Insurer’s Obligation to Pay Reasonable Settlement When It Refuses to Defend
/Insurer’s Obligation to Pay Reasonable Settlement When It Refuses to Defend
By David A. Gauntlett*
Introduction
Despite their legal obligations to defend any claims with even a potential for coverage under a policy,[1] insurers often fail to abide by that standard, looking for any excuse to deny a defense. Litigating to obtain policy benefits can take years in some cases,[2] so the underlying action is often resolved before the battle for coverage comes to a close. When that underlying action is resolved via settlement, the denying insurer is obligated to reimburse the policyholder, even if the claim would not have met the standard for indemnity coverage. A number of cases in jurisdictions across the country have addressed this issue and reached the same conclusion.
Catlin Specialty Ins. Co. v. J.J. White, Inc.
This law is well summarized in a recent decision applying New York law case, Catlin Specialty Ins. Co. v. J.J. White, Inc.[3] The insurer denied the policyholder a defense in the underlying wrongful death suit based on the policy’s “Retroactive Date Provision.”[4] The man who died worked in a factory exposed to toxic chemicals both before and after the Retroactive Date, and the court determined coverage would exist if his death was caused by exposure occurring before the Retroactive Date. Because the underlying case settled, this timing issue was never resolved at trial, but the relevant legal standard is only potential coverage. The court clarified that proof of actual liability of the claimant is not required to establish an insurers duty to reimburse a policyholder for the monies it paid in settlement to resolve an underlying action:
[T]here is persuasive precedent suggesting that . . . [The New York Court of Appeals] would conclude that an insured that enters into a reasonable settlement with a claimant for a covered claim is entitled to indemnity from the insurer even if it cannot prove actual liability to the claimant . . . . The New York case most often cited for this proposition is Luria Brothers & Company v. Alliance Assurance Company, 780 F.2d 1082 (2d Cir. 1986) . . . [which held that] the insured “need not establish actual liability to the party with whom it has settled ‘so long as a potential liability on the facts known to the insured is shown to exist, culminating in a settlement in an amount reasonable in view of the size of possible recovery and degree of probability of claimant's success against the insured.’”[5]
City of New York v. Zurich-American Ins. Group
In City of New York v. Zurich-American Ins. Group,[6] the underlying action sought recovery of damages for sexual assault. The City of New York brought the coverage action seeking defense and indemnification as an additional insured. Zurich provided counsel for the primary insured, but ignored the City's repeated requests for counsel. The City undertook its own defense and eventually settled for just over $1 million.[7] The court determined that Zurich was obligated to fully reimburse the City.[8]
Pekin Ins. Co. v. XData Solutions, Inc.
On similar facts, Pekin Ins. Co. v. XData Solutions, Inc.[9] concluded that Pekin’s reimbursement of a settlement paid by its insured, XData, was not barred by the policy’s “voluntary payment” provision because “[t]he purpose of the ‘voluntary payment’ provision is to prevent collusion between the insured and the injured party.”[10] XData quickly tendered defense of the underlying action to Pekin, but Pekin denied any potential coverage after a month of consideration and subsequently initiated the declaratory relief coverage action against Pekin, seeking a judgment affirming that it had no duty to defend the underlying case. Shortly after the filing of the coverage action, XData settled the underlying action. The court determined that the “voluntary payment” provision was no obstacle to reimbursement since XData had been abandoned by its insurer.[11]
Patrons Oxford Ins. Co. v. Harris
In Patrons Oxford Ins. Co. v. Harris,[12] the insurer was similarly obligated to reimburse a settlement despite agreeing to provide a defense. The policy covered a truck, which the insured and his son used to flee a hostile crowd. In doing so, they ran into a man, pinning him against another vehicle and injuring his legs. The injured man filed suit against the son, who was driving at the time of the accident. Patrons agreed to provide representation under the policy, but did so subject to a reservation of rights.[13]
Subsequently, Patrons filed a Motion to Intervene in the suit against the son. Patrons, with its Motion to Intervene pending, also filed a declaratory judgment complaint in the Superior Court, requesting that the court declare that the son was not covered by the policy. More than a month after Patrons filed its Motion to Intervene, the underlying parties filed a stipulation for entry of judgment. In exchange, the underlying plaintiff agreed not to collect a judgment from the son personally. He would instead attempt to collect such a judgment only from Patrons through Maine's reach and apply statute if coverage was later found.[14]
Before damages could be determined, the court denied Patrons's Motion to Intervene. Meanwhile, in the coverage action, the court determined the son did qualify as an insured under the policy. Patrons argued it should not be obligated to cover the damages since it was unable to intervene and control negotiation of the settlement. The court held that of the statutory defenses available to Patrons, fraud was inapplicable because Patrons was informed of the agreement at all times, and Harris's mere failure to cooperate with Patrons was not dispositive on the issue of collusion. The court therefore found that the underlying plaintiff could satisfy the damages judgment with money from the Ferguson policy.[15]
Conclusion
Cases exploring the breadth of coverage available to “additional insureds” may secure reimbursement for sums payable in connection with the settlement of the underlying action based on the logic of the referenced case authority.[16] The cases demonstrate a rule consistently applied in jurisdictions across the country: Insurers deny a defense at their own risk. Policyholders must be given every benefit of any doubt when assessing whether there is potential coverage entitling them to a defense. Should an insurer fail to participate in settlement negotiations and eventually be determined to have wrongfully denied potential coverage, it will be required to fully reimburse any reasonable settlement payment made to resolve an underlying action.
*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.
[1] Atlantic Mut. Ins. Co. v. J. Lamb, Inc., 100 Cal. App. 4th 1017, 1040 (2002) (“Even though it may ultimately be determined that Atlantic Mutual has a viable defense to coverage by virtue of the application of the ‘first publication’ exclusion, this can only affect its liability for indemnification. Its duty to defend depended on the existence of only a potential for coverage.”)
[2] See, e.g., W. Am. Ins. Co. v. Yorkville Nat'l Bank, 238 Ill. 2d 177, 190 (2010) (requiring six years and a decision from the Illinois Supreme Court to correct an insurer’s wrongful denial).
[3] Catlin Specialty Ins. Co. v. J.J. White, Inc., 387 F. Supp. 3d 583 (E.D. Pa. 2019) (applying New York law).
[4] The provision required that “the Pollution Conditions first occurred on or after the Retroactive Date,” which pre-dated the relevant death by several years. Id. at 586.
[5] Id. at 588–89.
[6] City of N.Y. v. Zurich-American Ins. Grp., 811 N.Y.S.2d 773 (App. Div. 2006).
[7] Id. at 610.
[8] Id. at 611 (“Where an insurer is involved in the underlying proceeding yet fails to challenge the reasonableness of the settlement there, it may not do so in a separate declaratory judgment . . . . There is no question that Zurich was obligated to defend and indemnify the City in the underlying action, and that it failed to do so. Therefore, the City was entitled to enter into a reasonable settlement of that case. . . . Not only did Zurich fail to challenge the reasonableness of the settlement in that case, but it participated in, and agreed to, the settlement.”)
[9] Pekin Ins. Co. v. XData Solutions, Inc., 958 N.E.2d 397 (Ill. App. 2011).
[10] Id. at 404.
[11] Id. at 405 (“Since the settlement agreement was entered into subsequent to tendering defense of the action to Pekin, XData did not breach the ‘voluntary payment’ provision. Second, because we have determined that Pekin breached its duty to defend XData by denying coverage, XData did not need Pekin's consent before entering into the settlement agreement.”)
[12] Patrons Oxford Ins. Co. v. Harris, 905 A.2d 819 (Me. 2006)
[13] Id. at 823.
[14] Id.
[15] Id. at 828 (“[A]n insured being defended under a reservation of rights is entitled to enter into a reasonable, noncollusive, nonfraudulent settlement with a claimant, after notice to, but without the consent of, the insurer. . . . If the insurer does not prevail as to coverage, it may be bound by the settlement, provided the settlement, including the amount of damages, is shown to be fair and reasonable, and free from fraud and collusion.”)
[16] City of N.Y. v. Harleysville Ins. Co., No. 22-CV-3306 (RA), 2023 U.S. Dist. LEXIS 121357 (S.D.N.Y. July 14, 2023) (“However, ‘additional insured coverage is not contingent upon a liability finding,’ . . . and it is also ‘of no moment that . . . the named insured on the [insurance] policy was not named in the [underlying] complaint.’ . . . The City is thus entitled to a defense in the Calderon Action as an additional insured under the Policy, at least until the incident ‘is later proven to be outside the policy's coverage,’ if so.”)