Duty to Defend vs. Duty to Indemnify: Why It Matters in Business Insurance Disputes

​If your business is sued by a client or another third party, your first question may be whether your firm’s liability insurance policy will fully cover the claim. Liability insurers generally have both a duty to defend you against claims and a duty to indemnify or compensate you for settlements or judgments that are covered under the policy, up to the policy limits. An insurer’s duty to defend is generally broader than its duty to indemnify, and it is important to understand how these two distinct obligations may apply to your situation.

Two Separate Obligations

Most commercial liability policies impose two distinct duties on insurers. The duty to defend requires that the insurer provide a legal defense when a lawsuit alleges facts that potentially fall within the policy’s coverage. This obligation typically includes retaining defense counsel, paying legal fees, investigating the claim and managing the defense. The duty to indemnify arises only if the insured becomes legally obligated to pay damages actually covered under the policy.

As the duty to defend is generally broader than the duty to indemnify, an insurer may be required to defend a lawsuit even if it is ultimately determined that the insurer has no obligation to cover the settlement or judgment.

The Duty to Defend

In determining if the duty to defend applies, courts generally compare the allegations in the complaint with the insurance policy language. If the allegations could reasonably fall within policy coverage, coverage is generally triggered, and the insurer must provide a defense.

Early in litigation, the facts of a case are often disputed or incomplete. Requiring insurers to defend whenever there is a reasonable possibility of coverage ensures that policyholders receive the protection they purchased until the factual issues can be resolved. In many jurisdictions, if a lawsuit contains multiple claims and only one of those claims is potentially covered under the terms of the policy, the insurer must still defend the entire action. Additionally, insurers generally cannot refuse to defend a lawsuit simply because it believes the allegations are groundless.

Even when a lawsuit lacks merit, defense costs in commercial litigation often reach hundreds of thousands of dollars. Having those expenses paid by the insurance company is a significant benefit for policyholders.

When an Insurer May Refuse to Defend

The insurer’s duty to defend is not unlimited, however. The insurer is generally not required to provide a defense if the allegations in the lawsuit clearly fall outside the policy’s coverage, or if they fit entirely within a policy exclusion. For example, commercial general liability (CGL) policies generally cover businesses for bodily injury, property damage, and in some cases personal injury that they cause to a third party. Like all insurance policies, CGL policies have exclusions; for instance, they typically exclude intentional wrongful acts. Therefore, if a business owner punches a customer, and the customer brings a lawsuit solely for assault, the insurer generally will not defend the lawsuit, since the policy excludes intentional wrongful acts.

The Duty to Indemnify

Whether the insurer has a duty to indemnify is determined based on the facts established during litigation or settlement. The insurer generally must pay the cost of a judgment or settlement, up to the policy limits, if the loss resulted from an occurrence that ultimately proves to be covered under the terms of the policy. If the facts show that the claim falls within an exclusion or otherwise lies outside coverage, the insurer will generally not owe the insured indemnification.

For instance, say an engineering company incurs $300,000 in penalties and interest due to tax filing errors by its accounting firm. The engineering company sues the accounting firm for negligence. The accounting firm has a professional liability insurance policy, which provides coverage for negligent acts, errors and omissions committed in the provision of professional services. The insurer defends the lawsuit, since it alleges negligence. But internal documents and emails uncovered during discovery show that the accountants intentionally falsified tax documents to conceal earlier mistakes. The court ultimately finds the defendant acted fraudulently rather than negligently, and orders a judgment be paid to the engineering firm. Since most professional liability policies exclude coverage for intentional fraud or dishonest conduct, the accounting firm will likely have to pay the judgment out of its own pocket – even though the insurer defended the lawsuit.

The Bottom Line

For companies facing a lawsuit, understanding the distinction between duty to defend and duty to indemnify can guide interactions with insurers while helping set realistic expectations during litigation.

If you are involved in a dispute with your business insurance company, contact Schwartz, Conroy & Hack, PC. We have the expertise, experience and tenacity to make insurance companies keep their promises to you and your business.

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