A year ago, we wrote an article lamenting the Northern District of Ohio’s opinion in IMG Worldwide, Inc., et al. v. Westchester Fire Ins. Co., Case No. 1:11 CV 1594 (N.D. Ohio May 13, 2013).  The practical effect of that opinion was that a policyholder whose primary and excess carriers both wrongfully denied coverage was stuck choosing between (1) litigating against its primary carrier to judgment, or (2) settling with its primary carrier and thereby waiving its rights to seek any defense costs from its excess insurer.

We are happy to report that last week the Sixth Circuit Court of Appeals reversed the trial court on a de novo review (IMG Worldwide, Inc., et al. v. Westchester Fire Ins. Co., et al., Case Nos. Nos. 13-3832, 13-3837 (6th Cir. July 15, 2014)), recognizing that allowing the trial court’s approach to stand “would not only penalize IMG, the non-breaching party, but also would run counter to the well-accepted public policy favoring settlement of insurance disputes, and would provide perverse incentives: encouraging insurers to disclaim their duties to defend.”

The Trial Court Gives IMG a Defense Costs Coverage Ulcer

By way of background, IMG sued its excess insurer, Westchester Fire Insurance Company, for reimbursement of a settlement and defense costs in connection with a Florida lawsuit alleging misrepresentations by IMG in connection with a high-end condominium project in Florida.  During the Florida lawsuit, IMG’s primary-layer insurer and Westchester both denied coverage and refused to provide a defense to IMG.  After sinking more than $8 million into its defense, IMG settled the Florida lawsuit for nearly $5 million. IMG continued pursuing its coverage claims, and eventually settled with its primary carrier for its $1 million policy limits plus $250,000 in defense costs.  In return, IMG gave its primary carrier a full release for all indemnity and defense costs.

Westchester continued to deny coverage through a trial between IMG and Westchester.  The jury returned a verdict in IMG’s favor on the issue of indemnity.  The trial court reserved to itself the question of whether Westchester owed IMG its defense costs in excess of what its primary carrier agreed to pay. 

During the post-trial motion phase, the trial court affirmed the jury’s indemnity award, but entered judgment against IMG on its demand for its unreimbursed defense costs arising from the underlying Florida lawsuit.  The trial court held that by its policy language Westchester reserved subrogation rights against IMG’s primary carrier.  The court reasoned that by settling with its primary carrier and giving it a release, IMG “eliminated Westchester’s subrogation rights” and thus “violated one of the conditions required for Westchester’s ‘drop down’ coverage.”  Consequently, the trial court concluded that IMG was barred from any defense cost recovery against Westchester.

The Sixth Circuit Serves IMG a Dose of Antacid

On appeal, the Sixth Circuit was having none of it, recognizing the unfairness of the result and reversing the trial court.  But Ohio policyholders and their lawyers should not break out the champagne and toast to the Sixth Circuit’s adoption of some new equitable doctrine, because the Sixth Circuit took pains to note that its decision was wholly driven by the policy language in question:  “Westchester’s obligations flow from the covenants it agreed to in the Policy, and not from any general legal principles under Ohio law.”

To reach its holding, the Sixth Circuit enforced the policy language stating that Westchester “will have the right and duty to defend the insured . . . when the ‘underlying insurance’ does not provide coverage. . . .”  Thus, “Westchester’s obligations under this provision turn on what it means to ‘provide coverage’ – and, more specifically, whether an underlying insurance that provides for coverage, but nevertheless improperly denies coverage, ‘provides coverage,’ under the terms of the Policy.”  The court decided it could reasonably be interpreted either way, so it found the language ambiguous and construed it in favor of IMG under Ohio’s doctrine that insurance policy ambiguities are construed in favor of the policyholder.  By denying coverage, IMG’s primary carrier did not “undertake to deliver coverage” and thus did not “provide coverage” such that Westchester had to step in and provide a defense immediately upon the primary carrier’s denial.

The Sixth Circuit did not stop there.  It adopted a second independent ground for its decision.  It relied upon the Westchester policy language that states, “If no other insurer defends, we will undertake to do so, but we will be entitled to the insured’s rights against all those other insurers.”  Upon denying coverage, the primary carrier did not defend IMG, thus immediately triggering Westchester’s defense obligations under this provision.  The court declined to evaluate what, if any, of IMG’s rights against its primary carrier remained for Westchester to pursue against IMG’s primary carrier, to whom IMG had given a release.

IMG Feels Good Again

By reversing the trial court’s ruling, the Sixth Circuit restored balance to the relationship between IMG and Westchester.  Rather than rewarding improper coverage denials and delays by insurers, the Sixth Circuit instead makes clear that excess insurers must stand behind the policy language they issue to policyholders.  If that policy language requires an excess carrier to defend a policyholder when the primary carrier refuses a defense, then defend the policyholder it must.  If Westchester and IMG’s primary carrier want to fight with each other about who properly should have defended the policyholder, they are free to do so, but the Sixth Circuit makes one thing clear:  “Certainly, as the non-breaching party, IMG must not be left holding the bag.”

How Policyholders Can Avoid Having Some of What IMG Had

Policyholders, if your primary carrier denies you a defense, consider whether that denial may have triggered a defense obligation by your excess insurer, using IMG Worldwide as a starting point for your analysis.  Two words of caution, though.  First, keep in mind thatIMG Worldwide is focused on the specific policy language that Westchester issued to IMG.  So make sure to read and know your excess policy language before settling with your primary insurer if you plan to ask your excess carrier to help with your defense.  Second, if you give your primary carrier a full release, think long and hard before including an agreement to indemnify your primary carrier in the settlement agreement, or at least make sure to keep it narrow.  IMG Worldwide did not consider whether that might come back to bite you if your excess carrier adopts the Sixth Circuit’s suggestion to sue your primary carrier.