Duty to Indemnify Determination Premature While Liability Case is Pending

Insurance companies often are first out of the box to file a declaratory judgement action concerning coverage.  Many times the goal of the insurer is to cut off its duty to defend its policyholder in a pending liability lawsuit.  Because the duty to defend is broader than the duty to indemnify, to successfully avoid its coverage obligations the insurance company must demonstrate that there is no possibility that it can be responsible to indemnify its policyholder against any potential outcome in the underlying litigation.

When a carrier is quick to file a declaratory judgment action, the policyholder is put in a difficult position.  The policyholder is already defending itself against a claim for damages, and is incurring substantial defense costs.  If the policyholder loses its coverage it may not be able to afford to defend the case, and a substantial uncovered judgment could put a policyholder out of business.  The insurer’s declaratory judgment action opens a second front in the war against the policyholder at the very time that the insurer should be protecting its policyholder against the underlying suit.

The policyholder in Caitlin Syndicate 2003 v. Ray Anthony International, LLC (S.D. Fla. Case No. 11-cv-61294-KMM) recently was placed in this precarious position by its insurer, a Lloyd’s syndicate.  The policyholder provided crane services on a construction project when a crane collapsed, resulting in a liability claim.  While the policyholder was fighting the liability claim in state court, its insurer filed a declaratory judgment action in federal court seeking a declaration that the insurer was not obligated to indemnify the policyholder.  Southern District of Florida Judge K. Michael Moore correctly noted in his December 21, 2011 decision that the duty to indemnify was not ripe for adjudication, since the state court action was pending, and the basis for the policyholder’s liability (and, hence, the basis for coverage) was undetermined.  Therefore, Judge Moore granted the policyholder’s motion to stay the coverage action pending resolution of the underlying state court action.

Strategically, it is usually best for policyholders to avoid a coverage fight when the underlying claim is still pending and the insurer is paying the defense fees.  When fighting a coverage battle, policyholders often must demonstrate the basis for the claim against them, potentially putting them in the awkward position of taking the side of the claimant.  In addition, discovery in the coverage case can lead to an unwanted treasure trove of information for the claimant.  No policyholder wants to walk the tightrope involved in responding to discovery requests propounded by both the claimant and its own insurer on the same claim.

There are instances, however, when it is best for the policyholder to obtain guidance from the court as to whether indemnity coverage exists.  For example, a case may be difficult to settle if the insurer is defending under reservation of rights but refuses to contribute meaningfully to settlement because it believes it has strong coverage defenses.  A claimant may also benefit from an early coverage determination if the policyholder is judgment-proof absent insurance.  It is frequently the case that settlement of a liability action turns on the availability of coverage, and none of the parties wants to waste their time litigating the underlying liability case if there ultimately will be no insurance available to pay a judgment.

Most courts (particularly federal courts) will stay a determination as to the duty to indemnify if the policyholder requests it.  If the coverage action is stayed, it is best to keep coverage counsel involved in the underlying case to avoid development of a record that will be unfavorable to a coverage determination later on.  Although the coverage battle may be postponed, a carrier that files an early declaratory judgment action is sure to put up a coverage fight later on.  A well-prepared policyholder will be ready when that time comes.