Litz v. State Farm Fire and Casualty Co.

RAKER, Judge. The primary issue we must decide in this case is whether the “business pursuits” exclusion in a homeowner’s liability insurance policy relieves the insurer from its duty to defend an innocent spouse who does not participate in the business pursuit of the other spouse against a suit brought by a third party who allegedly suffered injuries arising out of the business pursuit. I. This appeal arises out of a declaratory judgment action filed by Respondent, State Farm Fire and Casualty Company (“State Farm”) to determine its obligation to defend and indemnify Petitioners, David and Pamela Litz, in a pending tort action brought by Russell and Sharon Wright on behalf of their minor child, Stephanie. David Litz and his wife, Pamela Litz, were insured under a homeowner’s policy issued by State Farm.

The policy covered damage to the Litz residence and provided personal liability insurance protection. Several provisions in the policy are relevant to the matters in dispute. ²²¹ Under one such provision, State Farm agreed to defend and indemnify the “insured,” 1 as follows: COVERAGE L.—PERSONAL LIABILITY If a claim is made or a suit is brought against an insured for damages because of bodily injury or property damage to which this coverage applies, we will: 1. pay up to our limit of liability for the damages for which the insured is legally liable; and 2. provide a defense at our expense by counsel of our choice — Another provision, relied on by State Farm to deny coverage, which we refer to as the “business pursuits exclusion,” states that liability coverage is excluded for “bodily injury ... arising out of business pursuits of an insured.” Business is defined as “a trade, profession or occupation.” The final provision of importance to this case is entitled “Severability of Insurance,” which states as follows: This insurance applies separately to each insured. This condition shall not increase our limit of liability for any one occurrence. On October 21, 1992, Mr. and Mrs. Wright, on behalf of their minor child Stephanie, filed a complaint for negligence against Pamela and David Litz in the Circuit Court for Charles County. 2 The Wright complaint alleged that on December 31, 1986, while in the care and custody of the Litzes, ²²² Stephanie suffered serious injuries due to the negligence of David and Pamela Litz. 3 On February 22, 1994, State Farm filed a declaratory judgment action in the Circuit Court for Charles County seeking a declaration that it had no duty to defend or indemnify David Litz and Pamela Litz from the personal injury claim filed against them by the Wrights as parents of their minor daughter, Stephanie.

State Farm claimed that the policy provides no insurance coverage for allegations contained in the Wright complaint because Stephanie’s injuries had occurred while the Litzes were providing babysitting services. State Farm denied coverage under the “business pursuits” exclusion of the insurance policy. The tort case was scheduled for trial on August 3,1994, but by order of the circuit court dated July 28, 1994, was continued and reset for May 16, 1995, to allow for resolution of the declaratory judgment action. The Litzes requested that the declaratory judgment action be stayed pending final resolution of the minor’s tort claim.

The circuit court denied this request, and the declaratory judgment case proceeded to trial on January 25,1995. The circuit court concluded that “[t]he babysitting services provided by Pamela Litz 4 at the time of the alleged injury ... constitute a business pursuit as defined in the State Farm policy and as such, the business pursuits exclusion in the State Farm policy is applicable.” The court continued: “As a result ²²³ of the business pursuits exclusion in the policy there is no coverage for Pamela and David Litz.” The Litzes noted a timely appeal to the Court of Special Appeals. That court, by a divided panel, affirmed the judgment of the circuit court in an unreported opinion. The Court of Special Appeals held that the homeowner’s policy did not extend coverage to Mr. Litz because “[t]he event itself is beyond the scope of the coverage provided, regardless of who participated in that event.” The Court of Special Appeals also affirmed the circuit court’s denial of attorneys’ fees to Mr. Litz.

This Court granted the Litzes’ petition for certiorari to consider whether State Farm owed David Litz, an apparently innocent spouse, a duty to defend and attorney’s fees incurred in this declaratory judgment action. We will also consider whether the circuit court erred as a matter of law in entertaining the declaratory judgment action prior to the conclusion of the underlying tort case. We shall hold that the business pursuits exclusion of the Litzes’ homeowner’s liability does not exclude coverage for Mr. Litz and that State Farm had a duty to defend him. Consequently, Mr. Litz is entitled to attorney’s fees incurred in defending the declaratory judgment action.

Finally, we shall hold that the trial court erred as a matter of law in granting a declaratory judgment prior to resolution of the underlying tort trial.

II

Mr. Litz contends that the business pursuits exception should not exclude him from coverage under the policy because he did not participate in the business pursuits of his spouse. He argues that the liability coverage under the policy applies separately to each insured and, as such, the business pursuits of his wife do not deprive him of coverage under the policy. Mr. Litz further contends that the trial court erred in denying his motion for attorney’s fees because he incurred attorney’s fees in defending against a breach of the insurer’s duty to defend. Both Mr. Litz and Mrs. Litz also maintain ²²⁴ that the trial court erred in entertaining the declaratory judgment action prior to the resolution of the underlying tort suit.

State Farm disputes the Litzes’ interpretation of the business pursuits exclusion. State Farm contends that the exclusion denies coverage to all insureds when the injury arises out of an excluded activity, no matter who actually participated in the activity. Accordingly, State Farm denies that it is liable to Mr. Litz for attorney’s fees. It has not, State Farm continues, breached its duty to defend Mr. Litz against a claim potentially within the policy’s coverage because the business pursuits exclusion removes the claim from coverage.

State Farm also maintains that the trial court properly entertained the declaratory judgment action prior to the resolution of the underlying tort case because the issues decided in the declaratory judgment action were independent and separate from those to be resolved at the tort trial.

III

It is well established in Maryland that insurance policies are construed like other contracts. “[W]hen deciding the issue of coverage under an insurance policy, the primary principle of construction is to apply the terms of the insurance contract itself.” Bausch & Lomb v. Utica Mutual, 330 Md. 758, 779 , 625 A.2d 1021, 1031 (1993). We construe insurance policies as a whole to determine the parties’ intentions. Sullins v. Allstate Ins. Co., 340 Md. 503, 508 , 667 A.2d 617, 619 (1995).

This Court has summarized these principles of construction as follows: Construction of insurance contracts in Maryland is governed by a few well-established principles. An insurance contract, like any other contract, is measured by its terms unless a statute, a regulation, or public policy is violated thereby. To determine the intention of the parties to the insurance contract, which is the point of the whole analysis, we construe the instrument as a whole. Maryland courts should examine the character of the contract, its purpose, ²²⁵ and the facts and circumstances of the parties at the time of the execution.

Pacific Indem. v. Interstate Fire & Cas. 302 Md. 383, 388 , 488 A.2d 486, 488 (1985) (citations omitted).

IV

The duty to defend is broader than the duty to indemnify. Hartford Accident v. Sherwood, 111 Md.App. 94, 106 , 680 A.2d 554, 560 , cert. granted, 344 Md. 116 , 685 A.2d 450 (1996); 7C J. Appleman, Insurance Law and Practice § 4684, at 83 (1979, 1996-97 Supp.). The insurer’s duty to defend is a contractual duty arising out of the terms of a liability insurance policy. Judge Eldridge, writing for this Court in Brohawn v. Transamerica Ins.

Co., 276 Md. 396, 409-10 , 347 A.2d 842, 851 (1975), said: The promise to defend the insured, as well as the promise to indemnify, is the consideration received by the insured for payment of the policy premiums. Although the type of policy here considered is most often referred to as liability insurance, it is “litigation insurance” as well, protecting the insured from the expense of defending suits brought against him. The duty to defend exists “even though ‘the claim asserted against the insured cannot possibly succeed because either in law or in fact there is no basis for a plaintiffs judgment.’ ” Id. at 408-09 , 347 A.2d at 850 (quoting Burd v. Sussex Mutual Ins. Co., 56 N.J. 383 , 267 A.2d 7, 10 (1970)).

This Court has also held that an insurer has a duty to defend when there exists a “potentiality that the claim could be covered by the policy.” Id. at 408 , 347 A.2d at 850 (emphasis in original). Under the potentiality rule, the insurer will be obligated to defend more cases than it will be required to indemnify because the mere possibility that the insurer will have to indemnify triggers the duty to defend. Hartford Accident, 111 Md.App. at 106 , 680 A.2d at 560 . One commentator has noted: ²²⁶ Brohawn and its progeny make clear that any potentiality of coverage, no matter how slight, gives rise to a duty to defend.

The potentiality rule, in this regard, is perhaps better labeled the “possibility rule,” and courts have characterized it as such. The defense obligation extends even to those claims filed in bad faith for the sole purpose of raising a potentiality of coverage. Andrew Janquitto, Insurer’s Duty to Defend in Maryland, 18 U.Balt.L.Rev. 1, 13-14 (1988) (footnotes omitted). A potentiality of coverage is typically established by the allegations in the tort plaintiffs complaint.

Brohawn, 276 Md. at 407 , 347 A.2d at 850 . Sometimes, however, extrinsic evidence may also be used to establish a potentiality of coverage. Aetna v. Cochran, 337 Md. 98, 109 , 651 A.2d 859, 865 (1995). When extrinsic evidence, but not the allegations of the complaint, establish a potentiality of coverage, the insured may rely on evidence outside of the complaint.

Id., 651 A.2d at 865 . Judge Chasanow, writing for the Court in Cochran , explained that the insurer should not be allowed to refuse to defend based solely on allegations in the complaint because the insured is completely at the mercy of the tort plaintiffs pleadings to establish a potentiality of coverage. Id. at 111 , 651 A.2d at 866 . V. We turn now to determine whether there is a potentiality of coverage for Mr. Litz under the Litzes’ homeowner’s policy.

The allegations contained in the Wright’s complaint alone do not create a potentiality of coverage because those allegations, if proven, would establish that Mr. Litz was engaged in a business pursuit, namely babysitting, and thus excluded from coverage. The inquiry does not end here, however, and these peculiar facts do not necessarily deprive Mr. Litz of a defense. Cochran teaches that the insured may rely on evidence outside the four comers of the complaint to establish the potentiality of coverage. Here, we look to the Litzes’ answer to State Farm’s complaint in the declaratory ²²⁷ judgment action.

David Litz asserts in the answer that “regardless of whether or not his wife, Pamela Litz, was engaging in a ‘business pursuit’ out of which the alleged bodily injury arose, that he was never so engaged and as such, the purported exclusion does not apply to him.” Furthermore, both Mr. and Mrs. Litz stated in depositions that Mr. Litz was not at home during the hours that Mrs. Litz cared for Stephanie and did not participate in his wife’s babysitting activities. Before we can conclude that there exists a potentiality of coverage for Mr. Litz, we must interpret the business pursuits exclusion in the policy to determine whether the business pursuits of any insured excludes all insureds from coverage under the policy. The Court of Special Appeals agreed with State Farm’s contention that it was not necessary to consider whether the policy applied separately to each insured because “[t]he event itself is beyond the scope of the coverage provided, regardless of who participated in that event.” Before we can decide whether the Litzes’ extrinsic evidence establishes a potentiality of coverage, we must construe the business pursuits exclusion in the policy to determine whether the Court of Special Appeals was correct or whether, as Judge Hollander asserted in her dissent, the business pursuits of one insured do not exclude all insureds from coverage under the policy. A. The business pursuits exception in the Litzes’ insurance policy excluded coverage for injuries arising out of “business pursuits of an insured.” We must decide whether the business pursuits of “an” insured were intended to deprive coverage for “all” insureds.

We conclude that the business pursuits exclusion in David and Pamela Litz’s homeowner’s policy applies separately to each insured such that one insured’s excluded activity does not preclude coverage for other insureds who did not participate in the excluded activity. This Court concluded similarly in St. Paul Fire & Marine Insurance v. Molloy, 291 Md. 139, 150 , 433 A.2d 1135, 1140 (1981). ²²⁸ In our opinion, whether an innocent co-insured, notwithstanding his or her spouse’s misconduct, can recover under an insurance contract, depends primarily upon whether the parties intended, and thus whether the contract contemplates, the obligations of the co-insureds to be joint or several. To hold otherwise would be to deny the parties to agreements insuring jointly owned property the ability to determine the nature of the co-insureds’ contractual interests and obligations. ■ (citations omitted). See D. D’Antonio et al., Protecting the Innocent, A.B.A J., Feb. 1997, at 78 (describing “innocent co-insureds” as an insured who suffers a loss due to the other insured’s wrongdoing or omission but played no role in it).

We agree with the reasoning of Judge Hollander in her dissent to the Court of Special Appeals’ opinion. She stated: The policy in issue here specifically bars coverage for bodily injury arising “out of business pursuits of an insured.” (Emphasis added). To the extent that Pamela Litz, an insured, engaged in a “business pursuit,” she is not entitled to coverage with respect to the tort suit. But the policy leaves open the question of whether coverage is barred for all policy holders or merely for the particular insured who has breached the insurance contract; the policy does not expressly state that coverage is denied to all insureds based on the conduct of “an insured.” ...

As I read the policy language, its plain meaning leads to the conclusion that an insured’s business pursuits may result in the denial of coverage to that insured, but not to all other persons insured under the same policy. See Allstate Ins. Co. v. Worthington, 46 F.3d 1005, 1008 (10th Cir.1995) (construing similar policy language in an exclusion); McFarland v. Utica Fire Ins. Co., 814 F.Supp. 518, 525 (S.D.Miss.1992), aff'd, 14 F.3d 55 (5th Cir.1994) (“The language of the exclusion withholds coverage for ‘an’ act committed by ‘an’ insured, not ‘an’ act committed by ‘any* insured.

Hence, one also may reasonably conclude that the exclusion provision is directed only at the acting insured.”) ²²⁹ Our decision in St. Paul Fire & Marine Insurance Company v. Molloy, 291 Md. 139 , 433 A.2d 1135 (1981) supports this interpretation of the Litzes’ policy.