When it comes to what to consider when determining an insurer’s duty to defend, it generally works like this. About 33 or so states require an insurer to consider, besides the complaint, information contained outside the complaint – so-called extrinsic evidence. The rest limit the duty to defend determination to the information within the four corners of the complaint. In addition, when a state requires an insurer to consider extrinsic evidence, it is almost always a one-way street. In other words, the insurer must consider extrinsic evidence to possibly find a duty to defend, but may not use extrinsic evidence to deny a duty to defend.

That last part is what got the insurer in 2FL Enterprises, LLC v. Houston Casualty Ins. Co., No. 17-676 (W.D. Wash. Feb. 5, 2018) in trouble. At issue was an insurer’s duty to defend a construction defect suit. MCS retained a construction company, 2FL Enterprises, to make improvements on an apartment building. Leaks were discovered and MCS sued 2FL. 2FL sought a defense from Houston Specialty, which had issued several general liability consecutive policies to the construction company. The insurer took no action and a default judgment was entered against 2FL. The insurer then denied coverage on several grounds. 2FL sough coverage from another insurer and that insurer undertook its defense and had the default vacated. Houston Specialty agreed to defend but 2FL rejected the defense.

Coverage litigation ensued and the court addressed whether Houston Specialty owed and breached its duty to defend, and, if so, whether the breach was in bad faith.

The court held that the insurer breached the duty to defend. When assessing whether a defense was owed, the claims administrator for the insurer visited the website of the King County Assessor’s Office and learned that the present use of the building at issue was “Condominium: Residential.” The policies at issue contained a Condominium Exclusion. The insurer used this as one of its justification for denying coverage.

But here are the problems with this, as the court saw it: “Williams Court is not a condominium complex, it is an apartment building (which is covered under the policy). The second problem is that, under Washington law, an insurer is not permitted to utilize information extrinsic to (a) the complaint or (b) the insurance policy to arrive at a decision regarding denial of a tender of defense. The insurer may not rely on facts extrinsic to the complaint to deny the duty to defend - it may do so only to trigger the duty. (citation omitted) (As noted supra, the complaint described the building as the ‘Williams Court Apartments.’).” (emphasis in original).

Putting aside some other issues, the court turned to the question whether the insurer’s denial of coverage was in bad faith. The court concluded that evidence of bad faith “abounds here:” “There are a number of instances throughout the chronology of this event where Defendant acted in contravention of Washington law. The first and most egregious is its use of extrinsic evidence (e.g., the determination, based on the King County Assessor’s website, that Williams Court was a condominium building) to deny a defense to its insured- a violation of Woo. Additionally, HSIC claimed in its declination letter that Plaintiff began and concluded its work outside of the coverage periods, and that Plaintiff's subcontractors did not maintain CGL insurance, information which is found nowhere in the complaint.”

Lastly, the court rejected the insurer’s argument that it successfully rebutted the presumption of harm to the insured that was imposed upon the finding of bad faith. As the insurer saw it, the presumption of harm was rebutted because the underlying litigation was still ongoing and the default judgment had been vacated.

However, the court was unconvinced that this took care of any harm sustained by the insured: “The Court can conceive of numerous harms underlying a lengthy delay which culminates in a non-meritorious decision to deny coverage - e.g., the expenditure of time and effort to find another carrier to defend against the claims, the damage to financial credit that the existence of a default judgment and/or judgment lien (even a temporary one) can wreak on a business enterprise, and the damage to credibility and goodwill that the existence of such a judgment can impose (even if it is ultimately withdrawn). Defendant has done little or nothing to dispel the presumption of harm which its behavior has created, and Plaintiff is entitled to summary judgment on that issue.”

Determining whether an insurer has a duty to defend can be challenging. But knowing what standard to apply – four corners or extrinsic evidence – should not be.