On July 10, 2013, a majority of a three-judge panel of the Superior Court of Pennsylvania cut a new path for insureds and insurers with respect to defense under reservations of rights. See The Babcock & Wilcox Company, et al. v. American Nuclear Insurers, et al., 2013 PA Super. 174, 2013 PA Super. LEXIS 1630. According to the majority, when an insurer tenders a defense subject to a reservation, an insured may reject the insurer’s defense and bind the insurer to a settlement that the insurer did not consent, so long as the settlement is fair and reasonable. The decision is inconsistent with Supreme Court of Pennsylvania precedent, under which the insurer controls the right to settle where it honors its duty to defend.

The recent decision stems from a 1994 federal class action lawsuit filed against The Babcock Company and B&W Nuclear Environmental Services (collectively, B&W) by individuals who worked in or lived near nuclear fuel processing facilities (facilities) owned and operated by B&W. The employee plaintiffs alleged they sustained bodily injury and property damage due to the radioactive and toxic emissions from B&W’s facilities. American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters (collectively, ANI) agreed to defend B&W in the case under a reservation of rights.

In 1998, a jury awarded more than $35 million against B&W on eight “test cases” filed in federal court. Almost a decade later, with ANI defending throughout, B&W settled the claims asserted against it for approximately $80 million, an amount less than ANI’s policy limits. B&W then sought reimbursement from ANI for the full amount of the settlement plus prejudgment interest. ANI argued that it had no obligation to make any payment because, by settling the cases without its insurer’s consent, B&W violated the consent to settlement clauses in the policies. In the ensuing declaratory judgment action in Pennsylvania state court, B&A argued it could settle without the insurer’s consent so long as its settlement was reasonable. ANI countered that under existing Pennsylvania Supreme Court authority, an insurer that honors its defense obligation maintains control of settlement.

The trial court agreed B&W was entitled to reimbursement from ANI if the settlement was “fair and reasonable.” See American Nuclear Insurers, et al. v. The Babcock & Wilcox Company, et al., Nos. Civ. A. GD99-16227 & GD99-11498. After a jury determined that the settlement was fair, reasonable, and non-collusive, the trial court entered an order against ANI in the amount of $80 million plus prejudgment interest of more than $15 million.

ANI appealed the trial court’s decision. The Superior Court recognized that the trial court’s decision blurred the distinction between a defense under a reservation of rights and a denial of defense coverage. Notably, however, the majority opinion held that an insured may disregard both the cooperation clause and the consent to settlement clause in the absence of any breach by the insurer. According to the majority, an insured can disregard these policy provisions if it expressly rejects the insurer’s offer of a defense under a reservation of rights and funds its own defense. In setting forth this opinion, the majority analyzed the case law on which ANI relied, most notably Vincent Soybean & Grain Co., Inc. v. Lloyd’s Underwriters of London, 246 F.3d 1129 (8th Cir. 2001) (applying Arkansas law) and the case law on which B&W relied, most notably United Servs. Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987).

After a detailed examination of these cases and their progeny, the court stated that “the Morris and Vincent Soybean approaches tilt the playing field too much in favor of, respectively, the insured or the insurer.” The court noted that a third approach, articulated in Taylor v. Safeco Ins. Co., 361 So.2d 743 (Fla. Ct. App. 1978), “best balances the interests of the insurer and the insured.” In Taylor, the insurer rejected the tender, consented to a substantial judgment, and assigned its rights to the plaintiff in exchange for a release from personal liability. In the ensuing coverage litigation between the assignee and the insurer, the trial court granted summary judgment to the insurer. The Taylor appellate court reversed, holding that because the insured rejected the insurer’s defense, if coverage were established, the insurer would be obligated to indemnify the insured for the amount of the settlement up to the policy limits if the settlement was reasonable and entered into in good faith.

Writing for the majority of the Superior Court’s three judge panel, Judge David Wecht stated that the Taylor approach “best balances the interests of an insurer and insured, and better honors the binding nature of the insurance contract.” The panel majority further opined that this approach “honors the essence of a consent to settlement clause” because “[w]hen an insured avails itself of the insurer’s obligation to defend, the insured remains bound to the corollary requirement that the insurer have the sole authority to control the defense.”

Under the panel majority’s decision, an insurer’s defense under a reservation of rights permits the insured to either: (1) accept the defense, in which the insurer “retains full control of the litigation,” or (2) decline the insurer’s tender and furnish its own defense, in which case the insured “retains full control of its defense, including the option of settling the underlying claim under terms [the insured] believes best.” If the insured rejects the defense and subsequent litigation establishes coverage, the insured “may recover from the insurer the insured’s defense costs and the costs of settlement, to the extent that these costs are deemed fair, reasonable and non-collusive.” Because it was not clear if B&W rejected ANI’s defense before B&W settled, the Superior Court panel remanded the case to the trial court to determine if B&W rejected the defense and, if there was no rejection, if ANI’s refusal to accept the $80 million settlement constituted bad faith.

In a concurring and dissenting opinion, Judge Judith Olson agreed that the trial court’s judgment must be vacated, but did not agree that the case should be remanded for further proceedings consistent with Taylor. Judge Olson expressed that cases from the Pennsylvania Supreme Court provide the roadmap for insureds and insurers with respect to a defense under a reservation of rights. Under that authority, including Cowden v. Aetna Casualty and Surety Co., 134 A.2d 223 (Pa. 1957), an insured controls settlement where the insurer repudiates its duty to defend or unreasonably fails to settle. Judge Olson observed, “as an intermediate appellate court, I do not believe that it is within our prerogative to sidestep binding Supreme Court authority in favor of rules that we may deem preferable or even broadly accepted.”

The Superior Court’s opinion in The Babcock & Wilcox Company, et al. v. American Nuclear Insurers, et al., raises more questions than it answers for liability insurers, insureds, and their counsel. For example, the opinion does not address if an insured continues to have the right to independent defense counsel where the facts in the underlying matter determine coverage, or if that right is eliminated because the insured can elect to defend itself. The majority also does not consider the cost to excess insurers, who may find an increasing need to associate in the defense to ensure that matters are defended vigorously. The opinion further does not acknowledge that an insured who defends itself essentially absolves its insurer from the risk of a judgment in excess of policy limits. These questions remain unanswered by the majority and also by the fact that the ruling is not from Pennsylvania’s highest court. It remains to be seen whether B&W will appeal this decision and, if so, whether the Pennsylvania Supreme Court will uphold the Superior Court’s opinion or remain consistent with its existing precedent.