Liability insurance policies apply where the insured is liable for bodily injury, property damage, or wrongful acts (depending on the policy). What happens, however, when the policyholder denies that any injury or wrongdoing took place? Does that mean that insurance is not applicable?
Perhaps the most pointed illustration concerns Dow Corning, which denied that its breast implants caused injury but entered into a major settlement. In its coverage case, its insurers turned around and argued that, because the policies apply to “injury” and because Dow Corning denied there was “injury,” the insurers had no obligation (or technically that their policies had not been triggered). The court made short work of this argument:
[I]f an underlying plaintiff alleges that she suffered injuries caused by a Dow Corning breast implant . . . [and] Dow Corning settles claims on the basis of those allegations, defendants must indemnify Dow Corning based on those allegations. This conclusion is not based on a theory of res judicata or collateral estoppel, or law of the case. Rather, it is based on a plain reading of the policy language.
Dow Corning Corp. v. Continental Cas. Co., 1999 WL 33435067 at *5 (Mich. App. Oct. 12, 1999). As the court aptly put it, “the question in this insurance dispute is not ‘what really happened?’ Instead, the question is, . . . ‘what did Dow Corning fear a judge or jury might believe happened?’”. Id. at *5 n.8.
Insurers may not take the policyholder’s denial of wrongdoing and injury and offer it as a fact or some form of estoppel. See generally United Servs. Auto. Ass’n. v. Morris, 154 Ariz. 113, 120, 741 P.2d 246, 253 (1987) (finding that to establish coverage “the indemnitee need not establish that he would have lost the case; he need only establish that given the circumstances affecting liability, defense and coverage, the settlement was reasonable.”). Settlement agreements usually contain a clause stating that the defendant does not admit liability, but such disavowals of liability are not germane to proving whether coverage should apply. Instead, what governs in these circumstances effectively are the allegations – or more accurately the risk of adverse factfinding. See St. Paul Fire & Marine Ins. Co. v. American Int’l Specialty Lines Ins. Co., 365 F.3d 263, 274 (4th Cir. 2004) (“AISLIC contends that the lack of any judicial determination that Merritt’s injuries resulted only from ordinary negligence prevents any classification of the settlement liability for indemnification purposes. But AISLIC cites no authority for this proposition, and our independent review indicates that the weight of authorities would allow an indemnification claim to rely on a settled liability. Moreover, courts have relied on the type of fault asserted in the claims against the indemnitee in order to determine whether the relevant acts or omissions fall within the scope of restrictive language of fault contained in the indemnification agreement.”); American Motorists Ins. Co. v. General Host Corp., 946 F.2d 1482, 1489 (10th Cir. 1991) (determining duty to indemnify based on allegations in underlying complaint where no evidence settlement encompassed claims beyond those alleged in complaint); Northland Cas. Co. v. HBE Corp., 160 F. Supp. 2d 1348, 1360 (M.D. Fla. 2001) (“the duty to indemnify is measured by the facts as they unfold at trial or are inherent in the settlement agreement”); McNally & Nimergood v. Neumann-Kiewit Constructors, Inc., 648 N.W.2d 564, 578 (Iowa 2002) (crediting allegations in denying indemnity where settlement of claim was limited to such allegations, holding “an indemnitee cannot transform the underlying claim by the injured party into a different lawsuit by making [different] allegations”); Hyatt Corp. v. Occidental Fire & Cas. Co., 801 S.W.2d 382, 388 (Mo. App. 1991) (“In negotiating a settlement an insured need only be able to: ‘take into consideration the likelihood of success or failure, the cost, uncertainty, delay, and inconvenience of trial as compared with the advantages of settlement.’”) (quoting Berke Moore Co. v. Lumbermens Mut. Cas. Co., 185 N.E.2d 637, 639 (Mass. 1962));United States Gypsum Co., v. Admiral Ins. Co., 643 N.E.2d 1226, 1244 (Ill. App. 1994) (“[I]n order to recover a settlement, the insured need not establish actual liability to the party with whom it has settled so long as a potential liability on the facts known to the [insured is] shown to exist”) (internal quotations omitted); Luria Bros. & Co. Alliance Assur. Co., 780 F.2d 1082, 1091 (2d Cir. 1986); Uniroyal Inc. v. Home Ins. Co., 707 F. Supp. 1368, 1378-79 (E.D.N.Y. 1988) (“A reasonable settlement binds the insurer to indemnify . . . [and] a settlement is reasonable when it reflects the probability of loss and the probable size of that loss”); Nordstrom, Inc. v. Chubb & Son, Inc., 820 F. Supp. 530, 535 (W.D. Wash. 1992), aff’d, 54 F.3d 1424 (9th Cir. 1995).
A policyholder’s denial of liability prior to settlement has no legal significance and does not amount to a found “fact” or admission. It does not eviscerate the duty to defend nunc pro tunc. The assumed verity of the allegations form the basis from which one infers what were the facts concerning the settled claim. As the Tenth Circuit held, “where a reluctant insurer fails to participate in an insured’s settlement discussions, and the insured becomes party to a global settlement agreement, the insured may be indemnified [by its insurance] for any amount of the total settlement package for which it can establish a reasonable anticipation of liability.” Vitkus v. Beatrice Co., 127 F.3d 936, 945 (10th Cir. 1997). It would be more than passing strange to permit insurers to wrongly deny coverage, which frees the insured to settle without the insurer’s consent or participation (Samson v. Transamerica Ins. Co., 30 Cal.3d 220 (1981)), and then allow the insurer to force the policyholder to take the plaintiff’s case and prove it against itself as a condition for pursuing coverage. This result applies as well with respect to insurers that have yet to wrongly deny coverage. As the Tenth Circuit elaborated:
[There are] two important policy considerations in adopting a legal standard that requires courts to examine only the potential exposure of the settling party, rather than the actual liability of that party. First, if actual liability were the applicable standard, settling defendants would be in the ‘hopelessly untenable position of having to refute liability in the underlying action until the moment of settlement, and then turn about face to prove liability in the insurance action.’ [citation omitted] Second, requiring an insured to prove the case brought against it in order to receive insurance coverage would dissuade the insured from settling the underlying litigation. Faced with the choice of vigorously defending the underlying tort action or settling it without the hope of insurance coverage, the insured would choose the former. [citation omitted]
Vitkus, 127 F.3d at 945.
This rule works in favor of insurance companies, too, when they pay a claim and then seek subrogation; insurers are not required to prove that the payment made actually was covered by the insurance policy but only that it had a “reasonable basis for believing that it was obligated to provide coverage.” Id. at 943.
Policyholders thus are free to defend the cases against them, and then if they decide it is reasonable to settle the case, they may seek to prove their coverage cases later under a standard of proof that liberally construes the factual allegations in a manner that favors coverage. While this approach sometimes is criticized as collapsing the duty to indemnify standard, which typically is based on the actual facts, cf., Servidone Construction Corp. v. Security Ins. Co., 477 N.E.2d 441, 445 (N.Y. 1985), any other rule would work an absurd result. (This favorable factual presumption applies also to general verdicts, Hogan v. Midland Nat’l Ins. Co., 476 P.2d 825, 833 (Cal. 1970), and to default judgments, State v. Nat’l Auto Ins. Co., 290 A.2d 675 (Del. Ch. 1972); Nixon v. Liberty Mut. Ins. Co., 120 S.E.2d 430 (N.C. 1961).) Where the insured reasonably settles a matter, the factual matters that are actually or implicitly at issue are construed to be within coverage. To the extent their coverage defenses otherwise have been preserved, insurers remain free to assert that policy terms bar coverage to the facts as construed favorably to the insured, but they are not free to require the litigation of the facts where litigation was reasonably avoided in the liability action due to the insured’s settlement of the claim against it.
Note: A version of this commentary was published in Insurance Coverage Law Bulletin (March 2006) at 5 and is available also via Law.Com