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Pennsylvania Supreme Court Holds That an Insurer Defending Under a Reservation of Rights Must Reimburse an Insured for an Unconsented-To Settlement So Long as the Settled Claim Is Covered and the Settlement Is Fair and Reasonable

July 23, 2015
Special Law Alert

By R. Bruce Morrison and John J. Hare

The Pennsylvania Supreme Court has ruled in a 3-2 decision that an insurer defending under a reservation of rights must reimburse an insured for a tort settlement paid by the insured, despite the insurer’s lack of consent to the settlement, if the claim is covered by the policy and the settlement is fair and reasonable. Babcock & Wilcox and ARCO v. American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters, No. 2 WAP 2014 (Pa., July 21, 2015). (For a copy of the majority and concurring and dissenting opinions, click here or contact the authors.)

While this decision is discussed in more detail below, the primary initial takeaway is that an insured does not forfeit insurance coverage when it settles a tort claim without the consent of its insurer, which defends under a reservation of rights, so long as the claim is covered and the settlement is fair and reasonable.

Babcock & Wilcox arose from a 1994 federal class action lawsuit in which B&W and Arco, the Insureds, were sued for bodily injury and property damage allegedly caused by emissions from their nuclear power plants. American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters, the Insurers, which issued the Insureds a policy with $320 million limits, defended under a reservation of rights on the basis that aspects of the claims were not covered. In 1998, eight test cases were tried, and the jury returned a $36 million verdict for the plaintiffs. The federal court awarded a new trial based on evidentiary issues. Before the retrial, however, the Insureds reached an $80 million settlement with all of the plaintiffs (who numbered over 500). The Insureds then sued the Insurers in Pennsylvania state court to recover the amount of the settlement. The Insurers defended on the basis that the Insureds had violated standard cooperation and consent-to-settle clauses by pressuring the Insurers to settle and ultimately settling without the Insurers’ consent.

The question presented by the case was what standard should apply to determine whether an insurer must reimburse an insured for a settlement entered in violation of a consent-to-settle clause and while the insurer was defending under a reservation of rights. The trial judge, R. Stanton Wettick of Allegheny County, held that an insurer defending subject to a reservation of rights is required to reimburse an insured for a settlement reached in violation of the consent-to-settle clause where coverage is found to exist and the settlement is “fair and reasonable” and made in “good faith and without collusion.” The court then determined that coverage existed, and a jury concluded that the settlement was fair and reasonable. As a result, the trial court ordered the Insurers to reimburse the Insureds for the cost of the settlement plus interest. The Insurers appealed, and the Pennsylvania Superior Court reversed on the basis that, inter alia, the Insureds were required to demonstrate that the Insurers acted in bad faith in rejecting the settlement offer before the Insurers’ reimbursement obligation arose.

Noting that the standard adopted by the Superior Court had been advocated by neither the Insurers nor the Insureds, the Pennsylvania Supreme Court granted review of the following issue: “[W]hether an insured forfeits the right to insurance coverage when it settles a lawsuit without the insurer’s consent, where the insurer has defended the suit subject to a reservation of rights.” (Majority opinion, p. 10.) In a decision authored by Justice Baer and joined by Justices Todd and Stevens, the Supreme Court relied heavily on decisions from other states and ultimately embraced a “fair and reasonable standard limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and, thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” (Id., p. 29.) The court explained that a determination of whether a settlement is fair and reasonable requires consideration of the terms of the settlement, the strength of the insured’s defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured. This determination does not require a finding of bad faith before an insurer must reimburse an insured for the cost of a settlement. Instead, so long as the claim is covered and the settlement is fair and reasonable, the insurer must reimburse even if it did not act in bad faith.

In a concurring and dissenting opinion joined by Chief Justice Saylor, Justice Eakin expressed his view that consent-to-settle clauses, like any policy term, should be honored unless an insurer breaches the policy by acting in bad faith. No finding of bad faith was possible in this case, and none had been made, because the Insurers had carefully vetted the Insureds’ defenses and found them to be strong, and the Insurers had spent in excess of $40 million to defend the Insureds. The Insurers’ reservation of rights had not altered the Insureds’ duty to comply with policy terms, including the consent-to-settle clause. Relying on such basic principles of contract law, Justice Eakin concluded that “applicable Pennsylvania law does not treat an insurer’s good-faith decision to defend a claim rather than settle it as a breach of contract that triggers a free-for-all where the insured may take it upon itself to settle the case without permission in violation of the policy terms.” (Concurring and dissenting opinion, p. 7.) In contrast, the “fair and reasonable” standard embraced by the majority:

Essentially allows an insured to breach the contract’s requirement that the insurer must consent to any settlement when the insured anticipates an excess future verdict and, as a practical matter, permits the insured to determine for itself (in the first instance) that the insurer acted unreasonably in refusing to settle. (Id.)

As this review indicates, the Supreme Court split on the relevant standard for determining when an insurer operating under a reservation of rights must reimburse an insured for the cost of an unconsented-to settlement. The majority held that the reimbursement obligation arises so long as the policy covers the claim and the settlement was fair and reasonable. The dissent, on the other hand, would have limited the reimbursement obligation to those situations in which the insurer acts in bad faith. Unless and until the Supreme Court revisit this issue, the majority’s view is the law of Pennsylvania.

There remain certain open issues and considerations included in the court’s opinion which will generate debate and continued disputes. It appears, for example, that the insurer must first be presented with and have rejected the settlement opportunity before the insured can decide to settle the case on its own. Additionally, the majority recognized one of the points argued by the Insured to the effect that not all “reservations of rights” are created equal and not all reservations would justify abrogation of the consent to settle clause. Specifically, the court noted:

Parties and courts may need to consider whether a particular reservation of rights justifies diverging from the contract’s cooperation clause, a question which is not squarely before this Court. (P. 24, ff 15.)

As such, not all reservations will trigger application of this new Babcock decision, and it remains to be seen where that dividing line will be drawn.

Please contact us to further discuss this decision.

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