A Win for Contractors in the Area of Insurance Coverage

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A recent California Court of Appeal case strengthened contractors’ rights to insurance coverage and specifically the right to have the insurance company pay the attorneys fees and court costs of a lawsuit. The decision is not at all surprising. However, it is an important decision that contractors may use to obtain insurance coverage for defense costs and maybe even indemnification. It is important to note that there is a distinction between the insurance company’s duty to defend a claim and the insurance company’s duty to indemnify against a loss. California courts have uniformly held that the duty to defend is greater than the duty to indemnify. In short, the law is that if there is any likelihood that the claim is covered, then the insurance company must defend the entire claim. Thereafter, if it turns out that the damage is not a covered event, the insurance company may not have to indemnify. “Indemnify” in this situation means that the insurance company pays the judgment if its insured (i.e., the contractor) loses the lawsuit.

In this case, Construction Protection Services, Inc. (CPS) filed suit against a company for breach of contract. CPS alleged that the defendant owed $27,000 for security services that CPS provided for a construction project. In response to that lawsuit, the defendant raised an affirmative defense that CPS did not carry out its obligations correctly and therefore, the defendant was damaged. It is important to note that an affirmative defense is different than a cross-complaint. A cross-complaint for something that is covered by the insurance policy is uniformly defended by the insurance company. However, an affirmative defense merely seeks to deduct from what is owed an amount claimed to be due and owing as a result of some malfeasance by the insured. The insurance company took the position that because no cross-complaint had been filed, there was not a “suit” to defend. The insurance company took that position because it felt that an affirmative defense does not constitute a lawsuit. Therefore, the insurance company refused to defend because it claimed there was no duty to defend an affirmative action.

This court cut through all the smoke and mirrors and stated that under the insurance policy, the insurance company had to defend CPS in a civil action or suit seeking damages. Although a suit involves actual court proceedings initiated by filing a complaint, in this case the affirmative defense constituted a suit because it was seeking a deduction, i.e., damages. The affirmative defense had the potential to result in an award of damages against CPS. It arose to the level of a suit even though it was not technically a lawsuit. The Court of Appeal held that the affirmative defense, by seeking damages, created a duty to defend. Therefore, the Court of Appeals held that the insurance company breached its duty to its insured to defend its insured by its refusal to defend. As the Court of Appeals held, “an insured buys liability insurance in large part to secure a defense against all suits potentially within policy coverage, `even frivolous [ones] unjustly brought.'”