Insurer Orchestrated Settlements Purporting to Eliminate Coverage Are Suspect
Insurer Orchestrated Settlements Purporting to Eliminate Coverage Are Suspect
By David A. Gauntlett*
Introduction
In our previous blog,[1] we discussed how policyholders can potentially weaponize poorly drafted policies. This tactic of course relies upon an underlying complaint with sufficient fact allegations to trigger potential coverage, which occurs more often than insurers are prepared to admit. Complaints, however, can be amended. So what would happen if an insurer were to conspire with the plaintiff to remove all allegations triggering potential coverage, thereby leaving the policyholder stranded without a defense?
The Dangers of Negotiating with Insurers to Eliminate Coverage – Volm Bag
Although plaintiffs and insurers may, at times, share a common goal of eliminating the defendant’s coverage, care should be taken before entering into agreements with insurers that are designed to eliminate coverage while allowing the remainder of the suit to proceed against the defendant-insured. In Lockwood International, B.V. v. Volm Bag Co., Inc., 273 F.3d 741 (7th Cir. (Wis.) 2001), the insured, Volm Bag (“Volm”) was sued for breach of fiduciary duty, tortious interference with contract, unfair competition, and conspiracy. Included in the original complaint were express allegations that Volm had disparaged the plaintiff and its products and had spread “false rumors” about the plaintiff’s financial stability. Because these allegations fell within the policy offenses of “disparagement” and “misappropriation of advertising ideas or style of doing business,” Volm’s insurer agreed to defend.
Several years into the suit, Volm’s insurer filed a motion to intervene. In connection with this motion, Volm’s insurer negotiated a secret settlement agreement with the plaintiff. Pursuant to the terms of this agreement, the plaintiff received a 1.5 million dollar payment in return for filing an amended complaint which purported to eliminate all potentially covered claims. Remarkably, counsel for the insurer literally sat down with plaintiff’s counsel and did a line-by-line review of the amended complaint to ensure that it had been completely sanitized of any factual allegations which could potentially form the basis of a covered claim. The settlement agreement also included provisions that forbade the plaintiff from undertaking to prove specific facts at trial that could “resurrect” the insurer’s defense obligation.
At the trial court level, the insurer’s strategy was effective. The district court judge approved the settlement agreement and found that the insurer’s defense obligation was thereby eliminated. On appeal to the Seventh Circuit, Justice Posner had few kind words to say about this process:
In other words, the insurance company sat down with its insured’s adversary to contrive a complaint that would eliminate any remaining contractual obligation of the insurance company to defend the insured. (We limit our attention to defense costs, ignoring indemnity, in view of the fact that North River’s settlement agreement with Lockwood gave Volm more than the policy limit; thus only defense costs are at issue in this appeal.) It did this without consulting the insured or obtaining the latter’s agreement. We have difficulty imagining a more conspicuous betrayal of the insurer’s fiduciary duty to its insured than for its lawyers to plot with the insured’s adversary a repleading that will enable the adversary to maximize his recovery of uninsured damages from the insured while stripping the insured of its right to a defense by the insurance company.[2]
Such Agreements Are Nearly Impossible to Effectively Carry Out
Because the insurer’s defense obligation is based on facts and not legal theories, simply creating an amended complaint that eliminates specific causes of action will be ineffective to defeat coverage if the same factual allegations are retained.[3] The stratagem of reserving the right to amend the pleadings at trial pursuant to Fed. R. Civ. P. 11(b)(3) opens the specter of allowing all the fact allegations in that pared-down version of the complaint. Especially where the theories of the causes of action asserted require proof of fact elements that will trigger coverage, selective pleading of limited fact elements should not preclude a defense.[4] In theory, the agreement in Volm to not attempt proof of coverage-triggering facts would be effective to address this problem. However, procedurally there is no way to ensure adherence to such an agreement. As Justice Posner noted:
This effort to get around the principle that the insurer’s duties to the insured are determined not by legal theories but by facts portends unbearable awkwardness in the forthcoming trial. Suppose that in an effort to prove its remaining theories of liability, such as breach of fiduciary duty, which disparagement and other excluded charges would bolster . . ., Lockwood presents evidence in support of these charges at trial. Volm will be delighted, because the introduction of such evidence will trigger North River’s duty of indemnity and defense. North River will therefore have to have a lawyer in the courtroom to object whenever Lockwood crosses the line into forbidden territory. Either that (and what will the jury make of it?) or North River will sit out the trial but later sue Lockwood for breach of the settlement agreement if by crossing the line Lockwood resurrects Volm’s rights under North River’s policy. . . . No case that has been cited to us or that our own research has uncovered authorizes so convoluted a mode of proceeding.[5]
A “line by line” review of a proposed amended pleading may be more effective in eliminating the potential for coverage. Agreements that involve engaging in this process with the defendant’s insurer, however, may expose the plaintiff to interference with contract claims and, as evidenced by the Volm decision, are likely to be judicially invalidated. Thus, plaintiffs’ counsel should view efforts by insurers to negotiate coverage-eliminating settlements with a healthy dose of skepticism. Before any such negotiations are entered into, it is advisable to obtain the advice of competent coverage counsel.
What If Covered Claims Are Naturally Eliminated?
While Judge Posner was quick to call out the insurer’s egregious conduct in Volm, he also acknowledged that the outcome would be different had the same outcome evolved organically.[6] This principle is generally true in most jurisdictions.[7] For this reason, it is important to have coverage counsel work in conjunction with the attorneys defending the underlying action to avoid moving to dismiss claims that are critical to coverage.
Conclusion
Under no circumstances should an insurer collude with the underlying plaintiff as occurred in Volm, but the temptation to do so is obvious. The same principle supports policyholders’ right to independent counsel.[8] It is worth noting that even something as obviously underhanded as the events of Volm was not recognized as bad faith by the district court judge. Retaining expert coverage counsel is the most effective way to ensure you do not fall victim to similar tactics as the insurers’ bag of tricks is ever expanding.
*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.
[1] David A. Gauntlett, Turning Ambiguous Draftsmanship Against the Insurer, https://www.gauntlettlaw.com/news/turning-ambiguous-draftsmanship-against-the-insurer (Mar. 9, 2023).
[2] Id. at 744.
[3] Id. at 745.
[4] Dobrin v. Allstate Ins. Co., 897 F. Supp. 442, 444 (C.D. Cal. 1995) (“Raitt’s cross-complaint, however, states facts that would support an allegation of damage to Raitt’s business reputation or to his occupation. . . . Raitt ‘drafted the cross-complaint specifically so that there would be no coverage.’ . . . Allstate argues that it is permitted to rely on Raitt’s statement that he did not intend to amend his cross-complaint in determining that the possibility of coverage under the policy does not exist. As a matter of policy, however, the insurer cannot avoid coverage simply because the complainant seeks a tactical advantage in the lawsuit. The facts here clearly demonstrate that Raitt may have changed his mind and amended his cross-complaint at any time to allege such causes of action.”); Valley Bancorporation v. Auto Owners Ins. Co., 569 N.W.2d 345, 349 (Wis. App. 1997) (“The plaintiff, Agri-Supply, was unconcerned with issues involving the Bank’s insurance coverage for the liability claimed. Agri-Supply had a wholly solvent defendant from whom any judgment was collectible. Agri-Supply, therefore, proceeded to frame its claim in a fashion unrelated to the inquiry now before us. It is possible that acts of libel or slander could comprise either all or a portion of the conduct found to be bad faith or giving rise to punitive damages. . . . Where a claim consists of a variety of acts some of which are covered under the insurance policy and others that are not, it is well settled that resulting liability falls within the terms of the insurance policy unless the uncovered risk is the sole cause of damages.”).
[5] Volm Bag Co., 273 F.3d at 745–46.
[6] Volm Bag Co., 273 F.3d at 744 (“[I]f in the course of litigation the covered claims fall out of the case through settlement or otherwise, the insurer's duty to defend his insured ceases.”)
[7] See, e.g., Safeco Ins. Co. of Am. v. Dooms, No. 5:21-CV-05034, 2022 U.S. Dist. LEXIS 135537, *33 (W.D. Ark. July 29, 2022) (Arkansas law); Conway Chevrolet-Buick v. Travelers Indem. Co., 136 F.3d 210, 214 (1st Cir. 1998) (Massachusetts law); Meadowbrook, Inc. v. Tower Ins. Co., 559 N.W.2d 411, 417 (Minn. 1997) (Minnesota law); Commerce & Indus. Ins. Co. v. Bank of Haw., 73 Haw. 322, 329 (1992) (Hawaii law).
[8] See David A. Gauntlett, When Does Appointed Counsel Not Discharge an Insurer’s Duty to Defend?, https://www.gauntlettlaw.com/news/when-does-appointed-counsel-not-discharge-an-insurers-duty-to-defend (July 21, 2022).