Why it matters

An insured dissatisfied with counsel selected by its insurer was entitled to select counsel of its choice where its potential liability significantly exceeded the insurer’s policy limits, according to an Illinois federal court. The court ruled that a conflict of interest existed, even though the insurer had agreed to defend without a reservation of rights, since the claim was for an amount substantially larger than the policy limits. The commercial general liability policy provided $1 million in coverage with a $2 million aggregate limit, whereas the insured was facing potential liability of up to $50 million. As the court explained, there was a conflict of interest because of the risk that the counsel selected and compensated by the insurer would be indifferent to any judgment amount in excess of the policy limits. The court concluded, “in order to properly protect their interest in light of the conflict[, the insured] is entitled to the retention of independent counsel at [its insurer’s] expense to defend it in the underlying suits.”

Detailed Discussion

Perma-Pipe manufactured pipes for the University of California. In 2010, the university notified Perma-Pipe that the pipes were defective and caused damages of up to $50 million. Perma-Pipe notified its insurer Liberty Surplus Insurance Company (“Liberty”) and requested coverage. Liberty’s policy provided coverage of $1 million per occurrence with a $2 million aggregate limit. Liberty agreed to defend but issued a reservation of rights letter.

The reservation of rights created a conflict of interest between the parties, prompting Perma-Pipe to seek independent counsel of its choosing for its defense. Liberty subsequently withdrew its reservation of rights, announced its intention to defend the insured and appointed its choice of counsel.

Perma-Pipe objected, arguing that a conflict of interest remained between the parties due to the real possibility of a judgment or settlement in excess of Liberty’s policy limits. The court agreed with Perma-Pipe.

Under Illinois law, if a conflict exists between an insured and an insurer, the insurer must pay for independent counsel selected by the insured. The court recognized that conflicts can arise under a myriad of circumstances and not just because the insurer has an interest in limiting coverage. “In other words, because an insurer’s exposure is capped by a policy limit, it may decide to try claims exceeding the limit, hoping that the resulting liability, if any, will be less, despite the risk that its insured could be found liable for an amount far greater than the limit,” the court explained. Thus, “a conflict exists when there is ‘a nontrivial probability’ of an excess judgment in the underlying suit.”

Liberty attempted to distinguish the facts of the case because Perma-Pipe was aware of the potential coverage from the beginning and notified its excess carriers early on in the litigation. But not only did Liberty fail to offer evidence of such communications, the court said the mere existence of excess coverage did not alter the existing conflict.

“[B]ecause excess insurance applies only after primary coverage has been exhausted, its existence does not vitiate the conflict between the primary and the insured that arises from the likelihood of an excess judgment,” Judge Guzman wrote, finding the basis for the two conflicts the same. “Because the record establishes that there is a conflict between Perma-Pipe and Liberty, Liberty breached its duty to defend Perma-Pipe by refusing to pay counsel of Perma-Pipe’s choosing.”

To read the decision in Perma-Pipe, Inc. v. Liberty Surplus Insurance Corporation, click here.