDOA and the individual officers later terminated Petersen as their counsel, and subsequently brought a legal malpractice action against, inter alia, JDTP and Petersen.

JDTP’s professional liability insurer paid all of JDTP’s and Petersen’s defense costs incurred in excess of the policy’s $150,000 retention. JDTP paid the retention amount. The malpractice action ended in a settlement that the insurer funded under the policy.

Thereafter, JDTP served an arbitration demand on Petersen, in which, as amended, JDTP sought to recover its payment of the $150,000 retention, as well as about $100,000 in fees the firm allegedly incurred in dealing with Petersen’s departure from JDTP and in connection with the malpractice cases. Petersen submitted the arbitration dispute as a claim under JDTP’s professional liability insurance policy, seeking to have the insurer fund his defense and indemnify him. The insurer denied coverage for the dispute and Petersen filed an action for declaratory judgment against the insurer and for damages. In his declaratory judgment claim, Petersen sought a judicial declaration that the insurer has an immediate duty to advance his expenses incurred in defending against the JDTP arbitration claim. The parties filed cross-motions for summary judgment.

Among other things, JDTP’s professional liability insurance policy provides that “the Assureds and not the Company have the duty to defend Claims” (the “Company” being a reference to the insurance company), providing further that, subject to the policy’s other terms and conditions, “the Company on behalf of the Assureds shall Advance Claim Expenses … in excess of the applicable RETENTION, if any, before the final disposition of a Claim against the Assureds.”

The August 21 Opinion

In seeking a judicial declaration that the insurer must advance his defense expenses, Petersen argued in reliance on principles established under duty to defend policies that “to prevail on his claims he need only show a possibility that there is a covered claim.” He reasoned that “the duty to advance claims expenses is sufficiently analogous to the duty to defend that the same standard should apply.” The insurer argued that the “possibility of coverage” standard and other rules of law governing a policy with a duty to defend do not apply to a policy containing only a duty to advance claims expenses.

The court reviewed several cases on which the parties relied, determining first that the courts have indeed differentiated the duty to advance claims expenses from the duty to defend. Judge Selna also reviewed a decision on which Petersen sought to rely arising out of the WorldCom securities litigation and under New York law. Judge Selna discounted that case because it arose under New York law rather than California law, and concluded in any event that it was not persuasive of Petersen’s position.

After considering the cases applying California law and arising under policies providing for a duty to advance defense expenses rather than a duty to defend, Judge Selna turned to the policy in dispute. He noted to the “policy provides for the claims expenses to be advanced subject to several conditions”, including the insured’s obligation to obtain the insurer’s consent to reasonable attorneys’ fees and to settlements; as well as subject to the policy’s allocation provisions. Combined with the policy’s “explicit disclaimer of any duty to defend,” Judge Selna found that the policy “is not consistent with the broader duty to defend.”

Accordingly, Judge Selna determined that he “will not apply any legal rule … based on a duty to defend policy to the present case” and concluded that Petersen had the burden of establishing “that the underlying claims are within the basic scope of coverage.”

Judge Selna then proceeded to determination that the claims presented within JDTP’s arbitration demand were within the policy’s scope of coverage, he ruled that “the uncontroverted facts show beyond a genuine issue of material fact that the arbitration asserted against Peterson does not require the Insurers to advance claims expenses because he is not covered by the Policy.” Judge Selna granted the insurer’s motion for summary judgment and denied Petersen’s  cross-motion.

Discussion

In my current professional role as a representative of policyholders’ interests, I often read cases these days rooting for the policyholders. But for a large part of my career, I represented insurers’ interests, both as an advocate and as an advisor. I recall all too well from those days representing insurers how vexing it was when courts were insufficiently precise in their understanding of insurer’s policy obligations. I found it particularly confounding when courts would blur the lines and apply principles applicable to the duty to defend policies in the determination of insurer’s obligations under duty to advance policies.

Even though these days I root for policyholders’ interests when reading case decisions,in the end, what I really want is for coverage disputes to be resolved based on a correct judicial understanding of the parties’ respective obligations under the insurance policy. In this case, the court correctly understood the insurer’s defense obligations and correctly declined to apply principles derived from duty to defend cases to the determination of the insurer’s obligations.

In the long haul, all parties’ interests will be served if coverage disputes are resolved based upon a correct judicial understanding of the parties’ policy obligations. In particular, all parties’ interests will be served if courts do not inappropriately seek to determine carriers’ obligations under a duty to advance policy applying principles determined in connection with duty to defend policies.

One thing that should be clear from all of this is the basic point that insurers’ obligations under a duty to advance policy are different from insurers’ obligations under duty to defend policies. In some situations, policyholders have a choice of which kind of defense provisions to have in their policies (this is particularly true in the private company D&O insurance context).

It is critically important when the policyholder is choosing which kind of defense arrangement to have in its policy for the policyholder to be fully informed about the differences in the kinds of defense arrangements. There are advantages and disadvantages to each type of arrangement; being able to understand and explain these differences requires an informed understanding of the claims process and how the difference defense arrangements might affect future claims. This is one more reason why it is particularly important to have an experienced and knowledgeable advisor involved in the professional liability insurance placement process.

Special thanks to a loyal reader for providing me with a copy of the August 21 opinion.