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The Pennsylvania Superior Court created new law by holding an insured may decline an insurer’s defense tendered under a reservation of rights and later seek to be indemnified for any settlement and defense costs deemed fair, reasonable, and non-collusive.

This case stems from over 300 underlying claims alleging personal injury and property damage from radioactive emissions at two nuclear fuel processing facilities owned by Babcock & Wilcox and its predecessor Atlantic Richfield Company (collectively “B&W”). Beginning in March 1958, American Nuclear Insurers and Mutual Atomic Energy Liability (collectively “ANI”) provided coverage to B&W, with limits beginning at $3 million and increasing to $160 million per facility as of February 1979.

In 1998, the district court tried eight “test cases,” with the jury returning verdicts in favor of all eight plaintiffs and an aggregate of over $36 million in damages. The trial court subsequently granted a motion for a new trial based on evidentiary errors made in the test case trials. While the new trials were pending, ANI filed a declaratory judgment action in the Court of Common Pleas in Allegheny County against B&W. Before the court ruled on the declaratory judgment action, B&W reached a settlement agreement with all 300-plus plaintiffs and provided the agreed upon $80 million in settlement funds. ANI opposed the settlement.

Following the settlement, B&W sought reimbursement for the $80 million paid in settlement funds as well as counsel fees. ANI resisted, claiming it had no obligation to make any payment because B&W violated the consent to settlement clauses in the insurance policies. In trying to resolve this dispute, an issue regarding the appropriate standard to apply in determining ANI’s insurance coverage obligations arose. The trial court determined the Cowden standard should apply, requiring B&W to plead and prove the four-part test to be entitled to reimbursement.

The litigation progressed as expected until two years later when the trial court issued a new memorandum and order instructing the standard described in Alfiero v. Berks Mutual Leasing Co., 500 A.2d 169 (Pa. Super. 1985) be used in the pending trial. Despite previously being reserved for cases where a defendant sought indemnification for settlement funds following a bad faith action by the insurer, under the Alfiero standard, B&W would be entitled to reimbursement “if the settlement was fair, reasonable, and non-collusive.”

The Babcock trial court chose to break precedent and apply the Alfiero standard because it felt “there was no principled distinction between a case in which an insurer provides a defense subject to a reservation of rights… and a case where the insurer denies both defense and coverage.” The trial court further opined, “the insurance company should not be the sole decision maker where there is a possibility that only the insured’s interests will be affected by the outcome of the underlying litigation,” as is the circumstance when a defense is tendered under a reservation of rights. Id. Following this determination, the court directed the parties to trial to determine whether the $80 million settlement entered into by B&W was “fair and reasonable.” The jury determined that the settlement was fair, reasonable, and non-collusive, and the trial court entered an order reflecting the same.

ANI appealed the order, presenting a single issue to the Superior Court:

“Whether ANI had the right to deny coverage for B&W’s unauthorized $80 million payments to settle the [underlying] Action where: (1) the ANI Policy, which had combined limits of $320 million, unambiguously afforded ANI the right to control settlement and exclude coverage for unauthorized payments; (2) ANI was fully performing its policy obligations by funding B&W’s $40 million-plus defense in the underlying Action; and (3) ANI’s decision to continue defending the [underlying] Action comported with the Pennsylvania Supreme Court’s decision in Cowden.”

On appeal, ANI contended that by adopting Alfiero as the appropriate standard, the trial court had effectively adopted the standard articulated in United Services Auto. Ass’n v. Morris, 741 P.2d 246 (Az. 1987), and its progeny. In Morris, the Arizona Supreme Court held when an insurer tenders a defense under a reservation of rights it “[does] not breach any of its policy obligations” but “neither [does] it accept full responsibility for the insured’s liability exposure.” As such, it held “the cooperation clause prohibition against settling without the insurer’s consent forbids an insured from settling only claims for which the insurer unconditionally assumes liability under the policy… The insurer’s reservation of the privilege to deny the duty to pay relinquishes to the insured control of the litigation, almost as if the insured had objected to being defended under a reservation.” The Superior Court felt this mischaracterized the trial court’s ruling. Furthermore, such a ruling would be incongruous with Pennsylvania’s contract law because the Morris court found “the insurer’s defense with a reservation did not constitute a breach of contract,” yet still “relieved the insured of its own corresponding contractual duty.” Instead, the Superior Court chose to rely on Taylor v. Safeco Insurance Company, 361 So.2d 743 (Fla. Ct. App. 1978). In Taylor, the insurer tendered its defense under a reservation of rights, then withdrew its defense, only to retender the defense at trial, again under a reservation of rights. The insured rejected the defense, and, without counsel, consented to “a substantial judgment, assigning its right to seek reimbursement from its insurer to the plaintiff in exchange for a release from all personal liability for the judgment.” When the plaintiff sought reimbursement, the trial court granted the insurer summary judgment based on the insured’s failure to comply with the consent to settlement clause of the policy. The appeals court reversed that holding, finding “because the insured had rejected the insurer’s defense… if coverage were established, the insurer would be obligated to indemnify the insured for the amount of settlement up to the policy limit if the settlement was “reasonable” and was not entered into “in bad faith, fraudulently, collusively, or without any effort to minimize his liability.”

Following the Taylor line of case law, Pennsylvania’s Superior Court held:

“When an insurer tenders a defense subject to a reservation, the insured may choose either of two options. It may accept the defense, in which event it remains unqualifiedly bound to the terms of the consent to settlement provision of the underlying policy. Should the insured choose this option, the insurer retains full control of the litigation, consistently with the policy’s terms. In that event, the insured’s sole protection against any injuries arising from the insurer’s conduct of the defense lies in the bad faith standard articulated in Cowden.

Alternatively, the insured may decline the insurer’s tender of a qualified defense and furnish its own defense, either pro se or through independent counsel retained at the insured’s expense. In this event, the insured retains full control of its defense, including the option of settling the underlying claim under terms it believes best. Should the insured select this path, and should coverage be found, the insured may recover from the insurer and the insured’s defense costs and the costs of settlement, to the extent that these costs are deemed fair, reasonable, and non-collusive.”

After making this ruling, the Superior Court held that the trial court erred in constraining the trial to the question of whether B&W’s settlement was “fair and reasonable.” Rather, the questions presented to the jury should have been, “(1) whether B&W in fact rejected ANI’s defense; and, if so, (2) whether ANI acted in bad faith in declining to settle, or, as alleged by B&W, to participate in settlement negotiations with the [underlying] plaintiffs.” Based on this finding, the court vacated the underlying jury verdict and judgment and remanded to allow the trial court to conduct a new trial in conformity with the new standard derived from Taylor.

Date of Decision: July 12, 2013

Babcock & Wilcox Co. v. Am. Nuclear Insurers & Mut. Atomic Energy Liab. Underwriters, 2013 Pa. Super. LEXIS 1633 (Pa. Super. Ct. 2012) (Wecht, J.)