August 16, 2017

Turning Lemons into Lemonade: How Policyholders Can Use Denials to Expand Coverage

It’s hard to see anything positive in a denial letter from an insurer. But denials sometimes have a silver lining: an insurer’s wrongful denial may actually expand coverage for the insured. This article explores three legal theories that courts use to turn an insurer’s wrongful denial into greater coverage than the insured would have otherwise had: bad faith liability, estoppel, and waiver.

Bad Faith Denials Can Make an Insurer Liable for Uncovered Judgments

Some courts hold insurers liable for uncovered judgments if the insurer refused to defend in bad faith. In Amato v. Mercury Cas. Co., 18 Cal. App. 4th 1784 (1993) (“Amato I”), the insured injured his mother-in-law. Id. at 1788. The mother-in-law sued the insured, and the insured tendered the lawsuit to his insurer. Id. The insurer believed that the insured and his mother-in-law were co-residents at the time of the injury and, citing the “resident relative” exclusion in the policy, denied. Id. at 1788-89. But by the time of this denial, the insured had filed an official change of address with the DMV, and the insurer was informed that the insured did not live with his mother-in-law. Id. at 1788. As such, the insurer possessed information which, if true, indicated that the insured and his mother-in-law were not co-residents at the time of the injury. Id. at 1789. The insured did not defend himself in the underlying suit and suffered a default judgment. Id. The insured and his mother-in-law sued the insurer for bad faith. Id. at 1787. The jury found that the insured and his mother-in-law lied to the insurer and were coresidents at the time of the accident. Id. at 1789. Nevertheless, the court held that the insurer breached its duty to defend because the insurer “was precluded from relying either on subsequently discovered facts or the jury’s ultimate vindication of [the insurer’s] belief that [the insured] resided with [his mother-in-law].” Id. The court later held that the insurer was also liable for the uncovered judgment. See Amato v. Mercury Cas. Co., 53 Cal. App. 4th 825, 829 (1997) (“Amato II”). The court stated, “[W]here the insurer tortiously refuses to defend and as a consequence the insured suffers a default judgment, the insurer is liable on the judgment and cannot rely on hindsight that a subsequent lawsuit establishes noncoverage.” Id. at 833. The insurer’s bad faith effectively expanded coverage.

The Amato cases are not anomalous. In Kirk v. Mt. Airy Ins. Co., 134 Wash. 2d 558 (1998), the court held, “Where an insurer acts in bad faith in failing to defend . . . coverage by estoppel is one appropriate remedy.” Id. at 564. This “coverage by estoppel” potentially extends to uncovered liability:

When the insurer breaches the duty to defend in bad faith, the insurer should be held liable not only in contract for the cost of the defense, but also should be estopped from asserting the claim is outside the scope of the contract and, accordingly, that there is no coverage.

Id. at 565. “The coverage by estoppel remedy creates a strong incentive for the insurer to act in good faith, and protects the insured against the insurer’s bad faith conduct.” See id. Bad faith denials can yield coverage even for judgments that would otherwise fall outside the policy.

Denials Can Effect Waiver of Coverage Defenses

Waiver can also expand coverage. In Missionaries of Co. of Mary v. Aetna Cas. & Sur. Co., 155 Conn. 104 (1967), the insured sued its insurer for settlements and defense costs of an underlying suit after the insurer denied coverage. Id. at 106. The court found that, based on the allegations of the underlying complaint, the insurer should have defended the insured. Id. at 111. Instead, the insurer denied coverage “by looking beyond the allegations of [the claimant’s] complaint and by importing facts learned from outside sources.” Id. The court affirmed the general rule that “the duty to defend does not depend on the insurer’s ultimate liability to pay.” Id. at 112. The court noted that before the insurer rendered a coverage determination “[i]t could either refuse to defend or it could defend under a reservation of its right to contest coverage under the various avenues which would subsequently be open to it for that purpose.” Id. at 113. Because the insurer breached the insurance contract by simply refusing to defend, the insurer “in effect, waived the opportunity which was open to it to perform its contractual duty to defend under a reservation of its right to contest the obligation to indemnify the plaintiff . . . .” Id. at 113-14. “The defendant, after breaking the contract by its unqualified refusal to defend, should not thereafter be permitted to seek the protection of that contract in avoidance of its indemnity provisions.” Id. at 114. Accordingly, the insurer was liable for the settlement and defense costs of the underlying suit and the costs of the coverage litigation. Id. at 114-15.

Denial based on ambiguous allegations can also waive defenses. In St. Paul Fire & Marine Ins. Co. v. Vigilant Ins. Co., 919 F.2d 235 (4th Cir. 1990), the insurer refused to defend the insured in an underlying suit because the underlying complaint did not specify whether the claimant’s injuries occurred within the policy term. Id. at 237-38. The court held that the insurer breached its duty to defend because “[i]f there is any chance that [the claimant’s] claim even arguably developed during the [insurer’s] policy period, [the insurer] had a duty to defend.” Id. at 240. Therefore, the insurer waived any right to litigate whether the claimant’s injuries occurred during the policy term. Id. at 240-41 & nn. 5-6.

Even proper denials can waive defenses. In Hoover v. Maxum Indem. Co., 291 Ga. 402 (2012), the insurer refused to defend based on the policy’s employer liability exclusion. Id. In the coverage litigation, the insurer asserted an untimely notice defense, not the employer liability exclusion. Id. The court held, “An insurer cannot both deny a claim outright and attempt to reserve the right to assert a different defense in the future.” Id. at 405. The court added that if the insurer questions the validity of coverage, it should defend the insured under a reservation of rights, thereby preserving the option of litigating coverage. Id. Because the insurer refused to defend based only on the employer liability exclusion, the insurer waived the untimely notice defense. Id. at 407.

Wrongful Denials Can Estop an Insurer from Denying Full Coverage

Some courts invoke equitable estoppel to expand coverage. In Clemmons v. Travelers Ins. Co., 88 Ill. 2d 469 (1981), a claimant sued the driver of an insured vehicle. Id. at 472. The insurer refused to defend the driver because he drove the vehicle without the owner’s permission. Id. at 473. Citing “the general rule of estoppel that applies when an insurance policy grants the insurer the right and duty to defend suits brought against the insured,” id. at 475, the court held,

When a complaint against the insured alleges facts within or potentially within the scope of the policy coverage, the insurer taking the position that the complaint is not covered by the policy must defend the suit under a reservation of rights or seek a declaratory judgment that there is no coverage. If the insurer does not, it is later estopped from denying coverage in a suit to collect the judgment.

Id. The court also held that “the duty to defend must be determined solely from the language of the complaint and the policy.” Id. at 476. Thus, even though the insurer cited an accident report demonstrating that the driver did not have permission to drive the insured vehicle, the court held that the insurer’s refusal to defend was wrongful because “[n]othing in the complaint suggested that coverage did not exist.” Id. (emphasis added). The court explained that estoppel in this context, as in others, sounds in equity:

The general rule of estoppel is equitable in nature. In this context, its roots lie in the theory that because the insurer breached one of its duties under the contract of insurance (of which the putative insured is an intended third-party beneficiary), the insurer cannot later turn around and enforce another clause of the contract, to its complete protection. The court will not enforce the insurer’s protections under the policy where the insurer failed to act equitably, that is, failed to defend under a reservation of rights or to bring a declaratory judgment action to determine whether there was coverage under the policy.

Id. at 479. Accordingly, the court affirmed summary judgment in favor of the claimant, who sued the insurer pursuant to an assignment of rights. 482.

Equitable estoppel can render an insurer liable for an underlying judgment. In White Mountain Cable Const. Co. v. Transamerica Ins. Co., 137 N.H. 478 (1993), the claimant secured a default judgment against the insured for contractual indemnity. Id. at 481. In the coverage litigation, the court held that the insurer had a duty to defend the insured because the claimant’s complaint referenced the indemnity contract between the claimant and the insured, and the insurer was obligated to provide coverage to the insured for liability arising under the indemnity contract. Id. at 482-83. The court also held that a default judgment, such as the one entered against the insured, is “conclusive upon an insurer disclaiming coverage and refusing to defend when it had a duty to do so.” Id. at 485. The court explained that this consequence “is in the nature of equitable estoppel.” Id.

Recently, the Ninth Circuit also invoked equitable estoppel when precluding an insurer from raising defenses. In Dowson v. Scottsdale Ins. Co., D.C. No. 4:12-cv-00015-SEH (Mar. 23, 2016) (unpublished), the insurer’s denial letters “merely quoted various policy provisions and exclusions restricting the scope of coverage” without explaining how they applied to the facts of the underlying lawsuit. The Ninth Circuit found this to be a breach of the insurer’s duty to defend. The court noted that, under Montana law, an unjustified failure to defend estops the insurer from denying full coverage for the insured’s defense costs and judgment, including settlement. Accordingly, the Ninth Circuit found the insurer liable for 100% of the defense and settlement costs incurred in the underlying suit.


Bad faith liability, waiver, and estoppel can expand coverage following an insurer’s denial. If an insurer refuses to defend when it should have defended under a reservation of rights and separately litigated coverage, it can forfeit otherwise meritorious defenses and become liable for otherwise uncovered judgments.