I’ve always found it interesting that some very important coverage issues elude judicial review, while inconsequential ones get answered. Riddle me this: Why has the question whether bat guano is excluded by the pollution exclusion been addressed by three courts?

Once such significant coverage issue that wants for more judicial guidance is this: An insurer disclaims coverage for a defense. The insured now goes ahead and settles the underlying action. And it does so for an amount in excess of its policy’s limits of liability. It is ultimately determined that the insurer breached the duty to defend, but not in bad faith, and the insurer is obligated to indemnify the insured by paying the settlement amount. So far this is neither an unusual nor complex scenario. But here’s the rub: Does the insurer’s obligation to indemnify the insured include the portion of the settlement amount that exceeds the policy’s limits of liability? There is surprisingly little law addressing this not uncommon scenario. This question was one before the Missouri Supreme Court in Columbia Casualty Company v. Hiar Holdings, LLC.

Note that I am not speaking of a situation where an insurer refuses to settle an action, when there is a demand to do so that is within the limits of liability, an excess verdict comes in, and it is ultimately determined that the insurer should have settled, based on the liability and damages at issue. Here the insurer stands to be liable for the full amount of the verdict, even the portion in excess of the limits of liability. The situation in Hiar is one where the insurer’s refusal to settle was based on its determination that no coverage was owed.

Hiar Holdings LLC, a hotel, used a marketing services company to send approximately 12,500 unsolicited “junk faxes.” About 10,000 of them were received, including one by Karen S. Little LLC, which brought a class action against Hiar, under the TCPA, seeking injunctive relief and statutory damages of $500 per fax sent.

At the time it sent the junk faxes, Hiar was insured by Columbia Casualty Company under a commercial general liability policy with limits of $1 million per “occurrence” and $2 million aggregate. Hiar tendered defense of the suit to Columbia Casualty. The insurer refused to defend, asserting that the claims were outside the policy provisions. The class made a settlement offer to Hiar for an amount within its policy limits. Hiar presented the demand to Columbia Casualty, which again refused to defend or cover the claims and the insurer refused to participate in subsequent settlement negotiations. Hiar defended the suit at its own expense for five years before agreeing to a class-wide settlement for $5 million.

A final settlement approval hearing was held and the trial court approved the settlement, including determining that the settlement was fair, reasonable and not a product of collusion. The court entered a judgment for the class and approved Hiar’s assignment to the class of its claims against Columbia Casualty and any other insurers. The settlement amount plus interest totaled $8.4 million. The class brought a garnishment action against Columbia Casualty seeking the settlement amount plus post-judgment interest. Columbia Casualty filed a declaratory judgment action concerning its duties to defend and indemnify the class’s claims under the policy. The garnishment action was stayed pending resolution of the declaratory action.

To make a long story short, the Missouri Supreme Court, in the coverage action, examined a multitude of TCPA coverage issues and concluded that the trial court did not err when it determined that “property damage” and “advertising injury” coverage was owed under the Columbia Casualty policy and the insurer’s duty to defend was triggered.

Columbia Casualty argued that the settlement amount was not reasonable. The Missouri Supreme Court was not persuaded. “Columbia cannot refuse to defend and then relitigate the already-determined reasonableness issue where it has been the subject of a court judgment after a hearing and determination of reasonableness by the court. . . . The reasonableness hearing conducted by the trial court was sufficient to form and support its findings that the settlement was made in good faith and reflected ‘what a reasonably prudent person in the position of the [d]efendants would have settled for on the merits of [the class’s] claims.’ Columbia is not entitled to a reassessment of the reasonableness of the settlement.”

Now, to the most important issue. Columbia Casualty owed coverage, but for how much, since the settlement amount was well above the $1 million per “occurrence” and $2 million aggregate limit?

Columbia Casualty argued exactly what you would expect. “[I]t need not indemnify the class’s settlement because the trial court erred by finding that Hiar’s policy limits ‘do not matter.’ Columbia contends that the trial court wrongly awarded extra-contractual damages, even though the class made no request for extra-contractual damages, Hiar released its counterclaims for extra-contractual damages, and Columbia’s maximum indemnity obligation was $2 million in the absence of a successful extra-contractual damages claim. Columbia asserts that only a ‘bad faith’ claim could result in the award of extra-contractual damages, and it maintains that no ‘bad faith’ allegation was presented in this case.”

The Missouri Supreme Court did not accept Columbia Casualty’s show-me effort. The court held that Columbia Casualty’s wrongful refusal to defend Hiar put it in a position to indemnify Hiar for all damages flowing from its breach of the duty to defend. “Because Columbia wrongly denied coverage and even a defense under a reservation of rights, and also refused to engage in settlement negotiations, Columbia should not avoid liability for the settlement judgment entered in this case. Columbia cannot benefit from its wrongful refusal to assume control of the proceedings. As such, the trial court did not err in determining Columbia’s liability for the class’s settlement.”

The Missouri Supreme Court is correct that Columbia Casualty must face consequences for what was ultimately determined to be a wrongful refusal to defend. But to hold Columbia Casualty liable, under this scenario, for a settlement that exceeds (by a lot) its limits of liability, goes too far. Insurers are entitled to assert coverage defenses. And they need to take care when applying such defenses. But to saddle an insurer with these kind of consequences (limits “do not matter”), for a breach of the duty to defend, is a de facto taking away of this right. The duty to defend is broad – but not boundless. This situation called for a remedy, but not an extra-contractual one. [Even the ALI Principles, discussed herein, would not have held the insurer liable for the amount of the settlement in excess of the limit of liability.]

Of course, Hiar was not the only decision in 2013 to place harsh consequences on an insurer that breached a duty to defend. The most talked-about one was from the New York Court of Appeals in K2 Investment Group, LLC v. American Guar. & Liab. Ins. Co., where the Empire State’s top court held that an insurer, that wrongfully fails to defend its insured, loses the right to rely upon policy exclusions for purposes of determining its indemnity obligations. In September the Court of Appeals granted re-argument in K2.

Another decision in 2013 to change the equation concerning an insurer’s duty to defend – and here the insurer was agreeing to defend --was the Pennsylvania Superior Court’s in The Babcock & Wilcox Company v. American Nuclear Insurers. The court held that an “insured may decline the insurer’s tender of a qualified defense [read as, defense under an ROR] and furnish its own defense, either pro se or through independent counsel retained at the insured’s expense. In this event, the insured retains full control of its defense, including the option of settling the underlying claim under terms it believes best. Should the insured select this path, and should coverage be found, the insured may recover from the insurer the insured’s defense costs and the costs of settlement, to the extent that these costs are deemed fair, reasonable, and non-collusive.”