Insureds are wise to remember that an insurer’s duty to defend is significantly broader than its duty to indemnify  and  to  leverage  any  opportunity  to  obtain  a  defense  from  an  insurer  when  faced  with  an underlying action.  An increasing number of courts impose severe consequences on insurers who improperly deny  the  duty  to  defend,  including  estoppel  of  the  right  to  later  raise  coverage  defenses.           The  recent National American decision contains an express warning for insurers who fail to fulfill the duty to defend and serves as additional support that may be used to secure a defense from a reluctant insurer.

As the United States Court of Appeals for the Seventh Circuit wrote in the first line of its recent opinion in National American Insurance Company v. Artisan and Truckers Casualty Company, “[t]his case  provides  a warning for insurance companies who refuse to defend their insureds.” 796 F.3d 717, 719 (7th Cir. 2015). Consistent with the court’s admonishment, insurers in Illinois and elsewhere risk waiving, or being estopped from later asserting, their right to deny coverage based on various policy defenses, as a result of an improper denial of the duty to defend.

The underlying action in National American arose out of an August 2010 automobile accident in which a tractor- trailer truck rear-ended a pickup truck driven by Gustavo and Maria Bernal. The Bernals were seriously injured and filed suit “smartly,” according to the Seventh Circuit, against a host of potentially responsible individuals and entities, including: Viktor Barengolts, the driver of the tractor-trailer truck; Eduard Gaidishev, a passenger in the tractor-trailer truck; Michael Barengolts, the owner of the tractor-trailer truck and Viktor’s father; and Unlimited Carrier, the company whose placard appeared on the tractor-trailer truck at the time of the accident. Id.  Counts 1 and 2 of the Bernals’ complaint alleged an agency relationship between Viktor and Unlimited Carrier, while Counts 5 and 6 alleged an agency relationship between Viktor and his father, Michael.

Both Viktor and Michael were insureds under a liability policy issued by Artisan and Truckers Casualty Company (Artisan) in which Artisan agreed to “pay damages . . . for bodily injury, property damage . . . for which an insured becomes legally responsible because of an accident arising out of the ownership, maintenance or use of an insured auto.”  Id. at 720.  The policy also specifically insured the tractor-trailer truck involved in the accident on an attached auto coverage schedule.

Immediately  after  learning  of  the  Bernals’  suit,  Viktor  and  Michael  tendered  the  claim  to  Artisan  seeking  a defense and indemnity.   Artisan denied any duty to defend or indemnify, citing the policy’s Contingent Liability Endorsement (CL Endorsement).  The CL Endorsement provided that:

These coverages do not apply when the insured auto is being operated, maintained or used for or on behalf of anyone else or any organization whether or not for compensation.

Id. Artisan argued that because the tractor-trailer truck displayed placards for Unlimited Carrier at the time of the accident, it was being “used for or on behalf of” Unlimited Carrier—an organization and a use excluded from the policy’s coverage under the CL Endorsement. Notwithstanding Artisan’s initial denial, Viktor and Michael made several subsequent coverage demands with the assistance of coverage counsel—all of which were denied.

In the meantime, Unlimited Carrier’s insurer, National American Insurance Company (NAICO), agreed to defend against the Bernals’ suit, including the defense of Viktor and Michael, subject to a reservation of rights. When the suit later settled, NAICO also indemnified all of the defendants in exchange for an assignment of Viktor and Michael’s rights to recover under the Artisan policy.

NAICO then filed the instant action against Artisan in the Northern District of Illinois,  seeking  a  declaratory judgment that (1) Artisan had a duty to defend and indemnify Viktor and Michael in connection with the Bernals’ suit; (2) Artisan breached those duties; and (3) as a result of the breach of its duty to defend, Artisan was now estopped from raising coverage defenses.

NAICO moved for summary judgment, which was later granted. NAICO first argued that Artisan’s duty to defend was triggered by Counts 5 and 6 of the underlying complaint, which ostensibly pled vicarious liability by naming Michael—not Unlimited Carrier—as the principal in the agency relationship with Viktor. With respect to Counts 1 and 2, which alleged an agency relationship between Viktor and Unlimited Carrier, NAICO noted that the Barengoltses did not sign the lease with Unlimited Carrier until eight days after the accident, such that Viktor and Michael did not have the actual authority to display the Unlimited Carrier placard on the tractor-trailer truck at the time the accident occurred. NAICO also noted that Viktor was not in the process of picking up or transporting for Unlimited Carrier at the time of the accident.

Affirming the district court’s ruling, the Seventh Circuit held that Artisan had breached its duties to defend and indemnify and was therefore estopped from asserting any coverage defenses.   In evaluating its duty to defend Viktor and Michael, Artisan mistakenly “treat[ed] the duty to defend as if it were coterminous with the duty to indemnify,” when in fact “the duty to defend is far broader than the duty to indemnify.”  Id. at 724.  Agreeing with the  district  court’s  determination,  the  court  held  that  the  allegations  contained  in  Counts  5  and  6  of  the underlying complaint were enough to establish a theory of vicarious liability and trigger Artisan’s duty to defend. Id. at 723.   Indeed, Artisan was bound to that duty even if other Counts of the same complaint fell outside the scope of coverage.   Id. (citing Maryland Cas. Co. v. Peppers, 355 N.E.2d 24 (Ill. 1976) (“This duty to defend extends  to  cases  where  the  complaint  alleges  several  causes  of  action  or  theories  of  recovery  against  an insured, one of which is within the coverage of a policy while the others may not be.”)).

Artisan’s duty to defend was likewise not excused by the plain language of the CL Endorsement. As the court noted, the Exclusion is not written to apply when a person or organization exercises “authority and control over” the vehicle; instead, it is written to exclude coverage when the vehicle “is being operated, maintained or used for or on behalf of” an uninsured person or organization. Id. at 725. At the time the accident occurred, it was clear that neither Viktor nor Michael was operating the tractor-trailer truck on behalf of Unlimited Carrier, as NAICO aptly demonstrated by noting that the lease between the Barengoltses and Unlimited Carrier was not signed until eight days after the accident.

As a result of Artisan’s breach of its duty to defend Viktor and Michael, Artisan also was estopped from asserting any potential defenses to coverage, in effect, obligating Artisan to assume the duty to indemnify as well.   The consequence of estoppel, the court held, “incentivizes action over inaction” on the part of the insurer, which “ultimately inures to the benefit of the insured.”   Id.   In such situations, an insurer such as Artisan has three options:  (1) defend its insured against the underlying action under a reservation of rights; (2) seek a declaratory judgment to determine its duty to defend; or (3) refuse to defend its insured at its own risk.  By choosing either of the first two options, an insurer can eliminate the risk of later facing estoppel.  Artisan, however, chose the third option—as a result, Artisan “gambled and lost” and was ordered to reimburse NAICO for not only the defense costs, but also the settlement amount paid on behalf of Viktor and Michael in connection with the Bernals’ suit. Id. at 725-26.

The National American decision is not an isolated ruling, nor is it limited to Illinois law. In many jurisdictions, insurers who improperly refuse to defend their insureds do so at the risk of waiving, or being estopped from later asserting, their right to deny coverage based on various policy defenses. The Seventh Circuit’s express warning in National American should counsel insurers to more carefully evaluate the duty to defend their insureds and consider defending under a reservation of rights or initiating a declaratory judgment action, rather than risk surrendering their rights with an improper defense denial.