The Wisconsin Supreme Court Addresses Two Important Third-Party Insurance Coverage Issues
In two recent cases, Water Well Solutions Service Group Inc. v. Consolidated Insurance Co., 2016 WI 54, and Marks v. Houston Casualty Co., 2016 WI 53, the Wisconsin Supreme Court addressed two important third-party insurance coverage concepts: (1) whether an insurer’s duty to defend obligation should be determined by comparing the four-corners of the underlying complaint to the policy (referred to as the “four-corners rule”) without consideration of extrinsic evidence and (2) whether an insurer can consider policy exclusions in making a duty to defend determination. As to the former issue, the court declined to create an exception to the four-corners rule and concluded that extrinsic evidence should not be considered in making a duty to defend determination. As to the latter issue, the court determined that policy exclusions can be considered for purposes of the duty to defend determination.
In Water Well, the insured was sued relating to its installation of a well pump that fell to the bottom of a well, allegedly causing $300,000 in damages to the pump. Based on the allegations in the complaint, the insurer, who provided a standard commercial general liability policy, determined that the complaint triggered an initial grant of coverage. However, it also concluded that coverage was excluded by the “Your Product” exclusion (the complaint only alleged damages to the well pump itself — the insured’s own product) and by the “Your Work” exclusion (the complaint only alleged that the insured completed the work). Thus, the insurer declined to provide a defense.
In response, the insured claimed that extrinsic evidence demonstrated that the exclusions did not apply. It submitted an affidavit stating that there was damage to property other than the water pump itself (which would render the “Your Product” exclusion inapplicable) and a subcontractor of the insured completed some of the work (which would render the “Your Work” exclusion inapplicable because of the subcontractor exception to the exclusion). Against this background, the court addressed whether the insured’s extrinsic evidence could be considered for purposes of the duty to defend—i.e., whether Wisconsin recognizes any exception to the four-corners rule.
The court “unequivocally [held] that there is no exception to the four-corners rule in duty to defend cases in Wisconsin” and declined to consider the extrinsic evidence submitted by the insured. Reviewing precedent, the court noted that the four-corners rule is well-established in Wisconsin case law as it “generally favors Wisconsin insureds” because (1) it results in the efficient determination of defense obligations given that those obligations are based off of two documents, the complaint and insurance policy; (2) insurers are incentivized to provide a defense because the rule is predicated on the allegations in the complaint, not actual evidence; and (3) the plaintiff can always file an amended complaint following discovery to trigger the defendant’s insurer’s duty to defend.
Interestingly, the court explained that under the four-corners rule, in some instances, an insurer’s duty to defend may not be triggered, yet it may nonetheless have a duty to indemnify pending on the evidence. At first blush, this recognition may seem incongruent with the principle that the duty to defend is broader than the duty to indemnify, but that principle merely recognizes that because the duty to defend is based solely on the allegations in the complaint, it is triggered by arguable, as opposed to actual, coverage. However, where the complaint does not set forth allegations triggering the duty to defend, there is no defense obligation, even though later presented extrinsic evidence may trigger indemnity. Water Well seemingly presented this unique circumstance; although to be sure, the court did not address the indemnification aspects of coverage.
Ultimately, the court applied the four-corners rule and determined that the underlying complaint established that coverage was excluded by the “Your Product” exclusion. As such, the court found that the insurer did not breach its duty to defend.
In Marks, the insured was sued in a series of lawsuits arising from his involvement as an officer of Titan Global Holdings, Inc. (“Titan”). The insurer refused to defend the insured based on a policy exclusion relating to liability arising out of the insured’s services as an officer of a business not named in the policy’s declarations (Titan was not so named). The insured argued that policy exclusions could not be considered in making a duty to defend determination, and he primarily relied upon Grube v. Daun, 173 Wis. 2d 30 (Ct. App. 1992), as standing for the proposition that an insurer who fails to provide a defense is estopped from relying upon exclusions thereafter to contest coverage.
The court firmly rejected the insured’s contentions. It held that under the four-corners rule, the entire policy should be examined, including granting clauses, exclusions, and any exceptions to the exclusions. Further, the court “explicitly overrule[d]” Grube and a subsequent line of court of appeals cases that “suggest[ed] that exclusions may not be considered in an analysis of whether an insurer has breached its duty to defend its insured simply because the insurer declined to defend its insured.” Although not encouraged by the court, the insurer always has the option to decline to provide a defense, and if it so elects, it can later rely on exclusions in demonstrating that the underlying complaint gave rise to exclusions. However, if the insurer is later found to have made an improper determination and breached its duty to defend, it may be held responsible for all damages naturally flowing from the breach. In this case, the court determined that the insurer correctly denied coverage under the exclusion noted above.
In sum, the Wisconsin Supreme Court solidified that there are no exceptions to the four-corners rule—the only two documents an insurer can consider in making its duty to defend determination are the underlying complaint and the policy. Extrinsic evidence should not be considered for purposes of defense obligations. This is true both when (a) the evidence shows that there is no coverage and (b) the evidence shows that coverage may exist that is not triggered by the complaint (such was seemingly the case in Water Well). Further, policy exclusions can be relied upon by an insurer in making this determination. If an insurer relies upon exclusions in declining to provide a defense, it can also rely on those exclusions in a coverage lawsuit.
Finally, the court recognized that there may be unique situations in which the complaint does not trigger the insurer’s duty to defend, yet extrinsic evidence in the case may demonstrate that there is ultimately coverage and that the insurer has a duty to indemnify. In such instances, depending on the circumstances, an insurer may be better served by defending the insured to reduce potential indemnity exposure. At the very least, the insurer will want to actively monitor the underlying litigation to ensure the insured is mounting a defense and to assess potential indemnity coverage.