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(Article from Insurance Law Alert, July/August 2015)

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Our July/August 2013 Alert reported on a Pennsylvania decision holding that where an insurer is defending subject to a reservation of rights, the insurer’s duty to indemnify an underlying unauthorized settlement turns on whether the insurer acted in bad faith in rejecting settlement.  Babcock & Wilcox Co. v. Am. Nuclear Insurers, 76 A.3d 1 (Pa. Superior Ct. 2013).  The ruling vacated a trial court decision that endorsed a more lenient standard under which an insurer’s indemnity obligations in the reservation-of-rights context turned on whether the unauthorized settlement was “fair and reasonable.”  Last month, the Pennsylvania Supreme Court reversed and reinstated the trial court decision.  Babcock & Wilcox Co. v. Am. Nuclear Insurers, 2015 WL 4430352 (Pa. July 21, 2015).

The coverage dispute arose out of bodily injury and property damage claims against Babcock & Wilcox and Atlantic Richfield Company (“ARCO”) as owners and operators of two nuclear fuel processing facilities.  American Nuclear Insurers (“ANI”), Babcock’s and ARCO’s nuclear liability insurer, defended under a reservation of rights.  Babcock and ARCO settled the claims over ANI’s objection and then sought reimbursement.  ANI argued that the insureds had forfeited their right to reimbursement by violating the policy’s consent-to-settlement clause.  The insureds claimed that ANI breached its duty to settle and was therefore obligated to indemnify any fair and reasonable settlement.  The trial court agreed with the insureds, holding that ANI must reimburse them for all “fair and reasonable” settlement costs.  The appellate court reversed, reasoning that an insurer does not forfeit the right to enforce a consent-to-settlement clause by defending under a reservation of rights where the insured accepts the defense.  The appellate court therefore held that an insurer’s duty to indemnify an unauthorized settlement under such circumstances turns on whether the insurer acted in bad faith in rejecting the settlement.  The Pennsylvania Supreme Court reversed.

Acknowledging that courts across jurisdictions are split on this issue, the Pennsylvania Supreme Court ruled in a 3-2 decision that under the factual record presented, ANI’s duty to indemnify the unauthorized settlement turned on whether it was fair and reasonable.  The court stated: 

[W]e adopt a variation on the . . . fair and reasonable standard limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and, thus, subjects an insurer to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.

The court emphasized the fact-specific nature of its analysis, stating that “a determination of whether the settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured’s defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured.”  The court also noted that “not all reservations of rights are equal” and that “[p]arties and courts may need to consider whether a particular reservation of rights justifies diverging from the contract’s cooperation clause,” an issue that the court said was not before it.