Illinois Appellate Court Clarifies Application of Policy Consent Provisions and the Method for Analyzing the Reasonableness of an Insured’s Settlement
In a decision issued on September 30, 2014, the Illinois Appellate Court held that: (1) an insurer could not require that the insured obtain the insurer’s consent to a settlement when the insurer was not defending an insured and had assigned independent counsel; and (2) the insurer was nonetheless entitled to challenge the reasonableness of the settlement. The court also provided a detailed opinion clarifying the standards for the reasonableness inquiry. A copy of the opinion in Central Mutual Insurance Company v. Tracy’s Treasures, Inc., can be found here. This opinion is significant for two reasons. First, it extended the growing body of Illinois case law that limited the application of the consent defense in certain circumstances. At the same time, however, the opinion reconfirmed that insurers are only responsible for covering reasonable settlements, and the opinion provides perhaps the most extensive analysis by an Illinois Appellate court of the factors to be examined when evaluating reasonableness.
Tracy’s involved coverage for a TCPA class action. Tracy’s insurer, Central Mutual, declined to defend but did hire independent counsel to represent Tracy’s because of a potential conflict of interest. Central also filed a declaratory judgment action to obtain resolution of the coverage issues. Tracy’s then entered into a settlement with the underlying plaintiff providing for the entry of a $14 million judgment against Tracy’s which was enforceable only against Tracy’s insurance (the face value of which was $14 million). The court presiding over the underlying action held a fairness hearing and approved the settlement.
On appeal, the Appellate Court reversed the trial court’s ruling that TCPA settlements are uninsurable as a matter of law in light of the Illinois Supreme Court’s intervening decision in Standard Mutual Ins. Co. v. Lay. The court also rejected Central’s argument that there was no coverage for the TCPA’s liquidated damages under its policies. The court further held that it could not determine as a matter of law whether a prior settlement between Central and Tracy’s precluded coverage.
In the bulk of the opinion, the court addressed issues associated with consent and reasonableness. The court reiterated recent Illinois case law and held that when an insurer “cedes control of the defense of an action against its insured, the insured may enter into a reasonable settlement agreement without the insurer’s consent.” The court found that an insurer cedes a defense when there is a conflict of interest requiring independent counsel and when the insurer simply does not defend the insured. Ultimately, the court held that “[b]ecause Central surrendered control of the defense, it also surrendered its right to control the settlement of the action and to rely on policy provisions requiring consent to settle.”
The court did, however, reject Tracy’s argument that Central was bound by the settlement and could not challenge its reasonableness. The court held that because Central assigned independent counsel and filed a declaratory judgment action, it had adequately preserved all of its coverage defense and could also challenge the reasonableness of the settlement. In particular, the fact that the underlying court held a fairness hearing and approved of the settlement did not preclude Central from challenging whether the settlement was reasonable.
The court then examined in detail the two elements of the reasonableness inquiry. First, the decision to settle must be reasonable based upon “whether, considering the totality of the circumstances, the insured’s decision confirmed to the standard of a prudent uninsured.” Items that the court considered potentially relevant to this inquiry included the extent to which an insured would have believed it faced staggering liability, whether a prudent uninsured would have litigated certain defenses before settling, the costs of pursing various defenses, the likelihood of success of the defenses, the potential of obtaining contribution or indemnification from third parties, and whether a prudent uninsured would have agreed that all unclaimed settlement amounts would be given to charity (which the court noted was “extraordinarily generous and extremely helpful to class counsel’s quest for attorney fees”).
Second, the amount of the settlement must be reasonable based upon “what a reasonably prudent person in the position of the [insured] would have settled for on the merits of plaintiff’s claim.” As the court noted: “Fundamentally, the amount of the [underlying] settlement may be deemed unreasonable if there is evidence of bad faith, collusion or fraud by Tracy’s.” The court then examined out-of-state authority to provide examples of what makes a settlement collusive. Ultimately, the court determined that there were questions of fact with respect to both prongs of the reasonableness inquiry. As a result, the court rejected Central’s argument that the settlement should be found unreasonable and collusive as a matter of law.
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