Olson v. Farrar: When Insurance Coverage Litigation Moves Beyond the Four-Corners Rule
The four-corners rule is a core principle of insurance coverage litigation. When determining an insurer’s duty to defend an insured in a lawsuit, the analysis is limited solely to the contents—or “four corners”—of the complaint. Courts have coined the phrase “four-corners rule” to describe this method of analyzing the duty to defend.
Over the years, the four-corners rule has also been used to determine an insurer’s duty to indemnify. Specifically, insurers argue that if there is no duty to defend under the allegations of the complaint, there cannot be a duty to indemnify and hence there is no coverage. At the same time, many plaintiffs often argue that the four-corners rule applies to all coverage determinations, and they therefore draft pleadings that contain magic language to trigger coverage, knowing that extrinsic evidence will not be used to refute those allegations.
Recently, in Olson v. Farrar,[i] the Wisconsin Supreme Court addressed the proper function of the four-corners rule. For some, Olson changes the way insurance coverage will be litigated by allowing the court to consider extrinsic evidence when evaluating coverage. For others, the decision confirms the principle that the function of the four-corners rule is limited to determining whether the insurer owes a defense to the insured and whether that obligation has been breached.
I. Background: The Four-Corners Rule and the Basic Principles of Insurance Coverage Litigation
An insurer has two main duties—a duty to defend and a duty to indemnify.[ii] An insurer’s duty to defend is broader that its duty to indemnify, but the two are closely related.
An insurer has a duty to defend if it has a duty to indemnify the insured (i.e., pay the claim). It also has a duty to defend when the allegations of the complaint, if proven true, would give rise to a duty to indemnify.[iii] Accordingly, an insurer must defend all suits where there would be coverage if the allegations are proven, even if those allegations are “utterly specious.”[iv] Thus, it has been said that the duty to defend implicates arguable coverage while the duty to indemnify implicates actual coverage.[v] The practical implication of this is that insurers are obligated to defend their insureds against lawsuits even though they may ultimately have no obligation to pay the claim.
The four-corners rule determines the insurer’s duty to defend. When a complaint alleges facts that, if proven, would constitute a covered claim, the insurer’s duty to defend is triggered. The analysis is confined to the four-corners of the complaint, meaning that one does not look beyond the allegations of the complaint or rely on extrinsic evidence. In conducing this analysis, the court is to read the allegations of the complaint liberally. It is the nature of the alleged claim that is controlling, even though the suit may be groundless, false or fraudulent.[vi] Once the duty to defend is triggered, the insurer is required to provide a defense unless and until the court makes a final determination of the coverage question in the insurer's favor.[vii]
The consequences of breaching the duty to defend can be disastrous. Where an insurer improperly refuses to defend, it cannot later contest coverage.[viii] The insurer is liable to the insured for all damages that naturally flow from the breach. Damages include the amount of the insured’s attorney fees, as well as the costs for defending the suit. Damages also include the amount of any judgments or settlements rendered against the insured, even if those amounts exceed the policy limits.[ix]
When faced with a complaint where coverage is questionable, the insurer may choose to reject the tender of a defense and let the insured handle his or her own defense, all while hoping for the best. [x] In most cases, this is a risky proposition. There are wiser courses of action for the insurer to select.
Courts have identified four ways insurers may raise the coverage issue while retaining their right to contest coverage. First, the insurer may commence a declaratory judgment action where coverage will be decided in a separate lawsuit. Second, the insurer may enter an agreement with the insured to defend while retaining the right to challenge coverage. Third, the insurer may provide a defense under a reservation of rights, which allows the insured to pursue his or her own defense not subject to the insurer’s control, but the insurer agrees to pay for the legal fees incurred. Fourth, the insurer may request a bifurcated trial in which trial and discovery on the merits of the claim are stayed pending resolution of the coverage question.[xi] The Wisconsin Supreme Court has endorsed the bifurcation and stay method, and when it is followed, “the insurance company runs no risk of breaching its duty to defend.”[xii]
In practice, most insurers use a combination of options. It is commonplace to see the insurer appoint defense counsel under a reservation of rights and appoint coverage counsel, who moves to bifurcate the case and stay discovery and trial on the merits pending resolution of coverage. The reason is quite simple: the insured has 45 days to answer the complaint, and it is not likely that the insurer will successfully be able to obtain an order bifurcating and staying the merits before the deadline arrives for answering the complaint. By appointing defense counsel under a reservation of rights and moving for bifurcation and stay, the insurer does not risk breaching the duty to defend, and the insurer preserves its coverage defenses.
While the Supreme Court endorsed bifurcation and stay as the preferred method in its 1993 decision of Newhouse v. Citizens Security Mut. Ins. Co.,[xiii] the court did not provide much guidance about how the coverage litigation should unfold. Once the order for bifurcation and stay is entered, coverage counsel usually decide between two possible courses of action.
The first possible course of action is to litigate coverage just like any other case. Coverage counsel conduct discovery, and frequently have coverage determined on summary judgment by applying the policy provisions to undisputed or assumed facts. When facts relevant to coverage are disputed, a trial can be held to adjudicate the facts and decide whether there is coverage. The ultimate objective is to determine that the established facts ultimately will not give rise to a duty to indemnify the insured. This course of action can be long and expensive and frequently involves considerable overlap with the liability claim.
The other course of action is to contest the duty to defend based on the four-corners rule. If there is no duty to defend, there is no duty to indemnify. When the allegations of the complaint make coverage fairly debatable, the insurer can obtain a relatively swift coverage determination with minimal expense and no risk of breaching the duty to defend.
II. Olson: The Four-Corners Rule Has Limited Application.
In Olson v. Farrar, the Supreme Court clarified the proper role of the four-corners rule. The Olson decision amplified comments made in two short paragraphs written four years earlier in Estate of Sustache v. American Family Mutual Insurance Co., another Wisconsin Supreme Court decision.
Estate of Sustache was a wrongful death case. The insured punched Sustache in the face, causing him to fall to the curb and sustain severe injuries that resulted in his death. The insured claimed he acted in self-defense.
The insurer provided a defense under a reservation of rights, and argued there was no coverage because the attack did not constitute an “occurrence.”[xiv] The insurer moved for a bifurcated trial and a stay of discovery on the merits pending a determination of coverage. During the coverage phase, the insured asked the court to create an exception to the four-corners rule where self-defense is claimed.[xv] The insurer opposed such an exception and claimed that the four-corners rule prohibited any inquiry beyond the allegations of the complaint.[xvi]
In the end, the court did not create a self-defense exception to the four-corners rule. Instead, the court decided the four-corners rule was inapplicable.
Where the insurer has provided a defense to its insured, a party has provided extrinsic evidence to the court, and the court has focused in a coverage hearing on whether the insured’s policy provides coverage for the plaintiff’s claim, it cannot be said that the proceedings are governed by the four-corners rule.[xvii]
The insurer’s duty to continue that defense was contingent upon a court determination that the insured had actual coverage under the policy.
The four-corners rule returned to the forefront four years later in Olson. The insured used a tractor to haul plaintiff’s trailer home to a new site. The plaintiff followed the tractor in his truck. During the journey, the tractor stalled on a hill. The trailer home rolled backwards and crashed into plaintiff’s truck. The plaintiff sued the insured for property damage, and the insured turned around and tendered the defense to his insurer.[xviii]
The insurer contested coverage but provided a defense under a reservation of rights. It then moved to intervene in the lawsuit, bifurcate coverage from liability, and stay the liability proceedings until coverage was determined. The trial court granted the insurer's motions.
During the coverage phase of the litigation, the insurer moved for judgment on its policy defenses. The insurer employed the four-corners rule, and it maintained that, based on the allegations of the complaint, it had no duty to defend the insured.
The insured opposed the insurer’s coverage motion. However, instead of litigating within the four corners of the complaint, the insured submitted an affidavit containing extrinsic facts to show that the policy exclusions did not apply.[xix] The insured argued that the four-corners rule only applies to the initial determination of the duty to defend. Once the insurer appoints counsel, the insured reasoned, the case has moved beyond the initial duty to defend stage of the proceedings and the court is no longer confined by the four-corners rule.
The Supreme Court decided in favor of the insured. The court commented that the four-corners rule is implicated when the insurer makes an initial determination about whether it will defend its insured. The four-corners rule is also implicated in situations where it is asserted that the insurer breached the duty to defend.[xx] However, the court went on to state that the four-corners rule has no place in the coverage analysis once the insurer provides the insured with a defense.
[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.[xxi]
Olson makes clear what Estate of Sustache had mentioned four years earlier. The four-corners rule is not the proper standard for determining insurance coverage once the insurer provides a defense.
III. What Are the Practical Implications of Olson?
If the insurer provides a defense, the case moves beyond the four-corners rule and extrinsic evidence may be introduced to determine coverage. Coverage litigation may take different forms. Some may involve dispositive motions based on pure questions of law that are determined by applying undisputed facts to the terms of the insurance policy. Others may involve complicated issues of fact that require a trial.
The four-corners rule has been used in countless appellate decisions, both published and unpublished. In many of those appellate decisions, the four-corners rule has been used in situations where the insurer provided a defense under a reservation of rights. Olson does not expressly overrule any of those prior decisions, and the coverage analysis of those decisions probably remains sound, even though the court may have erroneously confined itself to the four corners of the complaint. In that regard, Olson does not alter the legal landscape or destroy the fabric of prior insurance coverage case law.
Olson does have significant practical implications, however. The four-corners rule could end up being much less prevalent in coverage litigation. At least in state court lawsuits, the bifurcation and stay method has arguably been the most prevalent process for litigating insurance coverage disputes. Equally prevalent are insurers that choose to protect their insureds by assigning merits counsel under a reservation of rights. In those situations, Olson now mandates that the four-corners rule is no longer applicable to determine coverage. As a result, except in the clearest of cases, coverage counsel will now need to engage in discovery and be able to prove that the insurer has no duty to indemnify based on established facts. Most likely, the limited role of the four-corners rule will make coverage litigation longer and more costly because many cases will require a full factual determination in order for coverage to be decided.
While coverage litigation may involve a greater investment in time and resources, Olson does bring insurers an unexpected benefit. Plaintiffs’ attorneys have been adept at taking advantage of the four-corners rule by drafting complaints that assert facts to trigger coverage, even though the true facts would not be covered. These days, it is not uncommon to see a plaintiff masquerade an intentional tort as an “accident,” and then try to litigate coverage within the four corners of the complaint. Following Olson, insurers are no longer going to be held captive to the allegations of the complaint, because extrinsic evidence can now be used to establish the real facts.
The four-corners rule is not dead. It is still the standard for insurers to use when evaluating whether to provide a defense. It will continue to be used in those rare cases where the insurer contests coverage without providing the insured with a defense, and it will also continue to be applied when the insurer is alleged to have breached its duty to defend. The Supreme Court's decision in Olson provides some long overdue clarity to the precise function of the four-corners rule and when extrinsic evidence is and is not admissible in coverage litigation.
[i] 2012 WI 3, ___ Wis. 2d ___, ___ N.W.2d ___.
[ii] Johnson Controls, Inc. v. London Mkt., 2010 WI 52, ¶ 28, 325 Wis. 2d 176, 784 N.W.2d 579.
[iii] Grieb v. Citizens Cas. Co., 33 Wis. 2d 552, 558, 148 N.W.2d 103 (1967).
[iv] Smith v. Katz, 226 Wis. 2d 798, 807, 595 N.W.2d 345 (1999).
[v] Fireman’s Fund Ins. Co. of Wis. v. Bradley Corp., 2003 WI 33, ¶ 20, 261 Wis. 2d 4, 660 N.W.2d 666.
[vi] Elliot v. Donahue, 169 Wis. 2d 310, 320-21, 485 N.W.2d 403 (1992).
[vii] Id. at 321.
[viii] Professional Office Bldgs., Inc. v. Royal Indem. Co., 145 Wis. 2d 573, 585, 427 N.W.2d 427 (Ct. App. 1988).
[ix] Newhouse v. Citizens Security Mut. Ins. Co., 176 Wis. 2d 824, 838, 501 N.W.2d 1 (1993); Radke v. Fireman's Fund Ins. Co., 217 Wis. 2d 39, 48-49, 577 N.W.2d 366 (Ct. App. 1998).
[x] Radke, 217 Wis. 2d at 45.
[xi] Baumann v. Elliott, 2005 WI App 186, ¶ 8, 286 Wis. 2d 667, 704 N.W.2d 361; see also Radke, 217 Wis. 2d at 45.
[xii] Newhouse, 176 Wis. 2d at 836.
[xiii] 176 Wis. 2d 824, 501 N.W.2d 1 (1993).
[xiv] Estate of Sustache v. American Family Mut. Ins. Co., 2008 WI 87, ¶¶ 5-7, 12, 311 Wis. 2d 548, 751 N.W.2d 856.
[xv] Id., ¶ 24.
[xvi] Id., ¶ 12.
[xvii] Id., ¶ 29.
[xviii] Olson, 2012 WI 3, ¶¶ 7-9
[xix] Id., ¶ 17.
[xx] Id., ¶ 33.
[xxi] Id., ¶ 34.