In an issue of first impression, the Supreme Court of Pennsylvania recently addressed whether an insured forfeits the right to insurance coverage when it settles a lawsuit without the insurer’s consent, in a case where the insurer has defended the suit subject to a reservation of rights.
In Babcock & Wilcox v. American Nuclear Insurers, the Court answered that question in the negative and adopted a fair and reasonable standard limited to those cases where an insured accepts a settlement offer after and insurer breaches its duty by refusing a fair and reasonable settlement while maintaining its reservation of rights, thereby subjecting the insured to potential responsibility for the judgment in a case where the policy is ultimately found to provide coverage.
In Babcock, the insured was a defendant in a class action lawsuit brought by plaintiffs alleging bodily injury and property damage from emissions from nuclear facilities. The insurer accepted defense of the suit pursuant to a reservation of rights asserting that the policy did not cover damages not caused by nuclear energy hazard, damages in excess of the policy limits, and claims for injunctive and punitive relief. The insurer then filed a declaratory judgment action in state court. The court stayed some issues, but did make a determination that the suit triggered coverage.
During the litigation of the class action, the insurer refused to consent to multiple settlement offers because it believed there was a strong likelihood of a defense verdict. After the litigation had continued for a number of years, the insured settled with the class action plaintiffs without the insurer’s consent for $80 million, which was less than the $320 million in potential coverage. The policy at issue provided that any defense fees and costs were included in the liability limits and, at that point in time, the insurer had already paid $40 million in defense fees.
The insureds filed suit against the insurer in state court for reimbursement of the settlement amount from the insurer. The insurer argued that the standard consent to settlement clause in the policy precluded coverage for the settlement, since the insured breached the contract when it settled without the insurer’s consent. The jury in the trial court found in favor of the insured and the insurer appealed to the Superior Court, which reversed the judgment of the trial court. The insured then filed the appeal at issue.
This case presented the issue of under what circumstances will a court require an insurance company, whose policy provides coverage, to reimburse an insured that settled the underlying litigation over the objections of the insurer in a case involving a standard consent to settlement clause when the insurer is defending the insured pursuant to a reservation of rights. The insured and insurer presented competing standards for the court to apply in deciding the issue; specifically, the Morris fair and reasonable standard and the Cowden bad faith standard.
The insured argued for application of the Morris standard, based on the case of USAA v. Morris, 741 P.2d 246 (Ariz. 1987), which held that an insurer should reimburse insureds for settlements so long as coverage applies and the settlement is fair, reasonable, and entered into in good faith. On the other hand, the insurer advocated for application of the Cowden standard, based on the Pennsylvania case Cowden v. Aetna, 134 A.2d 223 (1957), which held that the obligation to pay the settlement could only be imposed on the insurer if it acted in bad faith in refusing to settle.
In deciding which standard to use, the Court reviewed how Pennsylvania courts have addressed related disputes between insurers and insureds pertaining to pretrial settlement offers as well as other jurisdictions’ approaches to settlement absent the insurer’s consent in reservation of rights cases. After intensive analysis, the Court adopted a variant of the Morris fair and reasonable standard that is limited to those cases where an insurer defends subject to a reservation of rights and breaches its duty to settle in a case where the policy is found to provide coverage for the relevant claims.
Under this new standard, the court held that in such cases, an insured may accept a settlement over the insurer’s refusal where the settlement is fair, reasonable, and non-collusive. In applying this standard, the factfinder should determine whether the settlement was fair and reasonable from the perspective of a reasonably prudent person in the same position as the insured and in light of the totality of the circumstances.
Viewing the record, the Court determined that the jury correctly employed this standard is reaching its verdict in favor of the insurer and reinstated the judgment of the trial court.
