Insurance Indemnification Versus Defense

Contractors pay insurance for essentially one reason: to protect their business if someone gets hurt. Unfortunately paying a premium doesn’t always result in actually obtaining coverage. So what does a contractor get for paying a premium to an insurance carrier? First, the contractor gets a “defense” from the carrier. This means that the insurance carrier, if it is a potentially covered loss, will pay for the contractors’ defense costs. Second, the contractor gets “indemnification” from the insurer, up to the limits of insurance, should a judgment ultimately be rendered against the contractor for a loss that was covered by the policy. The insurer’s duty to defend is not the same as the insurer’s duty to indemnify.

An insurer’s duty to defend its insured is broader than its duty to indemnify (see Nationwide Insulation & Sales, Inc. v. Nova, 74 A.D.3d 1297, 905 N.Y.S.2d 234; Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131, 137, 818 N.Y.S.2d 176, 850 N.E.2d 1152) and “is triggered whenever the allegations in a complaint, liberally construed, suggest a reasonable possibility of coverage, or when the insurer has actual knowledge of facts establishing such a reasonable possibility” (City of New York v. Insurance Corp. of N.Y., York, 305 A.D.2d 443, 758 N.Y.S.2d 817). “Indemnification” is the action of compensating for loss or damage sustained. (Black’s Law Dictionary [9th ed. 2009], indemnification) If the allegations of the complaint in an action that falls within the insurance policy are even potentially within the language of the insurance policy, there is a duty to defend but not necessarily a duty to indemnify. (Town of Massena v. Healthcare Underwriters Mut. Ins. Co., 98 N.Y.2d 435, 443, 749 N.Y.S.2d 456 [2002]

The insurer may be relieved of this duty to defend and indemnify, however, if it can show that such obligations are outside the scope of the insurance policy. To be relieved of a duty to defend on the basis of a policy exclusion, the insurer bears the burden of demonstrating that the allegations of the complaint in the underlying claim lie wholly within that exclusion, and that that is the only way to interpret the exclusion, making it impossible to argue that there is any basis upon which the insurer might eventually be obligated to indemnify its insured. (Utica First Ins. Co. v. Star–Brite Painting & Paperhanging, 36 A.D.3d 794, 796, 828 N.Y.S.2d 488 [2d Dept. 2007]).

In Exeter Bldg. Corp. v. Scottsdale Ins. Co., 79 A.D.3d 927, 913 N.Y.S.2d 733 (2d Dept. 2010), for example, Scottsdale Insurance was the provider of several commercial general liability insurance policies to contractor Exeter Building Corporation. These policies did have exclusions though, and provided that Scottsdale would not defend or indemnify Exeter for any real property damage that was the result of Exeter’s faulty work, or that of its agents. An action was brought against Exeter alleging, in pertinent part, “substantial defects in the design and construction” of condominiums. Referring back to its policy exclusions, Scottsdale refused to extend coverage to Exeter.

The court in Exeter Bld. Corp. v. Scottsdale Ins. Co., found that since the complaint in the underlying action alleged that Exeter was responsible for various substantial interior and exterior construction defects, and that the commercial general liability policy provides for an exclusion for such coverage, Scottsdale was not obligated to provide Exeter with a defense or to indemnify it in the underlying action.

The lesson here is that while an insurer is more likely to have to defend an insured, as opposed to also having to indemnify the insured, it is important to carefully read the terms of the policy as a whole when you purchase it to see just what you are purchasing. A “general” liability policy ordinarily still contains exclusions, and certain acts of the insured may not be covered, which may leave the insured out of luck if it was not aware of such provisions when seeking defense and/or indemnification in an underlying action. For contractors, it is important to remember that all insurance policies are not created equally.