A recent California decision has held that an insurer may not take advantage of a California mechanism for forcing an attorney’s fees arbitration on its insured1 if the insurer breached its duty to defend its insured either by failing to pay the full amount owed or by failing to make timely payment of defense costs. In addition to upholding a policyholder’s right to litigate its breach of contract and bad faith claims before an insurer compels arbitration of the reasonableness of the defense costs, the recent decision also holds that an insured cannot be limited to so-called Cumis rates if its insurer is found to be in breach of the duty to defend.

The decision was issued by the California Court of Appeal for the Fourth Appellate District in Intergulf Development.2 Intergulf involved a dispute between the insured Intergulf and its liability insurer Interstate for the duty to defend a homeowners’ association lawsuit alleging defects in the construction of a condominium project. The insured tendered the complaint to Interstate, seeking defense and indemnity. Interstate did not respond to its insured’s request for independent counsel and later made only partial and delayed defense payments to its insured. Intergulf filed suit against Interstate for bad faith, breach of contract, and declaratory relief prompting Interstate to pay additional defense costs to its insured. Interstate then filed a petition to compel arbitration in a Section 2860 fee dispute arbitration (often called a Cumis fee dispute in reference to the eponymous landmark decision).

The plaintiff-insured in Intergulf challenged the trial court’s ruling granting an insurer’s petition to compel a Cumis fee dispute arbitration by filing a petition for writ of mandate in the California Court of Appeal.3 The California Court of Appeal denied the petition.4 The California Supreme Court granted Intergulf’s petition for review and transferred the matter back to the California Court of Appeal “with directions to vacate the order denying mandate and issue an order to show cause why the relief sought should not be granted.”5

Upon receiving the appeal for the second time, the California Court of Appeal concluded that the trial court had abused its discretion when it granted a party’s petition to compel arbitration under section 2860 before the parties resolved (1) whether the insurer, Interstate, owed its insured, Intergulf “a duty to defend in the first instance; and (2) whether Interstate breached that duty by failing to defend Intergulf ‘immediately’ and ‘entirely’ on tender of the defense.”6

In reversing the trial court’s fee dispute arbitration order, the California Court of Appeal held that “[u]nreasonable delay in paying policy benefits or paying less than the amount due is actionable withholding of benefits which may constitute a breach of contract as well as bad faith giving rise to damages in tort.”7 A breach of the duty to defend entitled the policyholder to damages consisting of “the insured’s cost of defense in the underlying action, including attorney fees” and “also result[ed] in the insurer’s forfeiture of the right to control defense of the action or settlement, including the ability to take advantage of the protections and limitations set forth in section 2860.”8

What This Means for Policyholders:

Policyholders faced with an insurer trying to assert the right to limit its insured to so-called Cumis rates or other billing guidelines and restrictions should insist on prompt and full payment, document each of the insurer’s failures to pay immediately and in full, and should pursue all remedies for the insurer’s breach in a timely manner.