The Duty to Defend and the Affirmative Defense

New York's Appellate Division, First Department, wrestled with this issue in P.J.P. Mechanical Corporation v. Commerce and Industry Insurance Company, 2009 N.Y. Slip Op. 04984 (June 18, 2009). In that case, the court held that an insurer had no duty to defend its insured against an affirmative defense of offset that had been raised in responsive pleadings.

In P.J.P., the policyholder contracted with a subcontractor to perform heating and ventilaton work. Over the course of performance, a pipe separated from a water riser and caused damage to the construction site in excess of $500,000. The general contractor immediately informed both the policyholder and the subcontractor that it considered them solely responsible for the property damage caused by the ruptured pipe. The policyholder in turn notified its insurer, which retained counsel in order to conduct an investigation and file a pre-suit motion to preserve the pipe as evidence.

Although no party ultimately commenced litigation seeking damages resulting from the burst pipe, the general contractor withheld the contract balance of approximately $650,000 that was owed to the policyholder because of its alleged negligence. Based on this set of facts, the policyholder turned to its insurer, seeking a “defense.” The insurer declined, taking the position that the claim did not qualify as a “suit” under the terms of the policy. Soon after, the policyholder hired its own counsel and served a complaint on the general contractor and other parties in an attempt to recover the disputed contract balance.

In answering the complaint, the general contractor asserted counterclaims for the policyholder's negligence as well as the affirmative defense of a right to offset against recovery based on the property damage that resulted from said negligence. For the third time, the policyholder tendered its defense. This time, the insurer assigned counsel to defend the policyholder but expressly limited the representation to defending against the general contractor's counterclaim for property damage. The insurer refused to reimburse the policyholder for legal fees and expenses incurred in connection with the prosecution of the underlying action or in connection with the affirmative defense.

The policyholder brought an action seeking a declaratory judgment, alleging that the insurer had an obligation to reimburse it for costs incurred in the underlying collection action. The policyholder and insurer filed cross-motions for summary judgment. The insurer argued that its obligation to defend extended only as far as the counterclaim, given that the affirmative defense was not an “occurrence” that triggered coverage under the terms of the policy. Further, it argued that because the underlying action ultimately settled, the reimbursement claim was not a claim for property damage and as such the insurer had no obligation to pay those sums. The policyholder countered by asserting that the terms of the policy did not differentiate between pre-suit claims for negligence, affirmative defenses of negligence and/or counterclaims for negligence.

The Ruling

In a matter of first impression, New York's First Department Appellate Division held in favor of the insurer. The court reasoned that the “contract language of the policy controls.” Id. at *198. Further, “The policy definitions, when read in conjunction with the entire policy, placed no obligation on [the insurer] to defend [the policyholder] against an affirmative defense filed in response to an action, even though that affirmative defense was couched in terms of plaintiff's negligence.” Id.

The court's reasoning turned on whether or not the affirmative defense could be considered a “suit” under the terms of the policy such that the insurer's duty to defend would be implicated. The court determined that the appropriate line to be drawn was between an action seeking “affirmative relief” and one that is merely a defense. This line of thinking in turn lead the court to differentiate between a counterclaim, which “[b]y its very nature ' seeks affirmative relief” and a defense, such as offset, that merely “seeks dismissal of the suit for the balance of the [offset] amount.” Id. at 200. In the court's view, the imposition of a duty to defend affirmative defenses would eliminate these pleading distinctions, and “would impact the long-established business practices of insurers, and lead to uncertainty in the drafting of insurance contracts.” Id. at 201. As such, only a counterclaim could be considered a “suit” under the terms of the insurance policy.

In attempting to illuminate the line drawing the boundary between an affirmative defense and a counterclaim, the court offered the following:

Facts pleaded which controvert the plaintiff's claim and serve merely to defeat it as a cause of action constitute a defense, and are inconsistent with the legal idea of a counterclaim, which is a separate and distinct cause of action. On the other hand, a claim that does not defeat the plaintiff's cause of action, but constitutes an independent cause of action for the defendant, should be pleaded as a counterclaim, and not as an affirmative defense.

Id.

The Ruling

In ruling that affirmative defenses cannot trigger an insurer's duty to defend, the P.J.P. court distinguished its holding from the holding of the California Supreme Court in Construction Protective Services, Inc. v. TIG Specialty Insurance Company, 29 Cal. 4th 189 (2002). In TIG Specialty, the court recognized that setoff was limited to defeating a plaintiff's claim in the same manner that an affirmative defense was so limited, but then went on to hold that “how the setoff was pleaded does not control.” Id. at 201. The New York court in P.J.P. specifically rejected such a holding as it would change “long-established New York law” regarding the eight-corners rule and render meaningless the pleading distinction between affirmative defenses and counterclaims.

The holding of the Supreme Court of California in TIG Specialty is illustrative of the fact that the state of California is somewhat unique in regard to its law on the duty to defend. Under California law, “when facts extrinsic to the complaint gathered from the insured or other sources suggest that the claim may be covered under its policy, the insurer is held to a duty to defend the action.” Horace Mann Ins. Co. v. Barbara B., 17 Cal. Rptr. 2d 210, 214 (Cal. 1993). Additionally, under the California Code of Civil Procedure, a plaintiff may plead “the legal effect of [a] contract rather than its precise language.” Id. at 198-99. Both of the above legal principles are at odds with the more stringent version of the “eight-corners rule” applied in states such as New York, where the words on the page rule the day.

TIG Specialty

The facts of TIG Specialty are extremely similar to those in P.J.P. In TIG Specialty, the policyholder was a subcontractor hired to provide security at a construction site. When a fire broke out at the site, the general contractor blamed the policyholder for the resulting property damage and refused to pay the policyholder for the amount due on the contract for the policyholder's security services. When the policyholder sued, the general contractor counterclaimed and asserted the affirmative defense of setoff, at which point the policyholder tendered the claim to its insurer. At issue was whether or not the duty to defend had been triggered by the affirmative defense.

As alluded above, the court in TIG Specialty pointed out that under California procedural law “[a]ffirmative relief may not be claimed in the answer” and instead a party seeking affirmative relief must file a cross-complaint. 29 Cal. 4th 189, 194-95 (2002). Unlike the New York Court of Appeals in P.J.P., however, the court in TIG Specialty held that this “interpretation of the Code of Civil Procedure does not ' resolve the question [of] whether a setoff claim constitutes a suit seeking damages.” Id.' at 198. The court found that the manner in which the setoff claim was plead was inconsequential because without the debt owed by the general contractor to the policyholder, the general contractor's claim against the policyholder “if asserted in a court of law, would unquestionably have been a suit for damages. But because of [the general contractor's debt, the claim was alleged] as a setoff rather than by way of complaint.” Id.

California's Court of Appeal for the Sixth Appellate District dealt at length with interpreting the above holding from TIG Specialty. There, the court distilled the holding into a two-part test, stating “We glean from TIG Specialty that a setoff affirmative defense could constitute a suit seeking damages for purposes of a CGL policy if the affirmative defense (1) would unquestionably have been a suit for damages if asserted in a court of law, and (2) fell within the scope of the contractual obligation.” CDM Investors v. Travelers Casualty & Surety Co., 139 Cal. App. 4th 1251, 1269 (Cal. App. 6th Dist. 2006).

A few other states have grappled with this issue and they have all either come to the same conclusion as the New York court in P.J.P., or have strongly hinted that they would do so.

Other Rulings

For example, the United States Court of Appeals for the Seventh Circuit, in applying Illinois law, used the same reasoning and came to the same outcome as the court in P.J.P. In Philadelphia Indemnity Insurance Company v. Chicago Title Insurance Company, the court found that a title policy did not require the insurer “to 'defend' against affirmtive defenses.” 771 F.3d 391, 401 (7th Cir. 2014). There, the “policy language limit[ed] the insurer's defense obligation to 'litigation in which any third party asserts a claim adverse to the title or interest of the insured.'” Id. The court plainly stated that “[a]n affirmative defense is not a 'claim.'” The court acknowledged that it was clear that “under Illinois law ' a counterclaim can trigger an insurer's duty to defend. But '[a] counterclaim differs from an answer or affirmative defense. A counterclaim is used when seeking affirmative relief, while an answer or affirmative defense seeks to defeat a plaintiff's claim.'” Id. (emphasis and alterations original).

The Superior Court of Maine, Cumberland County, cited to Philadelphia Indemnity in neatly dispatching with the duty to defend an affirmative defense analysis in one succinct paragraph. In the words of the opinion from Edwards v. Fidelity National Title Insurance Company, “The Policy clearly and unambiguously limits Fidelity's duty to defend to 'stated causes of action alleging matters insured against by this policy.' A cause of action cannot be equated with an affirmative defense. [See Philadelphia Indemnity' (title insurer had no duty to defend against an affirmative defense because policy limited duty to defend to 'causes of action' and an affirmative defense is not a cause of action)." 2014 Me. Super. LEXIS 251, *19-20 (Me. Super. Ct. Dec. 12, 2014) (parentheses in original).

In an unpublished opinion, the Fourth District Court of Appeals of Wisconsin ruled that there was no duty to defend because the policyholder had not shown that it would be "subject to paying damages to someone based on defenses or counterclaims." Kenneth F. Sullivan Co. v. Phillip McManamy, 341 Wis. 2d 490 (Wis. Ct. App. 4th Dist. 2012). Under the terms of the policy, the insurer was liable to pay for sums that the policyholder became obligated to pay as damages. In the words of the court, "So far as we can discern, the affirmative defenses [of offset] contemplate a reduction of the damages that [the policyholder] might have to pay [the general contractor], either directly or indirectly, and nothing more.” Id. As such, the policyholder had not shown that a duty to defend existed, because the defense of setoff alone cannot plausibly generate a scenario under which a policyholder would be liable to pay damages.

In Peckham v. Hanover, the Massachusetts Superior Court at Barnstable decided a curious case where a policyholder, Peckham, sued his insurance company, the Hanover Insurance Company. 2010 Mass. Super. LEXIS 234 (Mass. Super. Ct. 2010). In response, Hanover asserted an affirmative defense. Peckham subsequently claimed that Hanover owed him a duty to defend against the affirmative defense that Hanover itself had asserted. In interpreting the policy, the court ruled as follows:

The term “lawsuit” is clear, and where it is modified by the phrase “brought against anyone covered under this policy,” it can only be read to describe circumstances in which a party brings a legal action against Peckham. Peckham's argument that Hanover's affirmative defense to Peckham's lawsuit is tantamount to the commencement of a lawsuit against Peckham, and thus capable of triggering Hanover's duty to defend Peckham, is illogical and defies a rational reading of the caselaw to which Peckham cites. Therefore, under the unambiguous language of Peckham's standard automobile policy, Hanover had no duty to defend Peckham in his own lawsuit against Hanover.

With that, the court granted summary judgment.

Finally, the Supreme Court of North Dakota came tantalizingly close to dealing with the issue, but its holding stopped just shy of squarely settling it. See Hart Construction Company v. American Family Mutual Insurance Company, 514 N.W.2d 384 (N.D. 1994). The fact pattern is familiar: A general contractor refused to pay a policyholder-subcontractor because the policyholder's alleged negligence caused damage to a worksite. When the policyholder sued the general contractor, the latter answered with a counterclaim and affirmative defense.

The dispositive issue was whether or not the counterclaim or the affirmative defense constituted a suit for damages. In overturning the ruling of a lower court, the Supreme Court of North Dakota ruled that the counterclaim was a suit for damages; the court did not, however, rule on whether or not the affirmative defense was also a “suit for damages” that could trigger the duty to defend.

The court's silence in regard to affirmative defenses could arguably stand for the proposition that the court found that such defenses had not triggered the duty to defend. The safer reading of the opinion, however, is likely to be that the determination regarding the counterclaim merely rendered the affirmative defense issue moot, and thus the court found no reason to resolve the issue at that time.

Conclusion

The question of whether an affirmative defense can trigger the duty to defend appears to be in its infancy, as only a handful of jurisdictions across the country have addressed the issue. The majority rule is that an affirmative defense may not trigger a duty to defend. This bright-light rule conforms to the bargained for language contained in the policy.

At least California has held to the contrary: Its highest court ruled that under certain circumstances, allegations contained within an affirmative defense may trigger a duty to defend. Guided by the cases discussed herein, practitioners would be wise to consult their particular jurisdiction's duty to defend rules and codes of civil procedure should they be faced with this issue.

Jay Farmer is an associate and Seth A. Schmeeckle is a shareholder at Lugenbuhl, Wheaton, Peck, Rankin & Hubbard, which has offices in New Orleans, Baton Rouge and Houston. The views presented in this article are not necessarily the views of the firm or any of its clients.