Managing the Duty to Defend and Some Practical Approaches
Two recent Wisconsin Supreme Court decisions have drawn attention to duty to defend decision making by insurers. In Water Well Solutions Service Group Inc. v. Consolidated Ins. Co.1 and Marks v. Houston Casualty Co.,2 the court emphasized the continuing vitality of long-standing rules regarding the duty to defend in Wisconsin, most notably the four corners rule. The decisions rejected attempts to have the court create exceptions to the four corners rule.
In Water Well, the insured wanted the duty to defend analysis to be based on just part of the liability policy, the initial grant of coverage, ignoring the exclusions. The insured also wanted extrinsic evidence to be considered, namely, an affidavit from the insured’s employee intending to invoke the subcontractor exception to the “your work” exclusion. The Wisconsin Supreme Court rejected both of the insured’s arguments, stating as follows:
Longstanding case law requires a court considering an insurer’s duty to defend its insured to compare thefour corners of the underlying complaint to the terms of the entire insurance policy.... The four-corners rule prohibits a court from considering extrinsic evidence when determining whether an insurer breached its duty to defend.3
Marks stated the same rule:
The name [the “four-corners rule”] derives from the fact that “[t]he duty to defend is triggered by the allegations contained within the four corners of the complaint”, against the insured.... Put differently, “[w]hen a complaint alleges facts that, if proven, would constitute a covered claim, the insurer must appoint defense counsel for its insured without looking beyond the complaint’s four corners.” ... Thus, only two documents are germane in any fourcorners analysis: the insurance policy and the complaint against the insured. No examination of extrinsic facts or evidence takes place.4
Both decisions also emphasized that the insurance policy must be read and applied in its entirety when making the duty to defend decision, not just the insuring agreement without consideration of exclusions. As the court stated in Marks: “[A] rule that an insurer who declines to provide a defense may not rely on policy exclusions to protect itself against allegations of breach of the duty to defend makes no sense.”5
Denying the Duty to Defend—“Unilaterally” Deciding is Disfavored
Insurers have long had several options when addressing the duty to defend and concluding that the duty was not invoked. The seemingly simplest option is, of course, a denial without court involvement. This approach has declined over the years, in part because of the potential consequences of a denial that is later deemed a breach by the courts. As recognized by the Wisconsin Supreme Court in Liebovich v. Minnesota Ins. Co., Wisconsin decisions have acknowledged denial as an option, while at the same time loudly stating a preference for the insurer to get a court declaration of no coverage instead, and warning of dire consequences if a unilateral denial is later held to be mistaken:
We emphasize the preferred process for insureds to resolve duty-to-defend disputes. As we have explained, it is well established that an insurer may request a bifurcated trial on the issue of coverage while moving to stay proceedings on the merits of the liability action until the issue of coverage is resolved. Newhouse [v. Citizens Security Mut. Ins.], 176 Wis. 2d [824, 836, 501 N.W.2d 1 (1993)] (citing Elliott [v. Donahue], 169 Wis. 2d [310, 318, 485 N.W.2d 403 (1992)]). “When this procedure is followed,” we explained, “the insurance company runs no risk of breaching its duty to defend.” Newhouse, 176 Wis. 2d at 836. In addition to the Elliott/Newhouse procedure, insurers may raise the coverage issue in other ways, such as seeking a declaratory ruling or agreeing to provide a defense under a reservation of rights. See Baumann [v. Elliott], [2005 WI App 186, ¶ 8], 286 Wis. 2d 667,  704 N.W.2d 361. While these procedures are not absolute requirements, we strongly encourage insurers wishing to contest liability coverage to avail themselves of one of these procedures rather than unilaterally refuse to defend. A unilateral refusal to defend without first attempting to seek judicial support for that refusal can result in otherwise avoidable expenses and efforts to litigants and courts, deprive insureds of their contracted-for protections, and estop insurers from being able to further challenge coverage.6
Clearly the preferred process from the perspective of the court is a declaratory action for judicial confirmation of the insurer’s conclusion that there is no duty to defend, not unilateral insurer decision making. Obviously, that cannot be obtained without some risk, delay, and expense, which at times can be substantial. So, what is an insurer to do when it believes it has no coverage for the suit and no duty to defend?
Intervention, Stay, and Bifurcation
The traditionally endorsed response is for the insurer seeking a declaration of no duty to defend to move promptly to intervene and secure a stay and bifurcation for insurance issues to be addressed immediately while the merits of the case are stayed—i.e., all merits discovery and proceedings are put on hold. Wisconsin decisions have held that when an insurer takes that approach, there is no breach of the duty to defend:
[T]he proper procedure for an insurance company to follow when coverage is disputed is to request a bifurcated trial on the issues of coverage and liability and move to stay any proceedings on liability until the issue of coverage is resolved. When this procedure is followed, the insurance company runs no risk of breaching its duty to defend.7
When the insurer promptly moves to intervene, stay, and bifurcate, this should, at least theoretically, result in the insured having no need for a defense during the time of the stay and bifurcation. The duty to defend issue is then commonly decided via summary judgment.
Wisconsin decisions have not stated expressly that the stay must be obtained, but rather that the stay must be sought. So, for example, in Newhouse the court said that the insurer that moves for stay and bifurcation does not hazard being accused of breaching a duty to defend. The decision did not describe whether that stay had to be granted, or not. But what if the stay is denied? Or, what if the court will not assign a prompt hearing? In both circumstances the insured likely needs a defense, if only to answer, or respond to interrogatories or document requests served with the complaint. The insurer that does not provide a defense under that circumstance hazards the breach accusation.
In some instances insureds have opposed the stay, contending that they want to engage in early motion practice, e.g., a motion to dismiss. If the court refuses the stay, and then denies that motion to dismiss, the insured will argue that the motion work should be paid for by the insurer. This argument is made even though the dismissal motion practice should not have occurred in the first instance. The principles motivating the court’s desire for early resolution of coverage disputes are sacrificed for the supposed quick dismissal that invariably ends up faltering. To avoid this and stay true to the supreme court’s guidance, circuit courts should be granting stays without exception. Unfortunately, that does not always happen.
Defense at the Insurer’s Expense under a Reservation of Rights
When the stay and bifurcation cannot be quickly obtained, and even in some cases when they can be, an added precaution to protect both the insured’s defense and the insurer against a breach claim would be for the insurer to retain defense counsel unde a reservation of rights. The reservation of rights need not be in writing, although a writing certainly clarifies the insurer’s intent, informs the insured, and builds the right expectations, which is generally a good thing that the supreme court prefers:
We strongly urge insurers to communicate with their insureds about their potential coverage defenses, but we do not see the failure to issue a reservation of rights letter as grounds to require an insurer to provide insurance coverage that does not otherwise exist in the insurance contract.8
So, the insurer wishing to intervene and pursue a stay and judicial declaration has a choice to make: either (1) attempt immediately to secure a stay, by motion or party consent without hiring defense counsel; or (2) incur the expense of defense counsel under a reservation of rights during the pendency of the stay and bifurcation.
What are the sensible options when the intervention, stay, and bifurcation approach appears costly, particularly when compared to the plaintiff’s claimed damages, or when the stay likely cannot be granted quickly?
A. The Tender Withdrawal
I have increasingly found a preliminary step to be helpful, one that can attain the desired result at lesser expense. The insurer should have counsel call or write to the insured, or to the plaintiff and to the insured, to explain in detail why there is no duty to defend and supply a certified copy of the policy so that they can see it for themselves, and then ask them to withdraw their tender of defense in writing, essentially stipulating to the lack of a duty to defend. My initial approach is worded something like the following, to be followed by detailed application of the four corners rule, applying the policy to the complaint:
I am writing to you and providing the policy in the hope that you will agree there is no duty to defend or indemnify under the policy. I am hopeful we can reach agreement on that and that you would withdraw the tender, because if you do not then the insurer may have me intervene and seek a stay and summary judgment on insurance coverage, which would entail time and expense for your client and mine that should be unnecessary.
Counsel for the plaintiff and for the insured have agreed to this more frequently than you might expect. Perhaps it is because they recognize the strength of the insurer’s position and do not want to incur substantial unnecessary expense litigating coverage under a stay. Also, sometimes this approach works because the insured has a trusted regular defense counsel already engaged and they do not want to lose the choice of counsel or control. Another factor might be the availability of other insurers for a defense, something common in construction or environmental litigation where damages arguably stretch over a period of time and through several policies.
This tender withdrawal approach should be done quickly and if possible before responsive pleadings, like an answer, must be served. Remember, the insured’s tender withdrawal is only half the battle, because the plaintiff will still possess a direct action claim against the insurer, regardless of the insured’s position. That is, the insured’s stipulation to no coverage does not bind the plaintiff. Consequently, you will want to obtain the plaintiff’s stipulation as well in order to better secure complete litigation peace.
B. The Negative Enrollment
One variant of this approach in an action where the insurer is not a named party is the negative enrollment, which has benefits and detriments. Counsel for the insurer writes to the insured explaining in detail why there is no duty to defend, enclosing the certified policy and advising that if the insurer has not heard back within a stated period of time, say ten days, the insurer will assume that the insured is in agreement that there is no duty to defend. Of course, an insured’s silence is not express agreement, but it will also be true that the insurer has communicated with the insured as suggested by the Wisconsin Supreme Court in Towne Realty, Inc. v. Zurich Ins. Co.: “[I]f it is unclear or ambiguous whether the insured wishes the insurer to defend the suit, it becomes the responsibility of the insurer to communicate with the insured before the insurer unilaterally forgoes the defense.”9 And, the insured rightfully has a responsibility to respond, consistent with the burden placed on the insured in the first instance to establish coverage.10
This negative enrollment approach does leave the insurer with less than complete closure, in that the plaintiff could obtain a judgment and then pursue collection on it under the direct action statute. But the risk of that happening may be small, especially if the plaintiff did not name the insurer in the original suit. There is also the risk that the insured does not get the communication, or does not understand it, and fails to respond. It seems likely, though, that a court would not penalize the insurer in that instance, especially if the explanation was clear and plainly worded.
C. Stipulated Bifurcation and Stay Plus Indefinite Extension to Answer
Yet a third method to obtain a comparably desirable result with lesser expense is to immediately seek the plaintiff’s and the insured’s stipulation to intervention, stay, and bifurcation with an indefinite extension of time on the answer, so that the insurer can quickly move to summary judgment and avoid both the costs and risks of stay and bifurcation motion practice, and the cost of paying for counsel under a reservation of rights to defend the insured. The stipulation should be memorialized in a way that promotes expedition. I prefer an order under the five day rule in this circumstance.
All these approaches have support in Wisconsin decisions, although perhaps not expressed directly in them. For example, the agreement of an insured to withdraw a tender of defense to its insurer upon its request is a natural consequence of the communication suggested by the supreme court in Towne Realty. As another example, a stipulation to intervention, stay, and bifurcation protects the insured from the unnecessary expenses and efforts warned of in Liebovich.
D. Additional Considerations
Other accessories to these options can be employed as well. You may find efforts with the insured and plaintiff to be aided by reassurance that if pleadings are amended, they always have the right to retender their claims. In fact, this right is arguably their duty under the policy language anyway, which frequently requires an insured to “immediately send” to the insurer “copies of any legal papers received in connection with the claim or suit.”11 The reassurance should be tempered by an admonition that the facts alleged are dispositive, not labels or theories of liability. For example, labelling a cause of action “negligence” in an amended complaint does not transform the underlying intentional conduct into an accident to invoke a duty to defend.12
The insurer may also expressly reserve the right to recoup defense costs that it has paid under a reservation of rights if its position on the duty to defend is ultimately confirmed by court declaration. This gives some protection to the insurer against runaway defense expenses, which is particularly valuable if the insurer has allowed the insured to select counsel and is not controlling the defense. The recoupment threat serves to moderate uncontrolled defense conduct and expense. At least one Wisconsin decision has noted the possibility of such a recoupment.13 Other states like California have expressly allowed the recoupment under an unjust enrichment theory,14 with courts in some states like Minnesota conditioning it on a written reservation of rights letter stating the insurer’s intent to seek the recoupment if successful in pursuing a declaratory judgment.15 The insurer may also have business considerations that factor into whether to state that it is reserving its right to recoupment. That said, failure to state the reservation, in both a reservation of rights letter and in the intervenor complaint, may waive it.
The Cost Effectiveness Factor
The implementation of the duty to defend decision will likely be impacted by the perceived size of the claim. This is particularly so in seemingly small-dollar construction cases. If the claim is for a modest amount of home or building repair work, does it warrant the expense of a motion for intervention, stay, and bifurcation, and then summary judgment proceedings? A flat denial might appear more cost effective, yet it is possibly dangerous. We have at times in these situations sought to slow the process down to facilitate settlement with some insurer and insured participation. We propose to the plaintiff an indefinite extension of time for the insured to respond to the complaint, while demonstrating to the insured the lack of coverage but offering to discuss a modest insurer contribution to a settlement package. Quick telephone negotiation, or perhaps even formal mediation, all with an express reservation of rights, can produce a quick, cost-effective resolution.
Leaving the Four Corners
Deciding to provide a defense under a reservation of rights may take you outside of the four corners rule, a risk you should recognize. This risk is anticipated in the language of some supreme court decisions, such as Olson v. Farrar:
[T]he purpose of the four-corners rule has been served once the insurer has elected to provide a defense pending a final determination on coverage. At that point, the insurer has protected its insured by providing a defense. The insurer has also protected itself from liability for a breach of contract. The four-corners rule is not further implicated, and the court proceeds to a determination of coverage.16
The risk of leaving the confines of the four corners is that the insured may submit affidavits or other evidence to cloud the court’s analysis of the duty to defend, as was attempted in Water Well. Some courts might be confused into allowing an insured’s affidavit to make ambiguous what is otherwise clear in the complaint. A historical example can be found in Berg v. Fall.17 The law for many years, articulated in Berg, was that a complaint alleging a battery injury—i.e., a fight where the plaintiff alleged the defendant intended to injure—would require a defense if the defendant raised selfdefense as a defense via affidavit. Later Wisconsin Supreme Court decisions effectively overruled Berg as an improper deviation from the four corners rule.18 However, the same result might occur now if the insurer defends the suit under a reservation of rights while simultaneously moving for summary judgment declaring no duty to defend. The insured might point to the language in Olson and argue that an affidavit of self-defense properly suggests an “occurrence” or accident imposing a duty to defend. Will the court then feel compelled to see a fact issue on occurrence and require a defense? If it does, the court has effectively reinstated Berg, contravening the spirit, if not the word, of the four corners rule.
When the court is presented with this issue, counsel should make clear that hiring a defense lawyer under reservation of rights does not open the floodgates to extrinsic evidence offered by an insured to cloud or alter the complaint allegations. In Kreuger International, Inc. v. Federal Ins. Co., the Eastern District of Wisconsin noted that “an insurer is hardly blameworthy for defending under a reservation of rights, given the potential liability it faces for breach of contract.”19 The insurer’s hiring of a defense lawyer under a reservation of rights is merely an extra precaution, not a concession that the duty to defend might be invoked. An insurer’s hiring of a defense lawyer, after all, is protective of an insured’s interest, something the courts generally like. The insurer should not suffer the loss of the four corners rule and its clarity just because it acted to protect the insured’s interest while it went about asking for declaratory judgment on the duty to defend.
Olson suggests that the court may move past the four corners rule in its analysis when discovery has occurred and the case is headed toward a coverage trial.20 By contrast, where no, or limited, discovery has occurred and a stay is then imposed, the court’s duty to defend analysis is more appropriately guided by the four corners rule, particularly when the insurer promptly moves to have the duty to defend decided based only on a comparison of the complaint to the policy.
Jeff Leavell was admitted to the Bar in 1983. He graduated from the University of Chicago, with honors, in 1980, and the University of Wisconsin Law School, J.D., cum laude, in 1983. He was judicial law clerk for the Wisconsin Court of Appeals District IV from 1983-1985.
Mr. Leavell is a frequent lecturer and author, and has spoken to numerous Civil Trial Counsel of Wisconsin Conferences and Wisconsin Defense Counsel Conferences over the last two decades. He regularly represents insurers and other parties in duty to defend disputes, in Wisconsin and other states and federal venues. Some recent duty to defend decisions include Smith v. Anderson, 2016 WI App 16; Weis v. Kapinos, 2015 WI App 37; Schinner v. Gundrum, 2013 WI 71; Sawyer v. West Bend Mut. Ins. Co., 2012 WI App 92; Flejter v. West Bend Mut. Ins. Co., 2010 WI App 174; Martinez v. Calimlim, 739 F. Supp. 2d 1142 (E.D. Wis. 2010). He is the principal and founder of Jeffrey Leavell, S.C., established in 1994.
Mr. Leavell is a Board Certified Civil Trial Specialist by the National Board of Trial Advocacy. He has been elected by his peers as “Superlawyer” every year since 2006 as published in Milwaukee Magazine. Jeffrey Leavell, S.C., has been recognized annually since 1995 by Martindale- Hubbell in its Bar Register of Preeminent Lawyers as a most distinguished law practice, achieving the highest level of legal and ethical standards. He served on the Board of Governors of the Racine County Bar Association, and is past President of the Racine County Bar Association. He is past President of the Wisconsin Defense Counsel.
1 Water Well Sols. Serv. Grp. Inc. v. Consol. Ins. Co., 2016 WI 54, 369 Wis. 2d 607, 881 N.W.2d 285.
2 Marks v. Hous. Cas. Co., 2016 WI 53, ¶ 39, 369 Wis. 2d 547, 881 N.W.2d 309.
3 Water Well, 369 Wis. 2d 607, ¶ 15 (internal citations omitted).
4 Marks, 369 Wis. 2d 547, ¶ 39 (quoting Estate of Sustache v. Am. Family Mut. Ins. Co., 2008 WI 87, ¶¶ 20, 27, 311 Wis. 2d 548, 751 N.W.2d. 845).
5 Id., ¶ 71.
6 Liebovich v. Minn. Ins. Co., 2008 WI 75, ¶ 55, 310 Wis. 2d 751, 751 N.W.2d 764.
7 Newhouse v. Citizens Sec. Mut. Ins. Co., 176 Wis. 2d 824, 836, 501 N.W.2d 1 (1993) (internal citation omitted).
8 Maxwell v. Hartford Union High Sch. Dist., 2012 WI 58, ¶ 2, 341 Wis. 2d 238, 814 N.W.2d 484.
9 201 Wis. 2d 260, 269, 548 N.W.2d 64 (1996).
10 Day v. Allstate Indem. Co., 2011 WI 24, ¶ 26, 332 Wis. 2d 571, 798 N.W.2d 199 (“The insured bears the burden of showing an initial grant of coverage.”).
11 See, e.g., ISO Form CG 00 01 12 07, p. 11 of 16.
12 The court succinctly noted this in James Cape & Sons Co., 2009 WI App 154, ¶ 16, 321 Wis. 2d 604, 775 N.W.2d 117, that “[t]he duty to defend arises from the allegations within the four corners of the complaint ... [and] our focus is on the facts alleged, the incidents giving rise to the claims, not ... [the] theory of liability.”
13 Kreuger Int’l, Inc. v. Fed. Ins. Co., 647 F. Supp. 2d 1024, 1043-44 (E.D. Wis. 2008).
14 See Buss v. Superior Court of Los Angeles, 939 P.2d 766 (Cal. 1997).
15 See, e.g., Knapp v. Commonwealth Land Title Ins. Co., 932 F. Supp. 1169, 1172 (D. Minn. 1996). But see Westchester Fire Ins. Co. v. Wallerich, 527 F. Supp. 2d 896, 908 (D. Minn. 2007) (“[T]his Court is of the view that the Minnesota Supreme Court would refuse to allow reimbursement unless an agreement to the contrary is found in the insurance policy.”); Gen. Agents Ins. Co. of Am., Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1104 (Ill. 2005) (“In sum, we acknowledge that a majority of jurisdictions have held that an insurer is entitled to reimbursement of defense costs when (1) the insurer did not have a duty to defend, (2) the insurer timely and expressly reserved its right to recoup defense costs, and (3) the insured either remains silent in the face of the reservation of rights or accepts the insurer’s payment of defense costs. We choose, however, to follow the minority rule and refuse to permit an insurer to recover defense costs pursuant to a reservation of rights absent an express provision to that effect in the insurance contract between the parties.”).
16 Olson v. Farrar, 2012 WI 3, ¶ 34, 338 Wis. 2d 215, 809 N.W.2d 1.
17 138 Wis. 2d 115, 405 N.W.2d 701 (Ct. App. 1987).
18 Doyle v. Engelke, 219 Wis. 2d 277, 284 n.3, 580 N.W.2d 245 (1998).
19 647 F. Supp. 2d at 1044-45.
20 Olson, 338 Wis. 2d 215, ¶¶ 35-37.