A federal district court, applying California law, has held that a “no voluntary payment” provision precluded coverage for defense expenses voluntarily incurred by an insured pursuant to its agreement to indemnify its directors and officers prior to providing notice to the insurer of its indemnity obligation. Corthera, Inc. v. Scottsdale Ins. Co., 2016 WL 270951 (C.D. Cal. Jan. 22, 2016).

The insured sought coverage under its business and management indemnity liability policy—which imposed a duty to defend on the insurer—in connection with its obligation to indemnify its officers and directors as a result of a lawsuit alleging violations of a competitor’s intellectual property rights. The amended complaint named two additional insured directors as defendants, one of whom had a conflict with counsel previously consented to by the insurer. That director selected separate counsel, who then requested indemnification from the insured. The insured agreed to indemnify the director and notified the insurer of this additional obligation.

Upon receiving an invoice from the director’s separate counsel, the insurer advised the insured that it had not consented to separate counsel’s retention, believed the amount of the invoice did not appear reasonable, and would not recognize separate counsel’s fees incurred without its consent. While the insurer and the insured continued to negotiate regarding separate counsel, the court granted the motion to dismiss filed by separate counsel in the underlying action, which was then appealed. The insurer appointed new counsel in connection with the appeal, but the director would not permit appointed counsel to assume his defense. The insured then asserted that the insurer’s prior reservation of rights letter accepting coverage for the matter and consenting to counsel for the other insured defendants in the litigation created a conflict of interest that entitled the remaining director to separate counsel of his choosing. When the insurer disagreed, the insured initiated coverage litigation, and the parties filed cross-motions for partial summary judgment.

The court enforced the policy’s “no voluntary payment” provision as to those defense expenses incurred voluntarily by the insured prior to providing the insurer notice of the additional director’s claim. In doing so, the court first discounted the insured’s argument that its indemnification obligations were “incompatible” with the indemnity coverage provided by the policy. The court disagreed, explaining that the insured’s inability to control the defense of its officers and directors is separate and apart from its obligation to inform the insurer of the matter prior to incurring any defense expenses. According to the court, the insured’s bylaws cannot unilaterally enlarge the coverage provided by the policy.

The court then determined that the insured incurred the defense expenses at issue “when the task [was] performed because this is when the obligation to pay is created,” and not when the insured actually paid separate counsel’s invoices. The court also found that the defense expenses incurred from the time the insured received notice of the director’s retention of separate counsel until the insured provided notice to the insurer were incurred voluntarily, and, as a result, the “no voluntary payment” provision applied to preclude coverage for those amounts.

The court also denied the insurer’s motion for summary judgment on the insured’s bad faith claim because the court determined that the insurer’s request that its appointed counsel prepare a budget for filing a motion to dismiss similar to that filed by the director’s separate counsel “could have created a conflict of interest and thus demonstrate bad faith.” According to the court, a jury could find that the insurer had no reason to ask for such information other than to defeat coverage, particularly when the insurer made the request after the motion had been filed and granted. Finally, the court granted the insurer’s motion for summary judgment as to the insured’s claim for punitive damages because, according to the court, the insurer’s actions “do not rise to the level of being ‘evil, criminal, recklessly indifferent to the rights of the insured, or with a vexatious intention to injure.’”