PENNSYLVANIA SUPREME COURT ADOPTS FAIR AND REASONABLE STANDARD FOR INSURED’S UNILATERALLY SETTLING CLAIMS WHERE: (1) THE INSURER REFUSES TO SETTLE, (2) THE INSURER HAS ISSUED A RESERVATION OF RIGHTS LETTER ON CLAIMS AT ISSUE, AND (3) COVERAGE IS ULTIMATELY DUE (Pennsylvania Supreme Court)
In Babcock & Wilcox Co. v. American Nuclear Insurers, Pennsylvania’s Supreme Court had to determine under what circumstances an insured being defended under a reservation of rights could settle with a claimant, absent the insurer’s agreement, and later recover the settlement proceeds from the insurer. The Supreme Court ruled that: (1) where an insurer defends subject to a reservation of rights; (2) the policy is ultimately found to cover the relevant claims that were settled; (3) then the insured may accept a settlement over the insurer’s refusal; (4) where the settlement is fair, reasonable, and non-collusive.
As discussed below, the Court recognized that lower courts will have to look at the specific nature of the rights reserved in applying these principles.
Analytically, the insurer’s failure to settle within policy limits under these circumstances, i.e., rejecting a fair and reasonable settlement while maintaining a reservation of rights, is a breach of its contractual duty. The burden of proof is on the insured to make this case, and factors to consider include “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.”
The Supreme Court more generally stated the “risks of going to trial” had to be evaluated. The Court rejected two contrary possibilities.
First, it rejected the insurer’s arguments that the insured must prove bad faith, rather than the settlement’s fairness and reasonableness.
Second, the Supreme Court vacated the Superior Court’s ruling that had provided the insured with two options: (1) accept a defense subject to a reservation of rights, and be required to prove insurer bad faith to recover on any unilateral settlement; or (2) reject the insurer’s offer of a defense under a reservation of rights, hire counsel at the insured’s own expense, and then settle and recover from the insurer under a fair and reasonable standard if coverage is otherwise due.
As to defects in the Superior Court’s analysis, the Supreme Court accepted (1) the legal argument that the insured could breach the insurance contract by rejecting a defense offered by the insurer; and (2) the practical argument that many insureds could not even afford to hire private counsel to pursue this route.
In evaluating the insurer’s responsibility to reimburse the insured, the Court accepted a distinction between a “soft” reservation of rights and a “hard” reservation of rights. A “soft” reservation of rights involves circumstances where an insured is reserving rights which are “unlikely to alter the interests of the parties”; whereas with a “hard” reservation of rights “the insurer views the claims as possibly covered, requiring a defense, but ultimately unlikely to be covered by the policy, such as when intentional actions are also pled in negligence.”
The Court agreed “that not all reservations of rights are equal…. [and] [t]he mere fact that an insurer restates that it will not cover what the insurance policy does not cover, where it arguably might be part of the damages sought, does not automatically result in allowing the insured to settle the entire suit. Parties and courts may need to consider whether a particular reservation of rights justifies diverging from the contract’s cooperation clause,” i.e., does the insurer’s specific reservation of rights in a particular case permit a court to allow the insured to unilaterally settle the entire case, contrary to the insured’s normal contractual duty to cooperate in any settlement with the insurer and to only settle with the insurer’s consent.
[Note: By way of one hypothetical, assume a case is brought in negligence, but the claimant is also seeking punitive damages, which is possible under Pennsylvania law. The insurer issues a reservation of rights solely on the punitive damages claim. The insurer refuses to settle at the underlying plaintiff’s demand number because it concludes that there is a reasonable chance for a defense verdict on the covered claim. The insured later settles unilaterally at that same demand number because of the concern over punitive damages, which are clearly not covered under the policy. Thus, there could be an issue under as to whether the fair and reasonable standard even applies because the claim motivating the settlement of the entire case was not a covered claim.]