Attorneys
Insurance Law Update: Do Insurers Lose Right to Control Amount of Settlement Under Voluntary Payments Provision When Issuing a Reservation of Rights?
Insurers in the Illinois First Appellate District may think twice about reserving rights under certain coverage defenses that require the insurer to pay for independent counsel for an insured. A recent ruling by the Illinois First District Appellate Court found that, by giving up control of the insured’s defense, the insurer also relinquished the right to control settlement of the claim under the voluntary payments provision in that policy. The insurer in Myoda Computer Center, Inc. v. American Family Mutual Ins. Co., appeal No. 1-07-1915, 2009 Ill. App. LEXIS 180 (1st Dist. March 31, 2009), was still permitted, however, to dispute its obligation to indemnify the insured for the settlement amount.
American Family had issued an insurance policy which covered, inter alia, “advertising injury” in Section II and included “infringement of copyright, title, or slogan” as one of the covered offenses. The policy also contained the following voluntary payments provision:
If there is an occurrence or offense that may be covered under Section II which may lead to a claim or suit being made against you […]:
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h. Do not make any payment or accept any financial obligations without our authorization. If you do, we may not reimburse you, even if the cost is otherwise covered by this policy.
2009 Ill. App. LEXIS 180 at **2-3.
Policyholder Myoda Computer Center, Inc. was sued by Microsoft Corporation for copyright and trademark infringement for allegedly selling counterfeit Microsoft software. American Family agreed to pay for independent counsel for Myoda and reserved its right to later deny coverage. Several months later, Myoda informed American Family that it was negotiating a settlement with Microsoft and asked for the insurer’s position on contributing to any settlement. American Family responded that it was not in a position to authorize Myoda to settle the claim and asked for information enabling it to value the case and determine Myoda’s potential liability.
A week later, Myoda sent American Family a letter stating that it had potentially settled with Microsoft for $50,000. The letter included copies of underlying pleadings, underlying discovery responses and a copy of the U.S. Code concerning the amount of damages available in a breach of copyright case. American Family responded that the settlement was in breach of the insurance policy and that it would not reimburse Myoda for any settlement. Two weeks later, Myoda executed the settlement agreement with Microsoft. Id. at *4.
Coverage litigation ensued, and both sides filed motions for summary judgment under stipulated facts. The trial court granted American Family’s motion and denied Myoda’s motion, and an appeal followed.
Myoda’s argument on appeal was that American Family was not entitled to summary judgment solely because Myoda settled the underlying claim without first obtaining the insurer’s consent. Myoda equated the settlement with its defense and argued that American Family had given up control of the settlement by reserving rights and agreeing to pay for independent counsel. American Family countered that under Illinois law, unless an insurer was in breach of its obligations, an insured must obtain the insurer’s consent before settlement of a claim. 2009 Ill. App. LEXIS 180 at **4-5.
After discussing the standards for summary judgment and construction of insurance policies, the appellate court turned to Illinois case law regarding settlement of claims. The court noted that while the general rule is that an insured must obtain the insurer’s consent to settle a claim if the insurer is not in breach of its duty to defend, the insurer does not have unfettered discretion to withhold that consent. The court also noted that the fact that a settlement is within policy limits does not make it per se reasonable.
The court then stated that under a voluntary payments provision such as the one in American Family’s policy, an insurer will not be responsible for the insured’s voluntary payments incurred before tender of a lawsuit. This is to prevent collusion between the insured and the claimant, but the insurer must show prejudice to avoid paying under the voluntary payments provision. Id. at **7-8. The court’s analysis regarding whether American Family was properly granted summary judgment due to Myoda’s failure to obtain its consent before settling consisted essentially of discussing two cases, one relied on by Myoda and the other by American Family.
American Family relied on Alliance Syndicate, Inc. v. Parsec, 318 Ill.App.3d 590 (1st Dist. 2000), where the insured paid a $2,500,000 settlement against itself and CSX Corporation, a third party whom the insured had agreed to indemnify. The insurer there also argued that it was not responsible for paying the settlement because the insured had settled without first obtaining the insurer’s consent. The First District Appellate Court found that the insurer was relieved of coverage obligations due to a breach of the voluntary payments provision in the policy there. The same court in the Myoda case, however, distinguished that holding on the facts, because the insured there had violated the provision by accepting the tender of the third party and settling the case. 2009 Ill. App. LEXIS 180 at **9-11.
Myoda relied on Commonwealth Edison Co. v. National Union Fire Ins. Co., 323 Ill.App.3d 970 (1st Dist. 2001). In that case, the claimant was the estate of a woman killed by a downed power line. The estate sued insured Commonwealth Edison and Asplundh Tree Expert Company, the company that trimmed the trees around the power lines. National Union agreed to provide a defense for ComEd under a reservation of rights and relinquished control of that defense due to a potential conflict of interest. The case settled, with ComEd paying $15,000,000 and National Union paying another $15,000,000 on behalf of Asplundh.
National Union subsequently refused to indemnify ComEd because it failed to obtain the insurer’s consent prior to the settlement. On appeal, the appellate court rejected the insurer’s argument and found that “a reasonable settlement effectuated by the insured does not bar an action for indemnification against the insurer.” Myoda, 2009 Ill. App. LEXIS 180 at **11-12, quoting Commonwealth Edison, 323 Ill. App. 3d at 984-85. (Additional citation omitted.)
On this, the court in Myoda found that American Family was not entitled to summary judgment because reasonable minds may have differing inferences on the undisputed facts and reversed the case and remanded it for further proceedings. 2009 Ill.App. LEXIS 180 at **14-15. Based on the court’s ruling, American Family would still be entitled to litigate any coverage defenses it had other than the breach of the voluntary payments provision.
In the Myoda case, the court limited the scope of the voluntary payments provision so that it applied only before the insured gave notice and tendered the claim to American Family. The court does not discuss the reasoning behind that holding. The provision was located in the same section as the notice provision, but the court did not rely on that factor.
The case cited for limiting the effect of the voluntary payments provision to pre-tender costs, Westchester Fire Ins. Co. v. G. Heileman Brewing Co., 321 Ill.App.3d 622, 637 (1st Dist. 2001), involved an insured that had defended itself for almost two and a half years before giving notice, so its application to the Myoda settlement is unclear. However, by limiting the application of the voluntary payments provision to pre-tender costs, the court in Myoda in essence merged the right to settle claims into the right to control the defense, and found that by giving up the right to control the defense, the insurer also forfeited the right to any input in the settlement process.
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Michele Oshman is a member of the firm’s Appellate and Insurance Coverage practice groups and concentrates her practice in the areas of insurance coverage and complex defense litigation. Michele has represented the interests of insurance companies in state and federal courts throughout the country. Michele has also defended manufacturers in product liability cases, including nationwide class action matters.
