Why it matters: Better late than never doesn't apply to insurance coverage, a California federal court recently concluded, holding that an insurer lost its right to control the defense of its insured where it failed to provide the policyholder with a defense immediately after its duty to defend was triggered—even though the insurer later provided coverage. Centex Homes was hit with multiple construction defect lawsuits and requested defense from Travelers Indemnity Company of Connecticut. Waiting to hear back from the insurer, Centex retained its own counsel to defend against the suits. When Travelers eventually agreed to provide a defense, Centex refused to cede control. Travelers filed suit, seeking a declaration that it had the right to control the defense. Relying on the California Supreme Court's decision in J.R. Marketing v. Hartford, the court noted that no clear line exists where delay amounts to a breach of duty but found that Travelers crossed the line. A period of time existed where the insured had to provide its own defense counsel to meet court deadlines, the judge said. "A failure to provide counsel or to guarantee the payment of legal fees immediately after an insurer's duty to defend has been triggered constitutes a breach of the duty to defend, even if the insurer later reimburses the insured," the court wrote.

Detailed discussion: Several construction defect lawsuits were filed against Centex Homes in California state court. A participant in the development of residential communities, Centex operated as a general contractor, hiring companies as subcontractors to build the homes it sold. Each of its subcontractors purchased commercial general liability (CGL) insurance from various insurers, naming Centex as an additional insured.

Centex sought coverage under the policies for the construction defect lawsuits. But the insurers—Travelers Indemnity Company of Connecticut and St. Paul Fire and Marine Insurance Company, collectively referred to in the coverage dispute as Travelers—hesitated before providing a defense.

Faced with court deadlines, Centex retained a law firm to provide a defense in the underlying litigation. When Travelers finally stepped up to the plate, it insisted on appointing its own counsel. Centex argued that Travelers lost its right to control the defense by waiting too long to participate.

Travelers filed a declaratory action seeking an order that it had the right to control Centex's defense, along with claims for breach of contract and breach of the implied covenant of good faith and fair dealing. In a somewhat convoluted procedural history, the federal court first granted Centex's motion for partial summary judgment in May 2012 before reconsidering its decision and later reversing itself in April 2013.

Centex then filed a motion for reconsideration. The court granted the motion, finding that the April 2013 order was inconsistent with a decision from a California appellate panel in J.R. Marketing v. Hartford. When that case went up to the state's highest court, the judge stayed the Centex dispute pending review. The California Supreme Court affirmed the relevant part of the J.R. Marketing decision and the court lifted the stay.

Evaluating Centex's motion for reconsideration as to Travelers' right to control Centex's defense in two of the underlying suits—Acupan andConner—the court reversed itself again to grant summary judgment in favor of the insured.

The decision in J.R. Marketing stands for the proposition that an insurer forfeits its right to control the defense of an action where the insurer breaches its duty to defend, the court said. In the April 2013 order, the court held that an insurer can lose its right to control the insured's defense solely "through waiver, forfeiture, or estoppel," a position that was in error in light of J.R. Marketing, U.S. District Court Judge Samuel Conti wrote.

Although Travelers subsequently reimbursed Centex for its legal expenses in the Acupan and Conner actions, a gap existed between the insured providing notice of the claim and the insurer's agreement to provide a defense.

Did this delay result in the insurer's loss of its right to control the defense? Yes, Judge Conti said.

The burden is on the insured to make a prima facie showing that a third-party claim potentially falls within the insuring provisions of its policy, and an insurer's duty to defend will not ripen until a third party files a complaint against the insured, the court explained. However, the duty is not triggered the instant the insurer receives the complaint filed against the policyholder but when an insurer is required to act on the insured's behalf—such as filing an answer to the complaint.

"At that point, the insurer has an immediate duty to defend until it can show conclusively that the damages sought in the third party lawsuit are not covered under the policy," the court said.

In the Acupan action, Centex first notified Travelers on January 21, 2011 and made a prima facie showing that the action potentially fell within its coverage by February 1, when it submitted copies of subcontracts and other documents at Travelers' request. The actual complaint in Acupanwas filed on April 19, 2011. In California, a responsive pleading is not due until 30 days after the complaint is filed, triggering Travelers' duty to defend on May 19, 2011.

"Travelers did not accept Centex's tender, however, until June 1, 2011," Judge Conti wrote. "Thus, there were at least 13 days during which Travelers had a duty to defend Centex but did not provide a defense. As a result, Centex had to employ its own counsel."

As for the Conner lawsuit, Centex initially provided notice to the insurer on September 8, 2010 and made a prima facie showing that the action potentially fell within coverage on the same day. The Conner complaint was filed on October 15 and Travelers' duty to defend arose on November 15. "Travelers did not accept Centex's tender, however, until January 21, 2011," the court said. "Its acceptance, therefore, was made 67 days after its duty to defend was triggered."

Travelers argued that it had a right to conduct a reasonable investigation before accepting Centex's tender and that it reimbursed the insured for legal costs incurred prior to acceptance.

But the court said that was insufficient.

"The duty to defend imposes upon the insurer several responsibilities, including that it 'employ competent counsel to represent the insured,'" Judge Conti wrote. "A failure to provide counsel or to guarantee the payment of legal fees immediately after an insurer's duty to defend has been triggered constitutes a breach of the duty to defend, even if the insurer later reimburses the insured."

An insured's desire for defense coverage is "as significant a motive" for the purchase of insurance as indemnity for possible liability, the court said.

"Of course, an insurer is free to conduct an investigation beyond the point at which its duty to defend has been triggered," the judge added. "Such an investigation may lead to facts establishing that there is no possibility of coverage, thereby ending the insurer's duty to defend. An insurer may not, however, deprive an insured of the security implicit in the duty to defend—specifically, 'the right to [immediately] call on the insurer's superior resources' as opposed to having to marshal its own resources to mount a defense against a claim that possibly falls within the policy's coverage."

Judge Conti ruled that Travelers breached its duty to defend by failing to provide Centex with a defense at least 30 days after the complaints were filed in the Acupan and Conner actions and lost its right to control Centex's defense in the process.

To read the decision in Travelers Indemnity Co. of Connecticut v. Centex Homes, click here.