Scope of Coverage, Not Wingspan, Governs Duty to Settle a Non-covered Claim

This is the first guest blog post from Carrie E. Cope, Shareholder at Schuyler, Roche & Crisham, P.C. Ms. Cope is one of Chicago’s most respected authorities on insurance coverage, claims and regulatory law. She and her team provide specialty lines claim monitoring, litigation and coverage consulting services to the insurance industry. Her team’s emphasis is in executive liability (directors’ and officers’ liability, employment practices liability, professional and fiduciary liability) and cyber liability.

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There may be times when reasonable minds may differ over the intent of a particular policy provision, (but as an attorney who represents insurers, I must clarify that it happens in very few cases and then, only arguably.) Despite clear contract wording and immaculate conduct by the insurer, most insurance coverage attorneys routinely hear from policyholders’ advocates one of following “one size fits all” arguments when faced with a potential denial of coverage: 1) the wording is ambiguous; 2) the insurer committed bad faith; or 3) relevant policy language aside, the insurer is taking a huge risk by denying coverage because the courts in [pick a jurisdiction] disfavor insurers. In the event litigation is pursued, insureds will often “go for broke,” asserting claims and seeking damages substantially outside the scope of those contemplated by the policy.

In Carolina Cas. Ins. Co. v. Nanodetex Corp.,  No. 09-1183, 2012 U.S. Dist. LEXIS 92614 (D.N.M. July 2, 2012), the insureds sought damages for the portion of a judgment in excess of Carolina’s policy limits which related to a non-covered claim as well as some atypical damages that included loss of use of corporate funds, deferred corporate salaries and lost business opportunities. (The claim for deferred corporate salaries was subsequently withdrawn by the insureds.) Among their claims, the insureds asserted that Carolina had committed bad faith by failing to settle the claim. The U.S. District Court for the District of New Mexico found in Carolina’s favor and in its discussion of the issues cited California case law stating that an “insurer does not …insure the entire range of an insured’s well-being, outside the scope of and unrelated to the insurance policy, with respect to paying claims. It is an insurer, not a guardian angel.”

The parties’ coverage dispute centered on whether a Management Liability Insurance Policy issued by Carolina afforded coverage to Carolina’s insured, Nanodetex Corporation (“NDX”), for portions of a judgment awarded to Defiant Technologies in litigation involving the licensing and development of certain micro and nanotechnologies and detection devices. The court awarded Defiant $1 million for malicious abuse of process, $1 for tortious interference and $1 million in punitive damages and attorneys’ fees and costs, but did not specify the basis for the punitive damages award.  Carolina acknowledged coverage for the $1 awarded for the tortious interference claim but denied coverage for the malicious abuse of process claim based on a policy exclusion.

Despite the court’s earlier finding that Carolina was not obligated to indemnify NDX for Defiant’s malicious abuse of process claim based on a policy exclusion, NDX pursued a further ruling based on a tort theory of bad faith failure to settle a claim. NDX asserted, regardless of the extent of the policy’s limit of liability, that it was entitled to reimbursement for the entire excess judgment which was “tantamount to consequential damages flowing from Carolina’s bad faith in refusing to settle Defiant’s third-party claim.”

In determining that Carolina was not liable for the $1 million compensatory damage award based on the non-covered malicious abuse of process claim, the court noted that it was unaware of any case, in or out of New Mexico, that held an insurer liable under tort principles on an excess judgment for which it did not owe coverage. The court recognized that under New Mexico law, an insurer’s obligation is a question of contract law determined by reference to the terms of the insurance policy. The court looked to the law of other jurisdictions noting that when a suit that contains both covered and non-covered claims fails to settle resulting in a judgment in excess of policy limits, courts have consistently found that the insurer is, at most, only liable for the portion of the excess judgment that was covered by its policy.

The court also found in Carolina’s favor with respect to counterclaims filed by NDX against Carolina for breach of contract and violation of the New Mexico Insurance Code because they were all founded on the “same untenable premise…that Carolina exercised bad faith in failing to settle a non-covered claim.”  While the court acknowledged that the Tenth Circuit had ordered a new trial in another case (under Oklahoma law) on an insured’s bad faith claim even after finding that the insurer had no duty to settle non-covered damages, it noted that the Tenth Circuit did so because the insured had set forth specific evidence of bad faith regarding the insurer’s handling of the claim as a whole, not merely its failure to reach a settlement.

At first blush, the idea of an insurer that is a virtual guardian angel floating in to pay 100% of our claims and to ensure our well-being, despite those pesky policy conditions and exclusions, might be appealing. However, if a market existed where insurers were routinely expected to pay claims outside the scope of their policies, most insureds would likely not be able to afford the coverage.  There are good reasons why, despite years of soft markets and the commoditization of some types of insurance, insurers still include limitations in their policies and some risks are highly bargained for.  Thankfully, some courts continue to enforce the actual terms of insurance policies.[1] Notwithstanding the pitfalls, though, if some resourceful underwriter creates a “well-being” coverage option (which would, despite carefully drafted disclaimers and a high premium, undoubtedly break sales records), I couldn’t resist the challenge of handling those claims—even without wings and a halo.