The most contentious provision for insurers, during the drafting of the ALI’s Restatement of the Law of Liability Insurance, was the possible adoption of the so-called “waiver rule.” In general, the rule provides that if an insurer refuses to defend its insured under a reservation of rights or does not seek a declaratory judgment that it does not owe coverage, and it is determined that it breached the duty to defend, the insurer waives the right to subsequently assert that there is no duty to indemnify. In other words, while a duty to defend may be owed, based on the allegations in the complaint, the insurer that did not follow one of these courses loses the right to argue that there is no duty to indemnify – a determination made based on the actual facts established.
The waiver rule appeared in the original draft of the Restatement. However, it had a much lower profile in the version that was ultimately approved – being discussed in comments as a possible remedy for an insurer’s bad faith.
Illinois applies the waiver rule. And a recent decision from its Appellate Court demonstrates just how significant this penalty can be – and why insurers fought its adoption as aggressively as they did during the drafting of the Restatement.
Country Mutual Ins. Co. v. Badger Mutual Insurance Co., No. 1-17-1774 (Ill. Ct. App. June 29, 2018) involved coverage for a conventional construction defect claim. Roe Construction performed construction and remodeling work at the residence of Steven Gelsomino. Property was damaged as a result of Roe’s alleged negligent failure to perform the work. Gelsomino’s homeowner’s insurer, Badger Mutual, paid Gelsomino for certain of the damage. Badger brought a subrogation action against Roe Construction, alleging that, as a result of Roe’s negligence, the building sustained property damage, including water damage. Of note, the complaint did not specify when the property damage occurred, but that its existence was learned in March 2010.
Roe tendered the complaint to Country Mutual, its commercial general liability insurer. Country refused to defend and a default judgment was entered against Roe in the amount of $222,000. Eight days later, Country filed a declaratory judgment action against Roe, Badger and Gelsomino, alleging that no coverage was owed on account of various reasons – no occurrence, its policy expired in 2006 and various exclusions.
For purposes here it is not necessary to delve into the construction defect coverage analysis undertaken by the court. The trial court held that Country breached its duty to defend Roe. As a result, the trial court held that, under Illinois law – the waiver rule -- Country was estopped from denying coverage in an action to collect the default judgment.
The Illinois appeals court affirmed. In doing so it provided an important announcement about the scope of the waiver rule.
But first, to get there, you must start with the duty to defend. The court held that Country had such an obligation: “[W]e find that the allegations of the underlying pleaded facts raising a potential of ‘property damage’ that occurred within the policy period. The policy covered ‘property damage,’ which was defined to mean ‘Physical injury to tangible property including all resulting loss of use of that property.’ The underlying complaint alleged that Roe’s negligent construction work caused Gelsomino’s building to sustain ‘property damages, including water damage.’ We acknowledge that such allegations do not specify what particular property was damaged. Nonetheless, given the minimal pleading threshold to trigger a duty to defend, the allegations raised at least the potential that there were damages covered under the policy.”
On the issue of whether property damage occurred during the policy period, the court was likewise guided by the “low” threshold for determining a duty to defend: “Although lacking specificity, the underlying allegations asserted property damage occurring sometime between August 2005 and the time the plaintiffs ‘learned’ of the damage in March 2010. Although this is a wide time frame, it undoubtedly overlaps with the policy period, and thus alleges at least the potential that some of the damages were covered. Thus, the complaint triggered Country’s duty to defend.”
Having determined that Country breached the duty to defend Roe – and not having filed a timely declaratory judgment action -- the appeals court turned to the estoppel issue.
Country argued that, by applying estoppel, the court “creates coverage” for damages taking place beyond the policy period. [Remember, the policy expired in 2006.] In other words, as Country say it, estoppel is limited to the insurer’s waiver of “policy defenses” and “should not prevent Country from asserting that the damages occurred beyond the expiration of the policy.”
Observing that Country’s situation was “of its own making,” and it could have litigated the issues it now seeks to, the court was not pursued by a distinction between a “policy defense” and the argument that no coverage is owed based on the failure of a policy to provide coverage in the first place. “We acknowledge that estoppel has been described as precluding an insurer from raising ‘policy defenses.’ [citation omitted.] However, Country cites no binding authority that expressly limits the application of estoppel in this context to ‘policy defenses.’ To the contrary, our supreme court in Clemmons [v. Travelers Insurance Co., 430 N.E.2d 1104 (Ill. 1981)] stated: ‘When a complaint against the insured alleges facts within or potentially within the scope of the policy coverage, the insurer taking the position that the complaint is not covered by the policy must defend the suit under a reservation of right or seek a declaratory judgment that there is no coverage. [Citation.] If the insurer does not, it is later estopped from denying coverage in a suit to collect the judgment.’” (Emphasis added by Country court).
Yes, Country Mutual v. Badger Mutual demonstrates why insurers fought the adoption of the waiver rule as aggressively as they did during the drafting of the ALI’s insurance Restatement.
