Reservations Over Reserving Your Rights

By Allison L. Krupp, Esq.*

On July 10, 2013, the Superior Court of Pennsylvania issued its opinion in The Babcock & Wilcox Co., et al. v. American Nuclear Insurers, et al., 2013 Pa. Super. LEXIS 1630 (Pa. Super. July 10, 2013). The underlying case involved insurance coverage disputes for two nuclear fuel processing facilities and had a lengthy and complicated procedural and factual history. The defendant American Nuclear Insurers (ANI) provided insurance coverage for nuclear hazards at the two facilities owned and operated by the plaintiffs, The Babcock & Wilcox Co. and B & W Nuclear Environmental Services, Inc. (collectively, B & W), and which were previously owned and operated by Atlantic Richfield Company (ARCO). A class action lawsuit was filed against B & W in federal court for bodily injury and property damage allegedly sustained from radioactive emissions produced by the two facilities. A coverage dispute later arose regarding the limits of coverage available to indemnify the plaintiffs in the underlying tort action and whether the plaintiffs were entitled to counsel.

While the tort action was pending, ANI filed a declaratory judgment action in the Court of Common Pleas of Allegheny County against the plaintiffs, seeking a declaration as to whether it had a duty to provide separate counsel to ARCO in the tort action. ANI also alleged bad faith and breach of contract by B & W, which filed its own action seeking declarations regarding the coverage issues and alleging bad faith against ANI. These actions were later consolidated.

On April 5, 2001, the trial court ordered that ANI had a duty to pay for independent defense counsel to represent and defend the separate interests of B & W and ARCO in the tort action. The Superior Court subsequently affirmed the trial court’s order.

The underlying tort action was later settled for less than the policy limits through the negotiations of counsel retained by B & W. Settlement funds were provided by B & W, which then sought to recover from ANI, along with counsel fees. ANI disagreed with the decision to settle and refused to reimburse B & W. ANI argued that it had no obligation to make any payments because B & W had violated the consent to settlement clause in the policy.

The trial court analogized the instant case to Alfiero v. Berks Mut. Leasing Co., 500 A.2d 169 (Pa. Super. 1985) and ruled that B & W was entitled to reimbursement if the settlement was fair, reasonable and non-collusive. Underlying the court’s holding in Alfiero had been its finding that the insurer’s denial of coverage had constituted a repudiation of its insurance contract with the owner, leaving the insured free to negotiate a settlement, so long as it was fair and reasonable. The jury in the instant action had determined that the underlying settlement was fair, reasonable and non-collusive. Therefore, the trial court Judge R. Stanton Wettick ordered that ANI was obligated to provide insurance coverage to the plaintiffs in the amount of $80 million, plus prejudgment interest. ANI appealed.

Although the issue of an insured’s obligation to honor a consent to settle clause with an insurer who tenders a defense, subject to a reservation of rights, was one of first impression, the Superior Court noted that it had been addressed by numerous state and federal courts. It considered that an insurer’s defense of the insured does not waive the insurer’s claims that a policy exclusion applies and that an insurer has the right to control the defense and select defense counsel, even when tendered subject to a reservation of rights. Moreover, it stated that to defend subject to a reservation of rights does not, without more, constitute a breach of contract.

The court then discussed the potential conflicts of interest that are implicated when an insurer provides a defense, subject to a reservation of rights. For example, the court reasoned that an insurer could be just as interested in developing facts that would result in non-coverage as it would be in establishing facts showing that the insured is not liable. Regardless, some courts have held that these concerns may be ameliorated by the prospect of a post-verdict claim for insurer bad faith.

After examining the various approaches to resolving the dilemma, the Superior Court ultimately agreed with the Florida Court of Appeals’ decision in Taylor v. Safeco Ins. Co., 361 So.2d 743 (Fla. Ct. App. 1978). Based thereon, the Superior Court held that when an insurer tenders a defense subject to a reservation of rights, the insured may choose one of two options.

First, it may accept the defense, in which case it remains unqualifiedly bound to the terms of the consent to settle provision of the policy. The insurer retains full control over the litigation, and the insured is protected against injuries stemming from the insurer’s conduct in the defense through a potential bad faith suit.

Under the second option, the insured may decline the insurer’s tender of a qualified defense and furnish its own defense, either pro se or through independent counsel retained at the insured’s expense. The insured retains full control over the defense, including the option of settling the claim pursuant to its own terms. If the insured chooses this option, and coverage is found, the insured may recover the defense costs and costs of settlement from the insurer, to the extent the costs are deemed fair, reasonable and non-collusive. The significance of the second option is that the insured is not bound by the consent to settle provision of the policy. So long as the settlement is fair, reasonable and non-collusive, the insurer will be obligated to reimburse its insured.

Thus, the Superior Court decreed that the trial court should have determined whether B & W had rejected ANI’s defense and, if so, whether ANI had acted in bad faith in declining to settle or participate in settlement negotiations in the underlying tort action. The case was remanded for a new trial. A petition for allowance of appeal was filed with the Supreme Court of Pennsylvania by ARCO and B & W on August 9, 2013. Whether the Supreme Court will grant the petition and review the Superior Court’s opinion is currently uncertain.

Does the Babcock Decision Bring Pennsylvania Closer to Becoming a Cumis Counsel State?

Since the issuance of Babcock, questions have arisen as to whether this case may bring Pennsylvania one step closer to becoming a cumis counsel state. The United States Court of Appeals for the Ninth Circuit recently explained the use and purpose of cumis counsel:

Under California law, when an insurer agrees to defend its insured under a reservation of rights, a conflict exists between the insurer and insured. In those instances, the insured has a right to retain independent counsel to be paid for by the insurer, commonly referred to as “cumis counsel.”

Continental Cas. Co. v. Enodis Corp., 417 Fed. Appx. 668, 671 (9^th Cir. 2011) (citations omitted). The obligation to provide cumis counsel is triggered when the insurer issues a reservation of rights on a coverage issue and the outcome of the coverage issue can be controlled by counsel retained by the insurer for the defense of the underlying claim against the insured. Sovereign Gen. Ins. Servs. Inc. v. Nat’l Cas. Co., 359 Fed. Appx. 705, 707 (9^th Cir. 2009).

Pursuant to the Superior Court’s opinion in Babcock, in Pennsylvania, the insured has one of two options—either accept the defense provided by the insurer and allow the insurer to retain control over the litigation, or furnish its own defense at the insured’s expense. Under the second option, the insured is only reimbursed its defense costs if it is entitled to coverage and the settlement is deemed fair, reasonable and non-collusive. In a cumis counsel state, such as California, the insured may demand that the insurance company pay the fees up front for independent counsel. This is a significant point of distinction. As a result, I do not believe that Babcock moves Pennsylvania closer to becoming a cumis counsel state.

Other Potential Issues

Another potential issue that may arise is whether the insurer is obligated to specifically advise the insured of its right to furnish its own defense at the time the insurer issues the reservation of rights. While this issue is not specifically discussed in the Superior Court’s opinion, it is something that could become an issue in the future.

What constitutes a fair, reasonable and non-collusive settlement may also require further scrutiny and clarity by Pennsylvania trial and appellate courts. Calculating a potential verdict, particularly in a class action suit like in Babcock, could be a very challenging, subjective task.

Whether the insurer has the right to require certain minimum qualifications of the independent counsel could also become an issue in the future. While the Superior Court does not address this particular issue, its holding that the insured may choose independent counsel on its own suggests that the insurer has no control over the qualifications or experience of the chosen attorney.

It will take time to resolve the questions raised by Babcock and delineate the scope of the opinion. In the near term, the immediate question to be determined is whether the Babcock decision will be reviewed and upheld by the Supreme Court.

*Allison is an associate in our Harrisburg, Pennsylvania, office who can be reached at 717.651.3510 or alkrupp@mdwcg.com.

Defense Digest, Vol. 19, No. 4, December 2013

Defense Digest is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. Copyright © 2013 Marshall Dennehey Warner Coleman & Goggin, all rights reserved. This article may not be reprinted without the express written permission of our firm.