Washington State Supreme Court Reinforces Rights of Policyholders in Duty-to-Defend Cases

In its recent decision in Expedia, Inc. v. Steadfast Ins. Co.,[1] the Washington State Supreme Court made several rulings enhancing the rights of liability insurance policyholders in this State.  First, the Court reaffirmed that in duty-to-defend cases the “eight corners” of the insurance policy and the complaint filed in the underlying litigation generally determine whether a duty to defend is triggered.[2]  Second, the Court confirmed that when such a duty is triggered the insurance carrier must pay its insured’s defense costs in the underlying action while the carrier litigates defenses that might eventually relieve it of the duty to defend.[3]  Third, the Court held that “an adjudication of the duty to defend cannot be delayed by discovery.”[4]  Fourth, the Court held that in a duty-to-defend case, discovery that may prejudice the insured’s position in the underlying litigation should be stayed.[5]  Finally and importantly, the Court indicated that “[a]ll discovery logically related to the underlying claims” is potentially prejudicial to the insured’s position and should therefore be stayed until the underlying claims have been resolved.[6]

The case arose out of lawsuits filed by approximately 80 state, county, and municipal taxing authorities alleging that Expedia, and a number of its affiliated entities, had failed to collect enough local occupancy taxes from their hotel customers.[7]  Expedia tendered the claims to Zurich American Insurance Company and other carriers from which Expedia had procured liability insurance.[8]  Zurich denied coverage and, based on various asserted defenses, refused to defend Expedia against the lawsuits.[9]

Expedia sued Zurich for declaratory judgment, insurance bad faith, and violation of Washington’s Consumer Protection Act.[10]  Zurich counterclaimed, seeking a declaratory judgment that no coverage existed and it had no duty to defend or indemnify Expedia.[11]  In response to Expedia’s motion for summary judgment  declaring that Zurich had a duty to defend,   Zurich moved to continue the hearing on Expedia’s motion under CR 56(f) so it could obtain discovery from Expedia.[12]

The trial court granted Zurich’s CR 56(f) motion.  Expedia provided some discovery but refused to give Zurich other information on the ground that doing so would prejudice its interests in the underlying litigation.[13]  Expedia then filed a motion asking the trial court to protect it from Zurich’s discovery requests and rule on Expedia’s summary-judgment motion.[14]  The trial court agreed that allowing discovery to proceed would injure Expedia’s interests in the underlying litigation but nevertheless denied Expedia’s motion to adjudicate its summary judgment motion “because it could not ‘conclude, as a matter of law, that this discovery is not relevant to the [insurance] company’s defenses.’”[15]

In a 9-0 opinion on discretionary review, the Supreme Court essentially held that the trial court had turned the proper analysis on its head.  The Supreme Court held that the trial court had erred in refusing to decide whether Zurich’s duty to defend had been triggered, and in allowing Zurich to conduct discovery in advance of such a decision.[16]  Only after deciding whether the duty to defend had been triggered should the trial court have allowed Zurich to conduct discovery and attempt to prove its defenses – provided Zurich did not develop or present evidence that could prejudice Expedia’s interests in the underlying litigation.[17]  In the meantime, the Court held, Zurich should have defended Expedia.[18]

The Supreme Court vacated the trial court’s order denying Expedia’s motion to adjudicate its summary judgment motion and remanded to the trial court to determine whether Zurich’s duty to defend had been triggered.  The Supreme Court directed the trial court “to stay discovery in the coverage action until it can make a factual determination as to which parts of discovery in the coverage action are potentially prejudicial to Expedia in the underlying litigation.”[19]  In addition, the Supreme Court held that “[a]ll discovery logically related to the underlying claims should be stayed until such claims are fully adjudicated.”[20]

Expedia follows directly from cases like Mutual of Enumclaw Ins. Co. v. Dan Paulsen Constr., Inc.,[21] Woo v. Fireman’s Fund Ins. Co.,[22] and Truck Ins. Exch. V. VanPort Homes, Inc.[23]  The opinion is nevertheless informative and important because it clarifies that “[d]etermining whether the duty to defend has been triggered is a separate inquiry from whether an insurer may be relieved of its duty to defend or indemnify due to a defense such as a claim of late tender by the insured”;[24] because it appears to be the first Washington case squarely holding that, in a duty-to-defend case, discovery that may prejudice the insured should be stayed;[25] and because it takes an expansive view of what constitutes potentially prejudicial discovery.[26]

It bears noting, however, that although Expedia favors policyholders, it does not give them a free pass.  A diligent insurance carrier may be able to establish coverage defenses based on extrinsic evidence in a declaratory judgment action within a fairly short timeframe – particularly where the carrier’s defenses can be developed without any discovery “logically related to the underlying claims.”  Moreover, a carrier that has obtained a declaratory judgment in its favor would likely be justified in withdrawing payment of defense costs pending an appeal:  Under Washington law, a carrier may subject itself to bad-faith liability for denying its contractual obligations without reasonable justification.[27]  A declaratory judgment that there is no coverage and thus no duty to defend would very likely give a carrier reasonable justification to stop paying defense costs immediately, even if an appeal were threatened or taken.