Expert Commentary

Fairly Debatable Position Sufficient To Avoid Bad Faith Claim

Indemnity agreements and additional insured agreements go hand in hand. The insurer agrees to produce the defense and indemnify its insured in the indemnity agreement. Sometimes, the insurer is kept in the dark about a case for years only to learn about a suit shortly before trial or after a settlement is reached.

Claims Practices
April 2015

In Kmart Corp. v. Footstar, Inc., 777 F.3d 923 (7th Cir. 2015), the Seventh Circuit Court of Appeals was called on to resolve such a situation where, under an agreement between Footstar and Kmart, Footstar operated the footwear departments in various Kmart stores as though they were islands. Footstar employees could only work in those departments if they had written permission from Kmart. On July 27, 2005, a Footstar employee tried to help a customer get an infant carrier off a shelf outside the footwear department, and the customer was injured. She sued, and Kmart eventually sought indemnification for the settlement and defense costs from Footstar and its insurer, Liberty Mutual Insurance.


Section 18.1 of the Master Agreement required Footstar to defend and indemnify Kmart under certain conditions. On July 27, 2005, a customer named Judy Patrick walked into a Kmart store in Hollywood, Florida. According to her complaint, she asked for assistance from Alex Sehat, who turned out to be a Footstar employee, in getting a stroller down from a shelf. Sehat, along with a Kmart employee, reached up and attempted to bring the stroller down. As they were bringing it down, an infant carrier inside the stroller fell and struck Patrick in the face. The accident took place in the infant/stroller department, which is entirely outside of the Footstar department.

Patrick sued Kmart alleging negligence, with no mention of Footstar in her initial complaint. But, during the course of the litigation, Patrick's counsel discovered that Sehat was actually a Footstar employee and called Footstar a year into the suit to get Sehat's employment records. Footstar contacted Liberty Mutual.

Shortly thereafter, Kmart defense counsel wrote to Footstar formally requesting defense and indemnification for the first time. Footstar forwarded the request to Liberty Mutual, and Patrick amended her complaint 2 days later to include Footstar as a defendant. Liberty Mutual wrote Kmart refusing to defend or indemnify, stating, "Footstar is not responsible for the referenced claim as it is not a product liability incident."

Kmart settled with Patrick 8 months later for $300,000 and $10,000 in Kmart gift cards.

The Declaratory Relief Action

Kmart then filed a complaint in this action originally against Footstar only but then added Liberty Mutual, alleging both owed Kmart a duty of defense and indemnification for the Patrick suit. The magistrate judge entered partial summary judgment on Kmart's breach of contract and declaratory judgment counts, finding that both defendants owed a duty to defend, but only as of January 24, 2008, when Kmart first requested defense. The court found that Liberty Mutual and Footstar also had a duty to indemnify but only for Footstar's relative fault, which a jury apportioned at 15 percent.

The court also found that Liberty Mutual did not act in bad faith by denying coverage, and Kmart did not breach the notice provisions of the policy and Master Agreement. Kmart appealed, naming only Liberty Mutual as an appellee, while Liberty Mutual and Footstar cross-appealed.

The issues on appeal were whether:

  1. Footstar and/or Liberty Mutual had a duty to indemnify Kmart;
  2. Liberty Mutual and/or Footstar had a duty to defend Kmart and, if so, when that duty began;
  3. Liberty Mutual acted in bad faith by denying coverage;
  4. Kmart breached the notice provisions of the policy and Master Agreement; and
  5. the court erred in denying Kmart's motion for pre-judgment interest.

Duty To Indemnify

Liberty Mutual and Footstar appealed the magistrate judge's determination that they had a duty to indemnify Kmart for the Patrick suit. The magistrate judge found Liberty Mutual and Footstar liable because it determined the injury arose from Footstar's work. However, Liberty Mutual/Footstar contended that the court ignored the requirement that any injury had to arise "pursuant to" or "under" the Master Agreement to trigger indemnification, and the Master Agreement explicitly prohibited Sehat's out-of-department action that resulted in the injury.
The duty to indemnify only arises where the insured's activity and the resulting damages actually fall within the coverage of the policy. To determine whether the activity actually fell within the coverage of the policy, the court reviewed the plain language of the policy. Indemnity contracts are to be strictly construed, and any ambiguity in the agreement is to be construed most strongly against the indemnitee—in this case, Kmart.

Under subpart 1 of the additional insured clause, Liberty Mutual was liable to Kmart for injuries "arising out of" Footstar's "work." Under subpart 2, the policy applied only to "coverage and limits of insurance required by" the Master Agreement, but coverage would "in no event exceed[ ] either the scope of coverage or the limits of insurance provided by this policy."

Turning to Footstar, the court held it had a duty to indemnify for those injuries "arising out of [Footstar's] performance or failure to perform under this Agreement." Again, any indemnification obligation only relates to those acts taken "under [the] Agreement." A breach of contract, however, was not a "performance" under the Master Agreement—it was an act taken in direct violation of the contract. For the same reasons as with Liberty Mutual, the court held that Footstar had no indemnification obligation for its performance.

Duty To Defend and Pay Defense Costs

The duty to defend is broader than the duty to indemnify. The complaint alleged that Footstar caused Patrick's injuries by "negligently and carelessly … failing to properly remove" the infant stroller from the shelf. Based on these allegations and the expansive way "arising out of" has been interpreted by Illinois and New Jersey courts, the claim could have been potentially covered under subpart 1. There was certainly an argument that Patrick's injury arose from Sehat's "work or operation[ ]," especially if the injury does not have to be "pursuant to" the Master Agreement, as required by subpart 2.

Although the court rejected these readings for indemnity purposes, two triers of fact found that the injury arose from Footstar's work, including the jury and the magistrate judge, showing that the injury was potentially coverable under the terms of the Master Agreement and policy.

Bad Faith

While Liberty Mutual had a duty to defend, the flipside was that Liberty Mutual had a defensible position and therefore did not act in bad faith in denying coverage. "[I]n order to prove a claim of bad faith under New Jersey law, a plaintiff must prove that: '(1) the insurer lacked a 'fairly debatable' reason for its failure to pay a claim, and (2) that the insurer knew or recklessly disregarded the lack of a reasonable basis for denying the claim.'" Certain Underwriters at Lloyd's of London v. Alesi, 843 F. Supp. 2d 517 (D.N.J. 2011) (citation omitted).

Though Liberty Mutual's denial letter erroneously refused coverage based on the nature of the complaint—there was an indemnification requirement for personal injury and not just products liability—Liberty Mutual's position was, at the very least, "fairly debatable" at the time Liberty Mutual denied coverage.

Late Notice

Kmart did not alert Liberty Mutual or Footstar to the suit until 30 months after it first learned about the claim and 1½ years after the suit was filed. This was in contravention of the notice provisions in both the Master Agreement and the policy. However, that did not mean that Kmart's actions precluded it from recovering defense costs. Under New Jersey law, an insurer must show that it was appreciably prejudiced by its insured's failure to cooperate in order to disclaim coverage based on that failure. Absent any evidence that the case would have come out differently had the insurer been involved earlier, the court found no bad faith on Liberty Mutual's part.


Almost every policy of liability insurance and indemnity agreement requires prompt, if not immediate, notice to the insurer and the indemnitor. In this case, that prompt notice was not provided. Regardless, defense duty was owed because there was a potential for coverage, but only from the time of notice. Also, even though the insurer denied coverage in error, it had a fairly debatable position and thus avoided bad faith allegations.

Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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