The Ninth Circuit recently reaffirmed the California legal standards that mandate that insurers defend their insureds where the insured would reasonably expect a defense, and that a third party plaintiff’s factual allegations, not its legal conclusions, govern the duty to defend.  Goerner v. Axis Reinsurance Co., 2010 U.S. App. LEXIS 21624 (Oct. 20, 2010, 9th Cir. unpublished). 

In Goerner, the plaintiff was insured under a D&O policy issued by Axis in his role as the CEO of his employer entity.  Specifically, the policy provided defense and indemnity “for ‘any actual or alleged error’ committed by an insured individual ‘in his capacity as such.’” 

The underlying complaint did not specifically allege that Goerner acted in his capacity as the CEO of the insured when he committed the acts purportedly giving rise to liability.  Indeed, the complaint alleged that Goerner acted on behalf of two separate companies within the same industry as Goerner’s employee, the insured entity. 

Notwithstanding the underlying complaint’s characterization of on whose behalf Goerner acted when he committed the allegedly wrongful acts, the Ninth Circuit found that Axis had a duty to defend.  The Ninth Circuit rejected Axis’ argument that Goerner was not entitled to a defense if the underlying complaint did not specifically allege that Goerner was acting in his official capacity on behalf of the insured entity, even if his actions were directed by his employer’s board of directors. 

Instead, the Ninth Circuit reaffirmed the rule stated in the venerable case Gray v. Zurcih that the guiding principle in the duty to defend analysis is whether “’the insured would reasonably expect a defense.’”  The Ninth Circuit stated the question as “whether the actions at issue in [the underlying complaint] could have been taken by Goerner in his capacity as CEO of [the insured entity] TransDimension.  To establish a duty to defend, ‘the insured must prove the existence of a potential for coverage, while the insurer must estyablish the absence of any such potential.’” (quoting Montrose I)

Because Axis was only able to dispute that Goerner’s actions were taken in his capacity as CEO, as opposed to conclusively establishing that they were not, coverage existed.  Stating the rule from Horace Mann, the Ninth Circuit reaffirmed that the existence of a factual dispute that will ultimately determine coverage, means that the duty to defend exists.  The Ninth Circuit relied on the following facts to find that the duty to defend existed.  Goerner had shown that his former employer TransDimension had business dealings with all of the players in the underlying action.  And, the complaint alleged that TransDimension’s board of directors authorized and paid for Goerner’s travel expenses so that he could meet with two companies in Asia.  Those meetings were an important factual component of one cause of action in the underlying case.

The Ninth Circuit, not surprisingly, got it right.  The California Supreme Court has made it clear that the duty to defend exists whenever there is a mere potential for indemnity coverage.  In this sense, the duty to defend is broader than the duty to indemnify.  In contrast, an insurer seeking to establish that it has no duty to defend must prove the underlying claim cannot possibly be covered.  Thus, as in Goerner, when the existence of coverage turns on a factual issue (e.g., whether the insured was acting in his role as CEO in committing allegedly tortuous acts), the dispute must be resolved in the insured’s favor. 

Other important bedrock principles of the duty to defend are that the duty to defend also exists where “the policy is ambiguous and the insured would reasonably expect the insurer to defend him or her against the suit based on the nature and kind of risk covered by the policy.”  See, e.g., B & E Convalescent Ctr. v. State Comp. Ins. Fund, 8 Cal. App. 4th 78, 99-100 (1992) (“If the coverage provisions in any policy of insurance are unclear or the exclusions are ambiguous, so that a reasonable purchaser of the policy would not realize that the risk is excluded and thus would reasonably expect the insurer to furnish a defense, a defense is required.”).  And, once the duty to defend attaches, it continues until and unless the insurer can prove that there is absolutely no possibility of coverage.