After our December 15, 2015 post about the Discussion Draft of the Restatement of the Law on Liability Insurance, the American Law Institute released Council Draft No. 2 on December 28, 2015. Relevant to my last post, Council Draft No. 2 contains revisions to §19 of Chapter 2, addressing the duty to defend. While the Reporters’ Memorandum notes that no substantive changes have been made to the black letter law of this section, the comments section has been revised to reflect a proposed intermediate approach. ALI Restatement of the Law: Liability Insurance, Council Draft No. 2 (not approved), Dec. 20, 2105 p. xiv. These revisions reflect a more moderate position than that taken in the previous Discussion Draft.
Highlights of the most recent revisions include a revision to Section 19, titled “Consequences of Breach of the Duty to Defend,” which now states:
(1) An insurer that breaches the duty to defend a legal action loses the right to assert any control over the defense or settlement of the action.
(2) An insurer that lacks a reasonable basis for its failure to defend a legal action also loses the right to contest coverage for the action.
Id. at p. 24. The Reporters comments explain this intermediate approach, stating “[s]ubsection (2) articulates an intermediate rule that limits the extra-compensatory consequences of the minority rule in cases in which the insurer lacks a reasonable basis for the failure to defend. A “reasonable basis” means that the insurer has a reasonable legal theory pursuant to which, giving the insured the benefit of the doubt with regard to any and all disputed facts, the insurer has no duty to defend as a matter of law….The intermediate rule provides greater protection for insureds than the majority rule and it may provide greater protection than the bad-faith rule.” Id. at p. 27. The Reporters go on to note that while this proposed rule may “require more work on the part of courts than either the automatic forfeiture-of-coverage defenses rule or the no-forfeiture-of-coverage-defenses rule,” they believe that it strikes the right balance between protecting insureds from insurers transforming a duty to defend policy into a “defense-cost-reimbursement” policy and protecting the reasonable and good-faith defense determinations of insurers. Id. at p. 28.