3 Recent Insurance Cases That Defend The Duty To Defend

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1 Portfolio Media. Inc. 860 Broadway, 6th Floor New York, NY Phone: Fax: Recent Insurance Cases That Defend The Duty To Defend Law360, New York (September 15, 2015, 10:33 AM ET) -- Erica J. Dominitz Barry J. Fleishman The duty to defend in liability insurance policies has been under attack over the past decade. Insurance companies increasingly have used a wide variety of tactics (i) to delay making decisions on their obligation to pay, (ii) to delay reimbursing policyholders that have been forced to use their own funds to pay for their defense counsel and/or (iii) to refuse to agree to reasonable settlements when they are paying defense costs under a reservation of rights. These tactics have put great pressure on policyholders needing to decide how to respond and often prejudice those policyholders interests. On the one hand, policyholders have paid premiums and reasonably believe they have a solid right to coverage, particularly given the breadth of a carrier s duty to defend; but, on the other hand, the high cost of fighting insurance carriers in dispute resolution proceedings potentially can offset or even cost more than any potential recovery and that cost often cannot be recovered by the policyholder absent proof of bad faith, which itself can be extremely expensive to prove if a bad faith remedy even is available (and it isn t reasonably available in many states). In three recent decisions spanning from Hawaii to Pennsylvania, courts have warned insurance companies to end this pernicious trend. First, innautilus Insurance Co. v. Lexington Insurance Co., 132 Hawaii 283, 321 P.3d 634 (2014), the Hawaii Supreme Court ruled that insurance carriers cannot hide behind a so-called other insurance clause to avoid their duty to defend obligations. Second, in National American Insurance Co. v. Artisan and Truckers Casualty Co., No , Aug. 6, 2015, the United States Court of Appeals for the Seventh Circuit reaffirmed (under Illinois law) that insurance companies can be estopped from asserting coverage defenses if they wrongfully refuse their duty to defend. Third, in Babcock & Wilcox Co. v American Nuclear Insurers, et al., No. 2 WAP 2014, July 21, 2015, the Supreme Court of Pennsylvania held that policyholders must be reimbursed for reasonable settlements of underlying claims even if a defending insurance carrier has refused to agree to the

2 settlement. When combined, these cases stand for the following propositions that have been adopted by some but should be adopted by all United States jurisdictions: Once a policyholder establishes that there is a duty to defend under its policy: 1. The insurance company has an obligation to pay all covered defense costs even if other insurers arguably also have coverage obligations for the same claim and may be obligated to share in those payments; 2. The insurance company should be estopped from asserting coverage defenses if it refuses to provide a defense and fails to initiate a declaratory judgment action regarding its obligations under the policy; and 3. The insurance company should not be allowed to veto a fair and reasonable settlement when it is defending under a reservation of rights as to indemnity coverage. Adoption of these principles by all jurisdictions will go a long way towards ending insurance company abuse and abdication of the duty to defend and will provide crucial protection of the litigation insurance policyholders have spent significant premium dollars to purchase. Nautilus In Nautilus, the owner and developer of a tract of land was sued by residents for damages arising from alleged damage from construction. The owner had its own insurance from Lexington Insurance Co. and also was an additional insured on the policy of a subcontractor from Nautilus Insurance Co. Nautilus defended the owner, but Lexington refused to contribute to the defense based on its analysis of the two policies other insurance provisions, arguing that the Lexington policy should be deemed excess to the Nautilus policy and the Lexington duty to defend obligations therefore were not triggered. Nautilus contended, however, that Lexington s obligations should be assessed solely by the complaint in the case and the terms of the Lexington policy and Lexington should not be allowed to review the terms of any other insurance policy in order to determine whether it has a duty to defend its insured. The Hawaii Supreme Court held that Nautilus was correct and that Lexington s duty to defend indeed had been triggered. In clear and stark language, the court held that insurers should not be permitted to look to other policies in disclaiming the duty to defend, and that insurers should not be permitted to refuse to defend simply by pointing the duty to defend finger at another carrier: Where an insured has contracted for primary insurance, an insurer should not be able to refuse to defend and place the risk on the insured, of the insurer s erroneous understanding of another insurance policy that is not part of the original contract. Id. at 26. The court then summarized its determination that Lexington could not foist its duty to defend upon another carrier and leave the policyholder without coverage: Therefore, we hold that a primary insurer may not look to another insurance policy in disclaiming its duty to defend. If a primary insurer is tendered a defense and believes that it is actually an excess

3 insurer or otherwise has no duty to defend by operation of its other insurance clause, then that primary insurer must still defend the action. This is the appropriate remedy, rather than leaving the defense up to other insurers or, potentially up to the insured, where the insured has contracted for primary coverage. Id. at 29. The court correctly recognized that Lexington s remedy under the circumstances was to seek equitable contribution damages against Nautilus. This is precisely how the duty to defend should work where more than one carrier s policy potentially is triggered: the insured gets its defense coverage and then the carriers fight over how those costs should be allocated. Presently, many carriers refuse to pay and force the insured both (i) to pay its own defense costs, and then, to add insult to injury, (ii) to pay the costs of a coverage action to establish which of the carriers ultimately should pay and in what amount. This completely turns the duty to defend inside out by putting on the insured the financial burden and risk of handling and paying for its own defense and establishing its carrier s (or carriers ) duty to defend despite the fact that the insured has paid for, and is entitled to, defense coverage under more than one policy. Indeed, the policyholder in these cases paid twice for defense coverage and winds up getting coverage under neither. Courts around the country should take heed of the well-thought-out decision by the Hawaii Supreme Court in Nautilus and eliminate the nonsensical argument of insurance companies that the insured has the burden to resolve other insurance issues before tapping into the defense coverage it purchased. Rather, as the Nautilus court firmly and aptly recognized: When it comes to the duty to defend, a heavy burden is placed on the insurer if that insurer wishes to disclaim its duty. To reiterate, the duty to defend rests primarily on the possibility that coverage exists. NAIC The Seventh Circuit s powerful decision in NAIC begins as follows: This case provides a warning for insurance companies who refuse to defend their insureds. NAIC, at 1. The case arose out of a traffic accident, for which two insurance companies potentially were on the risk. One provided a defense under a reservation of rights. The other refused to participate in the defense. After the case was resolved, the defending carrier sued the refusing carrier on theories of equitable contribution and subrogation. The defending carrier asserted that the refusing carrier was estopped from raising policy defenses to its duty to defend because it had breached its policy by refusing to defend. Applying Illinois law, the Seventh Circuit first held that the refusing carrier indeed had a duty to defend under its policy and breached that policy by denying defense coverage. The court then laid out the options an insurance company has when it asserts it has no duty to defend: (i) defend under a reservation of rights; (ii) seek a declaratory judgment that there is no coverage; or (iii) do nothing and refuse to defend. The court held that if the carrier selects the third option i.e., refuses to defend and does nothing, and the carrier is wrong and is found to have breached its policy, it will be estopped from later raising policy defenses to coverage. NAIC, and 15, citing State Farm Fire & Casualty Co. v. Martin, 710 N.E.2d 1228, 1231 (Ill. 1999). As explained by the court: Estoppel incentivizes action over inaction, which ultimately inures to the benefit of the insured. By defending under a reservation of rights or seeking a declaratory judgment, an insurance company can eliminate the risk of estoppel altogether. Id. Illinois is one of only a few states that recognize estoppel as an appropriate remedy to incentivize insurance companies not to refuse to defend and do nothing. See, e.g.,sauer v. Home Indemnity Co., 841 P.2d 176,182 (Alaska 1992); Black v. Goodwin, Loomis & Britton Inc., 681 A.2d 293, ; Swank Enterprises Inc. v. All Purpose Services Ltd., 154 P.2d 52, 57 (Mont. 2007); Pulte Home Corp., v.

4 American Southern Insurance Co., 647 S.E.2d 614, 617 (N.C. Ct. App. 2007); Southeast Wisconsin Proffessional Baseball Park District v. Mitsubishi Heavy Industries America Inc., 738 N.W.2d 87, 107 (Wis. Ct. App. 2007). Some states recognize estoppel as a remedy only where the carrier denies coverage based on its assertion that the policyholder failed to satisfy a policy condition. See Garcia v. Underwriters at Lloyd s London, 156 P.3d 712, 723 (N.M. 2008); but see Winters v. Transamerica Insurance Co., 194 F.3d 1321 (10th Cir. 1999) (unpublished) (estoppel applies to any denial, not just a denial based on violation of a policy condition) and Valley Improvement Association v. U.S. Fiduciary & Guaranty Corp., 129 F.3d 1108, (10th Cir. 1997) (same). The Illinois rule stated in NAIC should be adopted by all jurisdictions. The major argument against estoppel is that it purportedly could allow a policyholder to get coverage for a risk that is not covered by the policy and for which the policyholder may not have paid a premium. See, e.g, Miller v. Elite Insurance Co., 161 Cal. Rptr. 322, 330 (Cal. Ct. App. 1980). The fatal flaw in that logic is that it is entirely within the control of the insurance carrier to assert its denial of the duty to defend and to have it tested in court by seeking a declaratory judgment, or to provide the defense under a reservation of rights. If the insurance company decides not to do so, the policyholder should not be prejudiced and be denied coverage that very well may be within scope of the policy and for which it very well may have paid a premium. Given that the insurance company controls the action, the insurance company should bear the risk that its determination of no duty to defend is wrong. This is particularly so when also considering the breadth of the duty to defend s mere possibility of coverage standard and the prejudice to an insured that has been sued only to find that its liability carrier has pulled the rug out from underneath it. The duty to defend is litigation insurance that must be provided immediately in order not to prejudice the policyholder. The Seventh Circuit correctly found that estoppel to assert coverage defenses is the appropriate remedy when an insurance company has breached its duty to provide that coverage, forces the policyholder to go it alone" and does not take any of the previously steps to protect its interest while not prejudicing the policyholder s rights. All states should endorse the estoppel incentive as the most appropriate means of protecting policyholders from insurance company abuse of its duty to defend obligations. Babcock & Wilcox In Babcock & Wilcox, the Pennsylvania Supreme Court properly held that an insurance company defending a claim under a reservation of rights cannot assert violation of a policy consent to settle condition when an insured makes a reasonable, noncollusive settlement of a claim against it over the insurance company s objection. In so doing, the Supreme Court underscored that policyholders should be allowed to control settlements of claims against them when they face a risk of no coverage so long as the settlement is objectively fair and reasonable and even if the insurance company seeks to roll the dice and take the case to verdict. Babcock & Wilcox involved a class action including more than 500 plaintiffs asserting bodily injury and property damage as the result of emissions from nuclear facilities owned by the policyholders. The insurance company defended the claims under a reservation of rights and cited several defenses to liability coverage. Over the course of the two-decade-old litigation, the insurance company spent more than $40 million defending its policyholder. An initial jury trial involving eight test cases resulted in a plaintiff verdict totaling more than $36 million or approximately $4.5 million per plaintiff. A new trial was granted, however, after appeal of certain evidentiary issues. Ultimately, the policyholder settled the case for a total of $80 million, well below the policy limits of $320 million.

5 The insurer refused to consent to any settlement based upon its belief in the strength of the defendant s case. When the policyholder finalized the settlement, the carrier denied coverage and asserted a violation of the policy s condition requiring carrier consent to any settlement. The Pennsylvania court was called upon to decide whether (i) the consent to settle condition would not apply if the settlement was fair, reasonable and not collusive or (ii) the consent to settle condition would apply unless the insurance company refused to settle in bad faith. The Pennsylvania Supreme Court ruled that it would be unfair to require the policyholder to meet a bad faith standard in order to recover: [W]e adopt a variation of the Morris fair and reasonable standard limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and thus subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims. Like our sister states, we observe that a determination of whether the settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured s defense against the asserted claims and whether there is any evidence of fraud or collusion on the part of the insured. Babcock & Wilcox, at 29, citing United Services Automotive Association v. Morris, 741 P.2d 246 (Ariz. 1987). Babcock & Wilcox thereby correctly resolves insurance company attempts to abuse their defense under a reservation of rights position on the back end by prohibiting an insurer from absolving itself from coverage responsibility by refusing a reasonable settlement and forcing the insured to choose between a potentially devastating underlying verdict and a potential loss of coverage per the consent-to-settle condition. All jurisdictions should adopt the Babcock & Wilcox standard. Conclusion Nautilus, NAIC and Babcock & Wilcox serve as very apt responses to insurance company abuse of their duty to defend obligations. The analysis and holdings in these cases strike an appropriate balance between the coverage rights of the policyholder and the leverage insurance companies can impose on the assertion of those rights. By Erica J. Dominitz and Barry J. Fleishman, Kilpatrick & Townsend LLP Erica Dominitz and Barry Fleishman are partners in Kilpatrick & Townsend's Washington, D.C., office. The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. All Content , Portfolio Media, Inc.