Pennsylvania Supreme Court Holds Insured Entitled to Settle Underlying Claim Even Absent Insurer Consent

In its recent decision in Babcock & Wilcox Co. v. American Nuclear Insurers, 2015 Pa. LEXIS 1551 (Pa. July 21, 2015), the Supreme Court of Pennsylvania, deciding a matter of first impression within the Commonwealth, had occasion to consider the question of whether an insured’s settlement of an underlying claim, without the consent of its insurer, vitiated its right to coverage.

At issue in the Babcock decision was the insureds’ right to coverage for a class action lawsuit filed against the insureds – Babcock and ARCO – concerning emissions from their nuclear facilities. Babcock’s and ARCO’s insurers, American Nuclear and Mutual Atomic Energy, provided a defense to the underlying suit, but did so under a reservation of rights with respect to certain categories of damages. Specifically, the insurers reserved their rights to disclaim coverage for harms not caused by a nuclear energy hazard, for amounts in excess of policy limits, and for amounts awarded as injunctive relief and punitive damages. In addition, the insurers later filed suit against Babock and ARCO, seeking a declaration with respect to several issues, including applicable limits and appointment of defense counsel.

Against the backdrop of these disputes, the insurers refused to consent to several settlement requests. The stated basis for withholding consent was the insurers’ belief that the underlying matter would result in a defense verdict. Despite the insurers’ lack of consent, ARCO and Babcock eventually settled the underlying suit for $80 million – an amount within its applicable limits of liability.

The insurers contended that this unilateral settlement of the underlying suit violated a consent to settle provision in the relevant policy stating that “[t]he insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense.” Thus, the question ultimately posed to the Court was whether the insureds’ violation of this clause impacted their right to coverage for the settlement, and more importantly, what standard should be applied to this question.

In addressing these issues, the parties pointed to case law from across the country on the issue. The insureds championed cases such as the decision from the Arizona Supreme Court in United Services Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987), whereby if an insurer is providing an insured with a defense under a reservation of rights to deny coverage, then the insured can unilaterally settle the underlying claim so long as the settlement is fair and reasonable, and coverage is found to exist. The insurers, on the other hand, pointed to opposing case law holding that an insured’s breach of a consent clause voids coverage unless it can be demonstrated that the insurer’s refusal to consent to the settlement was in bad faith, such as Eighth Circuit’s decision in Vincent Soybean & Grain Co., Inc., v. Lloyd’s Underwriters of London, 246 F.3d 1129 (8th Cir. 2001). Among other things, the insurers argued that the Morris rule treats an insurer as having breached its duty to defend merely by providing a defense under a reservation of rights.

After engaging in an extensive review of Pennsylvania law concerning the duty to defend and on issues of consent, as well as an analysis of case law on the issue throughout the country, the Court ultimately sided with the insureds. In doing so, it adopted a standard modeled on the rule articulated by the Iowa Supreme Court in Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa 2000), but to which the Court referred to as a variant of the Morris standard. Specifically, the Court adopted what it referred to as a “fair and reasonable” standard for situations in which the insurer is defending under a reservation of rights, thereby subjecting the insured “to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” The question of what is fair and reasonable explained the Court:

… entails 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.

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In its recent decision in Babcock & Wilcox Co. v. American Nuclear Insurers, 2015 Pa. LEXIS 1551 (Pa. July 21, 2015), the Supreme Court of Pennsylvania, deciding a matter of first impression within the Commonwealth, had occasion to consider the question of whether an insured’s settlement of an underlying claim, without the consent of its insurer, vitiated its right to coverage.

At issue in the Babcock decision was the insureds’ right to coverage for a class action lawsuit filed against the insureds – Babcock and ARCO – concerning emissions from their nuclear facilities. Babcock’s and ARCO’s insurers, American Nuclear and Mutual Atomic Energy, provided a defense to the underlying suit, but did so under a reservation of rights with respect to certain categories of damages. Specifically, the insurers reserved their rights to disclaim coverage for harms not caused by a nuclear energy hazard, for amounts in excess of policy limits, and for amounts awarded as injunctive relief and punitive damages. In addition, the insurers later filed suit against Babock and ARCO, seeking a declaration with respect to several issues, including applicable limits and appointment of defense counsel.

Against the backdrop of these disputes, the insurers refused to consent to several settlement requests. The stated basis for withholding consent was the insurers’ belief that the underlying matter would result in a defense verdict. Despite the insurers’ lack of consent, ARCO and Babcock eventually settled the underlying suit for $80 million – an amount within its applicable limits of liability.

The insurers contended that this unilateral settlement of the underlying suit violated a consent to settle provision in the relevant policy stating that “[t]he insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense.” Thus, the question ultimately posed to the Court was whether the insureds’ violation of this clause impacted their right to coverage for the settlement, and more importantly, what standard should be applied to this question.

In addressing these issues, the parties pointed to case law from across the country on the issue. The insureds championed cases such as the decision from the Arizona Supreme Court in United Services Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987), whereby if an insurer is providing an insured with a defense under a reservation of rights to deny coverage, then the insured can unilaterally settle the underlying claim so long as the settlement is fair and reasonable, and coverage is found to exist. The insurers, on the other hand, pointed to opposing case law holding that an insured’s breach of a consent clause voids coverage unless it can be demonstrated that the insurer’s refusal to consent to the settlement was in bad faith, such as Eighth Circuit’s decision in Vincent Soybean & Grain Co., Inc., v. Lloyd’s Underwriters of London, 246 F.3d 1129 (8th Cir. 2001). Among other things, the insurers argued that the Morris rule treats an insurer as having breached its duty to defend merely by providing a defense under a reservation of rights.

After engaging in an extensive review of Pennsylvania law concerning the duty to defend and on issues of consent, as well as an analysis of case law on the issue throughout the country, the Court ultimately sided with the insureds. In doing so, it adopted a standard modeled on the rule articulated by the Iowa Supreme Court in Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa 2000), but to which the Court referred to as a variant of the Morris standard. Specifically, the Court adopted what it referred to as a “fair and reasonable” standard for situations in which the insurer is defending under a reservation of rights, thereby subjecting the insured “to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” The question of what is fair and reasonable explained the Court:

… entails 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.