Nevada Supreme Court Rejects "Automatic Indemnity" for Breach of Duty to Defend

On December 13, 2018, in answer to a certified question concerning Nevada insurance law, the Supreme Court of Nevada overturned a trial court ruling that suggested insurers could have automatic liability for an excess judgment based on a good faith breach of the duty to defend. While the Nevada Supreme Court didn’t cap insurers’ exposure at policy limits plus costs of defense – as a majority of jurisdictions have done – it enunciated a standard that will often produce the same outcome or an even more conservative one. The Nevada Supreme Court held that an insured may recover consequential damages from an insurer that breaches its duty to defend, which could include a judgment that exceeds policy limits, but only if the insured can establish that the judgment was a consequence of the insurer’s breach and that the insured took “all reasonable means to protect himself and mitigate” the loss. 

The case arose from a motor vehicle accident in which the driver of a vehicle struck and seriously injured a bicyclist. The driver’s vehicle was sometimes used for personal use, and other times for his auto detailing business, Blue Streak Auto Detailing, LLC. The driver himself was covered under a personal automobile liability policy. At issue here, however, was a $1 million commercial liability policy issued by Century Surety Company covering Blue Streak. Upon review of the accident report and its own investigation of the facts, Century concluded that the driver was acting in a personal capacity at the time of the accident, and not in the course and scope of his employment. Century thus determined that the accident was not covered by its commercial liability policy. 

Thereafter, the claimant presented Century with a demand to settle the personal injury claim within policy limits, which Century rejected. The claimant then filed suit against the driver and Blue Streak. Having determined that there was no coverage for the accident under its policy, Century rejected tender of the defense. The defendants later defaulted, and the court entered a default judgment for $18,050,193. The parties entered into a settlement agreement in which the claimant agreed not to execute on any judgment against the defendants, and Blue Streak assigned its rights against Century to the claimant. 

As assignee of Blue Streak, the claimant filed a coverage action against Century, which removed the case to federal court. In the coverage action, the federal court found that Century did not act in bad faith but did breach its duty to defend and that Blue Streak was entitled to consequential damages. It then held Century liable for the $18 million default judgment, suggesting that an insurer has “automatic liability” for any excess judgment following a good faith breach of the duty to defend (unless it can establish that the judgment is the result of collusion or fraud). However, the district court stayed the proceedings and certified to the Nevada Supreme Court the following question of law: 

Whether, under Nevada law, the liability of an insurer that has breached its duty to defend, but has not acted in bad faith, is capped at the policy limit plus any costs incurred by the insured in mounting a defense, or [whether] the insurer [is] liable for all losses consequential to the insurer’s breach?

The Nevada Supreme Court’s answer was nuanced. While the court held that an insurer’s liability for breach of the duty to defend is not capped at policy limits plus costs of defense even in the absence of bad faith, it made clear that an insurer is not automatically responsible for the underlying excess judgment whenever it erroneously fails to defend. Rather, the test is whether the damages sought were foreseeable and necessary to put the policyholder in the same position it would have occupied absent the breach. And the court placed the burden on the policyholder to demonstrate that the damages sought were necessarily incurred as a consequence of the breach.

The court described consequential damages as those which “may fairly and reasonably be considered as arising naturally or were reasonably contemplated by both parties at the time they made the contract.” It held an insurer that breaches its duty to defend may be liable for a judgment that exceeds the policy limits, but only if the policyholder proves that the judgment was a consequence of the insurer’s breach. The court emphasized: “[W]e are not saying that an entire judgment is automatically a consequence of an insurer’s breach of its duty to defend; rather the insured is tasked with showing that the breach caused the excess judgment and ‘is obligated to take all reasonable means to protect himself and mitigate his damages.’” (Citation omitted.) Thus, under this standard, the insured not only bears the burden of proving that the damages it seeks were a foreseeable consequence of the insurer’s failure to provide a defense, but the insured also has a duty to mitigate and may not recover damages for loss that could have been avoided by reasonable efforts. 

In sum, the Nevada Supreme Court has charged policyholders with the burden of proving both that the damages sought were a reasonably foreseeable consequence of the breach and that they could not be mitigated by reasonable efforts, explicitly rejecting any suggestion that an insurer is “automatically liable” for the entirety of an excess judgment in the event of a breach of the duty to defend. Under this standard, an insured that has the ability to mount its own defense must do so and, as damages for the breach of the duty to defend, will then be entitled to recover the reasonable and necessary costs of defense, but not the amount of any judgment or settlement of an underlying claim, which results from a merits determination of the issues it presents, not the breach of the duty to defend. 

Under last week’s ruling, the determination of the insurer’s liability depends on the unique facts of each case and is left for the jury to determine. There is the potential for extra-limits exposure because the Nevada high court rejected the majority rule capping insurers’ exposure at policy limits plus costs of defense. However, except in limited situations where the policyholder cannot mount its own defense, the damages for breach of the duty to defend should be the costs of defense under the Nevada law standards announced.