In the August 26th issue of Coverage Opinions I wrote that, despite the fact that the insurer in The Babcock & Wilcox Company v. American Nuclear Insurers (Pa. July 21, 2015) lost the case, the Pennsylvania Supreme Court’s decision “will go down as a case that provided significant benefits for insurers as a whole.”

I received the following Letter to the Editor from long-time insurance coverage lawyer and scholar Bill Barker of Dentons US, LLP disagreeing with my conclusion:

To the Editor:

I write in response to your commentary (and the included comments of Justice Stanley Feldman) on Babcock & Wilcox v. American Nuclear Insurers. You treat this as a victory for insurers because it preserves some of an insurer’s rights: the right to contest coverage and the right to challenge the reasonableness of the insured's settlement. But those are no gifts to insurers: an insurer that performs its duty to defend is never obliged under the contract to pay for a noncovered loss and is never obliged to pay for more than the insured is liable for. Moreover, the rule adopted in Babcock & Wilcox strips the insurer of another valuable right reserved in the contract: the right to exercise its own judgment about the reasonable settlement value of the claim against the insured (subject to liability if an unreasonable judgment subjects the insured to an excess judgment). Loss of that right is hardly a victory, except in the sense that insurers are supposed to be grateful that even more rights were not taken away.

Justice Feldman suggests that loss of the insurer’s rights might be justified on the ground that it has committed an anticipatory breach by ‘erroneously refus[ing] to acknowledge its duty to indemnify.’ But a reservation of rights is not an anticipatory breach. It presupposes that the suit asserts both (1) claims which may be covered (and which the insurer would bound to defend and indemnify) and (2) noncovered claims (which it must defend but is not obliged to indemnify). A reservation of rights simply alerts the insured to the limits which are or may be imposed by the insurance policy on the duty to indemnify. It does not refuse anything, but merely notes where indemnification may be questionable. That allows the insured to take such questions into account in deciding whether to relinquish control of the defense and how extensively to engage with defense counsel regarding the defense. A reservation is a way to preserve the rights of all parties to the contract, not in any sense a repudiation.

Justice Feldman argues that ‘there is no policy language that gives the insurer the simultaneous right to refuse to acknowledge the duty to indemnify while at the same time retaining control of the defense.’ But he certainly agrees that the insurer has a duty to defend all claims in any suit that alleges any covered claim. The right to defend is coextensive with the duty to defend, so the insurer does have a right to defend (and therefore to control the defense of) any suit alleging both covered and noncovered claims. And there is no language that conditions that right on acknowledging a duty to indemnify noncovered claims.

You suggest that the insured must have some way of protecting against the risk of liability for the noncovered claims. And there is such a way. The contractual settlement restrictions do not absolutely forbid the insured to settle, but simply require that any settlement not consented to by the insurer be at the insured’s own expense. The insured is thus free to settle any noncovered claims by purchasing a covenant not to execute, leaving the insurer to defend the entire suit and, if a judgment results, to litigate the extent of coverage for that settlement. The insurer has no obligation to contribute to the settlement of noncovered claims, so it is appropriate to require that any such settlement be made solely at the insured’s expense.

In the end, American Nuclear Insurers waived all coverage defenses except for the settlement restrictions, so the court was able to treat the case as one where there was no coverage issue. But that was not the situation at the time the settlement occurred. And, if there really were no coverage issue, there is no reason why the insured ought not be required to simply await the judgment and (if the insurer’s settlement decision was imprudent) insist that the insurer pay any excess. (See WILLIAM T. BARKER & RONALD D. KENT, INSURANCE BAD FAITH LITIGATION, SECOND EDITION § 4.02[2][b]) Admittedly, that is a minority rule. But even the majority rule divests the insurer’s right to control settlement only if it refused a settlement that, had an excess judgment resulted, the refusal would have subjected the insurer to liability. And the latter rule (what in Pennsylvania is the Cowden test) was all that American Nuclear Insurers sought. By rejecting that rule, the court frees insureds to settle for an amount that the insurer could properly regard as excessive.

The result is to inflate settlement values, at the insurer’s expense. The inflation is limited in cases, like Babcock & Wilcox, where the insured actually pays cash for the settlement. But there is still room in determining reasonableness to inflate the value of the covered claims and correspondingly diminish the value of the noncovered claims. Insurers believe that courts are inclined to favor settlements that clear dockets and compensate injured parties and are not overly concerned with what is covered and what is not. Whether or not insurers are right about that, they value highly the right to make their own judgments, instead of being subjected to a court's post-settlement evaluation of reasonableness. The value of that right enters into the determination of the premium, and its is wrong for a court to deprive insurers of that right in cases where they are fully performing the duty to defend.

In closing, I note that you put aside the question of settlements made not in cash but for an assignment of rights. But few insureds have the funds to settle in cash, so almost all settlements that will seek to take advantage of the Babcock & Wilcox rule will involve assignments of rights. In such cases, the insured has no reason to resist inflation of the settlement amount, so the only limit on the plaintiff is how much counsel thinks might get past a reasonableness review. The predictable result would be substantial inflation of settlement amounts, inflation that insurers believe will not be adequately prevented by reasonableness review.

In no sense was the result in Babcock & Wilcox a victory for insurers.

Sincerely,

William T. Barker
Dentons US LLP
Chicago