What you need to know

The United States Court of Appeals for the Third Circuit has ruled in American Legacy Found. v. National Union Fire Ins. Co. that under Delaware law a policyholder is not entitled to recover advance defense costs under an Individual and Organization policy where it failed to pursue advance costs until after resolution of the underlying dispute.

What you need to do

Insurers should consider the impact of the Third Circuit’s decision in approaching demands by policyholders for advance defense costs.

Background

Lorillard Tobacco Company sued the American Legacy Foundation, a non-profit corporation dedicated to educating the public about the dangers of tobacco products, in connection with anti-tobacco advertisements that disparaged Lorillard and other tobacco firms. Lorillard asserted claims of breach of a Master Settlement Agreement which created the Foundation, violation of the covenant of good faith and fair dealing, violations of the Foundation’s bylaws and charter and similar claims. National Union denied coverage. The Foundation prevailed against Lorillard and judgment in its favor was upheld on appeal in 2006. In 2007, the Foundation sued its insurers to recover the $17 million it claimed to have spent defending against the Lorillard suit in state court. In particular, the Foundation sought recovery under National Union’s Individual and Organization policy, which obligated the insurer to “advance . . . at the written request of [the Foundation], Defense Costs prior to the final disposition of a Claim.” The Foundation did not request National Union’s approval of defense expenses, did not demand payment of accrued defense costs and did not contest National Union’s denial of coverage, before the underlying action was resolved. The policy barred coverage for claims arising out of contractual liability, unless liability would have attached in the absence of a contract. The Third Circuit affirmed summary judgment for National Union. See American Legacy Found. v. National Union Fire Ins. Co., __ F.3d __, No. 09-3336, 2010 WL 3960579 (3d Cir. Oct. 12, 2010).

The Court’s Ruling

The Third Circuit held that:

  • The insurer had no duty to advance defense costs because the policyholder did not contest National Union’s denial of coverage, did not request National Union’s approval of defense expenses and did not demand payment of accrued defense costs before filing suit against the insurer.
  • Where a policyholder is dilatory in pursuing its rights under an insurance policy, the determination of coverage may be based on the whole record, including evidence developed through discovery, rather than solely on the insurance policy and the underlying complaint.
  • The I&O policy barred coverage because Lorillard’s claims arose out of contractual liability under the MSA. The court rejected the argument that Lorillard’s claims were based on torts of slander, tort or disparagement, such that the exception to the contractual liability exclusion applied, and therefore ruled that the I&O policy did not cover the Lorillard claims.

Conclusion

The Third Circuit ruled that a policyholder is not entitled to recover advance defense costs where it failed to pursue advance costs until after resolution of the underlying dispute.