One of the areas often overlooked, but vital to an insured, is the defense costs coverage a liability policy provides. As some insureds may be aware, there are two types of defense costs payments, those policies that pay “in addition” to the limits and those whose payments are “within” the policy limits.
The vast majority of insurance policies, specifically, General Liability (GL) will provide defense costs, “in addition” to the policy limit; while other policies, principally, “Management Liability” (Directors & Officers, Employment Practices Liability, Professional Liability and Fiduciary Liability to name a few) and, sometimes, Pollution Liability policies provide defense costs “within” the policy limits.
While the policies generally operate one way or another there is a peculiar set of circumstances when you can start off with an “in addition to” policy where circumstances allow the limits to be eroded by defense costs.
In business agreements today, there is often an indemnity obligation between an insured and an “upstream” party. Traditionally, insurers have treated defense expenses paid to an indemnitee as “damages” thereby eroding limits. Beginning with the 1996 version of the ISO CGL, this is explicitly stated in the policy. The Contractual Liability Exclusion states that “Solely for the purposes of liability assumed in an ‘insured contract’ reasonable attorney fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages because of ‘bodily injury’ or ‘property damage…”
The Supplementary Payments section of the policy has an important exception. That provision notes that if certain conditions are met (Item B – sections A through F) then attorneys’ fees and litigation expenses will be paid as Supplementary Payments and will not be deemed to be damages for “bodily injury” and “property damage” and will not reduce the limit of liability. For instance, the obligation to defend the indemnitee or the cost of defense must be assumed in the “insured contract”; there must be no conflict between the insured and the indemnitee in the litigation; and the insured/indemnitee must agree to representation by the same counsel. The indemnitee must also agree in writing to: (1) fully cooperate in the defense of the action; and (2) notify all other potential insurers of the loss.
Often times, insureds are required to list another entity on your policy as an Additional Insured. This is done to provide that entity with a defense for their vicarious liability for the insured’s negligent actions should both parties be named in a suit. Generally, if the other party is an additional insured, the issue of defense expenses eroding limits is avoided as the defense of the insured and additional insured are, generally, paid as Supplementary Payments, outside the limits of liability.
Anyone who has been involved in a legal matter will tell you, those legal bills add up quickly! This is one of the reasons you want to be sure your policy provides you with defense costs “in addition” to the policy limits.
Defense costs, generally, include attorney fees (including paralegal and administrative expenses), court costs, expert witness testimony or reports, investigative costs and various other expenses associated with a legal defense.
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