Insured’s Settlement Without Consent Bars Coverage Under An OCIP

In its recent decision in Perini/Tompkins Joint Venture v. Ace Am. Ins. Co., 2013 U.S. App. LEXIS 24865 (4th Cir. Dec. 16, 2013), the United States Court of Appeals for the Fourth Circuit, considering both Maryland and Tennessee law, had occasion to consider whether an insured’s settlement of an underlying construction defect claim, without its insurer’s consent, precluded its right to indemnification.

Perini/Tompkins Joint Venture (“PTJV”) qualified as a named insured under a primary and excess layer owner controlled insurance program (“OCIP”) issued by ACE American Insurance Company with respect to the construction of a $900 million hotel and convention center in Oxon Hill, Maryland.  A collapse of the hotel’s atrium during the construction process resulted in significant property delays.  Following completion of the project, PTJV sued the owner on various theories for approximately $80 million in unpaid work, and the owner brought a separate suit against PTJV based on various theories of negligence in connection with its construction management activities.  The owner’s sought damages in the amount of $65 million.  PTJV did not notify ACE of the countersuit, but later settled the litigation.  Pursuant to the settlement, the owner paid PTJV approximately $42 million and PTJV credited $26 million back to the owner.
Some six months after the settlement, PTJV demanded that ACE pay the $26 million shortfall.  ACE issued a reservation of rights on several grounds, including breach of the policies’ prohibition on settlements without ACE’s consent.  Specifically, the policies contained clauses stating that “No insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.”  In the ensuing coverage litigation, the United States District Court for the District of Maryland granted summary judgment in ACE’s favor on the issue of voluntary payment. 
On appeal, PTJV noted that under Maryland law (which it argued governed the policies), Section 19-110 of the Maryland Code states that an insurer’s disclaimer of coverage based on an insured’s breach of a cooperation clause or notice clause will not be permitted unless the insured can demonstrate actual prejudice.  PTJV argued that ACE’s disclaimer of coverage based on a voluntary payment was tantamount to a disclaimer based on late notice, and that as such, ACE was required to demonstrate actual prejudice.  ACE, on the other hand, argued that its disclaimer of coverage was not based on untimely notice, but instead based on breach of the policies’ voluntary payment clause.  ACE argued that it would be unfair to require it to demonstrate prejudice, since having been shut out of the settlement negotiations, it would be “placed in the impossible situation of having to prove a negative.”
The Fourth Circuit agreed that "[t]he central issue in this appeal is whether the insured . . . can unilaterally settle a construction defect case . . . , present the settlement to its liability insurer as a fait accompli, and obtain indemnification despite its blatant breach of clear and unambiguous policy provisions.”  Looking to a Maryland state appellate court decision on the issue in Phillips Way, Inc. v. American Equity Insurance Co., 795 A.2d 216 (Md. Ct. Spec. App. 2002), the court concluded that Section 19-110 of the Maryland Code did not control the issue, and that ACE was not statutorily required to demonstrate prejudice in order to succeed on its motion for summary judgment.
The court also entertained PTJV’s alternative argument that prejudice must be demonstrated as a matter of common law.  In analyzing the question, the court looked to Maryland law, which is where the underlying events took place, and to Tennessee law, which is where the project owner resided and where the policies were issued.   The court found no precedent under Maryland law for the proposition that an insurer is required to demonstrate prejudice when an insured breaches a voluntary payment clause.  The court nevertheless observed that even if prejudice was a consideration, ACE was necessarily prejudiced by not having been afforded an opportunity to participate in the settlement discussions and by having been deprived of its opportunity to investigate, defend, control or settle the underlying suit.  Looking to Tennessee law, the court found no controlling authority from Tennessee’s Supreme Court on the issue, but nevertheless predicted based on lower court decisions that prejudice would not be a consideration, at least for settlements entered into prior to first notice to the insurer.