The Duty to Defend in New Jersey

It is often noted that the best defense is a good offense. This is as true in litigation as it is in sports, since the most vigorous defense is one that is proactive, not reactive; one that does not sit back on its heels, but rather takes the accusations and arguments against it head-on. From a policyholder's perspective, however, it can be argued that the best defense is one that the insurer is required to pay for.

In that regard, the question of whether and to what extent an insurer is obligated to undertake the defense of a lawsuit is not always easily answered. In particular, while it is well-established insurance law that the duty to defend is generally broader than the duty to indemnify, it is also axiomatic that an insurer has no obligation to defend a claim for which there is no possible indemnification obligation under the applicable policy. This begs the question, of course, regarding how to handle the situation ' as so often happens ' when a complaint against a policyholder alleges multiple causes of action: some that are indemnifiable and some that plainly are not.

Most courts take the “in for a penny, in for a pound” approach. That is, if any cause of action within a complaint may be covered, the majority of courts hold that the policyholder is entitled to a defense of the entire complaint ' even if the causes of action are groundless, false or fraudulent. But this raises obvious conflict-of-interest questions because an insurer could, in theory, attempt to steer a defense away from that based on a potentially covered claim (for example, based on negligence) and toward a finding of liability based on a cause of action that is not covered under its policy (such as one based on intent). In addition, a situation may arise where the trial of the underlying action will leave the questions of coverage unresolved, which likewise raises issues of conflict with regard to an insurer's defense of an action. To avoid such conflict scenarios, nearly all courts permit a policyholder to retain its own counsel and simply have the insurer pay for that counsel's defense of the action, thus avoiding any potential conflict that could arise from an insurer's control of the defense.

New Jersey, however, takes a vastly different approach to these situations. More than 40 years ago, the New Jersey Supreme Court in Burd v. Sussex Mut. Ins. Co., 56 N.J 383 (N.J. 1970), created a unique exception to the general rules governing duty-to-defend law whereby insurers are permitted to convert their duty to defend into a duty to reimburse in certain scenarios. That is, an insurer's obligation under Burd becomes an obligation to reimburse for defense costs to the extent that the defense is later determined to be attributable to covered claims. This distinctive approach to duty-to-defend issues is only found in New Jersey.

Recently, however, Burd's status in New Jersey insurance law has been called into question. Specifically, some have claimed that the case of Flomerfelt v. Cardiello, 202 N.J. 432 (N.J. 2010), overturned or, at the very least, significantly altered Burd. In Flomerfelt, the New Jersey Supreme Court held that an insurer was obligated to defend a policyholder against a third-party complaint even though, on the face of that complaint, only some of the claims against the policyholder would be covered under the applicable policy. A closer examination of the facts and reasoning in Flomerfelt, however, reveals that the New Jersey Supreme Court in Flomerfelt actually reaffirmed Burd by applying Burd to the unique facts of that case, which involved the assumption that an allegedly ambiguous exclusion (upon which the insurer had relied to deny coverage) must be read so as to assume coverage existed ' thus, eliminating any potential Burd conflict. Thus, despite recent protestations to the contrary, New Jersey duty-to-defend law retains the same unique position that it has for more than four decades.

Burd and Its Progeny

In Burd, the underlying complaint against the policyholder included two sets of claims ' one alleging conduct that was intentional and another alleging conduct that was negligent. Burd, 56 N.J. at 387. The insurer disclaimed coverage because the intentional conduct claims were excluded from the policy, and the policyholder commenced a declaratory judgment action. Id. The New Jersey Supreme Court subsequently held that the insurer was not obligated to immediately undertake its policyholder's defense for two separate reasons.

In particular, the court held that an insurer has no immediate duty to defend or pay defense costs where potential conflicts of interest were raised between the policyholder and the insurer regarding defense of a claim. The Supreme Court found that such conflicts arose in two situations when the question of coverage could not be decided by the complaint alone: 1) when the insurer could steer a defense in the underlying claim toward the resolution of a coverage question that would be adverse to the policyholder (the “first Burd exception”); or 2) although resolution of the underlying claim will not resolve the coverage questions, still the case could be defended in such a way by the insurer that could prejudice the policyholder (the “second Burd exception”). Id. at 389-394.

Detailing the first Burd exception, the court recognized that while the insurer and policyholder shared a common interest in seeing the underlying complaint defeated, their interests would be opposed for purposes of coverage on the issue of whether the policyholder acted intentionally. In particular, while the policyholder would benefit if the basis of its liability was found to be negligence, which would be covered under the policy, it would likely charge that the insurer was subject to potential conflicts of interest based on the unresolved coverage questions concerning whether the policyholder's conduct was intentional, which would not be covered:

[In a case alleging both intentional harm and negligence], the insured would want the basis to be negligence whereas the carrier would profit if the basis was an intentional injury within the policy exclusion. If plaintiff pressed his claim of negligence, the coverage issue [intentional harm] would remain open, for the carrier could hardly insist the injuries were intentionally inflicted. Willfulness is not a defense to a charge of negligence. And if plaintiff sought a judgment for intentional hurt, the carrier could not be expected
to resist that basis of liability with the fervor or fidelity of an advocate selected by the insured. Id. at 390.

Thus, because the question of coverage was undecided on the face of the complaint due to the inclusion of covered and uncovered claims, and because the insurer could potentially prejudice the policyholder by seeking to resolve the coverage question in its own favor, the Burd court held that the insurer did not have an immediate duty to defend. Rather, that duty was translated into a duty “to reimburse the insured if it is later adjudged that the claim was one within the policy covenant to pay.” Id.

And with regard to the second Burd exception, the court similarly explained:

[I]f the coverage issue is not thus decided in the tort action, or if a finding upon it is held not to be binding in the later litigation over coverage, still the carrier's control over preparation and trial of the tort action may well cast the die against the insured. ' [I]f the carrier does not defend the tort claim because a plaintiff's verdict will not resolve the coverage problem in the insured's favor or because the carrier cannot defend with complete fidelity to the insured's sole interest, then the carrier may be heard upon the coverage issue in a proceeding upon the policy. And of course if the carrier does not defend, it will have to reimburse the insured for the cost of defense if the tort judgment is held to be within the covenant to pay. Id. at 394.

In other words, the New Jersey Supreme Court found that because the underlying complaint included claims that would not necessarily require the insurer to indemnify even if they were proven, the insurer had no immediate duty to defend; rather, it would only be required to reimburse defense costs with respect to covered claims in the event that the policyholder ultimately prevailed in the coverage dispute. Id.

Accordingly, because of these potential conflicts of interest between the insurer and policyholder, the New Jersey Supreme Court held that, under both Burd exceptions, the insurer had no immediate defense obligation. Instead, the court explained that the duty to defend was transformed into a duty to reimburse if coverage was ultimately found to exist. Id. at 394. The court further recognized that such a determination of coverage may take place in a declaratory judgment action between the insurer and the policyholder either before or after litigation of the underlying complaint, if the parties determine such an action necessary at all. Id. at 391-392.

Thus, more than 40 years ago the New Jersey Supreme Court articulated two clear and distinct exceptions to general duty-to-defend law in New Jersey, the existence of either of which independently converts an immediate defense obligation into a duty to reimburse defense costs for covered claims after the questions of coverage have been resolved. While a policyholder could, of course, waive any potential conflict and permit an insurer to assume its defense anyway, such situations are an extreme minority and, as a practical matter, the Burd exceptions have controlled the duty-to-defend analysis in New Jersey for decades.

Indeed, these now well-settled exceptions have been consistently followed by New Jersey courts in multiple contexts, not just those including torts. To cite but a few well-known examples, in Trustees of Princeton University v. Aetna Cas. & Sur. Co., 293 N.J. Super. 296 (N.J. App. Div. 1996), the New Jersey Appellate Division recognized that an adjudication of the underlying environmental claims would not resolve the disputed coverage questions so as to instruct whether the insurer or policyholder would ultimately be responsible to pay. As a result, the court fully affirmed the underlying trial court's denial of partial summary judgment on the duty to defend, concluding that it “correctly determined that under the general rule enunciated in Burd, [the insurer] has no present duty to defend [the policyholder] in the underlying environmental coverage actions.” 293 N.J. Super. at 289-90. Similarly, in Rutgers v. Liberty Mut. Ins. Co., 277 N.J. Super. 571 (App. Div. 1994), the Appellate Division again acknowledged that while an insurer is generally obligated to defend whenever the complaint alleges covered liability, it may refuse to defend where the trial in the underlying matter will leave unresolved the question of coverage. 277 N.J. Super. at 575-78. Finally and more recently, in New Jersey Mfrs. Ins. Co. v. Vizcaino, 392 N.J. Super. 366 (N.J. App. Div. 2007), the Appellate Division again followed Burd, holding that an insurer, if it wishes, could properly offer a defense to its policyholder for a potentially covered claim but, at the same time, refuse to offer a defense to a potentially uncovered claim from the same complaint.

Flomerfelt

Last summer, the New Jersey Supreme Court handed down its decision in Flomerfelt. While Flomerfelt has led some to claim that Burd is no longer good law in New Jersey, a closer examination shows just the opposite. Indeed, the court reaffirmed Burd by applying Burd's “traditional analysis of the duty to defend.” Flomerfelt, 202 N.J. at 457. Moreover, a reading of Flomerfelt shows that its holding is clearly limited to its unique facts, namely, the reliance on a purportedly ambiguous exclusion to exclude coverage.

In Flomerfelt, the plaintiff sustained temporary and permanent injuries after she overdosed on alcohol and drugs during a party hosted by the defendant at his parents' home. 202 N.J. at 436. The plaintiff alleged that her injuries were caused by the defendant, who served her alcohol and drugs when she was visibly intoxicated and who failed to promptly summon emergency personnel when she was found unconscious on the porch the day after the party. Id. The defendant tendered his defense to his parents' homeowners' insurer. Id. The insurer declined, citing a policy exclusion for claims “'[a]rising out of the use, ' transfer or possession' of controlled dangerous substances.” Id.

The New Jersey Supreme Court noted that the appeal in that case “turn[ed] on the particular language of the policy that defines the coverage and the exclusion” ' specifically, the exclusion's use of the phrase “arising out of.” Id. at 451. To that end, the court stated that “[o]n the face of the complaint” only some of plaintiff's claims would be covered under the defendant's policy ' assuming that the “arising out of” language of the exclusion was clear and unambiguous. Id. at 454.

The court, however, shook loose this assumption and undertook a detailed analysis of the phrase “arising out of” under New Jersey law. Id. at 451-456. The court noted that New Jersey courts have interpreted the phrase “arising out of” as having numerous meanings, some of which, if applied in that case, would result in coverage under the policy at issue and some of which would not. Id. at 455. As such, the court determined that “[a]t a minimum ' the insurer's use of the phrase ["arising out of"] with no clarification of its intended meaning ' makes the phrase ambiguous, calling for an interpretation consistent with the reasonable expectations of the insured.” Id. at 456. Because under New Jersey law, “exclusions are ordinarily strictly construed against the insurer, and if there is more than one possible interpretation of the language, courts apply the meaning that supports coverage rather than one that limits it.” Id. at 442. As a result, the court interpreted the exclusion to provide coverage for plaintiff's claims rather than to exclude them. Id. at 456.

The court acknowledged that the facts of the case were not sufficiently developed to decide the ultimate question of the insurer's liability for indemnity. Id. at 457. However, the court held that “the duty to defend can be resolved utilizing our traditional analysis” under Burd. Id. (emphasis added). In particular, the court cited Burd approvingly and noted that because the “arising out of” exclusion ' pursuant to which the insurer denied a defense ' was ambiguous and, thus, coverage was presumed to exist, there was no Burd conflict to resolve and the insurer was required to defend:

The record before us does not permit us to resolve the question of the insurer's duty to indemnify. As we noted in Burd ' in those thorny situations in which there are some covered theories coupled with alternatives in which the claim would not be covered, the insurer has several options available to it. They include opting to defend under a reservation of rights, declining to do so, preferring to await the outcome and to reimburse its insured if the finder of fact decides the injury did not “arise out of” drug use, as we have defined it, or electing to litigate the coverage issue in advance of a trial on plaintiff's claim, disputing the proof of causation against its insured first. The duty to defend, however, is not dependent upon whether there is a finding that the claim is covered; instead, it attaches because our analysis of the exclusion demonstrates that there are potentially covered claims. Id. at 458.

In other words, the Flomerfelt court held that if an insurer solely relies on an exclusion to decline defense, the exclusion must be clear and unambiguous and must plainly show that there is no possibility of coverage for the underlying claims alleged. Id. at 457. Because the Flomerfelt court found that the exclusion was ambiguous, there was a presumption of coverage and, thus, under Burd's “traditional analysis,” there was no conflict and the duty to defend took hold. Id.

A False Controversy

Given Flomerfelt's uncontroversial application of Burd to its unique facts, why then have some claimed that Flomerfelt, in fact, overturned ' or at the very least, substantially altered ' New Jersey duty to defend law under Burd? Indeed, the viability of Burd was not even at issue in Flomerfelt ' evidenced by the fact that Burd was not mentioned during nearly an hour of oral argument before the New Jersey Supreme Court in that case.

The confusion appears to stem from the Flomerfelt court's description of the Burd exceptions. Specifically, the court noted that under Burd if a factual dispute central to deciding whether a policy provides coverage cannot be decided absent a trial, a policyholder must initially assume the costs of defense, subject to reimbursement by the insurer if the policyholder prevails on the coverage question. Id. at 446. The court then summed up the Burd exceptions thusly:

In short, in circumstances in which the underlying coverage question cannot be decided from the face of the complaint, the insurer is obligated to provide a defense until all potentially covered claims are resolved, but the resolution may be through adjudication of the complaint or in a separate proceeding between insured and insurer either before or after that decision is reached. Id. at 447.

It is this summation of the Burd exceptions that has apparently caused confusion, with some commentators and authorities misconstruing it.

In particular, some have latched onto the court's statement that “the insurer is obligated to provide a defense until all potentially covered claims are resolved” when the coverage question cannot be decided from merely looking at the complaint. This, it is argued, overturned (or at least substantially altered) Burd and imposes a duty to defend upon insurers immediately upon the filing of such a complaint. A full reading of the above-quoted paragraph, however, shows that the court made no such ruling.

Rather, when viewed in its full context, it is clear that the Flomerfelt court correctly summarized the Burd exceptions. The court simply stated that “all potentially covered claims” must be defended by the insurer until they are resolved but, under Burd, when the critical underlying question of what is covered and what is not cannot be gleaned from the face of the complaint, the resolution of those coverage questions may take place: 1) “through the adjudication of the complaint” (i.e., in a situation involving the first Burd exception); or 2) if that is not possible (i.e., in a situation involving the second Burd exception), either before or after the adjudication of the complaint “in a separate proceeding” ' that is, a declaratory judgment action in which the policyholder and insurer can resolve their differences and determine what is covered and what is not. Id. In either case, the duty to defend becomes a duty to reimburse the policyholder if the claims at issue are resolved in favor of coverage. Accordingly, the Flomerfelt court's summation of the Burd exceptions, while perhaps not artfully crafted, is, in fact, perfectly consistent with Burd. Far from overturning or altering Burd in any way, the Flomerfelt court's summary of the Burd exceptions is exactly in line with ' and taken from ' Burd itself. Indeed, the New Jersey Supreme Court tellingly did not give any indication whatsoever of overturning or disapproving Burd (its own decision, it should be noted), and instead approvingly applied Burd's “traditional analysis of the duty to defend.” Id. at 457. Those who claim otherwise appear to either misread Flomerfelt's discussion of Burd or quote language from that discussion out of context.

Conclusion

In sum, it is clear through reading the Flomerfelt court's discussion of Burd in its full context and giving it proper attention that the New Jersey Supreme Court did not hinder the application of its Burd exceptions ' valid and followed New Jersey law for more than 40 years ' in any way. Quite to the contrary, the court in Flomerfelt reaffirmed New Jersey law by applying its “traditional analysis of the duty to defend” under Burd to the unique facts of that case. Flomerfelt, 202 N.J. at 457. In the end, although the best defense remains a good offense, those who would attempt to force an insurer to defend under New Jersey law by taking the offensive against Flomerfelt do little more than turn that phrase ' and Flomerfelt ' on its head.

Daren S. McNally is a partner, and Matthew I. Gennaro is a senior associate, in Clyde & Co US LLP. McNally maintains a practice that is intensely focused on insurance coverage litigation and counseling, with an emphasis in complex insurance and reinsurance litigation, trials and arbitrations in both domestic and foreign arenas. Gennaro focuses his practice in the areas of insurance coverage law and litigation.

It is often noted that the best defense is a good offense. This is as true in litigation as it is in sports, since the most vigorous defense is one that is proactive, not reactive; one that does not sit back on its heels, but rather takes the accusations and arguments against it head-on. From a policyholder's perspective, however, it can be argued that the best defense is one that the insurer is required to pay for.

In that regard, the question of whether and to what extent an insurer is obligated to undertake the defense of a lawsuit is not always easily answered. In particular, while it is well-established insurance law that the duty to defend is generally broader than the duty to indemnify, it is also axiomatic that an insurer has no obligation to defend a claim for which there is no possible indemnification obligation under the applicable policy. This begs the question, of course, regarding how to handle the situation ' as so often happens ' when a complaint against a policyholder alleges multiple causes of action: some that are indemnifiable and some that plainly are not.

Most courts take the “in for a penny, in for a pound” approach. That is, if any cause of action within a complaint may be covered, the majority of courts hold that the policyholder is entitled to a defense of the entire complaint ' even if the causes of action are groundless, false or fraudulent. But this raises obvious conflict-of-interest questions because an insurer could, in theory, attempt to steer a defense away from that based on a potentially covered claim (for example, based on negligence) and toward a finding of liability based on a cause of action that is not covered under its policy (such as one based on intent). In addition, a situation may arise where the trial of the underlying action will leave the questions of coverage unresolved, which likewise raises issues of conflict with regard to an insurer's defense of an action. To avoid such conflict scenarios, nearly all courts permit a policyholder to retain its own counsel and simply have the insurer pay for that counsel's defense of the action, thus avoiding any potential conflict that could arise from an insurer's control of the defense.

New Jersey, however, takes a vastly different approach to these situations. More than 40 years ago, the New Jersey Supreme Court in Burd v. Sussex Mut. Ins. Co. , 56 N.J 383 (N.J. 1970), created a unique exception to the general rules governing duty-to-defend law whereby insurers are permitted to convert their duty to defend into a duty to reimburse in certain scenarios. That is, an insurer's obligation under Burd becomes an obligation to reimburse for defense costs to the extent that the defense is later determined to be attributable to covered claims. This distinctive approach to duty-to-defend issues is only found in New Jersey.

Recently, however, Burd's status in New Jersey insurance law has been called into question. Specifically, some have claimed that the case of Flomerfelt v. Cardiello , 202 N.J. 432 (N.J. 2010), overturned or, at the very least, significantly altered Burd . In Flomerfelt, the New Jersey Supreme Court held that an insurer was obligated to defend a policyholder against a third-party complaint even though, on the face of that complaint, only some of the claims against the policyholder would be covered under the applicable policy. A closer examination of the facts and reasoning in Flomerfelt, however, reveals that the New Jersey Supreme Court in Flomerfelt actually reaffirmed Burd by applying Burd to the unique facts of that case, which involved the assumption that an allegedly ambiguous exclusion (upon which the insurer had relied to deny coverage) must be read so as to assume coverage existed ' thus, eliminating any potential Burd conflict. Thus, despite recent protestations to the contrary, New Jersey duty-to-defend law retains the same unique position that it has for more than four decades.

Burd and Its Progeny

In Burd, the underlying complaint against the policyholder included two sets of claims ' one alleging conduct that was intentional and another alleging conduct that was negligent. Burd, 56 N.J. at 387. The insurer disclaimed coverage because the intentional conduct claims were excluded from the policy, and the policyholder commenced a declaratory judgment action. Id. The New Jersey Supreme Court subsequently held that the insurer was not obligated to immediately undertake its policyholder's defense for two separate reasons.

In particular, the court held that an insurer has no immediate duty to defend or pay defense costs where potential conflicts of interest were raised between the policyholder and the insurer regarding defense of a claim. The Supreme Court found that such conflicts arose in two situations when the question of coverage could not be decided by the complaint alone: 1) when the insurer could steer a defense in the underlying claim toward the resolution of a coverage question that would be adverse to the policyholder (the “first Burd exception”); or 2) although resolution of the underlying claim will not resolve the coverage questions, still the case could be defended in such a way by the insurer that could prejudice the policyholder (the “second Burd exception”). Id. at 389-394.

Detailing the first Burd exception, the court recognized that while the insurer and policyholder shared a common interest in seeing the underlying complaint defeated, their interests would be opposed for purposes of coverage on the issue of whether the policyholder acted intentionally. In particular, while the policyholder would benefit if the basis of its liability was found to be negligence, which would be covered under the policy, it would likely charge that the insurer was subject to potential conflicts of interest based on the unresolved coverage questions concerning whether the policyholder's conduct was intentional, which would not be covered:

[In a case alleging both intentional harm and negligence], the insured would want the basis to be negligence whereas the carrier would profit if the basis was an intentional injury within the policy exclusion. If plaintiff pressed his claim of negligence, the coverage issue [intentional harm] would remain open, for the carrier could hardly insist the injuries were intentionally inflicted. Willfulness is not a defense to a charge of negligence. And if plaintiff sought a judgment for intentional hurt, the carrier could not be expected
to resist that basis of liability with the fervor or fidelity of an advocate selected by the insured. Id. at 390.

Thus, because the question of coverage was undecided on the face of the complaint due to the inclusion of covered and uncovered claims, and because the insurer could potentially prejudice the policyholder by seeking to resolve the coverage question in its own favor, the Burd court held that the insurer did not have an immediate duty to defend. Rather, that duty was translated into a duty “to reimburse the insured if it is later adjudged that the claim was one within the policy covenant to pay.” Id.

And with regard to the second Burd exception, the court similarly explained:

[I]f the coverage issue is not thus decided in the tort action, or if a finding upon it is held not to be binding in the later litigation over coverage, still the carrier's control over preparation and trial of the tort action may well cast the die against the insured. ' [I]f the carrier does not defend the tort claim because a plaintiff's verdict will not resolve the coverage problem in the insured's favor or because the carrier cannot defend with complete fidelity to the insured's sole interest, then the carrier may be heard upon the coverage issue in a proceeding upon the policy. And of course if the carrier does not defend, it will have to reimburse the insured for the cost of defense if the tort judgment is held to be within the covenant to pay. Id. at 394.

In other words, the New Jersey Supreme Court found that because the underlying complaint included claims that would not necessarily require the insurer to indemnify even if they were proven, the insurer had no immediate duty to defend; rather, it would only be required to reimburse defense costs with respect to covered claims in the event that the policyholder ultimately prevailed in the coverage dispute. Id.

Accordingly, because of these potential conflicts of interest between the insurer and policyholder, the New Jersey Supreme Court held that, under both Burd exceptions, the insurer had no immediate defense obligation. Instead, the court explained that the duty to defend was transformed into a duty to reimburse if coverage was ultimately found to exist. Id. at 394. The court further recognized that such a determination of coverage may take place in a declaratory judgment action between the insurer and the policyholder either before or after litigation of the underlying complaint, if the parties determine such an action necessary at all. Id. at 391-392.

Thus, more than 40 years ago the New Jersey Supreme Court articulated two clear and distinct exceptions to general duty-to-defend law in New Jersey, the existence of either of which independently converts an immediate defense obligation into a duty to reimburse defense costs for covered claims after the questions of coverage have been resolved. While a policyholder could, of course, waive any potential conflict and permit an insurer to assume its defense anyway, such situations are an extreme minority and, as a practical matter, the Burd exceptions have controlled the duty-to-defend analysis in New Jersey for decades.

Indeed, these now well-settled exceptions have been consistently followed by New Jersey courts in multiple contexts, not just those including torts. To cite but a few well-known examples, in Trustees of Princeton University v. Aetna Cas. & Sur. Co. , 293 N.J. Super. 296 (N.J. App. Div. 1996), the New Jersey Appellate Division recognized that an adjudication of the underlying environmental claims would not resolve the disputed coverage questions so as to instruct whether the insurer or policyholder would ultimately be responsible to pay. As a result, the court fully affirmed the underlying trial court's denial of partial summary judgment on the duty to defend, concluding that it “correctly determined that under the general rule enunciated in Burd, [the insurer] has no present duty to defend [the policyholder] in the underlying environmental coverage actions.” 293 N.J. Super. at 289-90. Similarly, in Rutgers v. Liberty Mut. Ins. Co. , 277 N.J. Super. 571 (App. Div. 1994), the Appellate Division again acknowledged that while an insurer is generally obligated to defend whenever the complaint alleges covered liability, it may refuse to defend where the trial in the underlying matter will leave unresolved the question of coverage. 277 N.J. Super. at 575-78. Finally and more recently, in New Jersey Mfrs. Ins. Co. v. Vizcaino , 392 N.J. Super. 366 (N.J. App. Div. 2007), the Appellate Division again followed Burd , holding that an insurer, if it wishes, could properly offer a defense to its policyholder for a potentially covered claim but, at the same time, refuse to offer a defense to a potentially uncovered claim from the same complaint.

Flomerfelt

Last summer, the New Jersey Supreme Court handed down its decision in Flomerfelt. While Flomerfelt has led some to claim that Burd is no longer good law in New Jersey, a closer examination shows just the opposite. Indeed, the court reaffirmed Burd by applying Burd's “traditional analysis of the duty to defend.” Flomerfelt, 202 N.J. at 457. Moreover, a reading of Flomerfelt shows that its holding is clearly limited to its unique facts, namely, the reliance on a purportedly ambiguous exclusion to exclude coverage.

In Flomerfelt, the plaintiff sustained temporary and permanent injuries after she overdosed on alcohol and drugs during a party hosted by the defendant at his parents' home. 202 N.J. at 436. The plaintiff alleged that her injuries were caused by the defendant, who served her alcohol and drugs when she was visibly intoxicated and who failed to promptly summon emergency personnel when she was found unconscious on the porch the day after the party. Id. The defendant tendered his defense to his parents' homeowners' insurer. Id. The insurer declined, citing a policy exclusion for claims “'[a]rising out of the use, ' transfer or possession' of controlled dangerous substances.” Id.

The New Jersey Supreme Court noted that the appeal in that case “turn[ed] on the particular language of the policy that defines the coverage and the exclusion” ' specifically, the exclusion's use of the phrase “arising out of.” Id. at 451. To that end, the court stated that “[o]n the face of the complaint” only some of plaintiff's claims would be covered under the defendant's policy ' assuming that the “arising out of” language of the exclusion was clear and unambiguous. Id. at 454.

The court, however, shook loose this assumption and undertook a detailed analysis of the phrase “arising out of” under New Jersey law. Id. at 451-456. The court noted that New Jersey courts have interpreted the phrase “arising out of” as having numerous meanings, some of which, if applied in that case, would result in coverage under the policy at issue and some of which would not. Id. at 455. As such, the court determined that “[a]t a minimum ' the insurer's use of the phrase ["arising out of"] with no clarification of its intended meaning ' makes the phrase ambiguous, calling for an interpretation consistent with the reasonable expectations of the insured.” Id. at 456. Because under New Jersey law, “exclusions are ordinarily strictly construed against the insurer, and if there is more than one possible interpretation of the language, courts apply the meaning that supports coverage rather than one that limits it.” Id. at 442. As a result, the court interpreted the exclusion to provide coverage for plaintiff's claims rather than to exclude them. Id. at 456.

The court acknowledged that the facts of the case were not sufficiently developed to decide the ultimate question of the insurer's liability for indemnity. Id. at 457. However, the court held that “the duty to defend can be resolved utilizing our traditional analysis” under Burd. Id. (emphasis added). In particular, the court cited Burd approvingly and noted that because the “arising out of” exclusion ' pursuant to which the insurer denied a defense ' was ambiguous and, thus, coverage was presumed to exist, there was no Burd conflict to resolve and the insurer was required to defend:

The record before us does not permit us to resolve the question of the insurer's duty to indemnify. As we noted in Burd ' in those thorny situations in which there are some covered theories coupled with alternatives in which the claim would not be covered, the insurer has several options available to it. They include opting to defend under a reservation of rights, declining to do so, preferring to await the outcome and to reimburse its insured if the finder of fact decides the injury did not “arise out of” drug use, as we have defined it, or electing to litigate the coverage issue in advance of a trial on plaintiff's claim, disputing the proof of causation against its insured first. The duty to defend, however, is not dependent upon whether there is a finding that the claim is covered; instead, it attaches because our analysis of the exclusion demonstrates that there are potentially covered claims. Id. at 458.

In other words, the Flomerfelt court held that if an insurer solely relies on an exclusion to decline defense, the exclusion must be clear and unambiguous and must plainly show that there is no possibility of coverage for the underlying claims alleged. Id. at 457. Because the Flomerfelt court found that the exclusion was ambiguous, there was a presumption of coverage and, thus, under Burd's “traditional analysis,” there was no conflict and the duty to defend took hold. Id.

A False Controversy

Given Flomerfelt's uncontroversial application of Burd to its unique facts, why then have some claimed that Flomerfelt, in fact, overturned ' or at the very least, substantially altered ' New Jersey duty to defend law under Burd? Indeed, the viability of Burd was not even at issue in Flomerfelt ' evidenced by the fact that Burd was not mentioned during nearly an hour of oral argument before the New Jersey Supreme Court in that case.

The confusion appears to stem from the Flomerfelt court's description of the Burd exceptions. Specifically, the court noted that under Burd if a factual dispute central to deciding whether a policy provides coverage cannot be decided absent a trial, a policyholder must initially assume the costs of defense, subject to reimbursement by the insurer if the policyholder prevails on the coverage question. Id. at 446. The court then summed up the Burd exceptions thusly:

In short, in circumstances in which the underlying coverage question cannot be decided from the face of the complaint, the insurer is obligated to provide a defense until all potentially covered claims are resolved, but the resolution may be through adjudication of the complaint or in a separate proceeding between insured and insurer either before or after that decision is reached. Id. at 447.

It is this summation of the Burd exceptions that has apparently caused confusion, with some commentators and authorities misconstruing it.

In particular, some have latched onto the court's statement that “the insurer is obligated to provide a defense until all potentially covered claims are resolved” when the coverage question cannot be decided from merely looking at the complaint. This, it is argued, overturned (or at least substantially altered) Burd and imposes a duty to defend upon insurers immediately upon the filing of such a complaint. A full reading of the above-quoted paragraph, however, shows that the court made no such ruling.

Rather, when viewed in its full context, it is clear that the Flomerfelt court correctly summarized the Burd exceptions. The court simply stated that “all potentially covered claims” must be defended by the insurer until they are resolved but, under Burd, when the critical underlying question of what is covered and what is not cannot be gleaned from the face of the complaint, the resolution of those coverage questions may take place: 1) “through the adjudication of the complaint” (i.e., in a situation involving the first Burd exception); or 2) if that is not possible (i.e., in a situation involving the second Burd exception), either before or after the adjudication of the complaint “in a separate proceeding” ' that is, a declaratory judgment action in which the policyholder and insurer can resolve their differences and determine what is covered and what is not. Id. In either case, the duty to defend becomes a duty to reimburse the policyholder if the claims at issue are resolved in favor of coverage. Accordingly, the Flomerfelt court's summation of the Burd exceptions, while perhaps not artfully crafted, is, in fact, perfectly consistent with Burd. Far from overturning or altering Burd in any way, the Flomerfelt court's summary of the Burd exceptions is exactly in line with ' and taken from ' Burd itself. Indeed, the New Jersey Supreme Court tellingly did not give any indication whatsoever of overturning or disapproving Burd (its own decision, it should be noted), and instead approvingly applied Burd's “traditional analysis of the duty to defend.” Id. at 457. Those who claim otherwise appear to either misread Flomerfelt's discussion of Burd or quote language from that discussion out of context.

Conclusion

In sum, it is clear through reading the Flomerfelt court's discussion of Burd in its full context and giving it proper attention that the New Jersey Supreme Court did not hinder the application of its Burd exceptions ' valid and followed New Jersey law for more than 40 years ' in any way. Quite to the contrary, the court in Flomerfelt reaffirmed New Jersey law by applying its “traditional analysis of the duty to defend” under Burd to the unique facts of that case. Flomerfelt, 202 N.J. at 457. In the end, although the best defense remains a good offense, those who would attempt to force an insurer to defend under New Jersey law by taking the offensive against Flomerfelt do little more than turn that phrase ' and Flomerfelt ' on its head.

Daren S. McNally is a partner, and Matthew I. Gennaro is a senior associate, in Clyde & Co US LLP. McNally maintains a practice that is intensely focused on insurance coverage litigation and counseling, with an emphasis in complex insurance and reinsurance litigation, trials and arbitrations in both domestic and foreign arenas. Gennaro focuses his practice in the areas of insurance coverage law and litigation.