In the field of insurance law, most liability policies are designed to cover two primary and qualified contractual obligations assumed by the insurer—a defense expense obligation and an indemnification expense obligation. How the defense expense obligation is actually implemented through policy language can vary greatly between types of liability policies. The most frequently encountered liability policies—home, auto, commercial—implement the defense expense component through what is known as a duty to defend provision, in which the insurer assumes control of the defense of a claim and appoints defense counsel to represent the policyholder. However, there is another category of liability policies that do not contain a duty to defend provision but instead contain a duty to advance defense costs provision. These are typically found in higher exposure liability policies such as directors and officers (D&O), employment practices liability (EPL), or individual and organization (I&O) policies, where the policyholder, not the insurer, controls selection of counsel and exercises primary control over litigation, albeit with some limitations. Often, policies containing a duty to advance defense costs explicitly state at the outset that the insurer disclaims any duty to defend. This disclaimer, however, does not end the inquiry. Since policies containing a duty to advance defense costs are less frequently encountered by courts there is limited legal authority interpreting duty to advance provisions. We examine the differences between these two types of polices and how courts applying Pennsylvania law have addressed the topic. As discussed below, despite a duty to defend disclaimer, policies that contain a duty to advance defense costs provision most often are examined under the traditional duty to defend analysis.
Basic Duty to Defend Primer
A brief review of the basics of a duty to defend liability policy provides a foundation from which the issue has evolved. A typical liability policy containing a duty to defend will state the insurer’s defense obligation, with some variation, as follows: “the Insurer will have the right and duty to duty to defend the policyholder against any claim seeking damages for bodily injury or property damage; however, the insurer will have no duty to defend the policyholder against any claim for which this insurance does not apply.” The majority of courts, including those in Pennsylvania, have interpreted liability policies containing a duty to defend provision to create a broad obligation of the insurer to defend not only covered claims but also those claims which may potentially come within the coverage under the policy. See American & Foreign Insurance v. Jerry’s Sport Center, 2 A3d 526 (Pa. 2010). This is sometimes referred to as the “potentiality standard” in which the defense obligation is triggered by the mere potential, rather than the certainty, that a claim will be covered by the liability policy. This is also why the duty to defend is commonly referred to as being broader that of the duty to indemnify.
Pennsylvania courts have adopted what is known as the “four corners test” to determine whether there are any potential claims that may trigger an insurer’s duty to defend, as in Donegal Mutual Insurance v. Baumhammers, 938 A.2d 286 (Pa. 2007). The analysis under this test requires the comparison of the factual allegations contained within the “four corners” of the complaint against the “four corners” of the insurance policy to determine whether the insurer’s defense obligation has been triggered. Under the “four corners test,” any information beyond what is contained in the complaint itself is generally not permitted to be considered when making a determination concerning the duty to defend obligation. Given this standard, Pennsylvania courts also are keenly aware of the potential for artful pleading; therefore, the “four corners test” focuses only on the factual allegations of the complaint, not the causes of action asserted, as in Mutual Benefit Insurance v. Haver, 725 A.2d 743 (Pa. 1999).
Duty to Advance
In contrast to the duty to defend provision, a typical policy containing a duty to advance provision will explicitly disclaim the duty to defend by literally stating, “the insurer does not assume any duty to defend.” The duty to advance provision will then articulate the insurer’s defense obligation, with some variation, as follows: “the insurer shall advance nevertheless, at the written request of the policyholder, defense costs excess of the retention amount prior to the final disposition of the claim. Such advance payments by the insurer shall be repaid to the insurer by the policyholders in the event and to the extent that the policyholders shall not be entitled under the terms and conditions of the policy to such payment.” In addition to the foregoing, a duty to advance provision will also typically include the condition that before incurring any defense costs, the policyholder must seek written consent from the insurer, which shall not be unreasonably withheld, and only those defense costs incurred with the consent of the insurer are recoverable by the policyholder.
One of the seminal opinions applying Pennsylvania law that is widely cited on the duty to advance is Little v. MGIC Indemnity, 836 F.2d 789 (3d Cir. 1987), which has been characterized as “a light illuminating this legal landscape.” Pursuant to Little, under a duty to advance provision, the insurer’s obligation to advance defense costs is generally conditioned upon the following events occurring: written approval of defense counsel expenses from the insurer (or use of pre-approved counsel); satisfaction of the retention amount (if applicable); and a written request from the policyholder. Upon satisfaction of the foregoing conditions, the insurer’s obligation to advance defense costs is triggered when the policyholder becomes “legally obligated to pay” the defense obligation, which is typically understood to mean when defense counsel issues its bill to the policyholder, requiring contemporaneous advance payments of defense costs as they are incurred.
Overarching this duty to advance is the larger question of whether there is coverage for the claim, along with the timing and method for such a coverage determination. The same coverage standard under duty to defend provisions applies to duty to advance provisions, including the “potentiality standard,” the “four corners test” as well as the avoidance of artful pleading. However, whether an insurer can disclaim coverage to avoid its duty to advance obligation is a highly fact sensitive analysis and depends on the specific provisions of the policy upon which the denial of coverage is predicated. See Associated Electrical & Gas Insurance Services v. Rigas, 382 F. Supp. 2d 685 (E.D. Pa. 2004). Courts in New Jersey, where the duty to defend is assessed similar to Pennsylvania, also rely on Little and have ruled that where a policy “potentially provides coverage for the underlying” claim then an insurer is required to advance defense costs despite the insurer’s protestation that it is premature to advance defense costs given that the court assessing coverage had not resolved whether coverage under the policy was triggered, as in G-I Holdings v. Reliance Insurance, No. 00-CV-6189, 2006 U.S. Dist. LEXIS 99854 (D.N.J. Mar. 24, 2006). Notably, courts applying Pennsylvania law have taken the position that a policy provision that permits and insurer to seek reimbursement of advanced defense costs, “at its option,” cannot be construed by the insurer as having “discretion” to advance defense costs. Rather, such an “option clause” creates an ambiguity that will be resolved in favor of the policyholder, negating any discretion on the part of the insurer, and thereby requiring it to advance defense costs.
Thus, it is evident that despite a policy disclaiming a duty to defend, if it contains a duty to advance provision, a court likely will interpret the advance obligation consistent with a standard duty to defend clause. Accordingly, in order for an insurer to disclaim a defense obligation under this form of policy, the standard and court-recommended approach remains that an insurer should file a declaratory judgment action contemporaneous with advancing defense costs under a proper reservation of rights, as in American Legacy Foundation v. National Union Fire Insurance, 623 F3d 135 (3d Cir 2010). •