GUEST POST: MORE ABOUT THE DUTY TO ADVANCE COSTS & DUTY TO DEFEND
(Originally published on September 12, 2012 at D&O Diary)
As a regular reader of Kevin’s blog, I always find it be well-written, informative and timely – it is truly a great resource and I am thankful to him for helping me stay up-to-date on a variety of management liability issues (as well as the opportunity to submit this guest blog). And while I also find myself in agreement with the majority of his substantive commentary, I felt compelled to provide a different perspective on the Petersen v. Columbia Casualty he discussed here. (For the record, I had no involvement in the Petersen case.)
As discussed in greater detail there, Petersen ostensibly addressed the standard for determining whether an insurer must advance defense costs under a non-duty to defend policy. For Kevin, “the court [in Petersen] 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.” From my perspective, however, the court’s decision on the standard applicable to non-duty to defend policies did not expressly consider, and is in any event difficult to reconcile with, established Ninth Circuit precedent. (I’ll leave for others the issue of whether there is any actual conflict between our two stated perspectives.)
In refusing to apply duty to defend principles (most notably the principle that defense obligations are triggered by a “mere potential” for coverage) to the analysis of whether an insurer must advance defense costs, the court in Petersen appears to have relied nearly exclusively on Jeff Tracy, Inc. v. U.S. Specialty Ins. Co., 636 F. Supp. 2d 995 (C.D.Cal. 2009). Further, both Petersen and Jeff Tracy suggested that the only support for the insured’s “mere potential” argument was Gon v. First State Ins. Co. 871 F.2d 863 (9th Cir. 1989), which both courts distinguished as addressing the timing of when an insurer must begin to advance defense costs, not the method of determining whether such a duty exists in the first instance. Thus, in both Jeff Tracy and Petersen, the Central District concluded in one form or another that “the Ninth Circuit did not hold [in Gon] that the duty to defend or ‘potential for coverage’ standard still applied” to non-duty to defend policies. Jeff Tracy at 1003.
Now, admittedly, the specific reach of Gon (and a similar case, Okada v. MGIC Indem. Corp., 823 F.2d 276, 282 (9th Cir.1986)) is a little unclear, but the Ninth Circuit itself regards Gon and Okada as “circuit precedent requiring the advancement of defense costs for potentially covered claims.” Pan Pacific Retail Properties, Inc. v. Gulf Ins. Co., 471 F.3d 961, 970 (9th Cir. 2006). Moreover, although the court in Pan Pacific distinguished Gon and Okada on grounds that those cases are inapplicable when, as in Pan Pacific, the coverage action was brought after the conclusion of the underlying matter, the court made reasonably clear in a separate case that potentiality remains the test when contemporaneous advancement of defense costs is the issue. Unified Western Grocers, Inc. v. Twin City Fire Ins. Co., 457 F.3d 1106, 1112 (9th Cir. 2006).
Unified Western Grocers involved alleged fraudulent transfers in the context of a leveraged buyout. The insurer declined coverage on grounds that the underlying suit effectively constituted an action for restitution based on allegations of intentionally wrongful conduct. And, while the insured countered that the asserted breach of fiduciary duty was at least potentially covered, the insurer argued that the claim for breach of fiduciary duty and its related allegations were, in effect, inseparably intertwined with the non-covered, intentionally wrongful conduct and demand for restitution. Reversing the district court, the Ninth Circuit agreed with the insured, holding that the breach of fiduciary duty claim gave rise to a potential for coverage and the broad allegations of intentionally wrongful conduct did “not automatically subsume all allegations of a negligent character.” Id. at 1114.
As most relevant to this discussion, the Ninth Circuit stated that “[i]n determining whether an unproven claim is covered by an applicable insurance policy, we are reluctant to frame coverage based on isolated allegations in an underlying complaint.” Id. at 1112 (citingGon and the seminal California duty to defend case Gray v. Zurich Ins. Co. (1966) 65 Cal.2d 263 for the proposition that “the third party complainant, who may overstate the claims against the insured, should not be the arbiter of the policy's coverage.”) Based on this, the court applied a potentiality test to the two coverage issues raised by the insurer (intentionally wrongful conduct and restitution), ultimately holding that there remained a possibility of covered liability based on the not-necessarily-intentional conduct alleged in connection with the breach of fiduciary claim and that the relief sought was not necessarily restricted to restitution.
Further, lest one think that the Ninth Circuit missed that it was dealing with what appears to have been a pretty standard D&O policy that did not provide for a duty to defend, the court made clear that while “Gon and Gray involved interpretations of an insurer's duty to defend potentially covered claims” and are “not directly applicable to determining an insurer's duty to indemnify loss,” the determination that the district court’s decision below that there were “no covered claims as a matter of law . . . is closely analogous to the question of whether there is a potentially covered claim.” Id. at 1112 fn.8.
Returning to Petersen, it is difficult to reconcile the court’s apparent rejection of any form of a potentiality test with the precedent discussed above, especially Unified Western Grocers. For example, like Unified Western Grocers and unlike Pan Pacific, coverage in Petersen was determined during the pendency of the underlying litigation. Further, while it appears that the court in Petersen implicitly distinguished Olympic Club v. Those Interested Underwriters at Lloyd's London, 991 F.2d 497 (9th Cir. 1993) (an earlier Ninth Circuit decision in which the court explicitly held that potentiality is the test for non-duty to defend policies) on grounds that the policy in Olympic Club did not expressly disclaim the insurer’s duty to defend, that would not be sufficient to distinguish Unified Western Grocers as the policy there plainly had no duty to defend. The Petersen court also appears to have distinguished Olympic Club on grounds that the policy in Petersen did not provide coverage for allegations of wrongful conduct, an assertion which does not appear factually accurate, as the definition of “Act” quoted in the Petersen decision encompassed allegations of wrongful conduct.
The court in Petersen also appears to have been swayed by the presence of allocation provisions in the policy, which seems to suggest that the court viewed potentiality and allocation as mutually exclusive, i.e., that one cannot have a potentiality standard without also requiring the insurer to fund 100% of the defense of a mixed suit. Irrespective of the rationale, the policy’s allocation provisions would not in any event appear to be an adequate basis for distinguishing United Western Grocers, as the policy at issue there also contained an allocation provision. Lastly, while Unified Western Grocers did not mention the final policy attribute cited as militating against a potentiality standard in Petersen (i.e., that the policy required the insured to consult with the insurer before incurring defense costs), it is hard to imagine that factor being significant, especially since the “power of the purse” control that language provides the insurer makes the policy more akin to a duty to defend policy, arguably making it more appropriate to apply principles developed under duty to defend policies.
It seems worth noting that the Petersen court’s decision on the standard applicable to determining whether an insurer must advance defense costs could be considered dicta, as it is not clear from the recited facts that application of a potentiality standard would have yielded a different result. Nevertheless, whether dealt with on that basis or otherwise, I would question the suggestion that Petersen (or Jeff Tracy for that matter) represents the law in California federal courts concerning the duty to advance defense costs.