Seventh Circuit Limits Application of Duty to Settle

Posted on November 10, 2008 by Mike Aylward

When is a policyholder not an insured?  That was the issue considered by the Seventh Circuit last week in Iowa Physicians’ Clinical Medical Foundation v. Physicians’ Ins. Co. of Wisconsin, No. 08-1297 (7th Cir. October 31, 2008), an Illinois case in which the court declared that an insurer’s obligation to act in good faith in responding to offers to settle within policy limits only extends to insured entities.

The Estate of Dennis Goetz sued Dr. Randall Mullen and Iowa Health Physicians (IHP) for failing to properly vaccinate Goetz against malaria before he took a trip to Africa and, upon his return, for failing to properly diagnose or treat the malarial condition that ultimately killed Goetz.  At the time, Goetz was insured under a medical malpractice policy issued by Physicians’ Insurance Company of Wisconsin with limits of $1 million.  The policy was issued in the name of Iowa Health Physicians, Mullen’s employer, which also paid the premiums on behalf of Dr. Mullen as part of a financial package to entice him into working at the clinic.  Although IHP was listed as the policyholder, the policy itself made clear that it was not an insured and, indeed, IHP declined to pay the additional premium that would have entitled it to coverage under its policy.  Rather, IHP was covered through a combination of self-insurance and a separate commercial insurance policy.

Prior to trial, the Goetz Estate twice offered to settle for $900,000.  Despite the opinions of several experts that Mullen had provided substandard care to Goetz and that his Estate had suffered a significant loss in earnings, PIC failed to respond to these offers.  After a defense expert admitted in his deposition testimony that Mullen’s treatment was inadequate, the plaintiffs withdrew their $900,000 offer and demanded $1.5 million instead.  PIC eventually countered at $200,000.  Ultimately, the case went to trial and resulted in a verdict of $3.5 million against Mullen and IHP.  In the ensuing coverage litigation, the District Cout held that Mullen could pursue a claim for damage to his reputation and for emotional distress even though IHP had paid the $2.5 million excess judgment over the $1 million PIC limit.  However, the District Court ruled that IHP had no cause of action since it was not an insured under the policy.

Under Illinois law, an insurer is deemed to have a good faith obligation to settle within limits and may be liable for the entire judgment against its insured if it fails to act in good faith in responding to offers to settle.  See, e.g. Haddick v. Valor Ins. Co., 763 N.E.2d 299 (Ill. 2001)   Given the facts in this case, the Seventh Circuit opined that Dr. Mullen himself probably had a strong argument against his insurer.  The issue before the court, however, was whether the district court had acted correctly in declaring that the same duty of good faith extended to PIC as the non-insured policyholder. 

IHP argued that it should be treated as a de facto insured given its contractual relationship as a policyholder and customer of the insurer.  The Seventh Circuit rejected this analysis, however, observing that what was important was not the mere existence of a contractual relationship but rather the substance of the insurance contract itself.  The court emphasized the fact that IHP had chosen not to purchase insurance coverage.  “The duty to settle is meant to protect the bargained-for insurance coverage, not extend it.  An insurer who acts in bad faith may end up paying above the contracted policy limits but only when doing so protects the insured’s legitimate expectation of coverage under the policy. . . .” 

The Seventh Circuit also emphasized the fact that the Illinois Supreme Court’s analysis of this issue in cases such as Haddick had analyzed the duty to settle as arising out of the insurer’s exclusive control over the duty to defend, including the right to settle.  In this case, the court pointed out that although PIC had exclusive control over Dr. Mullen’s defense, IHP had arranged its own defense.

Finally, IHP argued that it was unfair to saddle it with an uninsured liability given the fact that it was blameless and merely faced vicarious liability as the result of the misconduct of its agent Mullen.  The Seventh Circuit held that there was a distinction between blame and liability and that IHP’s remedy was not insurance coverage but rather a claim for contribution or indemnification against Mullen depending on what the terms of its employment contract with him permitted.

 
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Insurer's Dividend Decisions Protected By Business Judgment Rule

Posted on September 22, 2008 by Sara Thorpe

 

The California appellate court (Los Angeles County) held the trial court was correct in granting summary judgment in State Farm’s favor in a class action that sought to question decisions made as to the amount of dividends paid to policyholders. Hill v. State Farm Mut. Auto. Ins. Co. (2008) __ Cal.App.4th __ (08 C.D.O.S. 12449). The policyholders claimed State Farm breached a duty to pay billions of dollars as dividends, which created an excessive surplus.

This decision in the case comes after ten years of litigation. Initially the case was dismissed on demurrer, but the appellate court reversed that decision, ruling plaintiffs had plead enough to proceed with their lawsuit for breach of contract, breach of the covenant of good faith, and unfair business practices. Thereafter a nationwide class of 50 million present and former policyholders was certified. The court, after reversal by the appellate court, determined Illinois law applied since State Farm’s corporate business was handled in Illinois.

In 2005, State Farm filed a motion for summary judgment/adjudication. The trial court granted the motion on the basis that policyholders could not question the decisions of the board of directors of State Farm. California’s appellate court affirmed, ruling that while policyholders of this mutual insurance company do not have a right to a dividend, State Farm “was obligated to consider from time to time whether dividends should be declared.” (Emphasis by court.)  In its considerations, State Farm “was bound by a duty of care, requiring the Board to make decisions in a prudent manner.” The policyholders argued that State Farm failed to act prudently, failed to deliberate, and merely rubberstamped management’s decisions.

State Farm relied in part on the business judgment rule, which (under Illinois law) presumes that directors of a corporation make business decisions on “an informed basis, in good faith, and with the honest belief that the course taken was in the best interests of the corporation.” This is a rebuttable presumption. Exceptions to the rule exist where, in the process, there is evidence of fraud, oppression, dishonesty, total lack of merit, illegality, or failure of the board to become sufficiently informed to make an independent decision. The business judgment rule does not focus on the merits of the board’s decision.

The court found State Farm’s decisions were protected by the business judgment rule and no exception applied. The evidence presented showed the board was involved, considered various factors, and made its own decisions on whether dividends would be paid.

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Illinois Bars First Party Claim by Innocent Spouse

Posted on August 20, 2008 by Mike Aylward

The Appellate Court has rejected a wife’s contention that she was entitled to coverage for the loss of the family home despite her husband’s conviction for arson. In Aurelius v. State Farm Fire & Cas. Co., No. 2-07-0266 (Ill. App. August 5, 2008), the Second District affirmed a lower court’s declaration that the homeowner’s policy unambiguously barred coverage for first party losses resulting from intentional acts by “you or any person insured under this policy.”

Further, the court ruled that the spouse’s claim was barred by reason of her husband’s lies during an examination under oath given the concealment or fraud language in the policy which states that the policy was void “as to you and any other insured, if you or any other insured under this policy” intentionally conceals or misrepresents facts.

The court also declined to imply ambiguity based on a claimed conflict with language in the liability provisions of the policy which stated that coverage was only precluded for intentional acts of “the insured” and required that the interests of each insured be considered separately, holding that the liability provisions were irrelevant to the scope of coverage for first party losses.
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Illinois Insured Loses Evidence And Coverage Too

Posted on May 9, 2008 by Mike Aylward
Spoliation issues have been a perennial concern to insurers. Not only do they present problems in cases that insurers are defending, whether due to the fact that the insured itself has lot a key bit of the plaintiff’s evidence or such evidence has gone missing after being forwarded to the insurer or its consultants for examination, such claims have recently become the subject of direct claims for coverage by policyholders. The recent opinion of the Illinois Appellate Court in United Fire & Casualty Co. v. Keeley & Sons, Inc., No. 5-06-0307 (Ill. App. May 2, 2005) has clearly explained, however, why general liability insurers should not afford coverage for such claims.

The dispute in Keeley arose out of a construction defect accident involving three of Keeley’s employees who fell from an I-beam and were injured. In addition to the claims for personal injury that the plaintiffs brought against Keeley, they claimed that he had subsequently destroyed or disposed of the I-beam, thwarting their ability to investigate and confirm its allegedly defective nature. Keeley’s insurer (United) denied coverage and brought a declaratory judgment action.


Earlier this month, the Illinois Appellate Court affirmed the absence of coverage for the spoliation claims. Keeley had argued that as the claims against him were because of lost property, they should fall within the policy’s definition of “property damage.” The Appellate Court disagreed.

The Appellate Court conceded that a spoliation claim may be considered to constitute two different claims for damage to property. The first would involve the damage to and loss of use of the I-beam itself. In this case, however, the court observed that the I-beam was at all times within the care, custody and control of the insured and was therefore subject to Exclusion J(4) in the CGL policy.

Alternatively, the court recognized that the lost use of the I-beam had damaged the value of the plaintiff’s lawsuit against Keeley. The court observed, however, that characterizing the claim in this manner took it out of the insuring agreement of the policy itself since coverage only applies to injury to tangible property whereas damage to a cause of action is not damage to “tangible property.” Accordingly, the court affirmed the lower court’s declaration that Keeley’s claims were not covered by his CGL carrier.

This Illinois ruling is in general accord with such limited case law as exists on this issue. Several years ago, the Florida Supreme Court ruled in Humana Worker’s Compensation Services v. Home Emergency Services, 842 So.2d 778 (Fla. 2003) that spoliation claims did not give rise to coverage under an employer’s liability policy whose coverage was limited to “bodily injury by accident.” The court ruled that even though the spoliation claim would not have risen but for the fact that a bodily injury occurred giving rise to a lawsuit against the employer, the employer’s destruction of evidence did not itself result in bodily injury. Thus, the court ruled that, “The accident did not result in bodily injury but rather in the latter not being available as evidence in the bodily injury claim.”

Keeley is in accord with Fremont Cas. Ins. Co. v. Ace-Chicago Great Dane Corp., (Ill. App. 2000) in which the Appellate Court held that a CGL carrier had no obligation to defend a product manufacturer for having lost a ladder that injured the plaintiff. The First District of the Appellate Court ruled that, “The inability to prove the cause of action against a third party does not fall within the plain and ordinary meaning of the term ‘bodily injury.’”



 
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Illinois Supreme Court Limits Targeted Tenders To Excess

Posted on December 3, 2007 by Mike Aylward

The Illinois Supreme Court has ruled that targeted tenders do not trump the rule of horizontal exhaustion in construction defect cases.  As a result, additional named insureds must now  exhaust their own primary insurance before they can reach the excess layer of additional insured coverage. The court declared that “extending the targeted tender rule to require an excess insurer to pay before a primary policy would eviscerate the distinction between primary and excess insurance.” The court ruled, therefore, that despite Kajima’s targeted tender to St. Paul after the sub’s primary exhausted, Kajima was required to exhaust its own primary insurance before St. Paul paid.

In Kajima Construction Services, Inc. v. St. Paul Fire & Marine Ins. Co., No. 103588 (Ill. November 29, 2007), a general contractor and its own insurer (Tokio Marine) sued St. Paul to recover $1 million that Tokio had contributed to a $3 million personal injury settlement.  St. Paul, which had issued primary and umbrella coverage to a subcontractor that named Kajima as an additional insured, paid its $2 million primary limit but stated that its umbrella policy was excess of Kajima's own primary insurance and need therefore not contribute.

For the last several years, Illinois has followed the unique path of allowing insureds to designate the particular line of coverage under which they wish to be covered where multiple policies cover a construction claim.  In most such cases, therefore, a general contractor's first line of coverage is the CGL policy issued to a subcontractor on which it is listed as an additional insured.   The logical extension of this "targeted tender" theory would make the sub's umbrella policy the second line of defense.   However, that analysis conflicts with the principle of "horizontal exhaustion," wherein all available primary insurance must be exhausted before an umbrella pollicy must pay.  As a result, most courts have ruled that the general contractor's own CGL policy must pay after the sub's primary insurance.

In adopting the majority rule, the Illinois Supreme Court seems to have implicitly acknowledged some of the practical and doctrinal problems that result from a court making up a legal doctrine that is rooted more in a court's vision of public policy than the language of the policies themselves.
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