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Federal Appeals Court: Duty To Defend = Duty To Indemnify
Must Read: Especially For Pennsylvania


I'm not sure what to make of the Third Circuit's recent decision in Liberty Mutual Insurance Co. v. Penn National Mutual Insurance Co., 2021 U.S. App. LEXIS 34378 (3d Cir. Nov. 18, 2021).

The facts are not complicated. Neither is the coverage issue before the court. And the court's decision is simply stated.

But the court's decision may have added a challenge for insurers, seeking to have coverage issues resolved, in the face of on-going underlying litigation. The case could raise this question: Does an insurer, that breaches the duty to defend, followed by a settlement by its insured (and/or another insurer of that insured), lose the opportunity to litigate certain coverage issues for purposes of determining duty to indemnify?  
Takeaways from this potentially important case are set out at the end.  
At issue in Liberty Mutual v. Penn National was coverage for a construction site fatality in Western Pennsylvania. An action for damages was brought against various parties, including Cost Company, a masonry subcontractor (insured by Liberty Mutual) and Pittsburgh Flexicore Company, which provided concrete panels (insured by Penn National). Liberty Mutual defended Cost and Penn National defended Flexicore (but did not defend Cost, as an alleged additional insured to the Penn National policy). The underlying action was settled, with both insurers participating in the settlement for their respective insureds.

Following the settlement, Liberty Mutual filed suit against Penn National, arguing that Cost was an additional insured under the Penn National policy, and sought reimbursement for the amounts it paid to defend Cost and settle the action. [Liberty Mutual had sought additional insured coverage for Cost, after the underlying action had been filed, but Penn National denied coverage for Cost.]  
The District Court held that, for purposes of duty to defend -- looking at the complaint allegations -- Cost qualified as an additional insured under the Penn National policy. The ins and outs of the additional insured issue, and why the court made that decision, are not relevant here. 

Having determined that Penn National owed a duty to defend Cost (which Penn National thus had breached), the court turned to whether Penn National owed a duty to indemnify. The court held that Penn National did – but, importantly, not because the facts at issue established that the terms of the additional insured endorsement were satisfied.

Rather, the lower court concluded that, because the settlement of the underling action involved multiple claims and multiple parties and multiple insurers, it could not be determined if the facts at issue satisfied the terms of the additional insured endorsement. Therefore, "the duty to indemnify follows the duty to defend."

The Third Circuit affirmed, including adopting the District Court's rationale that, because of the settlement, the duty to indemnify followed the duty to defend. It is worth reading the court's explanation verbatim:

"Unlike the duty to defend, the duty to indemnify requires a determination that the policy actually covered the claim at issue. . . . As a result, an insurer is entitled to an opportunity to introduce evidence that goes beyond the four-corners of the underlying tort complaint to prov[e] the applicability of [a] subject [policy] exclusion in the coverage action. This rule, however, does not mean that insurers may present all factual issues associated with the tort case for resolution as part of the insurance coverage action. Rather, where the underlying tort case has been settled, the insurers may seek resolution of only the factual disputes that would not have been resolved had the underlying tort suit been tried. Thus, where the coverage suit raises factual disputes about coverage that would have also been addressed in the settled underlying litigation, such disputes cannot be resolved in the coverage action. In such a situation, Pennsylvania law provides that the duty to defend itself triggers the duty to indemnify. See Linn, 766 F.2d at 766 (explaining that the duty to indemnify may follow the duty to defend where 'settlement ma[kes] it impossible to determine on what theories of liability, if any, the underlying claimants would have prevailed"')." (citations and internal quotes omitted and bold added).   
The appeals court agreed with the lower court that, because the settlement of the underling action involved multiple claims and multiple parties and multiple insurers, the coverage issue could not be resolved without factfinding. But since the underlying action had been settled, the court concluded that such factfinding could not take place. Translation, that there was a duty to defend (that was breached) meant that there was also a duty to indemnify. 
The court added this explanation for its rationale: "Were this not the case, 'an insurer would be able to settle a suit without an agreement with the insured, and attempt to avoid its duty to indemnify by claiming a jury would have found the claims in the underlying suit were not covered by the policy.' 12th St. Gym, Inc. v. Gen. Star Indem. Co., 93 F.3d 1158, 1167 (3d Cir. 1996)."

So what issues can insurers seek to have resolved, following a settlement, for purposes of determining whether it owes a duty to indemnify? The court provided an example based on a Pennsylvania Superior Court decision: In an underlying auto case, the coverage issue was whether the vehicle involved was a "temporary substitute vehicle." However, if the underlying case went to trial, the "temporary substitute vehicle" question would not have been relevant nor decided. Therefore, the settlement did not preclude the court from resolving whether the policy covered the claim.


On one hand, Liberty Mutual v. Penn National involves a dispute between two (settling) insurers over additional insured rights. While Penn National breached the duty to defend, the case had been settled and, presumably, the additional insured was covered and not affected by the dispute – which was between insurers over reimbursement for defense and indemnity.

But what about a more common situation.

Consider an insurer that declines to defend its insured. The insured, unable to defend itself and/or pay a judgment, settles with the plaintiff in exchange for an assignment of the insured's policy rights. The plaintiff, as assignee, now pursues the insurer for coverage. If the court holds that the insurer was obligated to defend, has the insurer now lost the ability to argue that it has no duty to indemnify, on the basis that the underlying action was settled, and the coverage issue, needed to determine the duty to indemnify, would have been addressed in such action?

While Liberty Mutual v. Penn National has nothing to do with that scenario, it would not be surprising that policyholders may would read it that way.

Of note, the court's rationale also focused on the insurance carrier settling without an agreement from the insured. But insurers that do not defend generally do not settle. Here, the fact that it was an insurer v. insurer situation gave rise to there being a settlement, despite a later-determined breach of the duty to defend. So the court's statement, about an agreement, may be limited to the facts here.  
Pennsylvania courts have long stated that insurers that decline to defend do so at their peril.    While the court did not make that statement, the decision can be read as consistent with that cautionary note. 

Liberty Mutual v. Penn National also speaks to the overall importance of insurers taking actions, to attempt to have coverage issues resolved or preserved, such as by declaratory judgment or intervention or in whatever manner is most appropriate for the scenario at issue. 


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