"Additional Insured" Coverage  
 

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   People are often injured on construction sites.  What begins as bodily injury claim against a subcontractor, by an employee of another subcontractor or an employee of the owner, or by a passer-by, can quickly become a complicated coverage case, because the subcontractor listed the contractor as a Named Insured.  You might, for example, insure a subcontractor.  A person has been injured on the worksite, and you receive a letter like this:

It is my understanding that the general contractor did not self-perform any of the relevant construction activities on this project, so that any liability arising out of the project is attributable to the actions of your insured.  Accordingly,  the g.c. and its carrier are looking to you to defend and indemnity them, and reimburse them for their defense costs to date.

Status as an “Additional Insured (also “AI” herein) is not created by the subcontractor’s insurance agent simply providing the general contractor (“g.c” herein) a “Certificate of Insurance.”  AI status may be created by (a) a policy endorsement which specifically names the Additional Insured  or (b) an automatic AI endorsement which provides that if the subcontractor contracts to name the g.c. as an AI, the g.c. is automatically named an AI.

Some carriers use an endorsement Form No. CG2033, edition 2001, “additional insured - owners, lessees or contractors – NC00000, automatic status when required in construction (contract).”

An additional insured (“AI” ) thereby becomes a “named insured” (“NI” herein).  Marathon Pipeline Co. v. Maryland Casualty, 5 F.Supp. 2d 1252 (1998).  Whether there are any limitations on the AI’s status will depend on the specific language of the endorsement. 

One form of endorsement in use in North Carolina is endorsement Form No. CG2033, addition 1001, “additional insured - owners, lessees or contractors - NC00000, automatic status when required in construction (contract).”  That particular endorsement form provides that when the insured enters into a construction contract which requires that it provide additional insured coverage, such coverage is provided for any such , but with some limiting language, as follows:

A.  Section II - Who Is An Insured is amended to include as an insured any person or organization for whom you are performing operations when you and such person or organization have agreed in writing in a contract or agreement that such person or organization be added as an additional insured on your policy.  Such person or organization is an additional insured only with respect to liability arising out of your ongoing operations performed for that insured.  A person’s or organization’s status as an insured under this endorsement ends when your operations for that insured are completed.

The endorsement contains several limiting terms:

  • “only”
  • “with respect to liability”
  • “arising out of”
  • “Your ongoing operations”
  • “performed for that insured.”

One form of endorsement in use in North Carolina is an endorsement Form CG 20 26 11 05  for “additional insureds” which is issued naming the specific additional insured party.  That particular endorsement form states the following:

A.  Section II - Who Is An Insured is amended to include as an insured ...  (additional insured’s name inserted here) ... but only with respect to liability arising out of ... (named insured’s name inserted here) ...’s operations.
           
The endorsement contains several limiting terms:

  • “only”
  • “with respect to liability”
  • “arising out of”
  • “(NI’s) operations.”

One form of endorsement in use in North Carolina is endorsement Form No. CG20100397 “additional insured” endorsement which provides coverage to a party named in a specific Schedule in the policy, as follows:

WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured.” 

The endorsement contains several limiting terms:

  • “only”
  • “with respect to liability”
  • “arising out of “ your ongoing operations performed for that insured.”

One form of endorsement in use in North Carolina applicable to architects, engineers or surveyors is automatic additional insureds Form number 71 0741 10 97, which provides as follows:

The following provision is added to WHO IS AN INSURED (Section II):

5.  Any person(s) or organization(s) (referred to below as “additional insured”) with whom you are required in a written construction contract or agreement to name as an additional insured but only for “your” acts or omissions arising from “your” ongoing construction operations at the location or project described in the contract or agreement.

The insurance provided to the additional insured does not apply to “bodily injury”, “property damage”, “personal injury” or “advertising injury”:

a.  Arising out of any act or omission of the additional insured(s) or any of their “employees”, including supervision of “your work” or the work of any other person or organization.

b.  Occurring after that portion of “your work” out of which the injury or damage arises has been put to its intended use by any person or organization other than other contractor or subcontractor engaged in performing operations for a principal as a part of the same project.

c.  Arising out of an architect’s, engineer’s, or surveyor’s rendering of or failure to render any professional services including:

(1)  The preparing, approving, or failing to prepare or approve, maps, shop drawings, opinions, reports, surveys, field orders, change orders or drawings, designs and specifications; and

(2)  Supervisory, inspection or engineering services.

The endorsement contains several limiting terms:

  • only for “your” acts or omissions,
  • arising from “your” ongoing construction operations
  • at  the location or project described in the contract or agreement.

It excludes certain specified injuries (including bodily injury)

  • “arising out of any act or omission of the additional insured(s) or any of their ‘employees’, including supervision” of various described persons,
  • “arising after that portion of your work... has been put to its intended use,”
  • “arising out of or failure to render any professional service.”

The language “arising out of” appears in all these endorsements.  “Arising out of” has been analyzed by the Supreme Court of North Carolina in a case involving whether a gunshot injury resulting from transporting a rifle in a pick-up truck was “arising out of” use of the truck.  The North Carolina Supreme Court, in State Capital Ins. Co. v. Nationwide Mutual Ins. Co., 318 N.C. 534, 539 (1986), defined “arising out of” broadly.

The recent case of Pulte Home Corporation v. Wake County American Southern American Insurance Company and Transamerica Investments, L.L.C. , No. COA06-747 was the first North Carolina state court appellate case specifically involving an additional insured in a construction contract context.  That opinion applied the broad scope of the term “arising out of” as found in the State Capital Ins. Co. v. Nationwide Mutual Ins. Co., opinion to a AI endorsement obtained by a subcontractor for the general contractor.

The specific AI endorsement used by the carrier which was a defendant in that case was the endorsement form which reads as follows:

A. Section II - Who Is An Insured is amended to include as an insured ...  (additional insured’s name inserted here) ... but only with respect to liability arising out of ... (named insured’s name inserted here) ...’s operations.
           
The carrier in the Pulte case denied a demand for the defense of the general contractor in a serious construction project accident which left a subcontractor’s employee a paraplegic.  The employee (who worked for a sub-sub) sued the subcontractor Trans-America for which his employer was subbing, sued the general contractor, Pulte, and sued a third party also working at the site.   The carrier which had issued the AI endorsement naming Pulte in the policy issued to TransAmerica denied a demand to provide a defense.  The g.c. settled the case.  The g.c. sued the carrier for its legal expenses and the cost of the settlement, a total amount in excess of $800,000.   Our C
ourt of Appeals began its analysis with the term “arising out of.” 

The North Carolina Supreme Court, in State Capital Ins. Co. v. Nationwide Mutual Ins. Co., 318 N.C. 534, 539 (1986), had defined “arising out of” (in a “use of a motor vehicle” case) as follows:

The words “arising out of” are not words of narrow and specific limitation but are broad, general, and comprehensive terms affecting broad coverage.  They are intended to, and do, afford protection to the insured against liability imposed upon him for all damages caused by acts done in connection with or arising out of such use.  They are words of much broader significance than “caused by.”  They are ordinarily understood to mean . . . “incident to” or “having connection with” the use of the automobile . . . . (Citations omitted.)

The parties do not, however, contemplate a general liability insurance contract.  There must be a causal connection between the use and the injury.  This causal connection may be shown to be an injury which is the natural and reasonable incident or consequence of the use, though not foreseen or expected, but the injury cannot be said to arise out of the use of an automobile if it was directly caused by some independent act or intervening cause wholly disassociated from, independent of, and remote from the use of the automobile.  (Citations omitted.)

Fidelity & Casualty Co. of N.Y. v. N.C. Farm Bureau Mutual Insurance Co., 16
N.C. App. 194, 198-99, 192 S.E.2d 113, 118, cert. denied, 282 N.C. 425, 192 S.E.2d 840 (1972) stated:

In short, the test for determining whether an automobile liability policy provides coverage for an accident is . . . whether there is a causal connection ... .

That decision is consistent with earlier North Carolina analysis of “arising out of” in a workers’ comp. case (“arising out of and in the course and scope of employment”), Plemmons v. White’s Service, Inc., 213 N.C. 148 (1938), which stated the following:

It has been said that the term “arising out of employment” is broad and comprehensive and perhaps not capable of precise definition.  It must be interpreted in the light of the facts and circumstances of each case, and there must be some causal connection between injury and the employment.  Chambers v. Oil Co., 199 N.C. 28, 153 S.E. 594; Harden v. Furniture Co., supra; Canter v. Board of Ed., 201 N.C. 836, 160 S.E. 924; Walker v. Wilkins, 212 N.C. 627, 194 S.E. 89.

In Hunt v. State, supra, Adams, J., said:  “’Arising out of’” means arising out of the work the employee is to do or out of the services he is to perform.  The risk must be incidental to the employment.”  Harden v. Furniture Co., supra; Chambers v. Oil Co., supra; Beavers v. Power Co., supra; Bain v. Mfg. Co., 203 N.C. 466, 166 S.E. 301.

  “Ongoing operations” has been defined in an “additional insured case.”  Marathon Ashland Pipe Line v. Maryland Cas. Co., 243 F.3d 1232 (10th Cir. 2001), as follows:

The dictionary defines “ongoing,” when used as an adjective, as “that [which] is going on; that [which] is actually in progress.”  Webster’s Third New International Dictionary (Unabridged 2000) at 1576.  “Operations” is defined as “a doing or performing especially of action.”  Id. at 1581.  The common and ordinary meaning of this phrase is that a company’s “ongoing operation” is simply those things that the company does, as opposed to the meaning suggested by Maryland Casualty which would limit “ongoing operations” to mean only the core or most prominent operations that a company might undertake.

Arising out of” is broader than “caused by.”  In Mid-Continental Cas. Co. v. Swift Energy Co., 206 F.3d 487 (5th Cir. 2000), the court noted the weight of case law as follows:

The majority view of these cases is that for liability to “arise out of operations” of a named insured it is not necessary for the named insured’s acts to have “caused” the accident; rather, it is sufficient that the named insured’s employee was injured while present at the scene in connection with performing the named insured’s business... .

“Performed for that insured” requires that the “ongoing operations” not be unrelated to the NI’s contract with the proposed AI.

 In some jurisdictions, an injury can be “arising out of” the operations of the original insured simply because its workmen were on the site at the time.   Moreover, the “liberal interpretation,” of additional insured coverage, described as “fast becoming the majority rule,” holds that there is coverage even if the “cause of the injury was the negligence of the additional insured.”  Marathon Ins., supra.
           
     There has been an attempt by carriers in various cases to limit AI coverage to vicarious liability, i.e., that it applies only where the liability of the AI results from the negligence of the NI.  That limitation, as applied here, would mean that the purported AI would be an AI only to the extent that it is liable to the plaintiff as a result of liability of HSE.   In North Carolina,  the scope of AI coverage  may be determined to be limited so as not to include the negligence of the AI itself, and to apply only to vicarious liability. However, to do so, it must be clearly stated.  

Prior to the Pulte opinion, no North Carolina appellate court had addressed this specific issue, but that there were a number of cases nationwide dealing with this issue.  Most of them have held that the coverage is not limited to vicarious liability despite what we might otherwise have thought about the effect of the language of the endorsement.

Marathon Ashland Pipe Line v. Maryland Cas. Co., 243 F.3d 1232 (10th Cir. 2001), a Wyoming case, involved a policy which  policy stated, “WHO IS AN INSURED (Section II) is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured,” “this policy language does not limit coverage to the additional insured's vicarious liability.”  That case involved a contractor and a steel erection subcontractor.  The Court held that the AI “endorsement provision . . . provides coverage for an additional insured's liability arising out of its own negligence.”)

Mid-Continent Cas. Co. v. Swift Energy Co., a Texas case, 206 F.3d 487, 496 (5th Cir. 2000) involved an "additional insured" endorsement that additional insureds are included as insureds "only with respect to liability arising out of [Air Equipment's] ongoing operations performed for that insured."  The court held that the additional insured “is covered as an additional insured under the Policy even though Air Equipment  [NI] was not negligent,” because “injuries ‘arose out of’ Equipment's operations.”)

Travelers Cas. & Sur. Co. v. Elkins Constructors, Inc., 2000 U.S. Dist. LEXIS 7746 (D. Ind. 2000) involved a policy which states "WHO IS INSURED . . . is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured," and "WHO IS INSURED . . . is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of 'your work' for that insured by or for you."   The court held that “the majority of courts to have considered the issue construe such provisions (which rely on language very similar to, or identical to, the language used in the additional insured provisions in the . . . policies) broadly, encompassing coverage to extend to liability beyond merely the additional insured's vicarious liability for the actions of the named insured.”

Andrew L. Youngquist, Inc. v. Cincinnati Ins. Co., 625 N.W.2d 178, 185 (Minn. App. 2001) involved a policy which stated “WHO IS AN INSURED is amended to include:  2.e. The person or organization shown in the Schedule but only with respect to liability arising out of your ongoing operations performed for that insured, HEREINAFTER REFERRED TO AS ADDITIONAL INSURED.”  The court rejected the insurer’s argument that "’arising out of [NI’s] ongoing operations performed for [AI’s]’ limits its liability to cover only cases in which Comm-Tech is primarily liable and Birtcher is vicariously liable for any fault of Comm-Tech,” and finding coverage where “”there is a causal connection between Klitzke's injuries and Comm-Tech's ongoing operations: but for Comm-Tech's operations, Klitzke would not have been injured.”)

Admiral Ins. Co. v. Trident NGL, Inc., 988 S.W.2d 451 (Tex. App 1999) noted the majority view for similar AI provisions, that “it is not necessary for the named insured's acts to have 'caused' the accident; rather, it is sufficient that the named insured's employee was injured while present at the scene in connection with performing the named insured's business, even if the cause of the injury was the negligence of the additional insured."

On the other hand, a couple of courts have addressed this provision and held that it provides coverage for the AI only for the AI’s vicarious liability, arising from the NI’s work.

Two of those favorable decisions are from Illinois and Missouri, and there is a decision from the U.S. District Court for the Western District of North Carolina, which upheld the limitation to vicarious liability.  The Illinois and Missouri cases follow.

Nat'l Union Fire Ins. Co. v. R. Olson Constr. Contrs., Inc., 329 Ill. App. 3d 228, 235 (Ill. App. 2002) (where policy states that it is “amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured," the endorsement “limit[s] coverage to liability solely and specifically resulting from the conduct of the named insured,” and “Coverage for the additional insured requires that the liability must arise out of Meyer's [NI’s] operations, but that coverage is specifically limited in that it does not apply to any liability resulting from Olson's [AI’s] own negligence.  There is no issue of strict or imputed liability applicable here, and the limited coverage is neither illusory nor void as against public policy.”; there is no coverage because “All of the allegations against Olson are for its own negligence and not for Meyer's negligence.  The complaint does not allege that Olson was somehow strictly liable or vicariously liable for Meyer's conduct.”)

G.E. Tignall & Co. v. Reliance Nat'l Ins. Co., 102 F. Supp. 2d 300, 305 (D. Md. 2000) (where amendment stated that policy “is amended to include as an insured the person or organization shown in the Schedule, but only with respect to liability arising out of your ongoing operations performed for that insured,” “policy limiting additional insured coverage to liability arising out of the named insured's work does not cover Tignall for its own negligent acts.”).

In St. Paul Fire & Marine Ins. Co. v. Hanover Ins. Co., 187 F. Supp. 2d 584, 587-588 (W.D.N.C. 2000), the GC (Hardin) hired an HVAC sub-contractor (J&A Mechanical), who in turn hired a secondary sub-contractor for duct work (Herin).  An employee of Herin (a Mr. Durham) fell from a scaffolding and sustained major injuries.  J&A Mechanical was insured by Travelers, and Herin was insured by Hartford.  Pursuant to contract, Herin was required to provide coverage for J&A Mechanical as an additional insured on its Hartford CGL policy.  Further, pursuant to contract, J&A was required to defend and indemnify Hardin.

There were two cases, which we call St. Paul I and St. Paul II.  In the first case, the insurer for J&A Mechanical, Travelers, had a policy which stated  the following:

This endorsement modifies insurance provided under the following:

Commercial General Liability Coverage Part

1. WHO IS AN INSURED (Section II) is amended to include any person or organization you are required by written contract to include as an insured, but only with respect to liability arising out of "your work."  This coverage does not include liability arising out of the independent acts or omissions of such person or organization.  The written contract must be executed prior to the occurrence of any loss... .”

   (Note: Emphasis supplied; it is essential to determine whether the endorsement under scrutiny in your case has the sentence underlined above.)

Hardin (and its insurers) argued that the Travelers policy provided coverage for Hardin (because J&A agreed to indemnify Hardin).  The court agreed that Hardin was an “insured” under the policy, finding that the contractual duty of J&A to defend and indemnify Hardin was tantamount to a duty to include Hardin as an insured.  (This holding is peculiar, but is not relevant to our issue.)  “Hardin is therefore an additional insured under J&A Mechanical's policy with Travelers.”

The statement that the general contractor is insured "only with respect to liability arising out of [the subcontractor's] work," when interpreted strictly in accordance with defendant's argument, creates a problematic situation in which coverage is defined in terms of liability.  While an insurance company's duty to pay is typically measured by the facts determined and liability established at trial, an insurance company's duty to defend is assessed before trial and before liability is established.  As noted earlier, the duty to defend is, in fact, broader than the duty to pay.  The insuring agreement in the Travelers policy underscores this point in its assertion that Travelers has "the right and duty to defend any "suit" seeking [the damages Travelers may ultimately be obligated to pay]."  When an insurance company undertakes the obligation to defend an insured, that undertaking is not contingent upon the existence of liability on the part of the insured.

To construe the policy's language in accord with governing law regarding the duty to defend, and to give effect to the language of the Durham complaint and the insuring agreement, the additional insured endorsement in the Travelers policy must be read to require a duty to defend where the "alleged liability" arises from the subcontractor's work, but not where the "alleged liability" arises from the independent acts of the additional insured.  The court agrees with defendant that, to give meaning to the "independent acts" provision of the endorsement, the court must construe the "arising out of [the subcontractor's work]" provision as one providing coverage in cases where the alleged liability is vicarious.  The court must therefore analyze the complaint in an attempt to determine whether the alleged liability arises from the subcontractor's work, i.e., whether Durham seeks to hold the Hardin plaintiffs liable for J&A Mechanical's acts or failure to act.

Durham's complaint broadly alleges negligence against Durham's employer (Herin), J&A Mechanical, and the Hardin plaintiffs, among others. After performing some of the HVAC work that he had been hired to complete, Durham fell headfirst into an unguarded concrete pool while descending from scaffolding onto a one-foot space between the scaffolding and the pool, the surface of which was bumpy, uneven, and littered with debris.  The allegations in the complaint describe numerous instances of fault and omission on the part of each and every defendant, and the complaint specifically alleges joint and several liability of the defendants.  The complaint does not, at any point, mention vicarious liability, nor does the complaint assert in lay terms that Durham seeks to hold Hardin liable for J&A Mechanical's negligent acts.  Thus, it would appear that Hardin's liability, as alleged in the complaint, does not arise out of J&A Mechanical's work but rather, out of its own independent acts and omissions, alleged in detail in Durham's complaint

The court then addressed whether the complaint alleged a claim for vicarious liability, stating the following:

North Carolina courts have "long recognized that a general contractor is not liable for injuries sustained by a subcontractor's employees. . . . North Carolina law provides that a general contractor does not have a duty to furnish a subcontractor or the subcontractor's employees with a safe place in which to work. . . .  Instead, it is the duty of the subcontractor to provide himself and his employees with a safe place to work and, also, to provide proper safeguards against the dangers of the work."  North Carolina courts recognize three exceptions to the rule that general contractors are not subject to liability when their subcontractors have been negligent: 1) situations where the general contractor/employer retains control over the manner and method of the subcontractor's substantive work; 2) situations where the work is deemed to be inherently dangerous; and 3) situations involving negligent hiring and/or retention of the subcontractor by the general contractor.

The court then went through a protracted analysis of North Carolina law regarding these exceptions, and concluded that they did not apply.   (“The inherently dangerous activity exception to the general rule of no-liability does not constitute a form of vicarious liability”).  It then concluded:

In short, the insurance that J&A Mechanical provided to Hardin at Hardin's request, in its most basic form, merely insures Hardin against liability arising from the subcontractor's work. Because the Travelers policy provides coverage for Hardin only for liability arising out of J&A Mechanical's work and not for Hardin's independent acts, and because this court reads the Durham complaint as one asserting  liability based upon the independent acts of the Hardin plaintiffs, among others, Hardin has not asserted a claim that comes within the parameters of the Travelers policy, and Travelers does not have a duty to defend in the Durham action currently pending in the Superior Court.

In a case which we refer to as “St. Paul II,” however, involving a different party’s policy in the same accident, the same court was faced with a policy which did not have the language which we underlined in our quotation of the endorsement language in St. Paul I.

In St. Paul Fire & Marine Ins. Co. v. Hanover Ins. Co., 2000 U.S. Dist. LEXIS 21792, 13-14 (W.D.N.C. 2000), the court addressed the issue of whether the Hartford policy issued to Herin provided coverage to J&A.  The policy provided that the following were additional insureds:

Any person or organization with whom you [Herin] agreed, because of written contract or agreement or permit, to provide insurance such as is afforded under this Business Liability Coverage Form, but only with respect to your operations, "your work" or facilities owned or used by you.

Pursuant to contract, Herin was required to provide insurance for J&A.  The court first noted that the AI provision in the Hartford policy was different from the AI provision in the Travelers policy in St. Paul I. All it said was “... with respect to your operations.”  The court concluded that language should be construed broadly, and is not limited to situations where the AI is vicariously liable.  The court held as follows:

The analyses provided by the courts [from other jurisdictions  with similar provisions] show that Hartford's proposed interpretation of the policy language at issue, limiting coverage to vicarious liability, is not the only reasonable interpretation of that language.  Indeed, the construction offered by the foregoing courts is equally plausible.  Because Durham was employed by Herin at the time of his injury, performing work for Herin as required by J&A Mechanical, it is not unreasonable to conclude that coverage is applicable because J&A Mechanical is insured "with respect to" Herin's work.  At the very least, the court must conclude that the policy language at issue is ambiguous. ...   Consequently, the court must construe the language against the insurer, Hartford, and in favor of the insured, J&A Mechanical, and hold that Hartford did have a duty to defend J&A Mechanical in this case based on the potentiality that the facts alleged by Durham would be covered by the Hartford policy.

So we have as precedents in St. Paul I one insurance policy which says that it applies to “...only with respect to liability arising out of your work,” and specifically “... does not include independent acts”  of the AI, and another policy in St. Paul II which simply said “...with respect to your work.”  By comparison some policies say  “...arising out of your work.”  In one sense, that the “arising out of your work” phrase is the same, St. Paul I may be claimed to apply; in another, sense, because there is not the specific disavowal of liability by the purported AI’s own acts, the St. Paul II case may be claimed to apply.

In Pulte, the N. C. Court of Appeals construed language more like that in St. Paul I, btt without the critical sentence contained in St. Paul I which specifically limits the AI coverage to coverage for vicarious liability, as follows: This coverage does not include liability arising out of the independent acts or omissions of such person or organization.

The Pulte opinion  held that the language “arising out of” is broad, and noted that the endorsement did not contain a provision such as that one from St. Paul I underlined above.   The Court reversed summary judgment by the trial court in favor of limited coverage, and remanded the case for entry of judgment in favor of the plaintiff and the subcontractor.  Significantly, the opinuion did not comment on the situation vis a vis another carrier involved, and the “other insurance’ provision of the policy, expressing no opinion on whether the defendant carrier would have the right to seek relief from other carriers.

The Duty to Provide a Defense

            When a carrier is considering denying coverage in a North Carolina claim, it is noteworthy that a carrier is held to a different standard if it denies coverage for indemnity as compared to a denial of a duty to defend.   The duty to provide a defense imposes a much higher standard on the liability carrier than the duty to provide coverage.  As with other policy provisions, an attempt to limit or terminate the duty to defend will be construed narrowly, and ambiguities will be construed against the insurer.  North Carolina Farm Bureau Mut. Ins. Co. v. Stox, 330 N.C. 697, 700 (1992).

The duty to defend is generally not affected by the validity of the claims. Stanback v. Westchester Fire Ins. Co., 68 N.C. App. 107, 114 (1984) (“Mrs. Stanback was clearly attempting to recover for malicious prosecution and physical injury brought about by mental anguish.  These torts are within the coverage of defendant's policy; therefore, even though it was later determined that the suit was groundless under the terms of the policy and the law of this state, defendant nevertheless had a duty to defend.”). 

The leading case on the duty to defend is Waste Management of Carolinas, Inc. v. Peerless Ins. Co., 315 N.C. 688, 692 (1986).  In that case, the North Carolina Supreme Court stated the following:

Generally speaking, the insurer's duty to defend the insured is broader than its obligation to pay damages incurred by events covered by a particular policy.  An insurer's duty to defend is ordinarily measured by the facts as alleged in the pleadings; its duty to pay is measured by the facts ultimately determined at trial.  When the pleadings state facts demonstrating that the alleged injury is covered by the policy, then the insurer has a duty to defend, whether or not the insured is ultimately liable.  Conversely, when the pleadings allege facts indicating that the event in question is not covered, and the insurer has no knowledge that the facts are otherwise, then it is not bound to defend.

Where the insurer knows or could reasonably ascertain facts that, if proven, would be covered by its policy, the duty to defend is not dismissed because the facts alleged in a third-party complaint appear to be outside coverage, or within a policy exception to coverage.  In this event, the insurer's refusal to defend is at his own peril: if the evidence subsequently presented at trial reveals that the events are covered, the insurer will be responsible for the cost of the defense. "This is not to free the carrier from its covenant to defend, but rather to translate its obligation into one to reimburse the insured if it is later adjudged that the claim was one within the policy covenant to pay."  In addition, many jurisdictions have recognized that the modern acceptance of notice pleading and of the plasticity of pleadings in general imposes upon the insurer a duty to investigate and evaluate facts expressed or implied in the third-party complaint as well as facts learned from the insured and from other sources.  Even though the insurer is bound by the policy to defend "groundless, false or fraudulent" lawsuits filed against the insured, if the facts are not even arguably covered by the policy, then the insurer has no duty to defend.

In order to determine whether such circumstances are covered by the provisions of TRS's liability insurance with Penn and Peerless, the policy provisions must be analyzed, then compared with the events as alleged. This is widely known as the "comparison test": the pleadings are read side-by-side with the policy to determine whether the events as alleged are covered or excluded. Any doubt as to coverage is to be resolved in favor of the insured.

Waste Management of Carolinas, Inc. v. Peerless Ins. Co., 315 N.C. 688, 692 (1986). See also Strickland v. Hughes, 273 N.C. 481, 487 (1968) (“Aetna's obligation to defend this action against the named insured, or any other person using the vehicle with the permission of the named insured, is absolute.  It becomes absolute when the allegations of the complaint bring the claim within the coverage of the policy.”); Pa. Nat'l Mut. Cas. Ins. Co. v. Associated Scaffolders & Equip. Co., 579 S.E.2d 404, 407 (App. 2003) (“The mere possibility the insured is liable and that the potential liability is covered may suffice to impose a duty to defend.”)

Where the complaint does not indicate when the injuries occurred, all insurers with possible coverage, based on the allegations of the complaint, have a duty to defend; this duty exists regardless of the actual date of the loss.  Ames v. Continental Cas. Co., 79 N.C. App. 530, 538, disc. review denied, 316 N.C. 730 (1986) (“In view of Continental's wrongful breach of the policy contract we find it unnecessary to discuss whether Lloyd's has failed to show that any amount of the settlement represents payment for wrongful acts occurring in 1971.”; where complaint alleged some activity during insurer’s policy period, insurer had duty to defend). St. Paul Fire & Marine Ins. Co. v. Vigilant Ins. Co., 919 F.2d 235, 240-241 (4th Cir. 1990); Naddeo v. Allstate Ins. Co., 139 N.C. App. 311, 533 S.E.2d 501, 506 (2000).

About the only occasion on which there is no duty to defend is where the pleadings allege facts indicating that the event in question did not occur within coverage period, i.e., the complaint alleged that the event occurred outside the coverage period.

The insurer is required to defend if an investigation would have shown the facts indicating coverage. Bruce-Terminix Co. v. Zurich Ins. Co., 130 N.C. App. 729, 736-737 (1998) (“Rather than ascertain whether there had been an inspection within twelve months of Gibson's ‘discovery,’ and despite the fact that Terminix's contract with their customers states annual inspections will be conducted, Zurich denied coverage because the Gibson complaint did not indicate that an inspection was made within the prior twelve months.”).

Similarly, the insured may go beyond the pleadings to establish a duty to defend. Duke University v. St. Paul Fire & Marine Ins. Co., 96 N.C. App. 635, 638 (1990) (“Although the insurer's duty to defend an action is generally determined by the pleadings, facts learned from the insured and facts discoverable by reasonable investigation may also be considered.  Therefore, the affidavits filed by plaintiff in this case are relevant to the determination of defendant's duty to defend.  Plaintiff was not required to establish ultimate liability, however, but only to show that the facts of the claim were within the coverage of the policy.”).

Although the insurer may have a duty to defend based on facts outside the complaint, North Carolina has not clearly addressed whether and when the insurer may rely on facts outside the pleadings to defeat a duty to defend.  Other jurisdictions are somewhat mixed on this point.  The only areas in North Carolina where the insurer can go beyond the complaint to avoid a duty to defend is where the insured does not provide timely notice of the incident. Great American Ins. Co. v. C. G. Tate Constr. Co., 315 N.C. 714, 717 (1986) (where insurer contends that insured did not provide timely notice of incident, there is “a three-part test in order to determine the insurer's duty to defend.”), or does not forward the suit papers, Royal Ins. Co. of Am. v. Cato Corp., 125 N.C. App. 544, 550 (1997) (insured’s violation of provision requiring that suit papers be forwarded negates duty to defend; ”Thus, we hold, as a matter of law, that Cato's delay in providing Royal with the Hurt legal papers eliminated any obligation under the Policy to provide Cato a defense to the Hurt action.”), or the existence of other insurance.  Allstate Insurance Co. v. Shelby Mutual Insurance Co., 269 N.C. 341, 152 S.E.2d 436 (the existence of other liability insurance was an event activating the exclusion clause of the garage liability policy relieving the insurer under the garage liability policy from any liability or duty to defend its insured who was covered by other liability insurance).  

An unjustified reservation of rights letter may lead to a Chapter 75 claim for unfair and deceptive trade practices. Country Club of Johnston County, Inc. v. United States Fid. & Guar. Co., 150 N.C. App. 231, 236 (2002) (where jury found that “USF&G unfairly or improperly sen[t] a ‘reservation of rights’ letter on 11/20/91 citing Exclusion C, without having an adequate or documented basis to reverse Mr. Funk's position to not reserve rights as to Exclusion C documented on 11/19/91,” and there as some evidence that insurer believed exclusion did not apply, and expert for plaintiff said reservation should not have been sent, court found insurer violated Chapter 75 and trebled damages (for insured’s legal fees in defending tort claim).

An insurer with no duty defend, who defends the insured in good faith, is entitled to reimbursement from an insurer with a duty to defend. Bruce-Terminix Co. v. Zurich Ins. Co., 130 N.C. App. 729, 736 (1998) (insured paid for settlement of claim and for its defense costs; entitled to reimbursement); Stanback v. Westchester Fire Ins. Co., 68 N.C. App. 107, 114 (1984) (insured recovered attorneys fees incurred in defending claim).

There is also case law holding that where two insurers have a duty to defend, they will generally share defense costs equally.  Ames, 79 N.C. App. 530; Nationwide Mut. Ins. Co. v. State Farm Mut. Auto. Ins. Co., 122 N.C. App. 449, 454 (1996) (“Given this duty [of the defending insurer], as in Fireman's Fund, plaintiff [defending insurer] may not recover any portion of its defense costs or settlement payments made under subrogation theory” but “may proceed by way of contribution.”)

Consequences of Failure to Defend

Where an insurer wrongfully refuses to defend, it will be liable for the resulting losses.  For example, as shown below, it is liable for the insured’s defense costs. Collins & Aikman Prods. Co. v. Hartford Accident & Indem. Co., 125 N.C. App. 412, 414 (1997) (“attorney's fees are awardable only in an amount equal to the value of the legal defense denied to the insured because of the insurer's breach.”).

Where the insured pays for its counsel, it is entitled to reimbursement for those expenses if the insurer wrongfully refused to defend. Bruce-Terminix Co. v. Zurich Ins. Co., 130 N.C. App. 729, 736 (1998) (insured paid for settlement of claim and for its defense costs; entitled to reimbursement); Stanback v. Westchester Fire Ins. Co., 68 N.C. App. 107, 114 (1984) (insured recovered attorneys fees incurred in defending claim).

Further, the insurer may be liable for the amount of the insured’s settlement.  The insurer in such a situation may not rely upon the policy provision prohibiting a settlement by the insured. Nixon v. Liberty Mut. Ins. Co., 255 N.C. 106, 111 (1961) (“By denying liability or refusing to settle claims against insured, which are covered by the automobile indemnity policy, the insurance company commits a breach of the policy contract and thereby waives the provisions defining the duties and obligations of the insured.”; “If, under such circumstances its insured entered into a reasonable consent judgment in good faith, then there is a positive obligation on defendant, created by its unjustified refusal to defend the suit instituted by plaintiff against its insured to recover damages for bodily injuries, to pay the amount and costs of such reasonable consent judgment entered into in good faith by its insured in the action brought against him by plaintiff”).

Further, there is strong authority to the effect that an insurer which refuses to defend is deemed to be estopped from contesting coverage for the insured’s settlement.  In Ames v. Continental Cas. Co., 79 N.C. App. 530, 538, disc. review denied, 316 N.C. 730 (1986), two insurers had duties to defend (they had different policy periods, both possibly triggered by the complaint).  One insurer contended that the acts or omissions did not occur during its policy period.  The court held that since there was a possibility of coverage (based on the complaint), there was a duty to defend.  It further held that the non-defending insurer was precluded from showing that the occurrences did not occur during its policy period, and it was liable for its pro rata share of the settlement, and for half the defense costs.

The recent Pulte opinion appears to have adopted the reasoning of Ames, and cites as in accord, Penske Truck Leasing Co. v. Republic W. Ins. Co, 407 F Supp.2d 441 (E.D.N.C.2000),  Naddeo (see above) Bruce Terminix (see above) and Duke University v. St. Paul Fire and Marine Ins. Co., 96 N C App 635, 386 S. E. 2d 762 disc. Rev. denied, 326 N. C. 595, 393 S.E. 2d 876 (1990.) 

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