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The Ninth Circuit reaffirms that an insurer cannot escape its duty to defend by showing that the underlying allegations have no basis of fact

A strategy pursued by insurers in insurance bad faith or declaratory relief actions is to try to show that allegations in the underlying action that trigger its duty to defend have no merit. For example, the insurer may bring a motion for summary judgment arguing that there is no potential for coverage because there are no facts supporting the allegations triggering its duty to defend. The insurer knows that the policyholder is caught between a rock and a hard place. If the underlying litigation is ongoing, the policyholder does not want to argue that the claims in the underlying litigation have potential merit especially when the declaratory relief action is an open public record. However, a recent decision of the Ninth Circuit Court of Appeals may put a damper on this strategy.

On November 12, 1997, the Ninth Circuit Court of Appeal issued its decision in Reese v. The Travelers Insurance Company, 97 D.A.R. 13923 (9th Cir. 1997) and held that an insurer owes a duty to defend its insured even if the policyholder cannot show that the allegations triggering coverage are potentially meritorious. In the Reese case, officers and directors of a metals reclamation operation were sued for damages as a result of environmental contamination. The defendants tendered the claim to Travelers, their company's commercial general liability carrier. Although the policy had an owned property exclusion, the complaint alleged that the contamination had migrated outside of the site triggering the insurer's duty to defend under its coverage for property damage.

Travelers initially accepted the tender of defense and then later withdrew. In a motion for summary judgment in the insurance bad faith and declaratory relief action, Travelers argued that there was no evidence that the contamination had migrated. The district court entered summary judgment for Travelers, but the Ninth Circuit reversed. The Ninth Circuit emphasized that the duty to defend clause provided a defense even if the claim was "groundless, false or fraudulent". The Court of Appeal held that the allegation of migration alone, even if groundless, was enough to maintain the insurer's duty to defend until conclusion of the case.

Travelers argued that under Montrose I, its duty to defend ended when it could conclusively establish that there was no potential for coverage, which the concurring opinion likewise cited. However, the majority stated that the issue in Montrose I was "whether or not the third party's complaint referred to a covered risk" and here the third party complaint did refer to a covered risk. "An insurer cannot avoid the duty to defend merely by concluding, based on its own investigation, that the insured has done no wrong" (97 D.A.R. at 13925 citing A-H Plating, Inc. v. American Nat'l Fire Ins. Co. (1997) ___ Cal.App.4th ___, 67 Cal.Rptr.2d 113.)

The Travelers' policy also had a limited pollution exclusion with respect to environmental claims expected or intended by the insured. However, the Ninth Circuit also reaffirmed that simply because a business was involved the disposal of toxic wastes did not preclude the possibility that the property damage may have resulted from accidental causes.