An insurer may be on the hook for a $14 million Telephone Consumer Protection Act suit, an Illinois appellate court has ruled.

The insurance dispute arose out of an underlying TCPA suit brought by Paul Idlas against Tracy’s Treasures, a company selling dating and social relationship services. Idlas filed a putative class action in March 2007 after receiving unsolicited faxed ads four years prior.

As the insured party under a number of primary and excess commercial liability policies issued by Central Mutual Insurance Company, Tracy’s Treasures tendered the complaint to the insurer. Central disclaimed coverage on several grounds but provided a lawyer as a “courtesy defense.” The insurer also filed a declaratory judgment action in state court seeking an order that it owed no duty to defend or indemnify Tracy’s.

A different lawyer filed a substitute appearance on behalf of Tracy’s and notified Central that he had been retained by the insured party in light of the conflict between Central and Tracy’s over coverage. Central consented to the substitution of counsel and paid the attorney a reasonable fee.

Even prior to writing to Central and filing an appearance with the court in the TCPA case, however, the attorney was discussing settlement with Idlas’ counsel. The parties subsequently filed a motion for preliminary approval of a settlement agreement providing for entry of a $14 million judgment against Tracy’s, enforceable only against Central’s policies. Central was not provided with notice of the deal.

In addition to providing pro rata cash payments to class members, the agreement expanded the class definition to include a period of time prior to when Idlas received his fax from Tracy’s and outside the statute of limitations applicable to TCPA claims. The updated class definition triggered an additional $5 million excess policy issued by Central.

The federal court judge overseeing the TCPA case granted final approval in May 2008.

In the declaratory judgment action, Central filed for summary judgment, arguing that neither coverage nor indemnification was required for the Idlas suit because TCPA awards constitute punitive damages. A trial court agreed.

Citing a subsequent decision from the Illinois Supreme Court that TCPA damages are not punitive in nature and insurable under state law, an appellate panel reversed.

The court also rejected Central’s contention that its policies did not cover liquidated damages such as those under the TCPA, which do not represent actual losses. Damages include all money necessary to right a wrong, the panel wrote, and the “fact that the sum is set by statute does not mean that it falls outside the definition of ‘damages.’ ”

“If Central wanted to exclude damages set by statute from the scope of its obligation to pay ‘those sums’ that Tracy’s would be required to pay ‘as damages,’ as a result of property damage or advertising injury, it could easily have done so,” the court said. “Central points to no provision of its policies that excludes such sums from the definition of ‘damages.’ ”

The court’s determination did not mean Idlas and the other plaintiffs walked away with $14 million, however.

Central reserved the right to contest coverage for the underlying settlement by filing a declaratory judgment action and did not breach its duty because it paid for Tracy’s defense, the court said. The insurer retained the right to challenge both the reasonableness of the settlement and whether the claims giving rise to the settlement were covered under its policies.

Calling for a hearing on the reasonableness of the settlement, the panel said several issues needed consideration by the trial court on remand.

Noting “strong indications” that the Idlas settlement was collusive, it noted that the trial court should evaluate relevant factors such as the reasonableness of Tracy’s decision to settle so early in the case without engaging in any motion practice.

The court also wondered whether the settlement total was an accurate assessment of the actual liability facing Tracy’s. By the time the deal was struck, the parties were aware of reduced numbers of class members likely to file a claim (less than 10,000), vastly lowering the estimated $60 million in damages (based on $1,500 willful damages for each of the estimated 40,000 class members). The court asked if the $14 million settlement was a good bargain or whether the parties could have reached a significantly lower figure with some effort.

Instead, the total amount of the settlement – $14 million – was precisely equal to the value of Central’s insurance. Perhaps the amount was a coincidence, but given facts on the record “that there was not even the illusion of adversity or arms’ lengths negotiations between counsel for Idlas and counsel for Tracy’s,” the court said the question should be considered at the reasonableness hearing.

Two other issues highlighted by the panel were the inclusion of a cy pres provision and the expanded class size. “In this context, the hypothetically prudent uninsured’s decision to settle on terms that allowed millions of dollars in anticipated residual settlement funds to be donated to charity strikes us both as extraordinarily generous and extremely helpful to class counsel’s quest for attorney’s fees,” the court wrote.

“Particularly troublesome” was the expansion of the class definition that triggered an additional $5 million of insurance coverage where the plaintiff did not even identify a class member who received a fax within the new time period. Although the existing record did not reflect any other reason for agreeing to add to the class (and potential damages) outside the statute of limitations, the appellate panel said the trial court should investigate.

To read the opinion in Central Mutual Insurance Co. v. Tracy’s Treasures, Inc., click here.

Why it matters: The Illinois appellate court’s decision has positive and negative ramifications for TCPA defendants. As an initial matter, the court relied upon the state’s highest court’s position that damages under the statute are not punitive in nature and uninsurable, holding that the insurer could be liable for indemnifying the $14 million settlement at issue. However, the panel also expressed concern about the facts and circumstances surrounding the deal itself, and remanded the case for a reasonableness hearing. TCPA defendants should take note of the terms identified as troubling by the court and steer clear. They should not agree to a settlement total in the same amount as the insurance coverage, or expand the definition of the class to reach additional insurance funds, or reach a deal at the earliest possible point in the litigation.