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(Article from Insurance Law Alert, October 2016)

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Reversing a lower court decision, the Seventh Circuit ruled that when an insurer defends under a reservation of rights or seeks a declaratory judgment regarding its defense obligations,  it is entitled to rely on evidence extrinsic to the underlying complaint in establishing that it has no duty to defend.  Landmark Am. Ins. Co. v. Hilger, 2016 WL 5239833 (7^th Cir. Sept. 22, 2016).

Two lawsuits filed against Peter Hilger alleged that he and other defendants overstated the value of life insurance policies that served as collateral for loans in order to persuade credit unions to fund those loans.  Hilger sought a defense from Landmark under a professional liability policy issued to a company that was a co-defendant in the suits.  Although Hilger was not a named insured, he argued that he was covered under a policy provision that defined “covered persons and entities” to include independent contractors that performed professional services on behalf of the named insured.  Landmark sought a declaration that it had no duty to defend.  An Illinois federal district court entered judgment on the pleadings in Hilger’s favor.  On appeal, Landmark argued that it is entitled to take discovery and offer evidence regarding the nature of Hilger’s relationship to the named insured company in order to dispute its duty to defend.  The Seventh Circuit agreed.

The Seventh Circuit ruled under Illinois law that “an insurer seeking a declaratory judgment on its duty to defend is entitled to introduce evidence outside the underlying complaint so long as it does not implicate an ‘ultimate issue’ in the underlying action.”  In so ruling, the court expressly abrogated prior case law that suggested that an insurer’s right to look beyond the complaint was limited to situations in which the insurer had a “strong reason to believe” that it had no duty to defend.  In addition, the court clarified that the strict “four corners” rule applies only when an insurer denies coverage without seeking a declaratory judgment or defending under a reservation of rights.  Under those scenarios, the relevant question is whether the insurer reasonably refused to defend based solely on the allegations in the complaint.  However, where, as here, the insurer files a declaratory judgment action, it is entitled to present evidence outside of the complaint to negate its defense obligations, so long as it does not determine an ultimate issue in the underlying dispute.