On August 23, 2017, the Second Appellate District of the California Court of Appeal reaffirmed the principle that even in the midst of coverage litigation filed by the insured, insurance companies must still “do no harm” to their insured’s interests. In Riddell, Inc. v. Superior Court, 2017 WL 3614305 (Cal. App. 2017), the court held that a liability insurance company should not be allowed to pursue discovery against its insured in a coverage lawsuit, even one filed by the insured, if that discovery might prejudice the insured in ongoing, underlying third-party litigation. Insurance companies cannot put their litigation interests ahead of their insured’s interests in defending against underlying litigation.
The case involves a dispute over coverage for underlying lawsuits against Riddell, alleging that former professional football players “suffered long-term neurological damage from repeated head injuries as a result of wearing Riddell helmets while playing football.” Id. at *2. The underlying lawsuits for the most part have been consolidated in a federal MDL proceeding, and all discovery in the MDL proceeding has been stayed while certain issues are being resolved. Riddell filed suit against its insurers, claiming they owe it defense and indemnity coverage for the underlying actions. Id.
The insurers propounded discovery seeking factual information relating to prior claims against Riddell, the helmet models worn by each underlying plaintiff, and the dates those helmet models were used. The trial court in the coverage case granted motions to compel filed by the insurers, and denied Riddell’s motion for protective order to stay the discovery. Id. at *1. Riddell filed a petition for a writ of mandate challenging those rulings, and that petition resulted in the Court of Appeal’s published decision.
The court agreed with Riddell that the discovery sought by the insurers was “logically related” to unresolved factual issues affecting Riddell’s liability in the underlying litigation and, therefore, a stay was appropriate. The court also determined that a confidentiality order in the coverage case would not protect Riddell from potential prejudice.
In reaching its decision, the court first set out the general principle that a liability insurer owes its insured a broad duty to defend against claims that create the potential for indemnity coverage, and that the duty to defend is broader than the duty to indemnify. The duty to defend is made by comparing the allegations of the underlying complaint with the terms of the applicable policy. Id. at *4-5. Unfortunately, liability insurers don’t always meet this basic defense obligation, and it becomes necessary for insureds to file suit against them to enforce their obligations.
Filing a coverage action to compel a defense is not without risk, and the Court of Appeal recognized that “[l]itigation of the declaratory relief action when the underlying action is pending may, however, create a risk of prejudice to the insured.” Id. at *5. For example, factual findings in the declaratory relief action may be asserted as collateral estoppel against the insured in the underlying action. See Montrose Chemical Corp. v. Superior Court (1994) 25 Cal.App. 4th 902, 910. Thus, it has long been the rule that where factual issues to be resolved in the coverage case overlap with issues in the underlying litigation, a trial court must stay the coverage action. See Great American Ins. Co. v. Superior Court (2009) 178 Cal.App. 4th 221, 235. Even in cases where a stay of the entire action is not necessary, the same principles apply in determining whether to stay discovery. Thus, discovery that is logically related to the issues affecting the insured’s underlying liability should be stayed pending resolution of the underlying action, unless a confidentiality order can protect the insured’s interests. See Haskel, Inc. v. Superior Court (1995) 33 Cal.App. 4th 963, 980.
The Riddell court agreed with this reasoning, stating that discovery in a declaratory relief action that is “logically related to issues affecting liability in the underlying action,” poses a risk of prejudice to the insured, including collateral estoppel. Riddell, at *6. Interestingly, the court also determined that if such discovery was allowed to move forward in the coverage case, the insured will be prejudiced “by having to pay the costs of discovery in the declaratory relief action that would, if it had taken place in the underlying action, have been paid for by any insurers with a duty to defend.” Id. The court summed up its reasoning as follows:
The upshot of these legal principles is that an insurer cannot, over the insured’s objection, use a declaratory relief action as a forum to litigate factual issues affecting the insured’s liability in the underlying action. Rather, such issues must be litigated in the underlying action. If the allegations in that action, together with the facts known to the insurer, show a potential for coverage, then the insurer must provide a defense in that action. If, in the course of defending that action, the insurer learns of additional, undisputed facts that conclusively eliminate the potential for coverage and thus negate the duty to defend, then the insurer may seek declaratory relief on that basis. But the insurer cannot use the discovery process in the declaratory relief action to investigate or develop those facts if they are logically related to issues affecting the insured’s liability. Rather, that factual investigation and development must take place in the underlying litigation, where any insurer with a duty to defend should be paying for the insured’s defense, including discovery costs. Id.
Applying these legal principles, the Court of Appeal determined that the discovery sought by the insurers should be stayed. All of it was “intimately related to factual issues affecting Riddell’s liability in the third party actions.” Id. at *7. If the insurers sought to use the evidence to litigate factual issues in the coverage case, then Riddell would suffer prejudice “by being collaterally estopped from relitigating any adverse findings in the third party actions while being unable to use any favorable findings to its advantage.” Id. Further, if Riddell was forced to respond to the discovery in the coverage case, as opposed to the underlying actions, it would have been forced to bear the expense of collecting and producing the evidence, when it should be borne by the insurers defending the underlying litigation. Id. The Court of Appeal determined that no confidentiality order could solve these problems and, besides, the federal court hearing the underlying litigation would not be bound by any confidentiality order in the coverage action. Id.
The Court of Appeal’s decision in Riddell, Inc. v. Superior Court should serve as a reminder to insurance companies that the duty to act in good faith to protect the interests of their insureds does not stop at the courthouse door. Even in the midst of coverage litigation initiated by an insured, an insurer must continue to look out for its insured’s interests, and this means refraining from any discovery in the coverage action that might overlap with issues being litigated in the underlying actions. Insurance companies also should not require their insureds, under the guise of discovery in the coverage case, to bear the expense of collecting and producing evidence that should be collected and produced in the underlying action, and paid for by the insurance company as part of its defense obligation.
Client Alert 2017-199
