Should it stand, the Superior Court's opinion in Babcock & Wilcox v. American Nuclear Insurers, 2013 PA Super 174, --- A.3d ---- (2013), will have a greater impact on Pennsylvania coverage disputes than any case decided by our appellate courts in decades. Of great interest, however, is what the court did not decide. While an admirable attempt at reconciling the bitter unfairness inherent in coverage disputes, Judge David Wecht's opinion leaves important questions unanswered.
In Babcock & Wilcox, the court held that when an insured is presented with an offer to defend subject to an insurer's reservation of rights related to coverage, the insured has two mutually exclusive options: (1) accept the defense; however, if it does so, the insured must obtain the insurer's permission to settle and stay "unqualifiedly bound" to the insurer's defense strategy, or, alternatively, (2) decline the insurer's defense, settle the case without the insurer's permission and, if coverage exists, thereafter institute an action to recoup the fair, reasonable and noncollusive amount of settlement.
Despite this straightforward choice, other fact patterns lurk. Consider, for instance, a scenario where an insurer prohibits an insured from settling the claim but has simultaneously instituted litigation denying that it owes the insured coverage — a scenario that did not present itself in the B&W litigation.
Although the court observed that insurers may and do "seek declaratory judgments regarding coverage during the pendency of the underlying litigation," the court was silent as to whether the insured, who has accepted a defense, must refrain from settling where its insurer has instituted a declaratory judgment action seeking to avoid coverage while the underlying claim against the insured is pending.
Indeed, the opinion observes that Pennsylvania law provides insurers the option to "simultaneously ... contest coverage" but also approvingly quotes a New York case that states that an insurer may only control the defense of a case if it does so "without any endeavor to demonstrate the policy does not afford coverage." Of course, active coverage litigation leaves an insured vulnerable to bearing alone whatever amount is awarded against him or her. The risk for insureds is particularly grave when the threatened judgment exceeds the amount of coverage available. Accordingly, it remains unclear whether the Superior Court intended for insureds to be bound to their consent to settlement clauses even where the insurer institutes coverage litigation during the pendency of the underlying action.
Further, the court did not address when an insured must accept or reject a proffered defense or, for that matter, whether an insured could disclaim a previously accepted defense.
Can an insured, unhappy with its insurer that provided a defense but that does not sanction a settlement, thereafter reject the defense that it had accepted, retain its own personal counsel and settle without permission before proceeding against an insurer? No clear conclusion can be reached because the opinion, strictly read, suggests that the decision must be made "when" a defense is tendered pursuant to a reservation of rights.
The court did not, however, clarify whether it was using the word when to mean "at that time" or, alternatively, in the sense of "under this set of circumstances." If the former, the insured must make its decision at the time the defense is tendered. If the latter, the insured has more leeway to base its decision to accept or reject a defense on the factual realities as they develop. Indeed, in the case on which B&W's framework is based, the insured had initially accepted the insurer's defense but later rejected it.
The question of whether an insured may disclaim an accepted defense is fraught with important policy implications. Requiring unsophisticated or financially limited insureds to make a decision that limits their ability to settle a claim because they opted for the defense option places an unrealistic burden on insureds when they are the most ignorant of the claims process and most invested in securing a defense. If this is what the B&W test entails, an unsophisticated insured may find himself or herself ensnared because he or she — at the height of his or her ignorance and desperate for protection — accepted a defense. On the other hand, allowing an insured — who has accepted a defense but later disclaims the defense so that he or she can resolve the case, contrary to the edict of the insurer — creates its own perils. Accordingly, if the courts preclude an insured from settling the case without an insurer's permission where the insured accepted the defense in the first instance, perhaps the law should mandate that a reservation of rights letter contain express language addressing the consequences for the insured if he or she were to accept a defense. Specifically, the reservation of rights letter should notify the insured that where he or she accepts a defense subject to a reservation of rights, he or she will forfeit rights to resolve the claim without the insurer's permission.
In summary, should B&W stand, at least two questions remain unanswered. First, is an insured prevented from reaching a settlement the insurer does not accept when that insurer has instituted litigation to avoid coverage during the pendency of the underlying action? Second, once the insured has accepted the insurer's defense, can it subsequently reject it, and, if so, when?
While we predict that these issues will ultimately reach the Pennsylvania Supreme Court, B&W stands as a classic example where a worthy solution to one thorny issue exposes but does not resolve other issues that inevitably will arise.