In a case with significance beyond the Commonwealth of Pennsylvania, the Pennsylvania Supreme Court recently ruled that an insured, while receiving a reservation of rights defense from its insurance company, may settle the underlying case over the objection of the insurer and obtain reimbursement from the carrier. The case is styled Babcock & Wilcox Co. v. American Nuclear Insurers, 76 A.3d 1 (Pa. 2015) and gives policyholders significant flexibility to settle without the carrier’s consent if the insured did not agree to defend unconditionally, so long as the settlement is “fair and reasonable.”
The underlying case was a class action filed in 1994 by individuals who lived near nuclear facilities owned by Babcock & Wilcox. The plaintiffs claimed that they suffered bodily injury and property damage arising from the release of radiation from the facilities. A jury trial of eight test cases resulted an initial verdict totaling over $36 million or approximately $4.5 million per plaintiff.
American Nuclear Insurance agreed to defend Babcock & Wilcox under a reservation of rights. The insurance policy required the insureds to obtain the insurers’ consent before settling any claim. During the course of the underlying lawsuit, the carrier refused consent to any settlement arguing that there was a strong likelihood of a defense verdict. The carrier resisted the insureds’ efforts, issued a supplemental reservation of rights claiming that the insureds were refusing to cooperate in the defense of the case and filed a declaratory judgment lawsuit seeking to resolve the coverage dispute among the parties. The insureds counterclaimed, arguing that the carrier had acted in bad faith.
After presenting multiple settlement offers to the insurer and failing to receive consent to settle, in order to protect themselves, the insureds settled the class action for $80 million, which was substantially less than the $320 million limits of liability.
The Trial Court Opinion
The insureds then filed suit seeking reimbursement of the amount it paid to settle the case. ANI argued that the insureds were not entitled to reimbursement because they breached the consent to settle and voluntary payments condition of the policy. The issue, according to the trial court, was whether an insurance company who defended its insured under a reservation of rights is required to reimburse an insured who settled the underlying litigation over the objections of the insurance company.
Relying on the standard adopted by the Arizona Supreme Court in United Services Auto. Ass’n v. Morris, the insureds argued that ANI was obligated to indemnify them so long as coverage applies and the settlement is fair and reasonable and entered into in good faith. 741 P.2d 246 (Ariz. 1987). The carrier argued that Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa. 1957) controlled and that it was obligated to pay the settlement only if it acted in bad faith in refusing to settle following a demand within policy limits.
The trial court ultimately agreed with the policyholders and adopted the Morris test, holding that if an insurer defends under reservation of rights, the policyholder may settle the case over the objection of the insurer, and receive reimbursement from the carrier, so long as the settlement was fair and reasonable. Following this ruling, the court held a two-week trial in which the jury ruled that the settlement was fair and reasonable. American Nuclear appealed, and the Superior Court reversed.
The Supreme Court Opinion
In a split decision, three justices of the Pennsylvania Supreme Court reversed the Superior Court and adopted the trial court’s analysis. The court held that
[i]f an insurer breaches its duty to settle while defending subject to a reservation of rights and the insured accepts a reasonable settlement offer, the insured need only demonstrate that the insurer breached its duty by failing to consent to a settlement that is fair, reasonable, and non-collusive.
Without controlling case law from Pennsylvania, the court looked to Morris as well to decisions from Minnesota and Iowa and found that if the carrier defends under reservation of rights, the insured may settle the case without the insurer’s consent and recover the settlement from the carrier so long as the settlement was fair and reasonable.
Babcock and Wilcox is a significant victory for policyholders. It places Pennsylvania among the jurisdictions recognizing that when an insurance company defends under reservation of rights, it places the insured in the difficult position. The insurer may believe the case is defensible, but with a reservation of rights in place, the policyholder has no assurance that the carrier will pay if there is an adverse verdict. The policyholder, in order to protect its interests, may wish the settle the case, but the policy requires the insurer’s consent. If the insurer refuses to allow the insured to settle, and the case heads south, the results can be catastrophic. The insured should have the right to settle, because the insurer has not agreed to stand by the insured and pay if the jury finds for the plaintiff.
If a policyholder receives a reservation of rights defense, it should be proactive during the course of the litigation to confirm the position of the insurance company on settlement. If the case becomes ripe for settlement, and the insurer refuses to participate in settlement negotiations, or refuses to settle when the insured believes a settlement is prudent, Babcock & Wilcox provides support in Pennsylvania for insureds that choose to settle and seek reimbursement from the insurance company.