A recent Illinois Appellate Court decision illustrates and endorses some prudent steps a corporate insured can take to protect its rights when an insurer fails to honor its defense obligation, abandoning the insured to mount and fund its own defense against an onslaught of mass tort claims. In Caterpillar, Inc. v. Century Indemnity Company, No. 3-09-0456, 2011 WL 488935 (Ill. App. 3rd Dist. Feb. 1, 2011), the Appellate Court affirmed an award to the insured, Caterpillar, of $17 million in damages and $4.6 million in prejudgment interest, representing the costs Caterpillar had reasonably incurred in defending against more than 2,000 underlying suits alleging bodily injury from asbestos exposure. In reaching its decision, the court rejected a series of hindsight-based and mostly insubstantial arguments that the insurer, INA, raised in the coverage litigation, years after leaving Caterpillar to fend for itself.

The picture painted by the court’s opinion is that of an insurer believing it can shirk its defense obligation with virtual impunity – a scenario we’ve encountered all too often in our representation of corporate insureds. INA’s noncommittal letters and inaction in response to Caterpillar’s claim notifications (see 2011 WL 488935 at *4-5) effectively forced Caterpillar to use its own best judgment on how to staff, structure and fund its defense. Basic fairness dictates that an insurer choosing that route should forfeit any right to second-guess the insured’s decisions – and indeed, under Illinois law, that insurer might even become legally estopped from raising otherwise valid coverage defenses. Yet some insurers appear to believe, as INA did, that they can sit back and wait, and if at some later point – maybe even years later – the insured still has the resources and resolve to pursue coverage litigation after litigating and resolving the underlying matters on its own, the insurer will face no real adverse consequences, because it will still have the opportunity to limit or evade financial responsibility altogether based not only on substantive coverage defenses, but also on allegations that the insured overspent on its defense effort, or made supposedly fatal errors in its presentation of the insurance claim.

In rejecting all of INA’s objections and arguments in those areas, the Caterpillar decision gives appropriate deference to the insured’s judgment in conducting its defense in the absence of insurer support; and thus promotes long-standing Illinois public policy favoring strict enforcement of the duty to defend. Further, insureds can glean from the decision practical guidance that will prove valuable if they encounter a wrongful refusal to defend. The following are some of the features of the Caterpillar case that illustrate how insureds can plan to achieve the same success that Caterpillar has had in recovering defense costs from a recalcitrant insurer.

Claim notification and ongoing communication.

According to the court, “Caterpillar regularly updated INA regarding the underlying actions and provided detailed explanations of the defense provided by [national coordinating counsel] and regional counsel, defense and indemnity costs incurred and paid, and exhaustion of deductibles.” 2011 WL 488935, at *3. This illustrates what we agree is best practice in dealing with insurers. Our experience in claims situations teaches us that the risk of dispute with regard to the insured’s notification and cooperation obligations is best managed through developing a good business relationship with the insurer and its counsel in claims situations. Initiating and maintaining a program of regular communication with the insurer and its counsel concerning the claims, including some combination of conference calls, meetings, written reports or document productions, and allowing direct access to defense counsel, all subject to appropriate confidentiality and privilege considerations, can be productive means of fostering a relationship of trust and confidence with the insurer and its counsel, and can lessen the risk that the insurer’s second-guessing on defense strategy later turns into coverage defenses based on asserted untimely notifications or failure to cooperate. An insurer’s declination of coverage and refusal to participate in the defense should, as a matter of law, relieve the insured of any continuing notification and consent obligations; but we often counsel clients to continue basic notifications following the declination, on the theory that it will remove any arguable grounds for a notice- or cooperation-based coverage defense in a later litigated dispute.

The court in Caterpillar endorsed these practices in turning aside INA’s arguments on the timeliness and content of Caterpillar’s claims notifications. One of INA’s themes – that Caterpillar had not overtly stated any need for INA’s participation, and thus appeared to have been content to conduct its own defense (see 2011 WL 488935 at *9-10) – was properly rejected in light of long-standing Illinois law making it clear that an insured’s claim notifications need not include “magic words” concerning the tender of defense. An insurer’s defense obligation is triggered when it receives actual notice of a claim; and if the insurer has any doubt about whether the insured desires the insurer’s participation, the insurer can easily dispel that doubt by asking for clarification. The Cincinnati Cos. v. W. Am. Ins. Co., 183 Ill. 2d 317, 329-330, 701 N.E.2d 499, 505 (1998).

Defense cost control and review.

We think that the most powerful, persuasive proof of reasonableness of defense costs is that a corporation had to reach into its own pocket to pay those costs, without any reason to expect it would receive reimbursement from an insurer. In our view, an insurer’s breach of its duty to defend (and consequent refusal to pay defense costs) should give rise to a presumption that the insured’s costs were reasonable and necessary.

Such a rule recognizes that a public corporation’s obligation to maximize shareholder value means that the corporation has every incentive to make responsible expenditure decisions and to exercise prudent cost control when faced with claims and liabilities for which there is no assurance of reimbursement or indemnification. See Taco Bell Corp. v. Continental Cas. Co., 388 F.3d 1069, 1075-76 (7th Cir. 2004).

Caterpillar (and our own experience) teaches that insureds should nonetheless be prepared to demonstrate the care with which they approached their responsibility to manage their company’s defense expenditure. Members of management and in-house legal departments should expect to be called upon to testify (or at least submit affidavits, as was done in Caterpillar) concerning their review of the qualifications of the outside lawyers and consultants chosen to handle the defense; their regular communications with and supervision of the lawyers and consultants; the cost control measures imposed on the work of the outside professionals and vendors; and the close scrutiny to which bills were subjected.

Among the specific defense cost issues that the Caterpillar decision addresses in a helpful way is the use of national coordinating counsel. Litigation pending in multiple jurisdictions naturally requires hiring local defense counsel in each jurisdiction. In that situation, responsible corporate defendants often engage a separate firm to oversee the entire defense effort nationwide. The use of national coordinating counsel promotes consistency and cost-efficiency by permitting centralized organization and management, including in the development and shared use of documentary and other evidence, legal and factual research and other work product. Naturally, all of this benefits the insurer as well as the insured.

Yet on occasion insurers will turn a blind eye to that common-sense reality, and instead argue that use of national coordinating counsel simply adds another layer of cost, needlessly duplicates effort and is therefore unreasonable. In Caterpillar, INA made even less persuasive arguments: that national coordinating counsel’s costs and fees associated were not covered because they were impermissible “‘administrative costs’” and because the costs could not be attributed to particular claims. 2011 WL 488935, at *11. The court held that nothing in the INA policies prohibited use of national coordinating counsel; and the court accepted the statements of a Caterpillar affiant (in-house litigation counsel) that national coordinating counsel’s activities were applicable to every claim, and that they were “‘legitimate defense costs.’” Id.

Use of an experienced consultant.

Partnering with a consulting firm experienced in coverage disputes should be considered at the very outset of the defense effort. Such a firm can provide valuable insight and assistance in managing the organization and flow of information concerning the multitude of claims. In coverage litigation, the firm can aid in preparing the presentations necessary for summary judgment motions and trial.

Among the tasks successfully undertaken by Caterpillar’s consultant were the following:

  • Summarizing the more than 2,000 underlying asbestos bodily injury complaints for the trial judge to review on summary judgment, relieving the judge of the unnecessary burden of reviewing all of the complaints. 2011 WL 488935, at *8.
  • Calculating an allocation of defense costs to specific policies, in line with the court’s 2007 unpublished ruling approving an “allsums” allocation method. Id. at *3.
  • Calculating statutory prejudgment interest on the unpaid defense costs. Id. at *3 and 12.

The Appellate Court overruled all of INA’s objections to the approaches the consultant employed.

As the Caterpillar decision makes clear, insureds facing a two-front war – mass tort claims, combined with an insurer’s refusal to honor its obligation to defend those claims – must manage the defense effort with an eye toward preparing for coverage litigation. With appropriate foresight and with the assistance of experienced professionals both inside and outside the insured’s organization, insureds can match Caterpillar’s success in recovering defense costs.