No Defense Provided
In Liquor Liab. Joint Underwriting Ass'n of Mass. v. Hermitage Ins. Co., 644 N.E.2d 964 (Mass. 1995), the JUA sought recovery from Hermitage for the defense costs and settlement amount from defending their mutual insured. The complaint against the insured alleged negligent serving of alcoholic beverages (within the coverage of the JUA policy) and negligent security (within the coverage of the Hermitage policy). Hermitage denied coverage, and the JUA defended the entire suit. The JUA requested an allocated verdict, but the judge denied the request, and an unallocated verdict was returned. The JUA settled after the verdict was returned, and there was no question that the settlement was "noncollusive and reasonable." Liquor Liability at 969.
The JUA had advised Hermitage of its obligations, but Hermitage nonetheless failed to defend when it could have done so under a reservation of rights. Because Hermitage breached its defense obligation, it had the burden of proving the claim was not within the policy's coverage and, therefore, bore the burden of allocating the underlying judgment between the covered and noncovered claim. Liquor Liability at 968-9. Any attempt by Hermitage to satisfy this burden "would be speculative and arbitrary, essentially amounting to an attempt to determine the particular amount that happened to be in the juror's minds as they returned the verdict," and therefore, Hermitage was responsible to the JUA for the entire unallocated settlement amount. Id. at 969. Cf. Peterson Tractor Co. v. Travelers Indem. Co. of Ill., 156 Fed. Appx. 21 (9th Cir. 2005) (once the insurer breaches the duty to defend, the insured is relieved of its burden to allocate although the insurer can still present any defenses not inconsistent with the judgment), and Welch Foods, Inc. v. Liberty Mut. Fire Ins. Co. (Mass. Super. 2005) (applying the burden to allocate defense costs as well and if unable, the insurer breaching its duty to defend is responsible for both covered and noncovered defense costs).
Defense Provided but No Notification to Insured of Need for Allocation
Courts have characterized shifting the burden to allocate to the insurer who fails to defend as "eminently fair" because the nondefending insurer "could (and should) have participated in the defense of the action ... under a reservation of rights ... and explained to the trial judge" the need to allocate. Palermo v. Fireman's Fund Ins. Co., 676 N.E.2d 1158, 1164 (Mass. Ct. App. 1997). However, some jurisdictions make the insurer responsible for the entire undifferentiated award even when the insurer defends under a reservation of rights.
In Duke v. Hoch, 468 F.2d 973 (5th Cir. 1972), Duke obtained a judgment against the insured and sued its insurer, demanding that the insurer pay the covered portion of a judgment entered in Duke's favor that included covered and uncovered claims. Under Florida law, Duke had the burden of proving which damages included in the judgment pertained to covered losses. Duke was unable to meet this burden because of the unallocated general verdict form. Despite this, the Fifth Circuit excused Duke from his burden of proof because of the conduct of the insurer.
The appeals court noted that because the insured had the burden of proof, the insurer had an interest in the verdict not being allocated. This conflicted with the interest of the insured, who would have been better served by an allocated verdict form in which the segregation of damages would have enabled the insured to prove which damages were covered. The attorney retained by the insurance company to defend Duke had not requested an allocated verdict at trial. Id. at 979.
The Fifth Circuit stressed that the insurer undertaking the defense of a suit against its insured has the right to control the litigation and must meet a high standard of conduct. The right to control the litigation in all of its aspects carries with it the corresponding duty to exercise diligence, intelligence, good faith, and honest and conscientious fidelity to the common interest of the parties. When the insurer undertakes the defense of the claim or suit, it acts as the agent of its insured by virtue of the contract of insurance between the parties. When a conflict of interest arises between the insurer, as agent, and insured, as principal, the insurer's conduct will be subject to closer scrutiny than that of an ordinary agent, because of the insurer's adverse interest. Id. at 978.
Thus, the court found that before trial, the insurer was required to make known to the insured the availability of a special verdict and the divergence of interest between the insured and insurer springing from whether damages were or were not allocated. Id. at 979; see also Doe v. Illinois State Medical Inter-Insurance Exch., 599 N.E.2d 983, 989 (Ill. App. 1992) (reflecting the insurer's obligation to allocate because it is the insurer who is aware of the issue). The court quoted the following provision from Section 4(b) of the Statement of Principles of the ABA and the Conference Committee on Adjusters:
The companies and their representatives, including attorneys, will inform the policyholder of the progress of any suit against the policyholder and its probable results. If any diversity of interest shall appear between the policyholder and the company, the policyholder shall be fully advised of the situation.
The court found that the insurer should not have been allowed to rely on the evidentiary advantage it gained by failing to follow the above principle, and the court accordingly relieved Duke of its burden of proof on the issue of the amount of covered damages. Id. at 979-80.
At least one court has applied this reasoning to an umbrella insurer with respect to an unallocated judgment in excess of the underlying limits. In Valley Bancorp. v. Auto Owners Ins. Co., 569 N.W.2d 345 (Wis. App. 1997), the primary insurer notified the excess insurer, Auto Owners, of the lawsuit 5 months prior to trial. Auto Owners asserted that there was no coverage, with one possible exception. Auto Owners was not notified of a subsequent pretrial strategy meeting and refused to participate in the posttrial settlement negotiations. Because Auto Owners had the opportunity to participate and did nothing to determine coverage or seek a declaratory judgment, the burden to allocate fell on Auto Owners, and because it could not do so, it became responsible "for the entire amount of the settlement in excess of [the primary] limits." Valley at 351.
Duke and Doe describe the notification requirements an insurer bears when defending a mixed complaint under a reservation of rights. In MedMarc Cas. Ins. Co. v. Forest Healthcare, Inc., 199 S.W.3d 58 (Ark. 2004), the insurer defended under a reservation of rights and directed counsel to seek an allocated verdict. The court refused defense counsel's request to allocate among policy periods because it "would confuse the jury." MedMarc at 60.
MedMarc filed suit seeking a declaration that its policy provided no coverage as two insurers were on the risk and the jury failed to allocate. MedMarc argued that allocation was the insured's burden, and the failure to allocate relieved the insurer from paying any amount under the policy. The insured argues that it was the insurer's burden and, further, that the circuit court's allocation was supported by trial testimony.
The MedMarc court concluded, like Duke, that one of the duties inherent in the right to control the litigation is "the duty not to prejudice the insured's rights by failing to request special interrogatories or a special verdict in order to clarify coverage of damages." MedMarc at 62 (citing Gay & Taylor, Inc. v. St. Paul Fire & Marine Ins. Co., 550 F. Supp. 710 (W.D. Okla. 1981)). Requesting allocation, but not receiving it, did not relieve MedMarc of its obligation to pay a portion of the judgment. The court remanded the case to provide "the reasoning and basis for the particular allocation in the form of findings of fact and conclusions of law." Id. at 63.
MedMarc seems anomalous because the insurer defended under a reservation of rights and notified its insured of the ability to seek an allocated verdict apportioning the damages attributable to the covered and noncovered claims. In fact, the MedMarc dissent found that because "MedMarc adequately notified [its insured] of [the] need for an apportioned verdict, ... MedMarc fulfilled its obligations" so that the burden of apportioning the verdict did not shift from insured to insurer. MedMarc at 64 (Thornton, J., dissenting).
Implicit in the MedMarc decision is the majority's reliance on MedMarc's decision to drop its appeal of "the issue of the failure to give the apportionment instruction." MedMarc at 63. Had the trial court's denial of the apportionment instruction been upheld on appeal, it is not clear whether the majority would still have found that MedMarc failed to fulfill its duty with respect to guiding its insured to seek an allocated verdict. Cf. Aetna Ins. Co. v. Borrell-Bigby Elec. Co., Inc., 541 So. 2d 139 (Fla. Dist. Ct. App. 1989) (the insurer is obligated to appeal from an adverse judgment where there is a good faith basis for doing so).