In the Absence of Coverage, a CGL Insurer May Avoid Payment of an Unauthorized Settlement, But it May Still Find Itself Liable for Bad Faith
The Indiana Court of Appeals recently held that a commercial general liability (“CGL”) insurer who has defended pursuant to a reservation of rights and has not breached the terms of the policy may invoke the policy’s “voluntary payment” and “legally obligated to pay” provisions to preclude coverage for a settlement which it did not authorized. Significantly, the Court also found that resolution of the contract dispute did not necessarily dispose of the tort-based bad faith claims and that entry of a final judgment on the bad faith claims would be premature. Klepper v. ACE American Insurance Company, 999 N.E.2d 86 (2013).
Klepper stems from the release of ethanol from a distillery owned and operated by Pernod Ricard USA, LLC d/b/a Seagram Lawrenceburg Distillery (“Pernod”). The ethanol caused mold to grown on nearby buildings. Plaintiff William Klepper, the owner of a neighboring property damaged by the emissions, brought suit against Pernod on behalf of a class of similarly situated property owners alleging nuisance, negligence, trespassing, and illegal dumping. During the relevant period, Pernod was insured by Ace American Insurance, Inc. (“ACE”) and XL Insurance America (“XL”) and Pernod tendered the claim to ACE and XL.
XL provided Pernod with a defense and ACE ultimately agreed to contribute to the defense, subject to a full reservation of it rights to dispute coverage. Summary judgment entered against Pernod on the illegal dumping claim and during settlement negotiations ACE was asked to contribute $1,000,000. ACE refused, offering to contribute only $250,000. Subsequently, the case was mediated. ACE attended the mediation but left early. After ACE’s departure, the class, CL and Pernod reached a settlement agreement, whereby judgment would enter against Pernod in the amount of $5,200,000. Of that amount, it was agreed that Pernod would contribute $1,200,000, XL would contribute $1,000,000 and the remaining $3,000,000 was to be collected from ACE to the extent the damages fell within the scope of the ACE CGL policy.
Thereafter, the complaint was amended to include a claim for declaratory judgment regarding coverage under the ACE policy. The class agreed to release Pernod and XL from any claims and to dismiss the claims against them with prejudice upon receipt of payment of the $2,200,000 from Pernod and XL, and that it would not execute any unsatisfied portion of the agreed judgment against Pernod and XL. Pernod subsequently assigned its claims to the class and the complaint was amended to include claims of bad faith and unfair claims handling against ACE.
The trial court adopted the report of a special master, and final judgment entered in ACE’s favor with respect to the claim for declaratory judgment. Specifically, the trial court adopted the special master’s conclusion that the “legally obligated to pay” and “voluntary payment” provisions in ACE’s CGL policy precluded coverage because Pernod breached its obligations under the policy by entering the agreed judgment without ACE’s consent, and that the class, as Pernod’s assignee, would have to live with the consequences of Pernod’s breach.
The Appellate Court affirmed after considering in detail Indiana law as set forth in Midwestern Indemnity Co. v. Laikin, 119 F. Supp.2d 831 (S.D. Ind. 2000), Cincinnati Insurance Company v. Young, 852 N.E.2d 8 (Ind. Ct. App. 2006), American Family Mutual Insurance Company v. CMA Mortgage Inc., 682 F. Supp.2d 879 (S.D. Ind. 2010), Morris v. Economy Fire & Casualty Co, 848 N.E.2d 663 (Ind. 2006), and State Farm Fire & Casualty Co. v. T.B., 762 N.E.2d 1127 (Ind. 2002). The Court explained:
[T]he resolution of the coverage question includes the consideration of ACE’s and Pernod’s rights, obligations, and breaches under the terms of the Policy. We believe that such an approach is in keeping with our supreme court’s decisions in T.B., which explains that an insurer can preserve its rights by defending the insured under a reservation of rights, and Morris, which concluded that the insureds breached their policy by refusing to comply with the policy conditions. This approach is also consistent with the longstanding principle that “[a] party first guilty of a material breach of contract may not maintain an action against the other party or seek to enforce the contract against the other party should that party subsequently breach the contract.”
999 N.E.2d at 96. The Court then went on to find that ACE did not breach its duty to
defend; it contributed to Pernod’s defense and took a reasonable settlement position. Accordingly, the Court held that ACE was entitled to rely on the policy’s “voluntary payment” and “legally obligated to pay” provisions, which precluded coverage under the Policy. It noted, that to hold otherwise, would effectively require the court to write those provisions out of the policy, which it cannot do.
Interestingly, the Court went on to find that its finding of no coverage does not necessarily dispose of all of class’ claims. Indeed, the Court found that the class’ bad faith claims might still be actionable even in the absence of coverage. The Court’s explanation of its holding was brief. It noted that a bad faith claim may be based on the insurer’s “manner of handling the claim” and that:
Given the two distinct theories upon which the Class seeks to recover and their separate elements and defenses, we cannot conclude at this stage of the proceedings that the resolution of the contract dispute necessarily disposes of the tort-based bad faith claim. Thus, the entry of final judgment on the Class’s bad faith claim would be premature. 999 N.E.2d at 98-99.
The Honorable Terry A. Crone dissented, in part, stating:
I respectfully disagree … with the majority’s determination that ACE may avoid the settlement agreement based on the Policy’s “voluntary payment” and “legally obligated to pay” provisions. An insurer who defends an insured under a reservation of rights should not be able to use those policy provisions as both a shield and a sword. Most relationships between insurers and insureds involve a substantial imbalance in sophistication, financial resources, and settlement leverage. Consequently, few insureds are in a position to effectuate a settlement without contribution from their insurer. When an insurer reserves its rights under a policy, it takes a position adversarial to its insured. Although the insurer may be funding the defense, the insured still faces the very real possibility of economic ruin. As such, the insured has every incentive to minimize its exposure, and unilaterally negotiating a settlement involving policy proceeds and a release and/or a covenant not to execute may be the least expensive and most expeditious means of doing so…. Courts should not reward insurers for putting their insureds in a perilous position, nor should they penalize insureds for trying to protect themselves. 999 N.E.2d at 99.
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