The most familiar form of insurance bad faith is when an
insurance company fails to take advantage of an opportunity to
settle within its policy limits and thereby exposes its
policyholder to a verdict in excess of the policy limits. The
rationale is that the insurance company, which has control of the
defense and the decision whether to settle or try the case, should
not gamble with its insured's money. The same rationale has now
been applied to hold that a primary insurer (a) must allow an
insured to assume control of its own defense when there is a
"nontrivial probability" of an excess judgment and (b)
may be liable if its failure to do so prevents the insured from
collecting from its excess insurer.
In R.G. Wegman Construction Co. v. Admiral Ins. Co.,
09-2022 (7th Cir. Jan. 14, 2011), Wegman was an additional insured
on an Admiral policy with a $1 million limit. Admiral provided and
controlled Wegman's defense, and the trial resulted in a $2
million verdict against Wegman. Wegman had a $10 million excess
policy but only put the excess carrier on notice days before trial,
resulting in a denial of coverage due to late notice. Wegman then
sued Admiral, contending that Admiral's failure to notify
Wegman of the risk of an excess verdict caused Wegman to lose its
own excess insurance coverage. The Illinois federal district court
granted Admiral's motion to dismiss, holding that an insurer
discharges its duties by providing counsel to defend the
insured.
The Seventh Circuit reversed and remanded, holding under Illinois
law that the "nontrivial probability" of an excess
judgment or settlement created a potential conflict of interest
between insurer and insured as well as a duty for the insurer to
notify the insured. Slip Op. at 13. The key is that the insurer
controlled the defense. By virtue of that control, however, the
insurer's duty to the insured includes not only the hiring of
competent counsel but also keeping abreast of progress and status
of litigation in order that it may act intelligently and in good
faith on settlement offers. Id. at 8. (Quotations omitted.) The
court added that once the insured is notified of the potential
conflict, the insured has the right to assume control of its own
defense and hire its own lawyer whose reasonable fees must be paid
by the insurer. Id. at 10. Moreover, the court specifically stated
that the loss of opportunity to trigger excess insurance coverage
is a form of harm that is protected by the insurer's duty of
good faith and can be remedied by a cause of action for breach of
that duty. Id. at 15.
When faced with high-stakes litigation, an insured may be able to
use Wegman as leverage to persuade its insurer to let the
insured choose its own defense counsel, who would be controlled by
the insured but paid by the insurer. Moreover, other recent
Illinois cases suggest that the insurer cannot force its own
billing rates and guidelines on the attorney selected by the
insured. See, e.g., American Svc. Ins. Co. v. China Ocean
Shipping Co., No. 1-08-1821 (Ill. App. 1st Dist. June 16,
2010), slip op. at 27, quoting Taco Bell Corp. v. Continental
Cas. Co., 388 F.3d 1069, 1077 (7th Cir. 2004) ("We add
that the duty to defend would be significantly undermined if an
insurance company could, by the facile expedient of hiring an audit
firm to pick apart a law firm's billing, obtain an evidentiary
hearing on how much the insured's defense costs it had to
reimburse.")
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