An insurer offers its insured a defense under a reservation of rights and files a complaint seeking a declaratory judgment determining coverage. This is not an uncommon sequence of events, either in Illinois or anywhere else. But does the insured then have the right to settle the case on its own, without the insurer’s consent?
Until recently, the answer under Illinois law has been clear: No. But in a decision published in the last days of January, the Appellate Court for the Fourth District cast doubt on that conclusion.
Standard Mutual Insurance Company v. Lay was one of the Illinois Supreme Court’s major decisions of last year. Our coverage of the decision is here. Our report on the oral argument before the Supreme Court is here.
The defendant was a small real estate agency in Girard, Illinois. The defendant hired a fax broadcaster to send a “blast fax” advertising a particular listing to thousands of fax machines. The broadcaster claimed that each potential recipient had consented to receiving the faxes, and the defendant trusted the broadcaster’s word. The problem was apparently it wasn’t true.
Enter the Telephone Consumer Protection Act of 1991, 47 U.S.C. § 227. The statute imposes a penalty of $500 for each unsolicited fax sent, which is trebled for willful violations. So the defendant was hit with a putative class action complaint, alleging willful violations of the TCPA, conversion and violations of the Illinois Consumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/2.
The defendant tendered to its insurer, which accepted under a reservation of rights. The insurer offered the defendant a defense (while noting its potential coverage defenses and the arguable conflict of interest). The defendant signed the waiver of the conflict proferred by the insurer and accepted the attorney.
In mid-July 2009, the putative class action was removed to Federal court. Not long after, the owner of the defendant real estate agency died, and his widow received letters of office. In late October, at the widow’s behest, a new lawyer wrote to the lawyer hired by the insurer, explaining in great detail the conflict between the insurer and the insured (which the insured had waived) and asking the lawyer to withdraw. The lawyer hired by the insurer never withdrew, but a few weeks later, the new attorney and the insured signed a settlement agreement.
In 2010, the settlement agreement was filed and ultimately approved. It provided for a payment of $1,739,000: $500 per fax for each and every one of alleged 3,478 recipients. Given that a finding of willful conduct – the necessary prerequisite to trebling – would have vitiated insurance coverage, this “settlement” amounted to the insured voluntarily paying 100 cents on the dollar on the case. In return, the class representative agreed not to execute on any of the defendant’s assets, and seek to recover solely from the insurer (the covenant not to execute remained valid whether or not the insurer’s policy was adjudicated to cover the policy).
In mid-2011, the trial court granted the insurer summary judgment in the declaratory judgment action, finding that TCPA damages were in the nature of punitive damages and thus uninsurable. The Supreme Court allowed a petition for leave to appeal and reversed on that point. The Court remanded back to the Fourth District for consideration of the remaining issues – including whether the insured had breached the policy by settling without the insurer’s consent.
The Fourth District originally issued its opinion reversing the Circuit Court in late November 2013, but later granted a motion for publication. The published opinion appeared January 25, 2013.
The court found that all three policies at issue covered the defendant’s “settlement.” One expressly related to the real estate business. The two remaining policies related to rental premises or vacant lots owned by the insured, but neither included “designated premises” limitations.
The insurer argued that the settlement was excluded from coverage by the professional services exclusion, but the Appellate Court disagreed. The real estate agency was not a professional advertiser, the court pointed out. The court specifically held that the TCPA damages were covered by both the property damage coverage and the advertising injury coverage.
But the most important part of the ruling came in two paragraphs on the final page of the opinion. The court noted that where an insurer had provided an attorney pursuant to a reservation of rights, noting the potential conflict of interest, “the insured is entitled to assume control of the defense.” At that point, the court held, the insurer lost the right to prevent the insured from unilaterally settling: “When an insurer surrenders control of the defense, it also surrenders its right to control the settlement of the action and to rely on a policy provision requiring consent to settle.” The court cited Myoda Computer Center v. American Family Mutual Insurance Co. in support of its holding. The insured’s liability was “clear,” the court commented, the settlement amount “was supported by simple math,” and “[a]bsent the settlement, the result would have been the same.” Therefore, the court held, the insurer was liable for the full amount.
The insurer has petitioned the Supreme Court for leave to appeal the case once again. A copy of the insurer’s petition is here. There, the insurer pointed out the grave implications of the Appellate Court’s holding approving of the insured’s behavior: “The Appellate Court’s decision sanctions an insured rolling over on its insurer anytime a defending insurer reserves its rights and files a declaratory judgment action.” The Appellate Court had simply gotten the law wrong, the insurer argues. Myoda involved an entirely different situation, where the insurer had allowed the insured to choose its own counsel from the outset, merely reimbursing costs. The insurer had been told of a prospective settlement and flatly refused to participate – something which never happened in Standard Mutual. The insurer argued that pursuant to long-settled Illinois law, absent a breach of the duty to defend, an insurer has every right to insist on the right to approve of and participate in settlement.
The insurer offers this powerful argument for the potential for abuse of TCPA litigation inherent in the Fourth District’s decision:
[T]arget a defendant, ensure that it carries insurance coverage, offer the defendant a deal where it can walk away unscathed and in the process obviate the need for any proof that offending faxes were ever received, and cash in on the defendant’s insurance policies. This game of ‘gotcha’ prejudices insurers which seek to honor their obligations while at the same time exercising their right to walk into court and seek a judicial declaration of their coverage.
The Fourth District’s holding on remand in Standard Mutual is a significant potential threat to insurers operating in Illinois. The insurer in Standard Mutual appears to have done everything right pursuant to a policy which expressly barred settlement without its consent: it provided (and paid for) counsel, carefully noted and reserved its coverage defenses and explained the potential conflict of interest, and offered the insured the opportunity to waive the conflict – which it did. The insurer then exercised its clear right to seek a judicial determination of coverage. As a result, the insurer was held liable for a 100-cents-on-the-dollar “settlement” entered into unilaterally by the insured.
The Supreme Court should allow this new petition for leave to appeal in Standard Mutual Insurance Co. v. Lay and hold that insurers do not authorize collusive settlements by their insured simply by virtue of proceeding pursuant to their rights under the policy.