In Babcock & Wilcox Co. v. American Nuclear Insurers, No. 525 WDA 2012, 2013 WL 3456969 (Pa. Super. Ct. July 10, 2013), a divided Pennsylvania intermediate appellate court vacated a jury verdict for policyholders and remanded the case back to the trial court for further proceedings. The appellate court took these steps based upon its conclusion that, where a liability carrier has defended its policyholder pursuant to a reservation of rights, Pennsylvania law forbids the policyholder from recovering costs of a settlement it enters into in the face of the carrier’s objections unless the carrier raised those objections in bad faith. Id. at *17. The court also stated in dicta that policyholders seeking to protect their right to settle under Pennsylvania law should reject their carriers’ offers to defend, and should instead pay for defense and settlement costs directly and thereafter seek carrier reimbursement. Id. at *18.

The policyholders in Babcock were owners and operators of two nuclear fuel processing facilities. Id. at *1. In 1994, they were sued by tort claimants alleging bodily injury and property damage arising from alleged radioactive emissions at the facilities. The policyholders tendered their defense to their carriers, and the carriers defended the policyholders subject to a reservation of rights. The tort claimants and policyholders then engaged in many years of litigation that ended when the policyholders agreed to pay the claimants $80 million. The policyholders entered into the settlement despite the objections of their carriers. Id. at *2.

Following the settlement, the policyholders and carriers litigated the question of whether the carriers should indemnify the policyholders for settlement costs. Relying principally on non-Pennsylvania precedent, the trial court concluded that policyholders were entitled to recovery if the settlement was “fair and reasonable.” Id. at *6. A jury subsequently applied this standard to find that the carriers were required to indemnify the policyholders in the amount of the settlement. Id.

In a lengthy opinion, a majority of judges on the appellate court vacated and remanded on grounds that the trial court had instructed the jury to apply the wrong standard. The majority first found an absence of controlling Pennsylvania authority addressing a policyholder’s ability to settle over a defending carrier’s objections. Id. at *7. It then criticized the trial court for, in effect, ignoring standard language in the carriers’ policies forbidding policyholders from settling without carrier consent. Id. at *8. The majority noted that carriers do not breach their policies when they defend under reservation, and that therefore the carriers were entitled to enforce consent-to-settlement provisions against the policyholders. Id. at *17. Relying principally on non-Pennsylvania authority, the majority concluded that where a carrier defending under a reservation of rights objects to a settlement, the policyholder may not recover its settlement payments unless the carrier’s objections were made in bad faith, i.e., in violation of the policy. Id.

In dicta, the majority opinion also provided a roadmap for policyholders seeking greater authority in the future to settle underlying actions. The majority stated that such policyholders should reject carrier offers to defend, and should instead pay their litigation and settlement costs directly. Id. According to the majority, such policyholders would generally be entitled to subsequent reimbursement from their carriers if they could show that coverage existed, that their costs were fair and reasonable, and that the settlement was non-collusive. The majority argued that this approach strikes the right balance between legitimate policyholder and insurer interests in the settlement context.[1] Id. at *16.

The Babcock decision is a significant one, for at least two reasons. First, it purports to create new Pennsylvania law governing the ability of policyholders to settle underlying litigation without insurer consent. Second, the decision underlines the continuing importance that some courts place on enforcement of the written provisions of insurance contracts, including provisions requiring insurer consent for settlement of underlying lawsuits.