On July 21, 2015 a sharply divided (and short-handed) Pennsylvania Supreme Court ruled 3-2 that an insurer defending an insured subject to a reservation of rights may be required to reimburse its insured for any “fair and reasonable” settlement its insured enters into even when the insurer does not consent to the settlement, and even where the insurer has not acted in bad faith. Babcock & Wilcox Co., et al. v. American Nuclear Insurers, et al., 2015 Pa. LEXIS 1551, No. 2 WAP 2014. The Court, however, did not give carte blanche to insureds to settle without insurer consent. Instead, the Court held that such a right is “limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and, thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” In other words, the Court held that an insurer defending under a reservation of rights either must (1) consent to and pay a fair and reasonable settlement offer presented to its insured, (2) withdraw any reservation of rights, or (3) risk having to reimburse its insured who settles without consent if the claim is found to have been covered under the policy. As the dissent emphasized, the Court’s ruling represents a substantial abrogation of the contractual rights of insurers under Pennsylvania law, which previously permitted policyholders to circumvent the “voluntary payments” provisions of typical liability policies only where their insurers were guilty of having acted in bad faith conduct in failing to settle the underlying claim.
Babcock & Wilcox (“B&W”), along with ARCO, had been sued in a long-running class action involving over 500 plaintiffs claiming bodily injury and property damage from alleged emissions from the defendants’ nuclear faculties. B&W’s insurer, ANI, had provided an aggressive defense, subject to a reservation of rights, expending more than $40 million over the course of two decades, pursuant to a policy with $320 million in limits (which were eroded by defense costs). The policy contained a standard consent to settlement/cooperation clause that provided, inter alia, that “[t]he insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense.”
Believing that there was a strong likelihood of a obtaining a complete defense judgment, and seeking to discourage potential “copycat” claims, ANI rejected all settlement offers presented. B&W, which for some time had been pressuring ANI to settle, entered into an $80 million settlement (well within the $280 million remaining policy limits) without ANI’s consent. B&W then sued ANI in state court for reimbursement of the settlement amount.
In the trial court, ANI contended that it had no obligation to reimburse Babcock & Wilcox because B&W breached the policy’s consent to settle requirement. Relying upon Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa. 1957) (holding that “an insurer must pay a judgment in excess of policy limits for its bad faith failure to settle below policy limits”), ANI argued that, under Pennsylvania law, an insurer could only be required to reimburse its insured for a settlement reached without its consent if the insurer acted in bad faith in refusing to settle. By contrast, B&W, framing the argument as one of first impression in Pennsylvania, and relying on case authority from other states, argued that an insurer is obligated to reimburse its insured for any fair and reasonable settlement entered into in good faith, regardless of a cooperation clause.
The trial court eventually held that “an insurer, defending subject to a reservation of rights, is required to reimburse an insured for a settlement reached in violation of the consent to settle clause where coverage is found to exist and the settlement is ‘fair and reasonable’ and made in ‘good faith and without collusion.’” Applying this standard, a jury found that the settlement reached between B&W and the underlying plaintiffs was reasonable and, accordingly, ANI was obliged to reimburse B&W.
ANI appealed and the Pennsylvania Superior Court reversed and adopted Florida’s “insured’s choice” test where an insured can either: 1) accept a defense pursuant to a reservation of rights and be bound by a consent to settlement provision provided that the insurer does not act in bad faith; or 2) reject a defense pursuant to a reservation of rights and, if coverage is found, hold the insurer is liable for defenses costs and the costs of any reasonable settlement.
The Supreme Court, in turn, reversed the Superior Court’s decision, holding that the “insured’s choice” test is irreconcilable with Pennsylvania law because an insured’s rejection of a defense under a reservation of rights relieves an insurer of its coverage obligation. Further, the Court criticized the “insured’s choice” as being largely illusory because many, if not most, insureds lack resources to fund an adequate defense. The Justices, however, diverged sharply as to what the applicable test should be for “determining whether an insurer is liable under its insurance policy for a settlement made by its insured without securing the insurer’s consent, when the insurer is defending the claim subject to a reservation of rights.” After reviewing the policy arguments proffered by the parties and their amici, and examining how courts in other jurisdictions have approached the issue, the Court held that “where an insurer defends subject to a reservation of rights and breaches its duty to settle . . . an insured may accept a settlement over the insurer’s refusal where the settlement is fair, reasonable, and non-collusive.” The Court’s holding was limited to situations when an insurer is defending under a reservation of rights and – because of the nature of the particular reservation of rights – its interests diverge from those of its insured. In such a situation, the “determination of whether the settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured’s defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured.” Here, the Court held that its new standard had been satisfied and reinstated the trial court’s judgment requiring ANI to reimburse B&W for the $80 million settlement.
In dissent, Justice Eakin, joined by Chief Justice Saylor, vociferously criticized the majority’s adoption of the “fair and reasonable” standard. In the dissenting Justices’ view, this was not a case of first impression at all. Rather, the dissenters insisted that the outcome of the case clearly was governed by the holding of Cowden, imposing liability for an excess verdict where the insurer’s failure to settle within policy limits was in bad faith. In the dissenters’ view, so long as ANI’s decision to continue defending rather than settling the underlying litigation was made in good faith, ANI was within its right to do so. The dissenting Justices criticized the new standard adopted by the Majority:
[The “fair and reasonable” standard] allows an insured to breach the contract’s requirement that the insurer must consent to any settlement when the insured anticipates an excess future verdict and, as a practical matter, permits the insured to determine for itself (in the first instance) that the insurer acted unreasonably in refusing to settle.
The majority repeatedly emphasized that not all reservations of rights are created equal, and that whether an insurers’ refusal to settle or give up its reservation of rights constitutes a policy breach must be examined on a case-by-case basis. The Court also admonished that settlements be closely vetted to ensure that they are in fact reasonable under the circumstances and non-collusive. Despite these cautionary notes, policyholders will doubtless argue that this decision gives them a broad license to settle over insurer objection, ultimately with an insurer’s money, whenever an insurer is defending subject to a reservation of rights that might defeat or limit coverage. Moreover, this decision, together with the Court’s ruling in December 2014 in Allstate Property and Cas. Ins. Co. v. Wolfe, 90 A.3d 699 (Pa. 2014), that statutory insurance bad faith claims are assignable, threaten to seriously undermine the insurer’s bargained-for rights to control the defense and settlement of claims against their policyholders.