Truck Insurance Exchange, Petitioner, v. VanPort Homes, Inc., et al., Respondents, 147 Wash. 2d 751

Chambers, J. — We are asked to determine whether policy provisions relieve an insurer of the duty of providing coverage. However, because Truck Insurance Exchange breached, in bad faith, its duty to defend, we hold that it is estopped from denying coverage. The insurer further argues that in order to establish damages the insured must prove that its settlements with claimants were reasonable.

We hold that where an insurer acts in bad faith in refusing to defend, the settlements entered into by insureds with third parties and approved by a court as reasonable will be presumed to be reasonable; such presumption may be overcome by the insurer upon a showing that the settlements were the product of fraud or collusion. The trial court’s judgment is affirmed as indicated, and the Court of Appeals is reversed to the extent it remanded for further findings regarding the reasonableness of the insured’s settlement with the claimants.

FACTS VanPort Homes, Inc., provided services in connection with the construction of new homes, and it offered two alternative contracts to its customers. It could act either as a general contractor or as a construction consultant to future homeowners wishing to build their own homes. All claims relevant to this appeal arose out of contracts to consult. VanPort’s boilerplate consultation contract provided that, with the exception of minor matters, the customer would “have complete and full authority as to the construction of [the] residence.” Clerk’s Papers (CP) at 428.

The customer’s responsibility included the selection of real estate, building plans, and design professionals. VanPort’s services included assisting with schedules, budgets, and compliance with government requirements, and were “limited to the advice and materials it provide[d] to client.” CP at 428-30. When Truck Insurance first insured VanPort in 1987, it requested and received a report from Equifax regarding the nature of VanPort’s business.

The report stated that the company would be “operating as building consultants to prospective clients who come to them and want to have a house built by themselves” and that they would be “strictly a consulting firm.” The report outlined VanPort’s role essentially as it was laid out in VanPort’s contracts with customers. CP at 372-73. In 1987, after receiving the report from Equifax, Truck Insurance issued a “T-410” policy. From May 1991, coverage was provided by a commercial general liability (CGL) policy.

Both policies provided coverage to VanPort as “engineers or architects, consulting, not engaged in actual construction.” CP at 484, 524. Thus, the policies acknowledged the fact that VanPort was not functioning as a general contractor but classified the company role as engineers and architects. Both policies imposed on Truck Insurance the duty to defend. Between 1989 and 1991, VanPort entered into construction consulting agreements with five sets of customers (collectively “customers”).

The customers complained of numerous incidents of defective labor and materials, which VanPort failed to catch in its inspections, and notified VanPort of the failure of several subcontractors to properly perform work. Dissatisfied with VanPort’s response, the customers sued VanPort in four separate lawsuits for violations of the Washington State Consumer Protection Act,

chapter 19.86 RCW, the federal Consumer Credit Protection Act, 15 U.S.C. §§ 1601-1693r, misrepresentation, usury, breach of contract, and negligence. CP at 105. Only the negligence claim is relevant to this appeal. The customers alleged undetected errors in constructing foundations, framing, window installation, electrical work, and flooring. In one house, rafters were not tied to the roof.

In another, a customer listed 56 defects, including severe cracks in the foundation, major leaks in the basement and through the roof, and omission of structural supports for the stairs and for certain load-bearing walls, all of which allegedly rendered the house valueless. Between July and October 1992, VanPort tendered the lawsuits to Truck Insurance. Over a year later, in December 1993, Truck Insurance responded and declined coverage.

The letter denying coverage quoted extensively from the policy language and endorsements but provided no analysis, and no attempt was made to explain how the policy language actually excluded the claim. The letter also stated that after a “thorough investigation” the insurer determined there was no coverage. CP at 553.

However, an internal memo dated November 1993 indicates that little or no investigation was actually made: At this time, it is difficult to assess any negligence that may be attributable to our insured due to the fact that we have not accepted the tender of defense, and therefore, have not [begun] to investigate all the liability issues with [regard] to this loss. CP at 335. In April 1994, VanPort wrote to Truck Insurance seeking an explanation for the denial of coverage.

The letter stated that VanPort feared the costs of litigation would “be responsible for putting what was otherwise a very profitable and successful corporation out of business.” CP at 560. VanPort also requested a meeting to discuss the denial. Truck Insurance never responded. Meanwhile, VanPort continued to defend the actions on its own. In February 1996, Truck Insurance finally acted by filing a declaratory judgment action against VanPort, its owners, and the customers, seeking a declaration that it had no duty to defend or indemnify.

Truck Insurance set out for the first time the basis of its denial of coverage as part of the declaratory judgment action, asserting that the claims were basically malpractice claims and that a CGL policy is not a malpractice policy. The action was stayed while the principal owners of VanPort completed bankruptcy proceedings and was resumed in July 1996. In November 1996, VanPort counterclaimed asserting estoppel, breach of contract, and bad faith, and sought damages to include the costs of defending against the suit brought by the customers. In February 1997, both parties moved for

summary judgment. In March 1997, VanPort and its customers settled their lawsuits for a total of $489,685.93. The customers agreed that they would collect only from VanPort’s insurer and not from VanPort itself. VanPort assigned its right to indemnification from Truck Insurance to the customers and assigned to them a percentage of any damages awarded in VanPort’s counterclaim. In the Truck Insurance declaratory judgment action, VanPort brought a cross motion for

summary judgment alleging that Truck Insurance had breached its duty to defend in violation of WAC 284-30-330(2), (6), (7) and (12). The trial court after argument entered an order holding that there was coverage, that Truck Insurance had a duty to defend, and later that Truck Insurance acted in bad faith in failing to defend. This was contested by Truck Insurance in two motions for reconsideration, both of which were denied. In September 1998, the trial court entered an order of final judgment on some of the claims.

The court held that Truck Insurance’s wrongful refusal to defend VanPort was an unfair or deceptive practice in violation of consumer protection regulation WAC 284-30-330, and the damages were therefore per se reasonable. Accordingly, the court declined to evaluate further the reasonableness of the settlements. The court awarded a total judgment of $689,741.46, with interest accruing at the rate of 12 percent per annum. The court stayed the claims for lack of good faith and other Consumer Protection Act violations. Truck Insurance filed an appeal.

In an unpublished opinion, the Court of Appeals affirmed the decision that Truck Insurance owed coverage and had a duty to defend VanPort, but remanded for further proceedings concerning the amount of the judgment, declining to find that the damages were per se reasonable. Truck Ins. Exch. v. VanPort Homes, Inc., noted at 99 Wn. App. 1051, 2000 WL 239592. We granted review.

ANALYSIS Duty To Defend It is unnecessary for us to reach the issue of whether or not coverage was excluded under specific policy provisions because we hold that an insurer that, in bad faith, refuses or fails to defend is estopped from denying coverage. It is well established that where an insurer has a duty to defend an action and the insurer refuses to defend, the insurer is bound by the decision of the trier of fact regarding issues necessarily decided in the litigation. Herendeen v. United States Fid. & Guar. Co., 19 Ariz. App. 399, 401, 507 P.2d 1011 (1973); Blais v. Quincy Mut. Fire Ins.

Co., 361 Mass. 68, 70-71, 278 N.E.2d 746 (1972); Senger v. Minn. Lawyers Mut. Ins. Co., 415 N.W.2d 364, 368 (Minn. Ct. App. 1987); Ramos v. Nat’l Cas. Co., 227 A.D.2d 250, 642 N.Y.S.2d 290 (1996); accord B. Roth Tool Co. v. New Amsterdam Cas. Co., 161 F. 709, 712 (8th Cir. 1908); U.S. Fid. & Guar. Co. v. Dawson Produce Co., 180 Okla. 119, 121, 68 P.2d 105 (1937); Carolina Veneer & Lumber Co. v. Am. Mut. Liab. Ins. Co., 202 S.C. 103, 107, 24 S.E.2d 153 (1943); S.W. Sur. Ins. Co. v. Thompson, 180 S.W. 947, 951 (Tex. Civ. App. 1915). An insurer’s duty to defend is broader than its duty to indemnify. Hayden v.

Mut. of Enumclaw Ins. Co., 141 Wn.2d 55, 64, 1 P.3d 1167 (2000). The duty is one of the main benefits of the insurance contract. Safeco Ins. Co. of Am. v. Butler, 118 Wn.2d 383, 392, 823 P.2d 499 (1992). The duty to defend arises at the time an action is first brought, and is based on the potential for liability. See Holland Am. Ins. Co. v. Nat’l Indem. Co., 75 Wn.2d 909, 911-12, 454 P.2d 383 (1969). The duty to defend “arises when a complaint against the insured, construed liberally, alleges facts which could, if proven, impose liability upon the insured within the policy’s coverage.” Unigard Ins. Co. v.

Leven, 97 Wn. App. 417, 425, 983 P.2d 1155 (1999). Only if the alleged claim is clearly not covered by the policy is the insurer relieved of its duty to defend. Kirk v. Mt. Airy Ins. Co., 134 Wn.2d 558, 561, 951 P.2d 1124 (1998) (citing State Farm Gen. Ins. Co. v. Emerson, 102 Wn.2d 477, 687 P.2d 1139 (1984)). If the complaint is ambiguous, it will be liberally construed in favor of triggering the insurer’s duty to defend. R.A. Hanson Co. v. Aetna Ins. Co., 26 Wn. App. 290, 295, 612 P.2d 456 (1980). Truck Insurance denied coverage claiming that after an investigation it had determined that no coverage existed.

There are two exceptions to the rule that the duty to defend must be determined only from the complaint, and both the exceptions favor the insured. If coverage is not clear from the face of the complaint but may exist, the insurer must investigate the claim and give the insured the benefit of the doubt in determining whether the insurer has an obligation to defend. See Ins. Co. of N. Am. v. Ins. Co. of Pa., 17 Wn. App. 331, 334, 562 P.2d 1004 (1977). Similarly, facts outside the complaint may be considered if “ ‘(

a) the allegations are in conflict with facts known to or readily ascertainable by the insurer or (

b) the allegations of the complaint are ambiguous or inadequate.’ ” Atl. Mut. Ins. Co. v. Roffe, Inc., 73 Wn. App. 858, 862, 872 P.2d 536 (1994) (quoting E-Z Loader Boat Trailers, Inc. v. Travelers Indem. Co., 106 Wn.2d 901, 908, 726 P.2d 439 (1986)). An insurer has an obligation to give the rights of the insured the same consideration that it gives to its own monetary interests. See Tank v. State Farm Fire & Cas. Co., 105 Wn.2d 381, 388, 715 P.2d 1133 (1986).

Put simply, an insurer may not rely on facts extrinsic to the complaint in order to deny its duty to defend where, as here, the complaint can be interpreted as triggering the duty to defend. If in doubt, it may file a declaratory judgment action. Once the duty to defend attaches, insurers may not desert policyholders and allow them to incur substantial legal costs while waiting for an indemnity determination. Kirk, 134 Wn.2d at 563.

If the insurer is unsure of its obligation to defend in a given instance, it may defend under a reservation of rights while seeking a declaratory judgment that it has no duty to defend. Grange Ins. Co. v. Brosseau, 113 Wn.2d 91, 93-94, 776 P.2d 123 (1989). A reservation of rights is a means by which the insurer avoids breaching its duty to defend while seeking to avoid waiver and estoppel. “When that course of action is taken, the insured receives the defense promised and, if coverage is found not to exist, the insurer will not be obligated to pay.” Kirk, 134 Wn.2d at 563 n.3.

We will briefly review Truck Insurance’s policy contentions in the context of its duty to defend. Truck Insurance argues that its CGL policy coverage is not a performance bond, and there is no coverage for VanPort’s failure to perform its contractual obligation. Truck Insurance relies on Hayden, 141 Wn.2d at 64, to support this contention; however, the citation is not well taken. In

section 1A of its policy, Truck Insurance agreed to pay all sums the insured becomes obligated to pay because of property damage resulting from an occurrence within the policy period. CP at 526. In Hayden, we specifically considered a policy exclusion for loss of use of tangible property, instead of a general grant of coverage. Hayden, 141 Wn.2d at 66. Hayden may be helpful in analyzing a similar exclusion within a similar policy, but certainly does not limit the coverage that an insurer may agree to provide to an insured.

Further, Truck Insurance contends that its policy does not apply to breaches of contract; however, customers alleged claims that sound both in contract and in tort. The customers’ complaints specifically set forth facts which, if proved, would trigger coverage. Truck Insurance also contends that even if the complaint triggered broad coverage provisions in the policy, policy exclusions apply. First, Truck Insurance argues its impaired property exclusion applies. We find it unnecessary to fully analyze the impaired property exclusion and merely note that it excluded damages for loss of use.

Under Hayden, the exclusion may apply to claimed damages that do not result in physical damage. However, reading the complaint on its face, damage to the customers’ property could be physical and thus the impaired property exclusion would not apply. In short, the applicability of this exclusion requires looking beyond the complaint and examining the acts which Truck Insurance could have done under a reservation of rights defense and timely declaratory judgment action but did not do. Second, Truck Insurance argues that its operation exclusion applies, excluding coverage for: j. “Property damage” to:

(5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the “property damage” arises out of those operations. CP at 528. Truck Insurance contends that VanPort’s supervisory role in the building of the homes constituted an “operation” within the meaning of the exclusion, while the customers assert that it was not an operation.

The policy neglects to define “operation.” If, as the customers allege, the property damage was caused by the work of others and VanPort’s role was to inspect, then it would appear that the exclusion would not apply. Once again, the applicability of the exclusion depends on a factual determination of VanPort’s role or operation and requires an examination of facts beyond the complaint. In short, we conclude that Truck Insurance’s indemnity policy may not have applied to some or all of the claims had they been fleshed out by investigation under a reservation of right.

However, the claims stated in the complaints were sufficient to impose a duty to defend. Bad Faith We concur with the trial court that Truck Insurance breached its duty to defend when it denied coverage without explanation, and this breach was in bad faith. The trial court ruled in its memorandum of opinion dated October 9, 1997 that the denial of coverage and failure to defend were in bad faith. Truck Insurance twice sought reconsideration; both times it was denied. Between July and October 1992, VanPort tendered defense of the lawsuits to Truck Insurance.

More than a year later, in November 1993, Farmers Group, acting on behalf of Truck Insurance, addressed the customers’ allegations in an internal memorandum recommending denial of coverage and citing various policy exclusions to justify the denial. The internal memorandum indicates that little or no investigation had been done. On December 7, 1993, Truck Insurance sent a letter to VanPort denying both insurance coverage and its duty to defend, based on a laundry list of exclusions without any analysis or correlation to the particular claims.

VanPort’s attorneys requested a more detailed explanation of the denial, seeking a clarification of relevant facts or applicable law. Truck Insurance never responded to the request and, instead, nearly four years after the first tender, instituted a declaratory judgment action against VanPort, its principals, and the customers, seeking a judicial declaration that the policy did not provide coverage. The trial court agreed with VanPort that Truck Insurance had violated Washington’s Consumer Protection Act.

One of the regulations promulgated to enforce the act requires an insurer to promptly provide a reasonable explanation for the denial of a claim. WAC 284-30-330(13). Violations of WAC 284-30-330 are per se violations of Washington’s Consumer Protection Act. Leingang v. Pierce County Med. Bureau, Inc., 131 Wn.2d 133, 151, 930 P.2d 288 (1997). Finally, the trial court ruled that the denial was in bad faith and awarded attorney fees. Based on the violation of the Consumer Protection Act, WAC 284-30-330(13), and Truck Insurance’s unconscionable delay in responding to its insured, we affirm the finding of bad faith.

REMEDY Truck Insurance argues that the trial court improperly imposed the customers’ settlements on Truck Insurance. In Besel v. Viking Insurance Co. of Wisconsin, 146 Wn.2d 730, 49 P.3d 887 (2002), we dealt with a related issue. There, an insurer that had issued a $25,000 liability policy refused in bad faith to settle the claim. The insurer failed to respond to numerous attempts by the claimant to settle. Finally, the insured settled his own claim for $175,000 with a covenant that the claimant would not execute against the insured. Instead, the claimant sued the insurance company as the assignee of the insured.

The settlement was contingent on finding by the trial court that the settlement was reasonable. The Besel trial court, applying the criteria established in Chaussee v. Maryland Casualty Co., 60 Wn. App. 504, 512, 803 P.2d 1339 (1991), found the settlement to be reasonable. We concluded that once a court determined the covenant judgment to be reasonable, it was presumptively reasonable and the burden shifted to the insurer to show that the settlement was the result of fraud or collusion. Besel, 146 Wn.2d at 738-39; Chaussee, 60 Wn. App. at 512; 14 Lee R. Russ & Thomas F.

Segalla, Couch on Insurance § 203:41 (3d ed. 1999); see also Utah Power & Light Co. v. Fed. Ins. Co., 711 F. Supp. 1544 (D. Utah 1989), aff’d, 983 F.2d 1549 (10th Cir. 1993). To place the burden of proving reasonableness of a settlement on a policyholder “ ‘would discourage settlement so necessary to the orderly disposition of cases.’ ” Griggs v. Bertram, 88 N.J. 347, 365, 443 A.2d 163 (1982) (quoting Griggs v. Bertram, 163 N.J. Super. 87, 96, 394 A.2d 174 (1978)). Whether the insurer acts in bad faith by refusing to settle in good faith or by refusing to defend, the consequences to the insured are the same.

The defense may be of greater benefit to the insured than the indemnity. The defense must be prompt and timely. An insurer refusing to defend exposes its insured to business failure and bankruptcy. An insurer faced with claims exceeding its policy limits should not be permitted to do nothing in the hope that the insured will go out of business and the claims simply go away. To limit an insurer’s liability to its indemnity limits would only reward the insurer for failing to act in good faith toward its insured.

We therefore hold that when an insurer wrongfully refuses to defend, it has voluntarily forfeited its ability to protect itself against an unfavorable settlement, unless the settlement is the product of fraud or collusion. See Utah Power & Light Co., 711 F. Supp. at 1556. To hold otherwise would provide an incentive to an insurer to breach its policy. We may affirm the trial court on any grounds established by the pleadings and supported by the record. See Mountain Park Homeowners Ass’n v. Tydings, 125 Wn.2d 337, 344, 883 P.2d 1383 (1994).

Since we decide this matter on alternative grounds, we do not reach the remaining issues raised by the parties. We reverse the Court of Appeals and remand this case to the trial court with directions to enter judgment against Truck Insurance. The trial court may proceed to hear, consistent with this opinion, any claims previously stayed. Johnson, Sanders, Ireland, and Owens, JJ., concur. The CGL policy listed VanPort as a contractor, but noted that the company did not engage in actual construction.

Because the CGL policy provided broader coverage, it is not necessary to consider whether there was coverage under the T-410 policy. If there was no coverage under CGL, there was necessarily no coverage under T-410. Conversely, if there was coverage under CGL, it is not necessary to determine whether there was also coverage under T-410, because CGL would have provided the coverage. The policies provided “General Aggregate Limit (Other Than Products— Completed Operations)” of $300,000. CP at 524. WAC 284-30-330 Specific unfair claims settlement practices defined.

The following are hereby defined as unfair methods of competition and unfair or deceptive acts or practices in the business of insurance, specifically applicable to the settlement of claims:

(2) Failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies.

(6) Not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear. In particular, this includes an obligation to effectuate prompt payment of property damage claims to innocent third parties in clear liability situations. .. .

(7) Compelling insureds to institute or submit to litigation, arbitration, or appraisal to recover amounts due under an insurance policy by offering substantially less than the amounts ultimately recovered in such actions or proceedings.

(12) Failing to promptly settle claims, where liability has become reasonably clear, under one portion of the insurance policy coverage in order to influence settlements under other portions of the insurance policy coverage. An insurer may be responsible for defense costs prior to tender. Griffin v. Allstate Ins. Co., 108 Wn. App. 133, 142, 29 P.3d 777, 36 P.3d 552 (2001). Once a claim against an insured is presented, “the insured must affirmatively inform the insurer that its participation is desired.” Unigard Ins. Co. v. Leven, 97 Wn. App. 417, 427, 983 P.2d 1155 (1999).

Truck Insurance policies require the insured to notify the insurer as soon as practicable of an “occurrence” that may result in a claim or as soon as a “claim” is made. CP at 532 (CGL policy § IV 2 (a), (b)). The trial judge’s opinion finding bad faith was not designated for review. However, we may consider orders not designated in the notice if review is “demanded by the necessities of the case.” RAP 2.4(a); See also Right-Price Recreation, L.L.C. v. Connells Prairie Cmty. Council, 146 Wn.2d 370, 378, 46 P.3d 789 (2002).

The final judgment and stipulation on less than all claims does not reference this determination, but does stay further litigation on the issue of the lack of good faith. CP at 741. Insofar as these issues remain, we do not reach them.