It may seem obvious that policyholder defendants should immediately notify their liability insurance carrier whenever they are faced with potentially covered litigation. Among other things, policyholders want the benefit of the insurer-paid defense their policy provides. But for a variety of reasons, this does not always happen, and in some cases policyholders find themselves funding their own defense for a period of time before their insurance carrier is aware of the litigation and has agreed to accept the defense. Frequently, this leads to dispute about whether such “pre-tender” defense costs are covered under the policy.

The Eleventh Circuit faced this situation in EmbroidMe.com, Inc. v. Travelers Property Casualty Company of America, and on January 9 held that under Florida law, Travelers was not required under Florida’s Claims Administration Statute (CAS) to reimburse its policyholder, Emboidme.com, for pre-tender defense costs incurred in an underlying copyright infringement suit.

Travelers insured EmbroidMe under a general liability policy that included web site injury protection. Embroidme.com was sued in a copyright infringement lawsuit in April 2010 and retained counsel to defend it in the lawsuit, but did not tender the suit to Travelers until October 2011. Travelers subsequently agreed to provide EmbroidMe with a defense, but declined to reimburse it for pre-tender defense costs of approximately $400,000. EmbroidMe argued that the policy did not expressly bar coverage for pre-tender costs and that Travelers’ disclaimer was untimely under the CAS.

The CAS states, in relevant part, that an insurer is estopped from denying coverage unless it gives “written notice of reservation of rights to assert a coverage defense” to the insured “[w]ithin 30 days after the liability insurer knew or should have known of the coverage defense.” The statute also addresses an insurer’s obligation to disclaim coverage or provide its policyholder a defense within 60 days. The statute defines a “coverage defense” as “a defense to coverage that otherwise exists.”

The Eleventh Circuit concluded that while Travelers’ reservation of rights letter was issued 42 days after EmbroidMe’s tender, the CAS’s 30-day requirement to communicate coverage did not apply to Travelers’ refusal to pay for pre-tender defense costs. Rather, Traveler’s refusal to pay pre-tender defense costs was based on an exclusion, not a “coverage defense” as defined in the CAS. Specifically, the policy at issue precluded the policyholder from “voluntarily assuming any obligation or incurring any expense without Travelers’ consent.” Thus, the CAS did not estop Travelers’ from asserting the exclusion as a basis to deny pre-tender defense costs.

“According to Florida law, the assertion of a coverage defense comes within the CAS and its corresponding time limits, but a defense that a policy provision excludes coverage is not subject to the CAS’ deadlines or even to its requirement that notice be given,” the court stated. “[B]ecause Travelers relied on an exclusion, not a coverage defense, its failure to notify EmbroidMe within the time period set out in the statute did not estop Travelers from relying on that ground in refusing to pay these unapproved expenses.”

The court further noted that under Florida law, the CAS cannot be used to create coverage where coverage did not otherwise exist. Because the policy specifically excluded expenses incurred by the policyholder without prior consent, the court found that Travelers’ refusal to reimburse pre-tender defense costs is not a coverage defense subject to the 30-day requirement under the CAS.

The Eleventh Circuit also rejected the policyholder’s argument that Travelers’ was not prejudiced by its payment of defense costs without Travelers’ consent. To the contrary, the court stated that “Travelers was obviously prejudiced by EmbroidMe’s decision to start the defense of its case, on its terms, without bothering to tell Travelers,” and that EmbroidMe paid its attorneys a substantially higher hourly rate ($400 versus $315) than Travelers ultimately agreed to pay and sought reimbursement at the full rate. The court did not address how Travelers would have suffered prejudice if it had been required to reimburse the policyholder for pre-tender defense costs at the agreed-upon rate. Instead, the Eleventh Circuit reasoned that the CAS’s 30-day deadline simply did not apply to exclusions pertaining to the duty to defend.

This case highlights an important lesson for policyholders that, when in doubt, notice of a claim or suit should be tendered to insurers early and often.