Ongoing efforts by insurers to recover amounts paid for uninsured losses after settlement or judgment have resulted in extensive litigation over allocation issues. Conflicting opinions have arisen over which party bears the burden of establishing which portion of a settlement or judgment is attributable to covered versus uncovered losses.
The majority view finds the burden of proof lies with the policyholder to allocate between covered and uncovered claims.1 However, courts will consider the facts and circumstances of each case to determine whether the burden should be shifted to the insurer.2 Of particular importance is whether one party controls the pertinent information and litigation and/or is in a superior position to know about looming allocation issues.3 Recent decisions have considered the following factors in determining the burden holder: (i) whether the right to allocate was set forth in a reservation of rights letter;4 (ii) whether the policyholder was provided notice in writing of the need to allocate any potential settlement or judgment; (iii) whether the policyholder was advised of any potential divergent interests; (iv) whether the policyholder had knowledge of the import of allocating any potential settlement or the need to request a special verdict form that provides for allocation; (v) whether the insurer was actively involved in the settlement process; or (vi) whether the insurer took pro-active steps for the use of a special verdict form at trial.
These issues were considered in a recent construction defect action, Uvino v. Harleysville Worcester Insurance Company.5 The homeowners (the Uvinos) sued the contractor (JBI) for construction defects and related claims, and JBI’s insurer, Harleysville, agreed to defend under a reservation of rights.6 Shortly before trial, Harleysville sought to intervene for the purpose of submitting special interrogatories to the jury (i.e., a special verdict form) to allocate between damages related to the repair and replacement of JBI’s faulty work versus damages to other property.7 Harleysville argued intervention was necessary because the “burdensome prospect of undertaking subsequent litigation to allocate covered damages favored allowing Harleysville to intervene to submit interrogatories at trial”.8 JBI opposed the motion, arguing that it would be prejudiced by confusion caused by the special verdict interrogatories.9 JBI argued Harleysville faced no prejudice because it could resolve the coverage issues in a later proceeding.10 The court denied Harleysville’s intervention request and no party made any further attempt to submit special interrogatories to the jury.11
JBI moved to disqualify counsel provided by Harleysville, arguing that Harleysville’s motion to intervene “revealed a conflict of interest because JBI’s counsel could defeat liability for Harleysville without defeating liability for JBI.”12 The court granted JBI’s motion to disqualify, which required Harleysville to hire independent defense counsel for JBI.13
At trial, a jury found JBI liable and awarded damages in favor of the Uvinos.14 A general verdict was used and the court made no determination whether the losses were covered under the Harleysville policy.15 Shortly thereafter, Harleysville disclaimed coverage and the Uvinos initiated an action seeking a judgment that Harleysville must indemnify JBI for the damages.16
Following a determination that the claims at issue may include claims covered under the Harleysville policy, the court considered the allocation issue.17 The court stated that the “insured generally has the burden of identifying covered damages”, but noted the burden “may be shifted to the insurer” if, for instance, “the insurer did not adequately make known to the insured the availability and desirability of receiving a special verdict, or if it is not clear that the insured was apprised its interest in receiving a special verdict”.18
The court concluded that Harleysville, by its actions, did not cause the burden to shift to it: “Harleysville, which moved to intervene for the purpose of requesting special interrogatories to forestall a coverage-allocation dispute and therefore made known both the availability of the interrogatories and the parties’ divergence of interests, did not fail in its fundamental responsibilities to its insured such that the burden of proving allocation should shift to Harleysville.”19 Nevertheless, the court concluded that, although the Uvinos failed to identify covered damages within the jury award at the trial stage, Harleysville was not entitled to summary judgment because of the possibility that “the parties or court relied on Harleysville’s statements regarding the expectation that an allocation trial would ensue in the absence of special verdict”.20 As such, the court held that the Uvinos could proceed with a post-verdict allocation proceeding at which they retained “the heavy burden of adducing proof competent to ‘establish in the mind of the factfinder a reasonable certainty that damages … awarded by the jury flow naturally from the cause of action established under the policy of coverage.’”21
The court in Transched Systems Limited v. Federal Insurance Company also considered the burden associated with allocation of covered and uncovered claims.22 In Transched, a judgment creditor brought an action against a judgment debtor’s liability insurer, seeking a declaration that the insurer was required under the debtor’s policy to pay a jury award against the debtor insured.23 In considering cross-motions for summary judgment, the court considered the majority rule that the burden rest with the insured, but stated that the burden “arises only after it has been demonstrated that a portion of the verdict or settlement is covered by the policy or policies and a portion is not.”24 The court further stated that “where a suit contains the potential for both covered and uncovered claims, the insurer has a duty to inform its insured that allocation in the form of a special verdict is available and potentially advisable.”25
In reviewing the relevant facts, the court determined that there was no evidence in the underlying action one way or another that the insurer discussed allocating through a special verdict form, that the insured did not propose an allocated verdict form, and that the third party judgment creditor did propose a special verdict form that asked the jury to allocate damages to each claim but was not successful in persuading the Delaware court to use it.26
Based on these facts, the court noted that “it is not necessarily in the insurance company’s best interest to have an allocated verdict where there are covered and uncovered claims”, particularly where it is the insurer’s position that it is the insured’s burden to allocate.27 If there is no allocation, the court stated, the insurance company can argue that the insured failed in its burden.28 The court noted that this conflicting interest has caused other courts to place the duty on the insurer to inform its insured that it should consider a special verdict form asking the jury to allocate the damages.29 The court ultimately concluded that the insured’s failure to request a special verdict, under the representation and advice from counsel paid by its insurance company, could not shift the burden to allocate the damages award post-verdict on the third-party judgment creditor.30
Upon determining that the third party creditor was relieved of the burden to allocate, the court was then faced with how the jury’s damages award should be apportioned. The court noted that, “[i]ronically, the case law tells us that apportionment is a question of fact to be decided at trial”.31 However, since the court stated that there had been “much litigation” already, the court did not believe more was necessary, especially since evidence at an apportionment trial would be from the underlying suit at which the third party creditor already prevailed.32 The court aptly noted that the “very uneconomical concept of litigating facts in multiple trials is the reason why apportionment of either a settlement or verdict ‘between covered and non-covered claims is typically resolved through negotiation and private agreement, rather than litigation, as litigation costs can be astronomical”.33 For this reason, the court ordered the parties to mediate the allocation amount.34
Based on these cases, the issuance of a reservation of rights letter, without anything more, can be insufficient to protect an insurer from the shifting burden.35 Rather, an insurer should take pro-active steps to ensure the policyholder is on notice of allocation issues and aware of the need to take certain actions to allocate a settlement or request a special verdict form to allocate a judgment at trial.
Pre-Approval of Proposed Allocations
Although apportionment may best be resolved through negotiation or private agreement, recent rulings indicate reluctance by courts to prematurely “greenlight” or pre-approve proposed allocations. However, this issue must be balanced with the reluctance of some courts (and the difficulty) to allocate after settlement or verdict. As such, the timing in which any request for allocation may be made is important.
Generally, insureds do not have the option of forcing the insurer to join the underlying litigation. Rather, issues concerning insurance coverage are typically addressed in separate declaratory relief actions, which can be filed concurrently with the underlying action, but are often stayed in the event the litigation of the declaratory judgment action has any prejudicial effect on the insured’s defense of the underlying action.
In one California case brought by an insured against subcontractors and insurers, the insured asserted a cause of action against the defendant insurance companies seeking a declaration of rights and obligations related to a dispute over allocation of the defense fees and costs of the insured between the insurer defendants and subcontractor defendants.36 The insured sought for the court “to determine the formula for allocation and not just a determination of an actual and present dispute concerning an insurer’s duty to allocate and/or a duty to pay for fees and costs incurred by an insured”.37 However, since the determination of how to allocate was “entirely contingent on the resolution of the related construction defect cases by settlement or judgment determining the allocation of responsibility for the claimed defects and the amounts incurred for the defense against a case that has reached a final judgment or settlement”, the court determined the cause of action was premature because it improperly sought an advisory opinion as to how to allocate both the present and future defense costs incurred in defending against the pending construction defect claims/actions.38
Additionally, courts will typically allow the insurer to participate in the allocation process and will not issue advisory opinions on allocation in the insurer’s absence. For example, a court in the District of New Jersey recently denied an insured’s motion for partial summary judgment against its insurer where the motion sought a ruling on the effect of a provisional settlement governing allocation of covered-versus-uncovered losses reached between the insured and a third party.39 The insured sought judgment that the provisional settlement agreement regarding the allocation between the insured and uninsured portions of loss would be binding.40 In essence, the insured asked the court for a “greenlight to move forward in its settlement” with the third party and for assurance that the agreement would lead to favorable circumstances for its signatories.41 The court denied the motion as seeking an advisory opinion and because it sought an endorsement of the insured’s and the third party’s allocation of covered-versus-uncovered losses, which implicated disputes between the insured and insurer, and would require factual development in order to be resolved.42
Further, the case of TIG Insurance Company v. Premier Parks, Inc., which held that the insurer’s conduct prevented its right to seek a post-settlement allocation, exemplifies the importance of the timing of a request to allocate (as well as the need for pro-active involvement by an insurer).43 In that case, TIG sought a declaration that either no coverage was available for any of the claims asserted against its insured or, in the alternative, that the court should allocate the general damages award from the underlying action against the insured between covered and non-covered claims based on the evidence adduced from trial.44
In rejecting TIG’s request, the court noted TIG’s failure to direct the attorneys TIG engaged to defend its insured to draft appropriate jury interrogatories to allocate damages as between covered and uncovered claims.45 The court concluded that it could not “reasonably be expected to perform a post-verdict allocation of damages as between covered and uncovered claims when the record provides little, if any, evidence of the jury’s methodology in reaching its damages awards.”46 The court further held that it was not satisfied that further proceedings would “illuminate a record darkened by ambiguity” and that the jury’s verdict could not be “dissected beyond what appears on the face of the verdict sheet because TIG did not, when it had the chance, provide the jury with the opportunity to explain itself.”47
These examples reiterate the courts’ inability to issue advisory opinions and demonstrate the reluctance by some courts to pre-approve potential allocations where underlying facts remain at issue or where the allocation is not agreed to by both the insured and its insurer. Whether the time for allocation may or may not be “ripe”, however, should not factor into any decisions by an insurer to expeditiously reserve its rights for an allocation and notify the policyholder in writing about the need for a special verdict or allocated settlement or to take affirmative steps to procure an allocated verdict or settlement (such as seeking intervention to request a special verdict form or initiating a declaratory relief action).48
In sum, determining the scope of covered versus uncovered losses is a complex, fact-based issue. When dealing with “mixed” cases involving potentially covered and uncovered losses and potential allocation issues, insurers should be aware that reservation of rights letters, on their own, may not provide protection against failing to prevent a general verdict or allocation of a settlement and the corresponding consequences. Instead, insurers should pro-actively enforce reservation of rights letters by communicating in writing with policyholders about allocation issues including, specifically, whether certain actions need to be taken to request an allocation of a settlement or a special verdict form at trial, advising the insured of potential divergent interests and, if necessary, taking steps to procure an allocated settlement or special verdict. Such pro-active steps may prove critical to preventing the burden to allocate from residing with the insurer.