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Vol. 3, Iss. 9
June 4, 2014


Chickens And Eggs: What Comes First: Underlying Case Or Coverage Case?


It is one of the most frequently occurring and important issues on the coverage landscape. Yet, for some reason, guidance can sometimes be unclear, inconsistent or just plain elusive. Here is the scenario. An insurer is defending its insured in an underlying action under a reservation of rights. Uncertainty over its coverage obligation has led it to file a declaratory judgment action. The underlying action and declaratory judgment action are proceeding on separate paths. The underlying action is going to be ready for trial before the declaratory judgment action will be resolved. So, in all likelihood, a pre-trial settlement demand, within policy limits, will be presented to the defendant (and its insurer) before resolution of the declaratory judgment action.

Faced with this situation a few things may happen -- with unpleasant endings for the insurer. The insurer may reject the settlement demand. After all, why would the insurer agree to fund a settlement when it does not believe the claim is covered? And, in fact, it did just what courts often advise insurers to do when there is doubt about their coverage obligations – it defended its insured and filed a declaratory judgment action. If the insurer rejects the settlement demand the case will likely proceed to trial – because the insured does not have the funds to settle or will not agree to reimburse the insurer if there is ultimately a finding of no coverage. [The insured should not be able to settle with the plaintiff, and exchange a covenant not to execute for an assignment of policy rights, since the insurer is defending the insured.]

If the case proceeds to trial, and there is a verdict for the plaintiff, the insurer will now be called upon to pay it. But, again, why would the insurer agree to do so when it does not believe that the claim is covered? And if the verdict for the plaintiff exceeds the policy’s limit of liability, expect to see the plaintiff and insured arguing that the insurer is liable for the entire amount. After all, there was a settlement demand within policy limits that the insurer refused to accept. And if the insurer chooses to appeal it will give rise to bonding issues, such as whose duty it is to collateralize the bond and what impact the bond may have on the insurer’s ability to enforce its coverage defenses. And if the insurer does not wish to appeal, but does not know its coverage obligations, the plaintiff may begin the process to execute against the insured’s assets.

All in all, these are a lot of potential bad outcomes for an insurer that undertook its insured’s defense and then did what the system allows for -- calls for, even -- to resolve its doubts about its duty to indemnify. One way to prevent this situation would be for the insurer’s coverage obligations to be determined prior to any trial, or pre-trial settlement demand, in the underlying action. If so, the insurer would have a clear picture of its obligations, options and consequences when confronted with a pre-trial settlement demand or call to pay a verdict against its insured. There are no easy answers to this situation and it has complexities and other issues that are well-beyond this brief discussion. Nonetheless, there is something wrong with a situation where an insurer does all that is asked of it and still faces the risk of obligations beyond simply those that it bargained for when it sold the policy.

The District of Oregon recently addressed the timing of underlying litigation and a declaratory judgment action in Scottsdale Insurance Company v. Ortiz & Associates, Inc., No. 13-1791 (D. Oregon May 9, 2014). The specific situation before the court does not fall within any of the scenarios described above. However, the case involves an insurer seeking relief to prevent an unwanted outcome on account of underlying litigation proceeding ahead of a declaratory judgment action.

In very general terms, Scottsdale initiated an action seeking a declaration that it had no duty to defend, indemnify, or provide coverage under an excess policy for an underlying suit involving an individual that was allegedly struck and killed by a dump truck while he was working on a highway construction project. Scottsdale maintained that the auto liability exclusion in its excess policy precluded coverage for the accident. Scottsdale moved for summary judgment to establish that the excess policy provided no coverage.

The case has some unusual aspects that are not necessary for purposes of discussion here. The important point here is that Scottsdale sought a judicial determination of its coverage obligations, before the resolution of the underlying bodily injury action, because, as the court put it: “Scottsdale argues if its rights are not clarified in this action, it could be forced to fund a settlement of what it believes is an uncovered claim, or risk having to defend against future claims for failure to fund a settlement.” Therein lies the issue discussed above.

The court denied Scottsdale’s request, holding that “until the issue of liability is resolved in the underlying lawsuit, this Court will not entertain the declaratory judgment determination that Scottsdale seeks. Doing so would place [the insured] in a conflictive position that could undermine its position in the underlying lawsuit and would require fact-finding identical to that which will occur in the underlying lawsuit in Washington State court.”

Even if that’s all true (and I’m not saying it is), it is equally true that, as Scottsdale says, if its rights are not clarified before attempts are made to settle the underlying case, it could be forced to fund a settlement of an uncovered claim or risk having to defend against future claims for failure to fund a settlement. I take this last statement to include efforts to collect an excess verdict based on the argument that Scottsdale failed to settle a claim in the face of a demand within policy limits.

The DJ-underlying action timing issue is not a simple one. But, as I said, I am constantly bothered by the fact that insurers can do all that is asked of them, in the face of claim with coverage issues, and still face the risk of obligations beyond simply those that they bargained for when they sold the policy.

 
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