By Michael J. McNaughton, Sedgwick Chicago
An all too familiar scenario: an insurer believes there is no coverage for a claim, but has a duty to defend its insured. In these situations, an insurer often pays for the insured’s independently-selected defense counsel and seeks declaratory judgment regarding coverage. But after the insurer surrenders control of the defense, it may also surrender the right to control a subsequent settlement. What happens if the insured seeks coverage for the settlement, but the insurer considers it unreasonable?
The Illinois Appellate Court recently addressed this scenario in Central Mutual Ins. Co. v. Tracy’s Treasures, Inc., 2014 IL App (1st Dist.) 123339 (September 2014). The Court considered whether coverage existed for the Idlas Telephone Consumer Protection Act (“TCPA”) class action settlement, and if the insurer could challenge the reasonableness of the settlement negotiated by the insured’s independent counsel.
In Idlas, Tracy’s Treasures, Inc. allegedly advertized its business services through unsolicited fax advertisements to a class of plaintiffs in violation of the TCPA. Central Mutual insured Tracy’s Treasures through primary and excess liability policies which contained $14 million in available limits. Central Mutual declined coverage in Idlas but provided the insured a “courtesy” defense. Central Mutual also filed a timely declaratory judgment against the insured seeking a determination of coverage. The insured obtained its own independent counsel in Idlas in light of the conflict with Central Mutual. Central Mutual consented to the substitution of counsel and agreed to pay a reasonable fee for his services.
The insured’s independent counsel did not disclose to Central Mutual that he had started settlement negotiations in Idlas a month before identifying himself to the insurer. Shortly thereafter, the insured filed a motion for preliminary approval of a settlement agreement in Idlas on behalf of the class, and participated in the subsequent fairness hearing. The insured’s counsel did not notify Central Mutual of these events. In the proposed Idlas settlement, the insured agreed to pay $14 million, collectible only against Central Mutual. Although the Idlas complaint defined the putative class to include persons who allegedly received unsolicited faxes from March 5, 2003 through March 5, 2007, the proposed settlement defined the class for the period from September 1, 2002 through July 22, 2003. Although no class members prior to July 22, 2003 came forward, the revised class definition triggered an additional $5 million excess policy issued by Central Mutual. Only 5,561 putative class members – roughly 4% of the total class – received the class settlement notice.
The circuit court approved the $14 million Idlas settlement. Plaintiff’s counsel would receive one-third of the amount collected from Central Mutual, plus costs. Each class member who submitted a claim would receive a pro rata share of the collected amount, not to exceed $500 pursuant to the TCPA. The plaintiff (and only class representative) would receive $9,500, nineteen times more than the potential recovery of every other class member. Unclaimed funds would be given to charitable organizations approved by the Court.
On Central Mutual’s motion for summary judgment in the coverage action, the court held amounts awarded to claimants under the TCPA were punitive in nature and not insurable as a matter of public policy based on the precedent set in Standard Mutual Ins. Co. v. Lay, 2012 IL App (4th) 110527. The insured appealed when Lay was subsequently reversed by the Illinois Supreme Court, which held sums recovered by TCPA claimants were liquidated rather than punitive damages.
Central Mutual raised the following issues on appeal to the Court: (1) although it conceded the applicability of the Illinois Supreme Court’s reversal in Lay, liquidated damages were not covered as a matter of law under its policies; (2) there was no coverage for the Idlas settlement because Central Mutual and the insured had already carved out personal and advertising injury from the relevant policies as part of a settlement for a prior TCPA lawsuit against the insured; and (3) the $14 million settlement was collusive and unreasonable as a matter of law.
The Court ruled in favor of the insured on the first two issues. First, it held the insurer should have included policy language that excluded sums for statutory penalties if it had wanted to avoid coverage for liquidated damages. Next, the Court noted that the confidential carve-out agreement between Central Mutual and the insured was not included as part of the appellate record. Even if available, the Court could not determine as a matter of law that the amount paid by Central Mutual was adequate consideration for the carve-out of personal and advertising injury coverage in its policies. The Court remanded for further consideration.
The primary focus of the Central Mutual decision was the issue of whether the Idlas settlement was collusive and unreasonable. The Court first addressed whether Central Mutual could challenge the settlement. Because Central Mutual “surrendered control of the defense,” the Court determined it also surrendered the right to rely on policy provisions which required its consent to settle. The Court indicated, however, that Central Mutual could still challenge the Idlas settlement because it had filed a declaratory judgment against the insured to preserve its coverage positions and provided a defense by paying reasonable fees for the insured’s independent counsel. Moreover, the Court recognized Central Mutual had been denied the opportunity to be heard on the reasonableness of the Idlas settlement. Although the Court could not hold the settlement collusive and unreasonable as a matter of law, it agreed with the trial court that the facts and circumstances regarding the settlement were “very troubling.” It remanded for further findings on whether the insured’s decision to settle and the settlement amount were both reasonable. The Court also provided guidance on the standard of reasonableness.
To determine if the insured’s decision to settle was reasonable, the trial court must examine the totality of the circumstances and whether the decision conformed to the standards of a prudent uninsured. The Court indicated that the trial court should consider whether a prudent uninsured would have: (1) foregone the opportunity to litigate potential defenses in light of the potential cost and chance of success; (2) sought contribution or indemnification from third-parties; (3) agreed to settle on terms which allowed unclaimed funds to be donated to charity; and (4) considered whether it truly faced “staggering” liability in Idlas from a “practical perspective” in light of the limited number of people notified of the class action and the trial court’s discretion to fashion a class action reward deterring future violations without destroying the insured’s business.
To determine if the amount of the settlement was reasonable, the trial court must examine what a reasonably prudent person in the position of the insured would have settled for on the merits of Idlas’ claim. The Court also stated this test was guided by a “commonsense consideration of the total facts bearing on liability and damage aspects of the plaintiff’s claim.” The Court stated the trial court should consider many of the same factors in its analysis to determine whether the Idlas settlement was reasonable, and further consider: (1) whether the settlement was the product of arm’s length negotiations; (2) what facts were available to the insured’s independent counsel which allowed him, in relatively short time, to value the Idlas claims at over $60 million with only a single class representative; (3) how the parties arrived at a $14 million settlement figure; and (4) any evidence showing there was bad faith, collusion or fraud.
An important takeaway from Central Mutual is to be mindful that the independent counsel’s sole obligation is to the insured. In its arguments, Central Mutual criticized the insured’s independent counsel for misrepresenting plans regarding the defense and settlement of Idlas. Although the Court recognized the insured’s counsel had attempted to “short circuit” Central Mutual’s ability to learn of or challenge the settlement, it also affirmed independent counsel had no duty to the insurer. Accordingly, an insurer should consider retaining monitoring counsel to protect its own interests after providing independent counsel for the insured.
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