Insurers’ Duty to Settle in the Context of a Continuous Trigger Case

What is the scope of the insurers’ duty to settle in a case involving a continuous trigger of coverage? Is it pro rata, as the carriers would argue, or is it joint and several, which the insureds would assert? Further, what is the impact of the insurer having a fairly debatable defense to coverage based upon an honest belief that its coverage has not been triggered? These are the questions that will be discussed in this article.

I. The Duty To Settle Arises Out of the Duty to Defend, and Specifically out of the Power Afforded to the Insurance Company Under the Insurance Policy to Control the Settlement Decision.

The duty to settle arises out of the grant of coverage set forth in the primary commercial or comprehensive liability policy (“primary policy”) as follows:

• The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of
  A. bodily injury or
  B. property damage
  to which this insurance applies, caused by an occurrence, and the company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient…

Thus, the primary policy dictates that the insurer “may make such investigation and settlement of any claim or suit as it deems expedient.”

Language granting the insurer the right, either on its own or together with the insured, to settle the claim “as it deems expedient” seems to grant the insurer broad discretion in this area. In fact, the duty is mandatory, as set forth in Brockstein v. Nationwide Mutual Ins. Co., as follows:

• While this broad statement appears to give the insurer unlimited settlement discretion, such is not the case — and for good reason. The policy confers upon the insurer the exclusive right to decide whether to settle or defend, but that decision may affect not only its own interest but also that of the insured. Since the insurer has that exclusive right, it must take responsibility for its exercise. While the insurer has an interest in paying out as little as possible on claims covered by its policies, the insured has an interest in not being exposed to a judgment beyond the policy limit. When these two interests conflict, the company has the unenviable duty of dealing fairly with them both

In other words, while language granting an insurer authority to settle the claim “as it deems expedient” seems to grant the insurer broad discretion in this area, it does not, and the duty must be exercised fairly.

The duty to settle arises out of the duty to defend, and specifically out of the power afforded to the insurance company under the insurance policy to control the settlement decision. As the Court stated in Cramer v. Insurance Exchange Agency:

• The “duty to settle” arises because the policyholder has relinquished defense of the suit to the insurer. The policyholder depends upon the insurer to conduct the defense properly. In these cases, the policyholder has no contractual remedy because the policy does not specifically define the liability insurer’s duty when responding to settlement offers. The duty was imposed to deal with the specific problem of claim settlement abuses by liability insurers where the policyholder has no contractual remedy. (Citations omitted.)

Therefore, the duty to settle is derivative of the duty to defend. Further, the exercise of the duty to settle relies upon a duty of good faith that is implied in the insurance contract, is set forth in Iowa Physicians’ Clinic Medical Foundation v. Physicians Insurance Company of Wisconsin, as follows:

• An insurer’s duty to settle in good faith on behalf of its insured, which is well-settled in Illinois***arises from the covenant of good faith and fair dealing implied in an insurance contract. This duty is a narrow exception to the Illinois courts’ otherwise steadfast refusal to recognize an independent tort arising from the breach of this contractual covenant. *** The paradigmatic duty-to-settle case involves three parties: the injured third party; the insured, who is being sued; and the insurer, who controls the insured’s defense. If the third party sues the insured for an amount above the policy limit and seeks a settlement at the upper limit of the policy, a conflict of interests arises. In this situation, the insurer may be tempted to decline the settlement offer, no matter how good the deal is for the insured, and go to trial. It makes no difference to the insurer’s bottom line whether the case is settled or the jury awards astronomical damages; in either event it will pay out only the maximum on the policy. And if the case goes to trial, at least there’s a shot that they will win and pay nothing. The insured, on the other hand, calculates the risks of trial differently because he will be stuck paying anything above the policy limit. ***. To combat the temptation to ignore an insured’s interest and to make sure that the intent behind the insurance contract is upheld, Illinois courts have recognized that an insurer has a “duty to act in good faith in responding to settlement offers,” and if that duty is breached the insurer is on the hook for the entire judgment, regardless of the policy limit. ***

Thus, the exercise of the duty to settle relies upon from a duty of good faith implied in the insurance contract. It requires an insurance company to “act in good faith in responding to settlement offers” such that it may be required to accept a settlement demand of payment of policy limits to protect its insured against the risk of an even higher judgment which may be later imposed at trial. Should the insurer ignore this duty, “the insurer is on the hook for the entire judgment, regardless of the policy limit.”

In Illinois, the cases are legion requiring that the insurer employ good faith in exercising the duty to settle. In construing a policy of liability insurance reserving to the insurance company the right to “make such investigation, negotiation and settlement of any claim or suit as it deems expedient,” the court in the seminal case of Cernocky v. Indemnity Insurance Company of North America, held:

• We hold it to be the law of Illinois that in investigating, defending, considering questions of settlement, and on the question of appeal, the insurance company must give the interests of the insured equal consideration with its own interests and it must in all respects deal fairly with the insured.

Thus, the duty to settle arises in the context of the duty to defend to which is applied a duty to “deal fairly with the insured.”

One well-known treatise has parsed the origin of the duty to settle between the duty to defend and the duty to indemnify, stating:

• Negotiating to reach a settlement can be seen as part of the duty of defense. But paying (or agreeing to pay) the claimant an amount agreed to in settlement of the asserted claims is a clear aspect of the duty to indemnify, rather than, as sometimes suggested, of the duty to defend.

Unfortunately, the authority for this conclusion is not stated and appears to be absent. The splitting of the duty to settle between a duty to pay, as opposed the duty to negotiate, a settlement appears to be one which potentially gives insurers, who would undoubtedly rather negotiate than pay, justification for not paying, and thus for not honoring the duty to defend. Moreover, such an approach would be particularly confusing in determining the duties of insurers on a claim where there is a continuous trigger of coverage.

II. The Duty to Settle Amongst Multiple Primary Insurers on a Continuous Trigger Claim is Joint and Several.

What happens, for example, where a complaint pending in state court in Illinois alleging continuous occupational exposure to a harmful chemical such as benzene, resulting in leukemia and death, is being actively defended by the insured’s primary carriers, and the plaintiff, the decedent’s surviving spouse, presents a settlement demand within the policy limits? Suppose further that the primary carriers’ chosen panel counsel advises that if the demand is not accepted, there is a substantial likelihood of a judgment at trial in excess of the limits of the various primary policies on the risk. Suppose further that, while the complaint does not allege specific dates of exposure, one co-worker’s deposition testimony pinpoints exposure during periods when the insured had policies with large self-insured retentions; these policies would be the sole policies triggered under a pro-rata approach to allocation of liability for the proposed settlement, leaving the other primary carriers off the hook. Accordingly, the other primary carriers are unwilling to grant panel counsel settlement authority. Finally, suppose that other deposition testimony is inconclusive regarding the dates of decedent’s exposure.

• A. The Joint and Several Nature of the Duty to Settle Derives from the Joint and Several Nature of the Duty to Defend.

As stated above, the case authority indicates that the duty to settle is a derivative of the duty to defend. Insurers recognize that the scope of the duty to defend is defined solely by reference to the allegations in the complaint. As the Illinois Supreme Court held in United States Fidelity & Guaranty Company v. Wilkin Insulation Company:

• To determine an insurer’s duty to defend its insured, the court must look to the allegations in the underlying complaints. If the underlying complaints allege facts within or potentially within policy coverage, the insurer is obliged to defend its insured even if the allegations are groundless, false, or fraudulent. *** An insurer may not justifiably refuse to defend an action against its insured unless it is clear from the face of the underlying complaints that the allegations fail to state facts which bring the case within, or potentially within, the policy’s coverage. ***

Because in the example the allegations in the complaint fail to specify dates of exposure, the primary carriers whose policies are even potentially triggered must defend. In that respect, the example is similar to Illinois Tool Works Inc. v. The Home Indemnity Company, where the court stated:

• Although the complaints do not specify the dates during which the contamination took place, it is not far-fetched to imagine that the contamination occurred during the American policy period – from 4/15/88 to 4/15/89. Illinois courts have adopted a “commonsense interpretation” when evaluating the pleadings to avoid leaving the insured “at the mercy of its adversary’s pleading skills.” *** Under a commonsense interpretation, this occurrence was “potentially” within the policy period when American was asked to defend these actions.

Similarly, here, primary carriers’ obligation to defend is based upon the complaint in the underlying suit, even though it does not specify dates of exposure.

The present example is not unlike that of Consolidated Rail Corporation v. Liberty Mutual Insurance Company, where the insurer sought to evade its duty to defend based upon its own independent investigation of the facts. In holding that the insurer had thereby breached its duty to defend, the court stated:

• The law is well settled in Illinois that an insurer is obligated to defend in those actions where the complaint alleges facts potentially within the coverage of the policy. *** In determining whether there is potential coverage, only the allegations of the complaint may be consulted. *** Independent investigations revealing facts which conflict with those alleged in the complaint do not relieve the insurer of his duty to defend.

Similarly, in Chandler v. Doherty, where the insurer possessed strong evidence that the putative insured’s car was not covered by the insurance policy, the court found that the insurer unjustifiably refused to defend. The court further found that:

• Under Illinois law, a liability insurer’s duty to defend arises when the insured tenders defense of a suit against him that alleges facts which, when taken as true, raise the potential for coverage occurring during the effective policy period. *** It is the law of this state that in determining whether it has a duty to defend a suit, an insurer is limited to comparing the bare allegations of the complaint with the face of the policy of insurance***.
• The threshold a complaint must meet to present a claim for potential coverage, and thereby raise a duty to defend, is minimal. ***. Any doubts about potential coverage and the duty to defend are to be resolved in favor of the insured. *** The duty to defend is not annulled by the knowledge on the part of the insurer the allegations are untrue or incorrect or the true facts will ultimately exclude coverage. 292 Ill. App. 3d at 801-802.

Thus, Illinois law is very clear that “[t]he duty to defend is not annulled by the knowledge on the part of the insurer the allegations are untrue or incorrect or the true facts will ultimately exclude coverage.”

In the stated example, a co-worker’s deposition testimony pinpointed dates of exposure to benzene to a specific time period. At first blush, this testimony may seem to justify a refusal to accept plaintiff’s settlement demand. However, as set forth in Consolidated Rail Corporation v. Liberty Mutual Insurance Company and Chandler v. Doherty, nothing in Illinois law would allow deposition testimony to supersede the import of the allegations of the complaint when determining the scope of the duty to defend or the duty to settle arising therefrom. The closest the Illinois courts have come to allowing pretrial evidence to play any role in a coverage determination was in allowing a federal pretrial order to be considered in defining the scope of the duty to indemnify, not the duty to defend. In McDonald’s Corporation v. American Motorists Insurance Company, the court noted that:

• This case involves whether the insurers had a duty to indemnify McDonald’s in the settlement of the Thermodyne litigation. The duty to indemnify is much narrower than the duty to defend. Unlike the duty to defend, the duty to indemnify cannot be determined simply on the basis of whether the factual allegations of the underlying complaint potentially state a claim against the insurer…

• In federal litigation, the final pretrial order supersedes the complaint. See e.g., Ash v. Wallenmeyer, 879 F.2d 272, 274 (7th Cir. 1989) (noting the effect of the pretrial order is to supersede the pleadings); Ghandi v. Police Department, 823 F.2d 959, 962 (6th Cir. 1987) (same); Hoagburg v. Harrah’s Marina Hotel Casino, 585 F.Supp. 1167, 1175 (D. N.J. 1984) (same). Therefore, in addition to examining the allegations of the underlying complaint, we will consider also the allegations as set forth in the final pretrial order.

Thus, in federal litigation only, Illinois courts recognize that the final pretrial order supersedes the complaint. Yet, here, the underlying suit is in state court. Moreover, the specific period of exposure is not in a pretrial order, but in deposition testimony.

That the insurer may not base a determination regarding the duty to defend, and, hence, the duty to settle, upon matters outside the complaint makes perfect sense in the context of the underlying complaint. Yet, insurers, and particularly the primary carriers under this example, would assert that the basis for any settlement is the duty to indemnify, not the duty to defend. The benefit to the insurers in asserting that the duty to settle arises out of the duty to indemnify, rather than out of the duty to defend, is that insurers believe they may then allocate the cost of their duty to settle on a pro rata, rather than on a joint and several basis. This method of allocation effectively limits their exposure in the cost of paying claims to only a piece of the pie, rather than the whole thing. This method of allocation also potentially allocates to the insured a portion of the indemnity costs for any gaps in coverage due to carrier insolvencies, coverage buy-backs, self-insured retentions or lack of insurance. Yet, this method of allocating payment under a duty to settle ignores the numerous judicial decisions, such as Cramer and Cernocky and Haddick v.

Valor Insurance, which link the duty to settle to the duty to defend, in that the duty to settle is created by the “conception of the insurance contract *** because the policyholder relinquishes his right to negotiate settlement on his own behalf when he enters into the contract. …” Thus, primary carriers have an already existing duty to settle created since they entered into their respective insuring agreements with the insured. It is that duty that governs their responsibility relative to settlement, not the duty to indemnify.

Moreover, the duty to indemnify is actually inapplicable because, for any settlement that has occurred prior to the entry of judgment, the duty to indemnify will not yet have even arisen. As set forth in Outboard Marine Corporation v. Liberty Mutual Insurance Co.:

• An insurer’s duty to indemnify is narrower than its duty to defend its insured. *** The duty to indemnify “will not be defined until the adjudication of the very action which [the insurer] should have defended.” *** In other words, the question of whether the insurer has a duty to indemnify the insured for a particular liability is only ripe for consideration if the insured has already incurred liability in the underlying claim against it. *** If so, the duty to indemnify arises if the insured’s activity and the resulting loss or damage actually fall within the CGL policy’s coverage. ***

Thus, in the settlement situation posed in the example, the duty to indemnify would not be ripe because there has been no adjudication.

• B. The Joint and Several Nature of the Duty to Settle is Also Derived from the “All Sums” Approach to Indemnification Amongst Continuously Triggered Primary Carriers.

Even assuming arguendo that the duty to settle arises out of the duty to indemnify rather than the duty to defend, the primary carriers must still exercise their duty to settle in the example, because the duty to indemnify is also joint and several. That is so, because the duty to indemnify arises out of the “all sums” portion of the grant of coverage, which states:

• The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies caused by an occurrence…

This “all sums” approach to indemnification amongst continuously triggered primary carriers was first adopted by the Illinois Supreme Court in Zurich Insurance Company v. Raymark Industries, Inc. In Zurich, the Court addressed the trigger of insurance coverage in cases involving bodily harm from asbestos exposure. The Court adopted the position advocated by the insured, that “each carrier whose policy is triggered is jointly and severally liable for the total indemnity and defense costs of a claim without proration,” holding as follows:

• The appellate court relied on the language of the policies. Zurich undertook to “pay on behalf of [Raymark] all sums which [Raymark] shall become legally obligated to pay as damages because of * * * bodily injury * * * caused by an occurrence.” Zurich further agreed “to defend any suit against [Raymark] seeking damages on account of such bodily injury.” The court found nothing in the policy language that permits proration. Zurich urges this court to adopt the pro rata approach set forth in Insurance Co. of North America v. Forty-Eight Insulations, Inc. (6th Cir. 1980), 633 F.2d 122, aff’d on rehearing (1981), 657 F.2d 814, cert. denied (1981), 454 U.S. 1109, 70 L. Ed. 2d 650, 102 S. Ct. 686.

• …Having rejected the premise underlying the pro rata approach adopted in Forty-Eight Insulations, we conclude that the appellate court did not err insofar as it declined to order the pro rata allocation of defense and indemnity obligations among the triggered policies. (Emphasis in original).

Thus Zurich holds that indemnity obligations should be allocated on a joint and several basis.

Even so, insurers assert, and particularly would assert under this example, that their obligation to settle must be allocated on a pro rata basis. Insurers justify this position on the following cases: United States Gypsum Co. v. Admiral Insurance Co. Outboard Marine Corporation v. Liberty Mutual Insurance Co. and AAA Disposal Systems, Inc. v. Aetna Casualty and Surety Co. Yet, these cases do not even address the issue of allocation at the primary coverage level. Instead, these cases merely deal with the issue of horizontal exhaustion as it relates to excess and umbrella coverage, and must be accordingly discounted.

The only instance where the viability of a pro rata approach to settlement has thus far arisen before the Illinois Supreme Court was in its decision in Employers Insurance of Wausau v. Ehlco Liquidating Trust (“Ehlco”), where it was rejected. In Ehlco, an insurer with an identifiable pro rata share of liability in a continuous trigger case was found liable for the entire amount of the settlement. While not explicitly discussing the duty to settle, the Court found that an insurer who had only offered to pay a 9% pro rata share of the settlement amount was liable for the entire settlement amount. The Court stated:

• [I]n June of 1992, Ehlco informed Wausau of a $1.3 million settlement offer by Union Pacific. Wausau did not object to the reasonableness of this settlement offer. Rather, Wausau merely offered to pay 9% of the settlement and 9% of the defense costs incurred. Ehlco then settled the suit and, as a result, the district court dismissed the suit with prejudice on November 5, 1992. Wausau did not file its complaint seeking declaratory judgment of noncoverage with regard to the Wyoming suit until February 26, 1993. This was almost four months after the underlying suit was concluded. Thus, Wausau’s declaratory judgment action was untimely as a matter of law.

Based upon an application the estoppel rule for the insurer’s failure to defend and the tardiness of the insurer’s declaratory judgment action, the Court affirmed the ruling of the trial court finding Wausau liable, inter alia, for the entire amount of the settlement. While the decision was not based upon the duty to settle, it is nevertheless instructive regarding the Court’s approach to these issues.

III. Notwithstanding a “Fairly Debatable” Defense to Coverage, the Primary Carrier Must in Good Faith Consider Offers for Settlement Within the Limits of the Insurance Policy.

Supposing the primary carriers in the example simply refuse to settle the underlying case on the basis of a “fairly debatable” coverage defense, i.e., that their primary policies have not been triggered, regardless of the scope of the duty to settle. The majority rule in this area is that reasonable beliefs about coverage do not excuse a failure to settle if settlement was otherwise the appropriate course of action. A leading case representative of that rule is Western Casualty & Surety Company v. Herman, which held that “‘notwithstanding an honest belief by the insurer that the policy is not in effect, the company must in good faith consider offers for settlement within the limits of the insurance policy.’” (Citations omitted.)

In Illinois, the majority rule was followed in Transport Insurance Company, Inc. v. Post Express Company, Inc. There, the insurer based its failure to take advantage of an opportunity to settle before trial upon a late notice defense to coverage. The district court agreed. The Court of Appeals reversed, finding that the insurer had waived the late notice defense. The court further held that a “fairly debatable” defense to coverage does not authorize the insurer “to throw its client’s interests to the winds” and fail to exercise its “fiduciary duty” to settle on favorable terms below the policy limits.

In so holding, the Transport Insurance Company court distinguished an Illinois state court decision, Stevenson v. State Farm Fire & Casualty Company, and a decision of the Wisconsin Supreme Court, Mowry v. Badger State Mutual Casualty Insurance Company, both of which represent the minority view on this subject. The Stevenson court, in expressing that view noted that an insurance carrier must give its insured’s interest consideration equal to its own in negotiating settlements on behalf of its insured. However, the court found that where a carrier can reasonably examine a set of facts and determine that the incident or occurrence which is the substance of the underlying controversy is not one contemplated by the policy, then it does not owe the same kind of duty as that otherwise required.

Similarly, in Mowry the court found that bad faith in deciding to litigate rather than settle a claim involves more that a mere finding of negligence on the part of the insurer. The court further opined that where there is no bad faith an insured may not surcharge an overage against his insurance company merely because of any possible negligence on the insurer’s part in deciding to litigate rather than to settle. An insurer will have committed the tort of bad faith, the court found, only when it has denied a claim without a reasonable basis for doing so, that is when the claim is not fairly debatable.

In analyzing both Stevenson and Mowry, the Transport Insurance Company court found that:

• Stevenson and Mowry have a vital fact in common: in each case the insurer, after contesting coverage, arranged for the insured to be represented by independent counsel. When this happens, there is little need to protect the insured from the carrier, and a potential need to protect the carrier from the insured. Stevenson remarked that “a carrier is required to provide independent counsel for its insured” in these situations. In Mowry Justice Steinmetz observed: “the duty to settle is not a contractual duty . . .Rather it is a fiduciary duty which only arises when the insurer assumes the exclusive management and control of the insured’s defense.” ***

The Transport Insurance Company court concluded that, unlike in Stevenson and Mowry, because Transport Insurance had failed to authorize the insured to hire independent counsel, it was required to “give the insured’s exposure equal weight with its own.”

In thereby distinguishing Stevenson and Mowry, the court exposed the fallacy behind the minority views represented by those decisions. Neither Stevenson nor Mowry were true “duty to settle” cases. Given that in each the insured was represented by independent counsel, the necessary predicate to the exercise of such a duty, i.e., that the insurer have exclusive management and control of the insured’s defense, did not exist. Accordingly, no duty was owed to the insured, regardless of the existence of a “fairly debatable defense.” Thus, in the present example, where the insured is being represented by panel counsel, the majority rule must apply that “‘notwithstanding an honest belief by the insurer that the policy is not in effect, the company must in good faith consider offers for settlement within the limits of the insurance policy.’”

In conclusion, the primary carriers’ duty to settle in a case involving a continuous trigger of coverage is joint and several. Further, even if the primary carriers have a fairly debatable defense to coverage based upon an honest belief that their coverage has not been triggered, the primary carriers must in good faith consider offers for settlement within the limits of the primary policies.