Pennsylvania Supreme Court Rules That Insureds Are Entitled to Reimbursement of Settlement Amounts Paid Despite Insurer’s Refusal To Settle

08.05.2015

In a recent case, Babcock & Wilcox Co. v. Am. Nuclear Insurers, 2015 WL 4430352 (Pa. July 21, 2015), the Supreme Court of Pennsylvania concluded that an insured may still have the right to policy proceeds if it takes a “fair and reasonable” settlement offer without the insurer’s consent where the insurer has elected to defend under a reservation of rights.  In reaching this decision, the Court rejected the insurer’s argument that it should be held accountable only if it acted in bad faith in refusing to settle.

The history of this case begins with the 1994 filing of a federal class action lawsuit against the insureds Babcock & Wilcox Company (B&W) and Atlantic Richfield Company (ARCO) brought by plaintiffs claiming to have suffered damages caused by emissions from nuclear facilities owned by the Insureds. The Insureds denied that the facilities released any emissions that caused the plaintiffs any harm, but a jury disagreed, and in 1998 reached a verdict totaling over $36 million. The federal court granted a new trial due to evidentiary issues, but the parties settled prior to the retrial.

During the lawsuit, disputes arose between the Insureds and their Insurer. The Insurer acknowledged that it would defend the Insureds, but it contested whether the policy covered all of the claims. For that reason, the Insurer defended the lawsuit subject to a reservation of its rights to later deny coverage or deny a defense.

Throughout the course of the litigation, the Insurer refused to consent to any settlement offers presented, believing that the case had a strong likelihood of a defense verdict.  In spite of the Insurer’s refusal to consent, the Insureds eventually settled the case with the plaintiffs for substantially less than the $320 million of potential coverage under the policies.

The Insureds then sought reimbursement of the settlement amount from the Insurer, who refused.  The Insurer argued that reimbursement was barred by the policies’ consent to settlement clauses, which required the Insureds to obtain the Insurer’s consent in order to settle.  The Insurer also claimed it could only be responsible for reimbursement if it had acted in bad faith in refusing to settle.  The Insureds argued that the Insurer should be required to reimburse them for the settlement so long as coverage applies and the settlement is “fair and reasonable.”

The trial court applied the “fair and reasonable” standard.  On appeal, an intermediate appellate court applied a new “Choice Test” that required the insured to choose one of two options:  (1) accept the insurer’s defense and remain bound to the terms of the consent to settlement provision, leaving the insurer in full control of the litigation; or (2) decline the insurer’s tender of a qualified defense and furnish its own defense, in which case the insured retains full control of the litigation, including the option of settling the claim.

The case was appealed again.  Both parties objected to the intermediate court’s adoption of the “Choice Test” because under Pennsylvania law, an insured does not have the option of rejecting an insurer’s defense, as this would constitute a breach of the policy.

The Pennsylvania Supreme Court ultimately rejected the “Choice Test” as unworkable in favor of the “fair and reasonable” standard applied by the trial court.  Importantly, the Supreme Court clarified that this standard is limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing a fair and reasonable settlement while also maintaining its reservation of rights – and thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover relevant claims.The Court went on to explain that whether a settlement is fair and reasonable entails consideration of the terms of the settlement, the strength of the insured’s defense, and whether there is any evidence of fraud on the part of the insured.

Contrary to the Insurer’s arguments, the Court held that the insured need not demonstrate bad faith by the insurer.  Rather, the insured need only show that the insurer breached its duty by failing to consent to a settlement that is fair, reasonable, and non-collusive in light of the totality of the circumstances.

This ruling is certainly a win for policyholders who find themselves between a rock and a hard place: the situation where an insured faced with potential liability at trial wants to accept a settlement offer, but the insurer has refused to consent to settlement and has issued a reservation of rights letter.  According to the Pennsylvania Supreme Court, even if the insurer does not consent to settlement, the policyholder may still recover settlement amounts if it can prove that the settlement was fair, reasonable, and non-collusive.

Jaime Wisegarver is an associate in the Litigation Section, where she handles a variety of civil and commercial matters, including insurance recovery litigation and counseling. For more information, please contact Jaime at (804) 771-5634 or jwisegarver@hf-law.com.