Why it matters: The Ninth Circuit recently ruled that a dispute between two competitors fell within a liability policy issued by St. Paul Mercury Insurance Company to Tessera, Inc. Competitor Powertech Technology Inc. (PTI) sued Tessera for breach of contract and fraud, asserting that Tessera misled consumers by claiming PTI's products infringed on Tessera's patents. Tessera turned to its insurer St. Paul. The insurer initially provided a defense but later filed suit seeking a declaration that it had no duty to defend. The Ninth Circuit, overruling the district court, ruled in favor of Tessera. The Ninth Circuit noted that the allegations in PTI's suit could reasonably be considered a claim for disparagement and therefore fell within the policy. Furthermore, the lower court improperly looked to the merits of the underlying claims, the Ninth Circuit added. "The existence of a slam-dunk defense, immunity or privilege with respect to the underlying claim against the insured does not affect an insurance company's duty to defend," the panel wrote.

Detailed discussion: Tessera, Inc., licensed the use of its patents to Powertech Technology Inc. (PTI). But in 2011, PTI filed suit against Tessera, asserting that Tessera initiated an investigation by the U.S. International Trade Commission (ITC) into the business activities of a PTI customer. That tip-off breached the licensing agreement between PTI and Tessera, PTI alleged, because its business was negatively impacted.

Tessera requested a defense from its insurer St. Paul Mercury Insurance Company. Although initially St. Paul accepted the defense, it later changed its mind and filed suit against Tessera. The insurer argued that PTI's claims of breach of contract and fraud were not covered by the policies.

Tessera offered a different read on the complaint. PTI's claims were not limited to breach of contract and fraud, the insured argued, but also included allegations of defamation, disparagement, malicious prosecution, and abuse of process—all of which required coverage under the St. Paul policies.

Although the district court granted summary judgment in favor of St. Paul, a three-judge panel of the Ninth Circuit Court of Appeals reversed, holding that the complaint potentially alleged a covered claim. The Ninth Circuit held the following:

"The district court erred when it held PTI's allegations against Tessera did not allege a potential disparagement claim," the panel wrote. "The facts alleged in PTI's complaint that Tessera made untrue accusations to PTI's customers that PTI's products infringed Tessera's patents could potentially allege a claim for disparagement."

Moreover, the Ninth Circuit noted that the district court improperly considered the merits of the underlying claims. California law holds that an insurer "may terminate its defense obligation by proving that the underlying claim falls outside the scope of policy coverage, but not by demonstrating that the claim lacks merit," the court noted, citing California's highest court in Montrose Chemical Corporation of California v. Superior Court, 861 P.2d 1153 (Cal. 1993).

"The existence of a slam-dunk defense, immunity, or privilege with respect to the underlying claim against the insured does not affect an insurance company's duty to defend," the Ninth Circuit explained. Insurers should not analyze and evaluate the underlying claim of liability in order to reject the defense of any claim that is not meritorious, the court noted.

The panel remanded the case to the district court to consider whether an intellectual property exclusion applied to the dispute.

To read the decision in St. Paul Mercury Insurance Company v. Tessera, Inc., click here.