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Pennsylvania Supreme Court Adopts New Rule in Breach-of-the-Consent-to-Settle-Clause Cases

Insurance Coverage Alert | August 19, 2015
By: Sean Mahoney

In Babcock & Wilcox Company, et al. v. America Nuclear Insurers, et al., the Pennsylvania Supreme Court recently held that where a liability insurer has agreed to provide a defense to its insured in an underlying tort action subject to a reservation of rights but refuses to consent to a settlement in that action, the insured may nevertheless accept the settlement over the insurer’s objection where the settlement is “fair, reasonable, and non-collusive” from the perspective of a reasonably prudent person in the insured’s position in light of the totality of the circumstances and is covered. Babcock & Wilcox Company v. America Nuclear Insurers, No. 2 WAP 2014, 2015 WL 4430352 (Pa. Jul. 21, 2015). This decision fills an important gap in Pennsylvania precedent addressing the rules applicable when an insurer refuses to consent to an insured’s settlement of a lawsuit.

In Babcock, the underlying plaintiffs sued Babcock & Wilcox Company and Atlantic Richfield Company (“the Insureds”) alleging that the Insured’s nuclear facilities caused bodily injury and property damage. The Insureds’ liability insurers agreed to defend the Insureds subject to a reservation of rights. The insurers later refused to consent to an offer to settle the underlying action for a total of $80 million because they believed the Insureds were likely to succeed on the merits. Nevertheless, in 2009, the Insureds accepted that offer and settled the underlying action for $80 million, notwithstanding the insurer’s refusal. The Insureds then sought reimbursement of the $80 million settlement from their insurers, who rejected that request on the ground that the Insureds had breached the consent-to-settlement/cooperation provisions of the implicated policies.

In the ensuing litigation, the Pennsylvania Supreme Court ultimately granted review to consider whether an insured forfeits insurance coverage by settling a tort claim without the consent of its insurer, when the insurer defends the insured subject to a reservation of rights. The Supreme Court considered three possible approaches to answering this question:

    • The Morris Approach: the insurer must cover the settlement despite its refusal to consent so long as coverage applies, the settlement is fair and reasonable, and it is entered into in good faith. Compare U.S. Auto Association. v. Morris, 741 P.2d 246 (Ariz. 1987);
    • The Vincent Soybean Approach: the insurer is only obligated to cover the settlement despite its refusal to consent if the insurer acted in bad faith in refusing to settle. Compare Vincent Soybean & Grain Company v. Lloyd’s Underwriters, 246 F.3d 1129 (8th Cir. 2001); and
    • The Taylor Approach: where the insurer elects to defend under a reservation of rights, the insured has the options of either (1) accepting the insurer’s defense and being bound by the consent-to-settlement clause, or (2) declining the insurer’s defense, furnishing its own defense at its own expense, and settling as it sees fit. Under this approach, if coverage is found, the insurer is obligated to reimburse the insured’s defense costs and the costs of settlement, so long as those costs are fair, reasonable, and non-collusive.

It is noteworthy that the trial court adopted the Morris Approach and that the Superior Court of Pennsylvania rejected the Morris Approach in favor of the Taylor Approach. 

The Supreme Court, however, rejected the Taylor Approach as inconsistent with Pennsylvania precedent, because Pennsylvania law does not allow the insured to “reject” the insurer’s defense without breaching the policy and releasing the insurer from its coverage obligation.

Ultimately, the Supreme Court adopted a variation of the Morris Approach, “limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” Babcock, supra, 2015 WL 4430352 at *16. The Court explained that the determination of whether the settlement is “fair and reasonable” “necessarily entails 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.” Id. In the event the settlement is indeed fair and reasonable, then the insurer is only responsible for the settlement up to its policy limits. Id.

The Babcock decision now fills a gap in the existing Pennsylvania precedent addressing various scenarios in which an insurer refuses to settle the insured’s case. Cowden v. Aetna Casualty and Surety Company, 134 A.2d 223 (Pa. 1957) addresses the situation in which an insurer defending its insured refuses – in bad faith – to settle within policy limits, and then the insured is eventually held liable for a verdict in excess of the policy limits. In this scenario, the insurer can be liable for the entire amount of the verdict, even if the verdict is in excess of the policy limits. Alfiero v. Berks Mutual Leasing Company, 500 A.2d 169 (Pa. Super. 1985) addresses the situation in which an insurer wrongfully refuses to defend the insured at all, and then the insured settles the underlying action without the insurer’s consent. In this scenario, the insured is free to negotiate a settlement as it sees fit, and the insurer can be held to cover the settlement so long as it was fair, reasonable, and in good faith. Now, Babcock complements these two decisions by setting the parameters of an insurer’s potential liability for a settlement to which it declined to consent where the insurer had not breached the policy and continued to defend its insured under a reservation of rights. In that case, provided the settlement is fair, reasonable, and non-collusive from the perspective of a reasonable person in the insured’s position under all of the circumstances, and the settled claims are covered by the policy, the insurer can be liable up to the policy limit for the settlement.

For additional information on these matters or questions involving insurance coverage, please contact Sean Mahoney (215.864.6342; mahoneys@whiteandwilliams.com).

This correspondence should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult a lawyer concerning your own situation and legal questions.
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