An insurer’s decision whether to defend a lawsuit against its insured can be a critical issue involving tens of thousands, if not millions, of dollars for Wisconsin companies who are sued. The Wisconsin Supreme Court recently refused to join the national trend that allows insureds to use information not contained in the plaintiff’s complaint to prove that their insurer owes them a defense. Wisconsin thus remains one of the minority of states in which courts are to look only at the “four corners” of the plaintiff’s complaint when deciding whether the lawsuit raises a claim that the insurer must defend.

In Water Well Solutions Service Group, Inc. v. Consolidated Insurance Company, 2016 WI 54, a 5-2 decision, the court reaffirmed Wisconsin’s longstanding “four-corners” rule and rejected an invitation to join the majority of states that allow the use of other information when deciding whether the insurer has a duty to defend the suit. This is a disappointing decision for insureds. It means that whether they are entitled to a defense from their insurer depends on how their opponent in litigation chooses to frame the issues in the complaint. 

Water Well arose when, because of allegedly improper work by Water Well Solutions, a pump and associated equipment fell to the bottom of a City of Waukesha water well. It cost Waukesha over $300,000 to repair the well. Its insurer, Argonaut, paid the claim and then sued Water Well Solutions to recover that amount. Water Well tendered the defense of the case to its insurer, Consolidated, but Consolidated denied the tender. Consolidated based its refusal to defend on two policy exclusions. The first eliminated coverage for claims for products made, sold, or handled by Water Well (the “Your Product” exception). The second eliminated coverage for claims arising out of the insured’s work (the “Your Work” exception). 

Argonaut’s complaint against Water Well did not clearly allege that equipment not supplied by Water Well was damaged in the accident, even though that was the case. Likewise, the complaint did not assert that some work on the well was done by a subcontractor under the direction of Water Well, even though that was also the case. These omissions in the complaint were significant because the “Your Product” exception did not apply if other products were damaged, and the “Your Work” exception did not apply to damages caused by a subcontractor. Water Well thus faced a situation where, under the four corners of the complaint, it was not owed a defense due to the two policy exclusions, but under the easily ascertainable facts, those exclusions did not apply, and Consolidated was obligated to defend. Since Consolidated refused the tender, Water Well was forced to defend itself and eventually settled with Argonaut. Water Well then sued Consolidated for breach of its duty to defend and for bad faith. 

The Circuit Court for Waukesha County agreed with Consolidated that it had no duty to defend Water Well, and a divided Wisconsin Court of Appeals panel affirmed in Water Well Sols. Serv. Grp. Inc. v. Consolidated Ins. Co., 2015 WI App 78. Both courts reviewed the four corners of Argonaut’s complaint, compared it to the terms of the entire insurance policy, and concluded that the exclusions cited by Consolidated applied, notwithstanding Water Well’s evidence which showed that neither exclusion was applicable. 

Water Well’s primary argument in the Wisconsin Supreme Court was that there should be a limited exception to the four-corners rule allowing extrinsic evidence in cases where:

  1. The policy’s general grant of insurance provides coverage for the claim 
  2. The insurer refuses to defend based on exclusions to that general grant of coverage 
  3. The underlying complaint is ambiguous regarding the facts that determine insurance coverage 

The Supreme Court rejected that argument “unequivocally,” holding that “there is no exception to the four-corners rule in duty to defend cases in Wisconsin.” Id. ¶ 24. 

The majority of the court opined that strict adherence to the four-corners rule actually favors insureds (notwithstanding that it cost Water Well dearly) by preventing insurers from reflexively refusing to defend, hoping that the facts ultimately show that no coverage existed. Id. ¶ 25. The court was not persuaded that plaintiffs were likely to engage in artful pleading to defeat insurance coverage, because plaintiffs benefit from a defendant having insurance coverage (a deep pocket), and so have ample incentive to amend their complaint if facts are discovered that would trigger coverage. The court also rejected Water Well’s assertion that the four-corners rule encouraged insurers to refuse to defend in close cases, warning that an insurer who simply denies a defense tender does so “at its own peril” because of the potential consequences of an erroneous denial. Id. ¶¶ 27-29. 

Justice A. W. Bradley pointed out in dissent that blind adherence to the four-corners rule is silly because it prevents courts from finding the truth when deciding duty to defend questions. Further, the majority ignored the possibility that a plaintiff might seek a significant tactical advantage by structuring the complaint in a way that defeats the duty to defend. 

The majority’s reasoning that the four-corners rule benefits insureds and does not incentivize insurers to deny a duty to defend is faulty – as a simple hypothetical based on the facts of the case demonstrates. The Water Well majority repeatedly emphasized that the four-corners rule only applies when – as Consolidated did – the insurer refuses to defend on the basis of policy language without seeking a judicial determination on whether the claims asserted in the complaint are covered under the policy. The majority also pointed out that the recommended practice in Wisconsin, where there is a question of coverage, is for the insurer to provide a defense while reserving its rights, and then use one of several available procedures to obtain a judicial determination of its obligations under the policy. Water Well, at ¶ 27. When those procedures are used to determine coverage, the four-corners rule does not apply. Id. ¶ 16, fn. 11. 

So, hypothetically, if Consolidated had done what the majority opinion recommended – conditionally accept the tender of defense from Water Well and seek a judicial declaration of its rights – Water Well could have introduced evidence outside of the complaint, which would have shown that the “Your Product” and “Your Work” exclusions did not apply. Water Well would have then received a defense and insurance coverage from Consolidated. Instead, because of the majority’s decision to strictly apply the four-corners rule, Water Well did not receive either. 

This decision can only encourage insurers to find situations where they can deny a duty to defend based on a comparison of the allegations in the complaint with the language of the policy. In those instances the four-corners rule puts blinders on the courts when determining whether the insurer must defend the case. Unless the legislature enacts a contrary statute, the Wisconsin Supreme Court has a near complete turnover in justices who reexamine the question, or the insured can persuade the court that the duty to defend should be decided under the law of a state other than Wisconsin, this ruling has the potential to deprive Wisconsin companies of the insurance protection for which they have paid.