We cannot all be masters, nor all masters Cannot be truly follow'd.
Othello, ACT I Scene 1.
It is long-established in Illinois that an insurer owes a duty of good faith and fair dealing to its policyholders. Insurers may also owe various duties to their shareholders, to other policyholders and to insurance regulators. A recent Illinois Appellate decision found that a second-tier excess insurer owed a duty to a third-tier insurer to act in good faith in the settlement of a claim, even where there was no question that the settlement would reach the third-tier insurer's policy. Central Illinois Public Service Co. v. Agricultural Ins. Co., no. 5-06-0181 slip op. (5th Dist. January 14, 2008).
The case involved an elevator accident at a Central Illinois Public Service Company ("CIPS") power plant in Newton, Illinois in which 23 boilermakers were injured. The claimant boilermakers sued CIPS and Dover Elevator Company (" Dover") for their injuries. CIPS had a $5 million primary insurance policy, a $10 million first-level excess policy, a $15 million second-level excess policy from Great American Assurance Company ("Great American") and a $25 million third-level insurance policy from American International Specialty Lines Insurance Company ("AISLIC"). CIPS and Dover settled the first 10 claims for approximately $20 million, with Dover's insurers paying $5 million and CIPS's primary and first-level excess insurers paying the remaining $15 million.
CIPS then asked Great American and AISLIC to consent to an additional $29 million settlement with the remaining 13 claimants. Those insurers agreed to fund the settlement, and all of the parties agreed that liability for the second settlement would be decided in an allocation trial between CIPS and Dover. A jury subsequently decided that CIPS was 95% responsible for the underlying damages, meaning CIPS was liable for $27.5 million of the second settlement.
CIPS had filed a declaratory judgment action, naming each of its insurers. AISLIC filed a counterclaim against Great American alleging that it was negligent and acted in bad faith by ignoring AISLIC's request that Great American negotiate settlement in good faith or tender its policy limits and turn the negotiations over to AISLIC. After various motions, in which AISLIC contended that Great American could have settled the allocation issue with Dover on a 50/50 basis, AISLIC amended its counterclaim to allege bad faith and negligence under direct duty and equitable subrogation theories, and the failure to settle the allocation issue on a 50/50 basis or that it could have been settled on a more favorable basis that the 95/5 split determined by the jury. Note that this still would have involved AISLIC's policy and thus, these contentions go beyond arguing that Great American could have settled within its policy limits. The trial court granted Great American's Motion to Strike or Dismiss the counterclaim, finding it failed to state a cause of action, and AISLIC appealed.
The Fifth District phrased the issues as follows:
The Court in CIPS noted that the only Illinois decision discussing the duties owed by an underlying excess insurer to a higher-level excess insurer was the federal decision of Liberty Mutual Ins. Co. v. American Home Assurance Co., 348 F. Supp. 2d 940 (N.D. Ill. 2004). The Fifth District Appellate Court used the federal court's analysis as a framework for its discussion in the case. The CIPS court noted that the federal court in the Liberty Mutual case looked at the status of the two insurers, meaning whether the first layer insurer over the self-insured retention was a primary insurer or an excess insurer, and found that the first layer insurer was an excess insurer because it had no duty to defend. CIPS, slip op. at pp. 5-6, citing Liberty Mutual, 348 F. Supp. 2d at 952-54. The CIPS court agreed with the conclusion of the federal court that the duties of primary carriers describe the responsibilities of excess insurers, slip op. at p. 6, which engendered a discussion of Schal Bovis, Inc. v. Casualty Ins. Co., 314 Ill. App. 3d 562, 732 N.E.2d 1082 (1st Dist. 1999).
In Schal Bovis, two primary insurers refused to pay their policy limits to settle a case and were sued by the insured and by an excess insurer when there was a verdict in excess of the primary limits in the underlying case. The court in Schal Bovis found that the primary insurer owed a direct duty to the excess insurer to settle within the primary limits, finding a "three-way relationship between the policyholder, the primary insurer and the excess insurer" which created reciprocal duty of care to act reasonably and in good faith toward one another. Schal Bovis, 314 Ill. App. 3d at 572. The Liberty Mutual court looked at Schal Bovis and at Illinois federal decisions regarding duties owed among insurers, and found that the Illinois Supreme Court would find no direct duty running from an underlying insurer to an excess insurer. CIPS, slip op, at pp. 8-9.
At that point, the CIPS court rejected the Liberty Mutual court's conclusion that whether the underlying carrier lacked control of the litigation should determine if the underlying insurer owed a duty to a higher-level insurer. CIPS, slip op. at p. 9. The CIPS court reasoned that this analysis failed to address the actualities of complex litigation, where the control an insurer has changes through the stages of the case. Id. at p. 10. The CIPS court rejected the control criterion for determining whether an insurer is primary or excess, astutely noting, "The categorization of an insurer as excess or primary is based on when coverage is triggered, which in turn affects the control of the litigation, and not vice versa." Id.
The CIPS court then discussed the parties' contentions about the progression of settlement in the underlying matter, including that AISLIC contended that Great American took control of the litigation and possessed the right to defend, and that AISLIC was powerless. Great American disputed these contentions, and the CIPS court found that the issue of control was a question of fact. The court therefore found that the trial court had improperly dismissed AISLIC's counterclaim.
The CIPS court then discussed the policy considerations underpinning the Schal Bovis decision, including the effect of encouraging fair settlements, and found that those considerations favored its own decision. CIPS, slip op. at p. 12. The CIPS court further found that the trial court had erred in finding that the underlying excess insurer only owed a duty to the higher-level insurer in cases involving settlement within the underlying insurer's policy limits. Id. The court found that the proper standard was whether the underlying excess insurer had failed to participate in settlement discussions in a meaningful way such that the higher-level insurer was exposed to greater damages. Id. at p. 14. The case was then remanded.
This decision may make sense when viewed in the context of large policyholders such as CIPS that have complex insurance programs, in that a sophisticated insurer is likely aware that a sophisticated insured may have higher-level insurance. Finding that the insurer owes a duty to a stranger to its insurance policy certainly wreaks havoc with the notion of privity of contract. It remains to be seen whether decisions such as this promote the laudable goal of encouraging fair settlements.
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Michele Oshman is a member of the firm's Appellate and Insurance Coverage practice groups. She concentrates her practice in the areas of insurance coverage and complex defense litigation. If you have questions regarding this article, please feel free to contact Michele via moshman@querrey.com, or via 312-540-7590.
