Insurer May Allocate Defense Costs Under Duty to Defend Policy

Applying Louisiana law, the United States District Court for the Eastern District of Louisiana has held that an allocation provision in a duty to defend policy allowed an insurer to allocate defense costs between covered and non-covered causes of action. Housing Auth. of New Orleans v. Landmark Ins. Co., 2016 WL 772649 (E.D. La. Feb. 29, 2016).

The insured, a housing authority, was sued for its demolition of four public housing developments in New Orleans after Hurricane Katrina. The housing authority tendered the suit to its directors and officers liability insurer. The insurer agreed to provide a defense under a reservation of rights, subject to the policy’s allocation provision, because certain causes of action could be covered under the policy but refused to pay for the defense of non-covered causes of action. The insurer thus paid an allocated portion of defense costs incurred by the housing authority. The housing authority filed litigation against the insurer seeking coverage for all defense costs incurred in the lawsuit. The insurer contended that it satisfied its obligations under the policy by paying all defense costs attributable to potentially covered causes of action.

The court held that the insurer could allocate defense costs between covered and non-covered causes of action. The insured asserted that the insurer was required to pay all defense costs in the lawsuit because the policy stated that “[i]t shall be the right and duty of the Insurer to defend any Claim against the Insured for which coverage applies under this policy.” The insurer argued that the policy expressly provided for allocation of defense costs between “covered and non-covered causes of action” and only required the advancement of defense costs that the insurer believed to be covered, subject to a later allocation determination.

The court reasoned that there was no conflict between the duty to defend and allocation clauses because the duty to defend only extended to claims “for which coverage applies under this policy” and the housing authority had no reasonable expectation of complete defense coverage for any potentially covered claim because D&O policies do not contain broad duty to defend clauses found in most general liability policies. Thus, the court held that “[r]ead together, [the insurer’s] duty to defend is apparent. If the claim is covered, the insurer must provide a defense. If the claim is only partly covered, the parties need to work to allocate expenses. If the claim is not covered, then there is no duty to defend.”

In addition, the court held that Louisiana public policy did not prohibit the insurer from contractually limiting its duty to defend to covered causes of action. Because the duty to defend is a contractual duty, the insurer could limit its defense obligations through unambiguous policy language.