Northwest Pump & Equipment Co. v. American States InsuranceNorthwest Pump & Equipment Co. v. American States Insurance
Lead Opinion
Defendant petitions for reconsideration of our opinion,
No Oregon decision defines precisely the consequences of an insurer’s wrongful refusal to defend. Courts in other jurisdictions have taken various approaches. A substantial number hold that an insurer that has wrongfully refused to defend is estopped from denying coverage. See, e.g., Joslyn Mfg. Co. v. Liberty Mut. Ins. Co.,
Other courts reject the extension of coverage by estoppel and hold that an insurer that wrongfully fails to defend is responsible for settlement costs only to the extent that the underlying claim is covered. See, e.g., Polaroid Corp. v. Travelers Indem. Co., 414 Mass 747, 762-63,
“The insurer’s breach [of the duty to defend] should not * * * be used as a method of obtaining coverage for the insured that the insured did not purchase. When a contract is breached, the injured party is entitled to receive what would have been obtained if there had been no breach; the injured party is not entitled to receive more.”
Allan D. Windt, 1 Insurance Claims and Disputes § 4.37 at 268 (3d ed 1995).
Oregon is among the jurisdictions that have rejected the rule that insurers that wrongfully fail to defend are estopped from contesting coverage as to settlement costs. In Timberline Equip, v. St. Paul Fire and Mar. Ins.,
“That argument is incorrect. When a contract is breached the injured party is entitled to receive what he would have if there had been no breach; he is not entitled to receive more.”
Id. at 646. Timberline, however, did not address the question of what other consequences, if any, attend an insurer’s wrongful failure to defend. More precisely, Timberline did not address whether Oregon follows the decisions of other states holding that an insurer that wrongfully fails to defend generally will not be liable for settlement costs unless the underlying claim is covered. To answer that question we work from more fundamental principles of Oregon contract and insurance law. Three such principles are pertinent to the disposition of this matter.
First, the duty to defend is a contractual duty, and, under general principles of contract law, the breach of that duty gives rise to a claim for damages. Georgetown Realty v. The Home Ins. Co.,
Second, the duty to defend is different from the duty to indemnify, and the breach of one does not, in and of itself, establish the breach of the other. See, e.g., Ledford v. Gutoski,
Third, the duty to indemnify cannot be extended by estoppel. The scope of an insurer’s risk is determined by the terms of the policy, not by the conduct of the parties subsequent to execution.
Application of those three principles leads to the conclusion that an insurer’s breach of the duty to defend does not give rise to a duty to indemnify unless the underlying claim is covered. That conclusion is the only one consistent with the general rule that an insured is entitled to the benefit of its bargain, and no more. The policy contains provisions specifying the conditions of coverage, exclusions and exceptions to the exclusions. To allow coverage beyond those terms — for example, to require an insurer to cover a loss that is otherwise subject to an exclusion — would be to allow the insured to obtain more than it bargained for: coverage for a noncovered claim. The foregoing conclusion also is the only one that maintains the distinction between the duty to defend, which is established by the allegations of a complaint compared with the terms of a policy, and the duty to indemnify, which is established by the actual facts demonstrating a right to recover under the policy. Finally, it is the only conclusion that is faithful to the principle that coverage may not be extended by waiver or estoppel.
The dissent does not propose the adoption of an outright rule of estoppel. But neither does it propose that an insurer’s obligation to pay settlement costs depends on whether the underlying claim is covered. The dissent stakes out something of a middle position, which would require the insurer to pay the insured’s settlement costs to the extent that they are reasonable. What constitutes a “reasonable” settlement depends on what a hypothetical insurer would have done under the circumstances. Whether the claim actually is subject to coverage is irrelevant, however, if it can be shown that a reasonable insurer would have settled anyway, either because a reasonable insurer would not have known at the time of the hypothetical settlement that a policy exclusion applied or because the reasonable insurer would have assessed the risks in such a way that it would have settled notwithstanding the applicability of the exclusion. The dissent’s proposed rule is apparently borne of concern that insurers not be allowed to take advantage of information as to the applicability of a policy exclusion that the insurer obtained only after having lost the battle over its duty to defend. That concern is perhaps meritorious (although it is uncertain precisely how often, in the real world, insurers will not know the facts as to the event underlying the coverage dispute only after the litigation over the duty to defend). The problem is that the legal theory cannot be reconciled with Oregon contract and insurance law.
First, the dissent’s proposed rule is at odds with the traditional measure of contract damages. It does not give the insured what it bargained for, which is coverage in accordance with the terms of the policy. It gives the insured more, namely, the possibility of coverage for a noncovered event. The dissent does not explain by what legal theory it arrives at that result. It appears that the dissent relies on a variation of consequential damages theory, but such an analogy is inapt.
Consequential damages are, by definition, those that the parties to a contract reasonably contemplate at the time of execution, not at some later date. See, e.g., Siegner v. Interstate Production Credit Assn.,
Second, to the extent that the dissent’s proposed rule limits the evidence on which an insurer may rely in determining its duty to indemnify, it punishes an insurer for having failed properly to defend by preventing it to assert the applicability of a policy exclusion. Thus, the consequence for violating the duty to defend is the expansion of the duty to indemnify. That improperly conflates the two independent duties of defense and indemnification. It also effectively extends coverage by estoppel by limiting the extent to which an insurer can rely on an exclusion solely because of its wrongful conduct.
The dissent cites no Oregon authority for its proposal to so punish insurers that wrongfully fail to defend. It relies instead on a judgment that it is better policy to punish insurers for their wrongful conduct than to punish insureds for entering into settlements without the benefit of the defense to which they were entitled. What is before us, however, is not a policy judgment. The dissent’s complaint that it is innocent insureds who are being “punished” for an insured’s breach, moreover, begs the question of whether a plaintiff that claims coverage for an event that may not, in fact, be a covered event is really being “punished.”
The dissent further takes us to task for our insistence that the duties to indemnify and to defend are distinct. According to the dissent “[w]hen an insurance company fails to undertake its duty to defend it leaves the insured with less than the bargained-for protection of the insured’s interests against a third party.”
With the foregoing principles in mind, we return to the facts of this case. Defendant declined to provide a defense as to claims brought against plaintiff, its insured. Plaintiff proceeded with a defense at its own expense and ultimately settled those claims. Plaintiff then sued for recovery of its settlement costs, which included both the costs of providing the defense and the cost of the liability itself. Defendant breached its duty to defend, and, as defendant itself concedes, it is liable for the costs of defense. As to the settlement, however, defendant asserts that it is not liable, because the underlying event that gave rise to the claim is subject to an exclusion clause in the insurance policy. Defendant is entitled to assert the applicability of the exclusion provision. If the provision applies, it is not liable for the settlement costs. If not, then it will be liable for those settlement costs to the extent that they are reasonable. On remand, therefore, the case should proceed on the merits as to coverage.
Petition for reconsideration allowed; opinion modified; reversed and remanded for further proceedings consistent with the court’s opinion of May 22,1996, as modified by this opinion.
Dissenting Opinion
In Northwest Pump v. American States Ins. Co.,
“refrain from entering summary judgment in favor of [plaintiff] with respect to amounts paid in settlement until it has determined whether those amounts were covered indemnity losses under the policy.”
The majority accedes to that request. It holds that “ [defendant is entitled to assert the applicability of the exclusion provision!,]”
The relevant policy provisions in this case are as follows:
“The company will pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of
A. bodily injury, or,
B. property damage
to which this insurance applies, caused by an occurrence, and the company shall have the right and duty to defend any suit against the insured seeking damages on account of such bodily injury or property damage, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient, but the company shall not be obligated to pay any claim or judgment or to defend any suit after the applicable limit of the company’s liability has been exhausted by payment of judgments or settlements.” (Boldface in original; emphasis supplied.)
The majority’s starting premise, like defendant’s, is that the duty to defend is wholly independent of the duty to indemnify. Id. at 226.1 believe the majority reads too much into the Supreme Court’s statement in Ledford v. Gutoski,
In this case, an express provision in the policy gives defendant the right to settle any claim, even one that is groundless, false or fraudulent, “as it deems expedient.” The policy also provides that defendant’s duty to indemnify has a stated limit and that once that limit has been reached by payment of judgments or settlements, its duties both to indemnify and to defend cease. See North Pacific Ins. Co. v. Wilson’s Distributing,
The majority is correct,
In Polaroid Corp. v. Travelers Indem. Co., 414 Mass 747,
“We have not decided which party has the burden of proof as to the sudden and accidental discharge. * * * Here, even if we were to assume that the burden would normally be on the insured, we place it on the insurer when the insurer is in breach of its duty to defend.” Id.
Similarly, in Hirst v. St. Paul Fire & Marine Ins. Co.,
Appellate courts should adopt rules that encourage parties to adhere to the obligations that they voluntarily undertake when they enter into contracts. Instead, the majority adopts a rule that permits an insurer to breach its duty to defend and then to force the insured to prove that, if the original case had gone to trial, the insured would not have lost on a covered claim, while the insurer takes advantage of whatever information it may have acquired or can acquire after settlement in the subsequent action involving indemnity.
I think the better approach on remand is for the trial court to answer the following questions: If a reasonable insurer had accepted its duty to defend, would it reasonably have settled the claim against plaintiff? If so, when would it have settled? If it had settled, would the amount of a reasonable settlement have been at least as much as the actual settlement? Plaintiff is entitled to recover from defendant the amount for which a reasonable
In making its factual determination regarding the amount, if any, of the settlement that plaintiff is entitled to recover from defendant, the trial court should take into account a number of factors that a reasonable insurer would consider. They include, but are not limited to: the projected costs associated with defending the case if it had gone to trial; the likelihood of a judgment against plaintiff that is within the policy’s coverage and the potential amount of that judgment; the likelihood of a judgment against plaintiff that is not within the policy’s coverage and the potential amount of that judgment; and plaintiffs willingness to contribute to the settlement in the light of the risk to plaintiff of noncoverage under the insurance policy. Because plaintiff is entitled to recover what it would have received if defendant had not breached its duty to defend, the court’s findings should be based on evidence that is limited by what defendant knew at the time that it reasonably would have settled the case.
The majority rejects this approach on the grounds that it “punishes an insurer for having failed properly to defend by preventing it to assert the applicability of a policy exclusion,” that it has the effect of expanding the duty to indemnify, and that it extends coverage by estoppel.
This approach does not, as the majority suggests, extend coverage by estoppel or expand the duty to indemnify in violation of Timberline Equip. That case has no bearing on the issue in this case. In Timberline Equip., the court held as a matter of law that one of the third party’s claims was excluded from coverage but that another claim was within the policy’s coverage. The court held St. Paul liable for all of Timberline’s defense costs and remanded to the trial court “to determine the amount to which [Timberline] is entitled” regarding settlement costs. Timberline Equip.,
For the foregoing reasons, I dissent.
Notes
Defendant’s petition states:
“[Defendant] asks the Court to reconsider that part of the Court’s opinion, beginning at p. 9, which holds plaintiff Northwest Pump & Equipment Co. (‘Northwest Pump’) is entitled to recover from [defendant] the amounts paid in settling an underlying action, based purely upon the allegations of the complaint and without any proof of coverage.”