The Insured has the Duty to Prove Coverage for Defense

Insured Obligated to Prove Exception to an Exclusion

Nov 02, 2021

FACTS

Throughout the 2000s, thousands of homes in Nevada were built by subcontractors under the direction of several development companies. During that period, these subcontractors were insured by appellants Zurich American Insurance Company and American Guarantee and Liability Insurance Company (collectively, Zurich). After the work on the homes was completed, the subcontractors switched insurers, obtaining insurance from respondent Ironshore Specialty Insurance Company (Ironshore). Ironshore’s policy insured the subcontractors against damages attributed to bodily injury or property damage that occurred during the new policy period. The policy provides that if the insured becomes legally obligated to pay damages because of bodily injury or property damage that qualifies under the policy, Ironshore will pay those sums. It further provides that Ironshore will have the right and duty to defend the insured if the suit seeks damages to which the policy applies. The policy applies only if the bodily injury or property damage is caused by an occurrence within the coverage territory and applicable policy period.

The Ironshore policy contains a “Continuous or Progressive Injury or Damage Exclusion” that modifies the insurance coverage provided under the policy. The exclusion provides that the policy does not apply to any existing bodily injury or property damage, except for “sudden and accidental” property damage:

This insurance does not apply to any “bodily injury” or “property damage” . . . which first existed, or is alleged to have first existed, prior to the inception of this policy. “Property damage” from “your work[, ]” … or the work of any additional insured, performed prior to policy inception will be deemed to have first existed prior to the policy inception, unless such “property damage” is sudden and accidental and takes place within the policy period.

Between 2010 and 2013, homeowners who had purchased homes within these development projects brought 14 construction defect lawsuits against the developers in Nevada state court, alleging the properties were damaged from construction defects. Zurich settled claims against the subcontractors and then, in Nevada Zurich I, sued Ironshore in federal court seeking contribution and indemnification for the defense and settlement costs, as well as a declaration that Ironshore had owed a duty to defend the subcontractors against the underlying lawsuits. [Assurance Co. of Am. v. Ironshore Specialty Ins. Co. (Nevada Zurich I, No. 2:15-cv-00460-JAD-PAL, 2017 WL 3666298, at *1 (D. Nev. Aug. 24, 2017).] Ironshore moved for summary judgment, arguing that it had no duty to defend because there was no potential for coverage under the terms of the policy.

The federal district court granted summary judgment in favor of Ironshore. The court rejected the argument that the “sudden and accidental” exception to the exclusion of the coverage applied, reasoning that none of the complaints in the underlying lawsuits alleged that the damage occurred suddenly, and that without any evidence to support such an allegation, Zurich failed to carry its burden. In issuing this holding, the court implicitly concluded that the insured has the burden of establishing that an exception to an exclusion applies. The court also assumed that Zurich could have introduced extrinsic evidence to satisfy its burden, but it did not directly address the question.

Around the same time, another federal district court, in Assurance Co. of America v. Ironshore Specialty Insurance Co. (Nevada Zurich II, No. 2:13-cv-2191-GMN-CWH, 2015 WL 4579983 (D. Nev. July 29, 2015), reached a different conclusion in a substantially identical case. The judge in that case concluded that Ironshore owed a duty to defend because the underlying complaints “did not specify when the alleged property damage occurred and did not contain sufficient allegations from which to conclude that the damage was not sudden and accidental.”

The Nevada Zurich II court concluded that Ironshore failed to satisfy its burden of proving that the exception to the exclusion did not apply, implicitly concluding that the insurer had the burden of proving the nonapplicability of the exception to the exclusion. The Nevada Zurich II court also assumed that extrinsic evidence was admissible but did not address the issue directly.

DISCUSSION

In Nevada, insurance policies are treated like other contracts, and thus, legal principles applicable to contracts generally are applicable to insurance policies. When reading a provision of an insurance policy, the court’s interpretation must include reference to the entire policy, which will be read as a whole in order to give reasonable and harmonious meaning to the entire policy. Under an insurance policy, the insurer owes two contractual duties to the insured: the duty to defend and the duty to indemnify. Only the duty to defend is at issue.

The insurer bears a duty to defend its insured whenever it ascertains facts which give rise to the potential of liability under the policy. Conversely, there is no duty to defend where there is no potential for coverage. If there is any doubt about whether the duty to defend arises, this doubt must be resolved in favor of the insured. However, the duty to defend is not absolute. A potential for coverage only exists when there is arguable or possible coverage.

Courts in many jurisdictions have concluded that the insured bears the burden of proving the sudden and accidental exception to an exclusion of coverage. The trend clearly appears to place the burden on insureds to prove that an exception to an exclusion applies to restore coverage. Some courts do not agree.

Nevada law provides that an insurance policy should be read according to general contract principles. Furthermore, Nevada law requires that the insured establish coverage under an insurance policy, whether claiming a duty to indemnify or a duty to defend. The majority approach is in accordance with basic tenets of evidence law in Nevada. The party that carries the burden of production must establish a prima facie case. The burden of persuasion rests with one party throughout the case and determines which party must produce sufficient evidence to convince a judge that a fact has been established. In Nevada, the burdens of production and persuasion rest with the insured, who has the initial burden of proving that the claim falls within policy coverage.

The duty to defend arises when there is a potential for coverage, whereas the duty to indemnify arises when the insured’s activity and the resulting damage actually fall within the policy’s coverage.

The Insured May Use Extrinsic Facts Available To The Insurer At The Time Of Tender To Prove The Insurer Had A Duty To Defend

An insurer bears a duty to defend its insured whenever it ascertains facts which give rise to the potential of liability under the policy. Thus, under Nevada law, an insured may present such extrinsic facts to the insurer, and rely upon them, in order to argue that the insurer owes a duty to defend as within an exception to an exclusion.

Neighboring California has held that “[a]n insurer’s duty to defend must be analyzed and determined on the basis of any potential liability arising from facts available to the insurer from the complaint or other sources available to it at the time of the tender of defense.” Waller v. Truck Ins. Exch., Inc., 900 P.2d 619, 632 (Cal. 1995) (quoting CNA Cas. of Cal. v. Seaboard Sur. Co., 222 Cal.Rptr. 276, 278-79 (Ct. App. 1986)). Since the duty to defend must be determined at the outset of litigation based upon the complaint and any other facts available to the insurer, the Nevada Supreme Court held that the insured may use extrinsic facts that were available to the insurer at the time it tendered its defense to prove there was a potential for coverage under the policy and, therefore, a duty to defend.

The certified questions were, therefore, answered as follows:

the burden of proving the exception to an exclusion is on the insured, not the insurer; and
in fulfilling its burden to prove the exception to an exclusion applies, the insured may utilize any extrinsic facts that were available to the insurer at the time the insured tendered defense to the insurer.

ZALMA OPINION

Accepting the rule followed by the majority of the courts in the U.S. and basic common sense, the Nevada Supreme Court applied the basic rule of law that it is the insured who is obligated to prove that coverage applies and can use extrinsic evidence to establish the coverage. So, in this who’s on first routine, the insured is on first to prove that an exception to an exclusion applies and if it succeeds the burden shifts to the insurer to prove the opposite.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders.

He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business.

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He is available at http://www.zalma.com and zalma@zalma.com. Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award. Over the last 53 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.

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