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Vol. 3, Iss. 3
February 12, 2014


No “K2” Mountain To Climb:
Circuit Court Of Appeals Does Not Penalize Insurer For Breaching The Duty To Defend


Lately I’ve seen a trend in courts harshly penalizing insurers for breaching the duty to defend – and in situations where the breach was not in bad faith. Of course there is going to be some consequence for insurers that are found to have breached their duty to defend. I’m talking here about consequences that go above and beyond what you usually see in such scenarios.

For example, in 2013, the Missouri Supreme Court held in Columbia Casualty Company v. Hiar Holdings, LLC that, if an insurer breaches its duty to defend, its obligation to indemnify the insured includes the portion of the insured’s settlement amount that exceeds the policy’s limits of liability. Last year, in K2 Investment Group, LLC v. American Guar. & Liab. Ins. Co., New York’s top court held that an insurer, that wrongfully failed to defend its insured, lost the right to rely upon policy exclusions for purposes of determining its indemnity obligations. [Re-argument granted.]

The Pennsylvania Superior Court’s 2013 decision in Babcock & Wilcox Company v. American Nuclear Insurers did not involve a breach of the duty to defend (the insurer was defending). However, the court changed the equation concerning an insurer’s duty to defend. 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.” [Appeal granted, but not on this issue.]

And just last week the Fourth Circuit held in Graham v. National Union that an insured can present evidence of aggravation and inconvenience suffered in connection with seeking damages for a breach of its insurer’s duty to defend.

One day after Graham was decided the Eleventh Circuit also addressed what happens when an insurer breaches the duty to defend. Here the court did not saddle the insurer with any consequences – other than the most basic -- for breaching the duty to defend.

Nationwide Mutual Ins. Co. v. Sharif, No. 13-11151 (11th Cir. Feb. 4, 2014) (Alabama law) involved a duty to defend issue under the following tragic circumstances. Moshen Musa, age sixteen, worked at Bashir Abdosale Mohammed’s grocery store. Musa and Tawfiq Ahmed Sharif were standing in the cash-register area of the store near closing time. Mohammed stored a pistol under the cash register for protection. Musa and Sharif each handled the pistol, mistakenly believing it to be unloaded. While Musa was handling the pistol it discharged and killed Sharif.

Sharif’s estate sued Musa and Mohammed in state court. Nationwide declined to defend them because it believed that the employment exclusion applied. Sharif asserted two alternative sets of claims, the first assuming that Tawfiq was not an employee of Bashir’s and the second assuming that he was. Prior to trial, Musa and Mohammed moved to dismiss the second set of claims due to a lack of evidence that the decedent was an employee of Bashir’s. The court granted the motion. The court conducted a bench trial and ultimately entered a joint-and-several judgment against Musa and Mohammed in the amount of $950,000. Now in federal court, after Nationwide filed a coverage action, Sharif sought to recover this judgment from Nationwide.

The district court ordered a bifurcated trial to first decide whether Nationwide was liable under the policy. If so, the question would be whether Nationwide handled Bashir’s claim in bad faith. The jury found that Nationwide breached the policies by failing to defend Musa and Mohammed in the state liability action. However, the jury also found that the employment exclusion eliminated any duty to indemnify. The jury awarded Musa and Mohammed $9,000 in compensatory damages -- the cost of their defense in the liability action. Musa and Mohammed filed a motion for judgment as a matter of law, arguing that it was inappropriate for Nationwide to attempt to prove that Sharif was an employee of Bashir’s in light of the state court’s contrary finding. The district court denied the motion and found collateral estoppel inapplicable because “the privity element had not been established.” A determination was also made that Nationwide’s breach of the duty to defend was not in bad faith.

The case proceeded to the Eleventh Circuit, which addressed the privity issue: “Nationwide was not a party to the state-court action, which involved only [Musa and Mohammed[ on one side and Sharif, as administrator of the decedent’s estate, on the other. [Musa and Mohammed] must therefore show that they and Nationwide were in privity. The test for determining if two parties are in privity focuses on identity of interest. Nationwide’s interests were not identical to [Musa and Mohammed] on the issue of the decedent’s employment status because a finding that the decedent was employed by Bashir’s would trigger the employment exclusion and eliminate Nationwide’s duty to indemnify. In this way, Nationwide’s and [Musa and Mohammed’s] interests were opposed rather than identical. Thus, [Musa and Mohammed] cannot show they were in privity with Nationwide with respect to the coverage action, and collateral estoppel is not appropriate.” (citations and internal quotes omitted).

Musa and Mohammed also cited numerous authorities for the proposition that Nationwide, having refused to fulfill its duty to defend them in the liability action, should now be bound by the findings rendered in that proceeding in a subsequent action for coverage. However, the Eleventh Circuit noted that the Supreme Court of Alabama has rejected such a rule. The appeals court stated: “The cases [Musa and Mohammed] cite concern an insurer’s attempt to prove in a coverage action that the insured was not liable in the first place after having failed to assert this argument on the insured’s behalf in the underlying liability action. . . . In the instant case, Nationwide did not attempt to prove [Musa and Mohammed] were not liable for the decedent’s death. Rather, Nationwide sought to prove that the policies do not cover such liability because of the applicability of the employment exclusion. Accordingly, [Musa and Mohammed’s] argument is without merit.

In summary, Nationwide breached the duty to defend (but not in bad faith). It was obligated to pay the $9,000 that its insureds incurred to defend themselves. Nationwide was then not precluded from raising a coverage defense for purposes of the determination of its indemnity obligation – even when the fact issue concerning the coverage defense had been decided the other way in the liability action. Needless to say, courts vary in how they respond to insurers’ breaches of the duty to defend.

 
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