The thesis of this article is that a liability insurer, in determining whether it has a duty to defend a suit against one claiming to be an insured should be entitled to consider any evidence extrinsic to the complaint against the insured that bears on facts not at issue in the suit it has been called upon to defend; in certain circumstances, it may even be entitled to consider evidence bearing on facts that are at issue in that suit. That issue is now in dispute in the process of drafting a “Restatement of the Law of Liability Insurance.” This article will describe the dispute and criticize both of the competing drafts.
II. The Restatement and Extrinsic Evidence
The Restatement reflects conventional doctrine on the breadth of the duty to defend: “An insurer that has issued a liability insurance policy that includes a duty to defend must defend any legal action brought against an insured that is based in whole or part on any allegations that, if proven, would be covered by the policy, without regard to the merits of those allegations.”
Courts in different jurisdictions take a variety of views on the use of extrinsic evidence in determining the duty to defend. Under the Restatement, a defense must be provided, not only when a potentially covered claim appears from the face of the complaint, but also when such a claim appears based on “[a]ny additional allegation, not contained in the complaint or comparable document stating the legal action, that a reasonable insurer would regard as an actual or potential basis for all or part of the action.” In contrast to this use of extrinsic evidence to trigger a duty to defend, the Restatement clearly states that
[t]he general rule is that insurers may not use facts outside the complaint as a basis for refusing to defend, with the result that even an insurer with a strong factual basis for contesting coverage must defend under a reservation of rights and then file a declaratory-judgment action in order to avoid a duty to defend.
The precise scope of the exceptions to this rule is unsettled, because the relevant section of the Restatement was amended at the Annual Meeting. The amendment has not yet been submitted to the ALI Council, so neither the Tentative Draft (approved by the Council) nor the amended version is the policy of the ALI (because concurrence of both the Council and the Annual Meeting is necessary for such policy). The Tentative Draft provided that:
Unless undisputed facts that are not at issue or potentially at issue in the complaint or comparable document stating the legal action for which a defense is sought establish as a matter of law that the legal action is not covered, the insurer must defend until its duty to defend is terminated.
Under the amended version, an insurer may use extrinsic evidence to deny the duty to defend only in three specified situations:
(1) when undisputed facts demonstrate that the defendant in the action is not an insured under the insurance policy pursuant to which the duty to defend is asserted, (2) when undisputed facts demonstrate that the automobile involved in the accident at issue was not a covered automobile under the insurance policy pursuant to which the duty to defend is asserted, and (3) when undisputed facts demonstrate that a claim was reported late under a claims-made-and-reported policy in circumstances in which the notice-prejudice rule does not apply.
Under either version, the insurer may, in other types of cases, seek a declaratory judgment that there is no duty to defend and may utilize extrinsic evidence in that action. Moreover, if all of the facts and circumstances would have permitted the insurer to deny the defense, it can withdraw from a defense that it has undertaken.
While some jurisdictions allow an insurer to consider a broader range of extrinsic evidence as a basis for denying a defense (at the risk of breaching the duty to defend if its view of those facts turns out to be incorrect), that rule is rejected.
The problem with this approach is the uncertainty it creates for insureds, who would in a wider range of situations be put in a position of having to finance their own defense and then to bring a separate breach-of contract action against their insurers to recoup those costs. The possibility of such an after-the-fact remedy would be of little comfort to insureds, who would find such litigation expensive and daunting. By contrast, under the rule followed in this Section …, there is substantially less uncertainty borne by insureds regarding when they can expect to receive a defense from their liability insurer. As long as the complaint contains allegations that if proven, would form the basis of a covered action, or the insured can offer evidence outside of the complaint that supports coverage, the insured can be confident of receiving a defense.