August 29, 2013
My last post examined the theoretical and practical obstacles to wrestling control of settlement decisions from insurance companies. This post discusses the recent contribution of the Pennsylvania Superior Court in Babcock & Wilcox Company v. American Nuclear Insurers, __ A.3d __, 2013 WL 3456969 (Pa.Super. July 10, 2013), to the analysis of the theoretical basis for freeing insureds to settle over their insurers’ objections.
The insured’s willingness in Babcock & Wilcox to accept liability for the full amount of settlement meant that the insured had an incentive to keep the settlement amount as low as possible, obviating the need for the court to discuss the practical problems associated with no-personal-liability settlements. However, the Pennsylvania appellate court’s analysis of the theoretical issues gives rise to a host of new practical problems. This post will focus on the new choice the court’s decision affords policyholders. My next post will focus on the practical implications of that choice.
The issue before the court was whether American Nuclear Insurers (ANI), was obligated to indemnify its insured, Babcock & Wilcox (B&W), for $80 million that B&W paid to settle hundreds of bodily injury and property damage claims allegedly arising from exposure to radiation at two nuclear fuel processing facilities owed and operated by B&W. B&W entered into the settlement over ANI’s objections while ANI was fulfilling its duty to defend subject to a reservation of rights to contest coverage. The amount of the settlement was well within the $320 million combined limits of the two ANR policies covering the B&W’s facilities, and ANI apparently did not contend that the underlying claims fell outside its policies coverage provision or within an exclusion. Instead, ANI contested coverage on the ground that the settlement violated the policies’ consent-to-settlement clauses, which prohibit the insured from settling claims, agreeing to any judgment, or otherwise interfering with ANI’s prerogatives in defending and determining whether to settle lawsuits against the insured.
The Parties’ Arguments
B&W maintained that ANI’s reservation of rights to contest coverage was tantamount to a denial of coverage which freed it of its obligations under the consent-to-settle provision to obtain ANI’s approval before entering into a fair and reasonable settlement. ANI argued that a defense under a reservation of rights is a complete defense that cannot reasonably be construed as a repudiation of the contract, particularly here where ANI had spent more than $40 million defending the underlying action. The insurer contended that the Pennsylvania Supreme Court’s 1957 decision in Cowden v. Aetna Casualty and Surety Co., 389 Pa. 459, 134 A.2d 223 (Pa.1957), provided B&W with sufficient protection against the possibility of a judgment in excess of policy limits. Under Cowden, an insurer must accept a settlement offer within the limits of the policy issued to the defendant “when there is little possibility of a verdict or settlement within the limits of the policy” unless the insurer has a “bona fide belief” that it can obtain a defense verdict. Cowden requires “that the chance of a finding of non[-]liability be real and substantial and that the decision to litigate be made honestly.”
Appellate Court’s Decision
In a split, 2-1, decision, the Superior Court of Pennsylvania, found problems with both B&W’s and ANI’s proposed standards for determining which party controls settlement. The court instead adopted a third approach, distilled from decisions from other jurisdictions, that gives B&W the option to settle without ANI’s permission only if it rejects a defense subject to a reservation of rights and takes control of its own at its own expense. Under the court’s approach, a policyholder may recover its defense costs and the costs of settlement after rejecting a qualified defense, if such costs are found to be fair, reasonable, and non-collusive, if it later prevails in its coverage dispute with the insurer. However, if the policyholder accepts the defense, the insurer retains control of the defense and is liable only if it is found to have declined to settle in bad faith under the Cowden standard. Although acknowledging that “it appeared undisputed” that B&W had accepted ANI’s defense, the court refused to draw that inference based on the record before it. Moreover, even if B&W accepted ANI’s qualified defense, the court allowed for the possibility of ANI’s liability under Cowden despite the absence of “an excess verdict that lies at the heart of most bad faith law.” 2013 Wl 345669, *18. Accordingly, the court vacated the trial court’s order and remanded the case back to the trial court.
Appellate Court’s Reasoning
Central to the court’s analysis was the question of how best to protect an insured’s policy rights when the insurer reserves the right to contest coverage while controlling the defense and settlement of claims against the insured. The court analyzed the theoretical underpinnings of both the trial court’s approach and the approach proposed by ANI, and concluded that each “tilt[s] the playing field too much in favor of, respectively, the insured or the insurer.” The problem with B&W’s—and the trial court’s—approach was the willingness of the court to deem the consent-to-settlement clause unenforceable without finding a breach or repudiation of the insurance contract by the insurer. In addition, the court pointed out that allowing insureds to settle without the insurer’s consent whenever the insurer reserves its rights to contest coverage reduces the insurer’s incentive to undertake the defense at all, especially if it believes its coverage defenses will prevail.
On the other hand, the court characterized as “cavalier” the assumption that the prospect of a post-verdict or post-settlement claim for bad faith failure to settle provides sufficient protection for the insured. For example, the court pointed out that “should the insurer successfully challenge coverage and the verdict exceed the rejected settlement offer, the insured will be liable to a greater extent than it would have been under the settlement” that the insurer rejected. Moreover, “delay in resolving litigation, by itself, may inflict harm upon the insured arising from uncertainty as to the fact, extent, and timing of liability, exacerbated by questions regarding coverage.”
In the end, the court concluded that the insured should not be forced to put itself at risk as the price for preserving its contractual right to indemnification against liability for covered claims. The court determined that the better approach is to give the insured the option to reject the insurer’s defense when the insurer reserves the right to contest coverage for any resulting judgment, while protecting the insurer’s right to control the defense when the defense is accepted by the insured. The court determined that “[t]his approach also honors the essence of a consent to settlement clause: When an insured avails itself of the insurer’s obligation to defend, the insured remains bound to the corollary requirement that the insurer have sole authority to control the defense.”