Many business owners have a complicated relationship with their liability insurance policies.  On one hand, a headache—time spent shopping brokers and policies, long calls with risk management teams, and sometimes painful reminders on the expense sheet.  Industry and location can drastically sway the total cost.  On the other hand, a savior—financial protection when an unplanned disaster strikes.

When most look to headlines involving big-figure litigation, they focus on the dollar amount of the final judgment or settlement.  Typically, for a lack of excitement, these headlines often overlook the duty to defend: an insurance company’s obligation to defend any lawsuit brought against the policyholder that alleges and seeks damages for a claim that is potentially covered by the policy.  The duty to defend, or “litigation insurance,” is necessarily broader than the duty to indemnify and, frequently, defense costs can represent a huge portion of the policyholder’s overall exposure.  For example, lawsuits against 3M Technologies alleging defects and personal injury related to Combat Arms Earplugs created a saga that included a multi-district litigation and large chapter 11 bankruptcy.  After a global settlement was reached, 3M and its subsidiary fought out an insurance coverage dispute with its insurance company up to the Delaware Supreme Court, including over $370 million in defense costs.[i]  Bear in mind that defense costs under most commercial general liability policies are paid “outside of limits,” meaning they are unlimited and do not erode the policy’s indemnity limit of liability, which is often capped at $1 million or $2 million.

So, when does this important tool come into play?  In New York, the duty to defend is not split by claim.  If any allegation in the complaint is potentially covered by the insurance policy, the insurance company is obligated to defend the entirety of the action.  For example, a plaintiff may accuse an accountant in one count of negligence and in a second count of committing fraud.  In the typical errors and omissions policy, the insurance company would likely be required to provide coverage for only the first count alleging negligence.  New York law, however, requires that the insurance company defend both counts even though it would not be responsible to pay any amounts for indemnity on the fraud claim.  In contrast, while California initially requires an insurance company to defend the entire case, it permits an insurance company to reserve its rights to later seek reimbursement from its policyholder for its cost of defending claims that are not even potentially covered by the policy, provided the insurance company does so at the earliest possible time.[ii]  New York prohibits the insurance company from seeking recoupment of defense costs for claims that are not covered unless the policy explicitly provides for such a right.[iii]

Through the course of defense, it is not infrequent that conflict arises between the interests of the policyholder and the insurance company.  The Georgia Court of Appeals has recently acknowledged the practicalities of the tripartite relationship between an insurance company, its appointed counsel, and its policyholder, noting “that a lawyer's future business from the company depends on being in the continuing good graces of the insurance company.”[iv]  For example, it may be the case that an insurance company has undertaken the defense of an action while also reserving its rights to disclaim coverage.  In those circumstances, appointed defense counsel may be tempted to develop evidence supporting a coverage denial or accept a quick settlement for sums reasonable to the insurance company that would exhaust the indemnity limit of liability and cut off defense coverage under the policy for other outstating litigations.  In many states, where a strategic or other conflict exists between a policyholder’s and its insurance company’s interests, the policyholder is entitled to choose independent defense counsel paid for by the insurance company.  In New York, the failure of the insurance company to advise the policyholder of its right to independent counsel constitutes a deceptive act or practice within the meaning of New York General Business Law § 349.[v]

The duty of an insurance company to defend its policyholder typically lasts until the exhaustion of policy limits through the payment of a judgment or settlement.  So, if an insurance company acknowledges coverage, can it pre-pay or tender its indemnity policy limits in a quick settlement to terminate the duty to defend, i.e., “dump and run”?  As noted above, the duties to defend and indemnify are distinct, and can often be equally as important financially.  State law acknowledges this distinction and prevents insurance companies from terminating defense early through prepayment.[vi]

With the duty to defend being so broad—and potentially expensive—crafty insurance companies may attempt to abscond from their duty.  In certain states, policyholders have strong tools to encourage insurance company cooperation.  In New York, for example, the Mighty Midgets rule allows a policyholder to recover its attorneys’ fees incurred in forcing the insurance company to honor its defense obligations under the policy.

Business owners spend exorbitant sums on liability insurance premiums and should familiarize themselves with the protections afforded by these products.  When push comes to shove, the duty to defend can save policyholders from millions of dollars of legal defense costs and, in some circumstances, the death of the company.

[i] See In re Aearo Techs. LLC, 346 A.3d 584 (Del. 2025).

[ii] See Northfield Ins. Co. v. Sandy's Place, LLC, 530 F. Supp. 3d 952, 969 (E.D. Cal. 2021) (quoting Buss v. Superior Court, 939 P.2d 766, 776 (Cal. 1997) (“If an insurer tenders a defense and adequately reserves its rights, it ‘may indeed seek reimbursement for defense costs’ for any claims in an underlying action that are not covered by the insurance policy.”)).

[iii] See Am. W. Home Ins. Co. v. Gjonaj Realty & Mgmt. Co., 192 A.D. 3d 28, 41 (N.Y. App. Div. 2020) (finding insurance company cannot unilaterally create a right of reimbursement through a reservation of rights letter if reimbursement is not afforded under the provisions of the policy).

[iv] Hoffman v. Se. OB/GYN Ctr., LLC, No. A25A2184, 2026 WL 178075, at *2, *2 n.2 (Ga. Ct. App. Jan. 22, 2026) (citing John D. Hadden and Jarome E. Gautreaux, Ga. Law Of Torts, Preparation for Trial § 4:14 (2025 ed.)).

[v] See Elacqua v Physicians' Reciprocal Insurers, 52 A.D. 3d 886, 888 (N.Y. App. Div. 2008).

[vi] See Kirk v. Allstate Ins. Co., 2012 IL App (5th) 100573, ¶ 24 (“Illinois cases have long held that an insurer cannot discharge its duty to defend simply by paying policy limits.”); Cnty. of Santa Clara v. U.S. Fid. & Guar. Co., 868 F. Supp. 274, 277 (N.D. Cal. 1994) (“Moreover, the primary insurer cannot extinguish its defense obligation simply by tendering its indemnity limits to the insured and walking away from the fray[.]”); Maguire v. Ohio Cas. Ins. Co., 412 Pa. Super. 59, 66, 602 A.2d 893, 896 (1992) (“Similarly, the requirement of good faith prevents an insurer from tendering the amount of its policy limit into court pending a determination of liability in order to avoid its duty to defend.”).