Kelly v. Iowa Mut. Ins. Co., 99-319.

• Decision Date: 16 November 2000
• Docket Number: No. 99-319.,99-319.
• Citation: 620 N.W.2d 637
• Parties: Donna Rae KELLY, Individually, and as the Administrator of the Estate of Leo J. Kelly, Deceased, and as Parent and Next Friend of Amy Kelly, a Minor, Appellant, v. IOWA MUTUAL INSURANCE CO., Appellee.
• Court: Iowa Supreme Court

620 N.W.2d 637

Donna Rae KELLY, Individually, and as the Administrator of the Estate of Leo J. Kelly, Deceased, and as Parent and Next Friend of Amy Kelly, a Minor, Appellant, v. IOWA MUTUAL INSURANCE CO., Appellee.

No. 99-319.

Supreme Court of Iowa.

November 16, 2000.

As Amended on Denial of Rehearing January 22, 2001.

Philip Willson and Michael J. Davenport of Willson & Pechacek, P.L.C., Council Bluffs, for appellant.

Roy M. Irish of Patterson, Lorentzen, Duffield, Timmons, Irish, Becker & Ordway, L.L.P., Des Moines, for appellee.

Fred M. Haskins of Patterson, Lorentzen, Duffield, Timmons, Irish, Becker & Ordway, L.L.P., Des Moines, for amicus curiae Iowa Insurance Institute.

Considered en banc.

TERNUS, Justice.

This case requires the court to decide whether an insured being defended under a reservation of rights breaches his duty of cooperation by agreeing to a stipulated judgment with the claimant. We hold that if the insurance company has breached the contract by wrongfully rejecting a reasonable settlement offer, the insured may accept the settlement offer over the insurer's objection without breaching policy duties and losing his right to seek coverage. Because the record before the district court was insufficient to allow a resolution of this issue, we reverse the court's summary judgment ruling in favor of the insurer, and remand the case for further proceedings consistent with this opinion.

I. Background Facts and Proceedings.

On April 18, 1993, Leo Kelly was killed while making repairs to a farm implement owned by Philip McCarthy. The appellee, Iowa Mutual Insurance Company, insured McCarthy at the time under a farm liability policy. The policy specifically excluded coverage for bodily injury sustained by "any employee ... as a result of his or her employment by the `Insured.'"

The appellant, Donna Rae Kelly, individually and as the administrator of the Estate of Leo Kelly and as parent and next friend of Amy Kelly (hereinafter "the estate"), made a claim against McCarthy for damages arising from Leo Kelly's alleged wrongful death. In turn, McCarthy sought coverage for this claim from Iowa Mutual.

Iowa Mutual believed that Kelly was McCarthy's employee and that his fatal injuries occurred as a result of his employment by McCarthy. Based on this belief and the employee exclusion contained in the policy, Iowa Mutual disputed coverage. Accordingly, on September 29, 1993, Iowa Mutual instituted a declaratory judgment action against McCarthy and the estate, seeking a declaration that the employee exclusion precluded coverage for any claims of the estate against McCarthy. The estate, in addition to filing an answer, also filed a cross-claim against McCarthy seeking damages for Kelly's wrongful death. At this point, Iowa Mutual provided McCarthy with an attorney to defend him on the wrongful death claim. The insurer also requested, and the court granted, a severance of the wrongful death cross-claim from the coverage action.

The declaratory judgment action proceeded to trial. The sole issue was whether Kelly was McCarthy's employee at the time of the accident. The jury found against Iowa Mutual, but the trial court granted the insurer's motion for judgment notwithstanding the verdict, ruling that Kelly was McCarthy's employee as a matter of law. The trial court's judgment NOV was reversed on appeal. Iowa Mut. Ins. Co. v. McCarthy, 572 N.W.2d 537, 545 (Iowa 1997). This court reinstated the jury's verdict and remanded "for the entry of a declaratory judgment that Iowa Mutual's policy provides coverage for the estate's wrongful death claim." Id.

During the pendency of the appeal of the declaratory judgment action, McCarthy and the estate entered into settlement negotiations, the nature and extent of which are not clear from the summary judgment record. It does appear, however, that Iowa Mutual was notified of these discussions, but refused to agree to any kind of settlement because, it contended, its insured, McCarthy, had no liability to the estate and the tort claim could be successfully defended.

Despite Iowa Mutual's objection, McCarthy settled the estate's wrongful death claim. Pursuant to the settlement agreement, McCarthy agreed that a judgment could be entered against him for $507,500 and costs. The estate agreed to accept a $7,500 payment from McCarthy, leaving a balance of $500,000 due on the judgment. (Iowa Mutual's limit of liability was $500,000.) The estate promised that it would not make any further claims against McCarthy, that it would refrain from executing upon or otherwise enforcing the remaining judgment against McCarthy, and that the balance of the judgment would not be satisfied by attachment of, nor become a lien upon, any assets of McCarthy. As part of the settlement, McCarthy assigned to the estate any claims he had against Iowa Mutual. The estate agreed that it would seek to satisfy the remaining judgment only from the proceeds of Iowa Mutual's policy. Pursuant to the agreement, the district court entered a judgment in the stipulated amount, and McCarthy paid the estate $7,500 in partial satisfaction of that judgment.

A few months after the coverage action was resolved, the estate filed the present action against Iowa Mutual seeking payment of the remaining $500,000 judgment, plus interest and costs. Iowa Mutual filed a motion for summary judgment alleging that McCarthy's settlement of the wrongful death case over Iowa Mutual's objection constituted a breach of policy conditions and resulted in a forfeiture of coverage.¹ The estate resisted, claiming that Iowa Mutual breached the policy and, consequently, McCarthy was excused from performance of the policy conditions. The district court granted summary judgment to Iowa Mutual and the estate filed this appeal.

II. Scope of Review.

Our review of a summary judgment ruling is for the correction of errors of law. See Continental Ins. Co. v. Bones, 596 N.W.2d 552, 555 (Iowa 1999)

. Summary judgment is appropriate where the moving party shows there are no genuine issues of material fact and it is entitled to judgment as a matter of law. See Iowa R. Civ. P. 237(c). In determining whether the moving party has met this burden, we view the record in the light most favorable to the party opposing the motion for summary judgment. See Met-Coil Sys. Corp. v. Columbia Cas. Co., 524 N.W.2d 650, 654 (Iowa 1994). This court's role on appeal is "to determine whether a genuine issue of material fact exists and whether the law was correctly applied." Red Giant Oil Co. v. Lawlor, 528 N.W.2d 524, 528 (Iowa 1995).

III. General Legal Principles.

We note initially that the estate, as McCarthy's assignee, stands in the shoes of McCarthy, and its recovery under the Iowa Mutual policy is subject to any defense that Iowa Mutual has against its insured. See id. at 533; 2 Allan D. Windt, Insurance Claims & Disputes § 9.15, at 61-62 (3d ed.1995) [hereinafter "Windt"]. It is also well established under Iowa law that a party seeking to recover under an insurance policy "must prove compliance with its terms." Am. Guar. & Liab. Ins. Co. v. Chandler Mfg. Co., 467 N.W.2d 226, 228 (Iowa 1991). In cases such as the one before us, where a third party seeks to establish coverage, the burden shifts to the insurer to introduce evidence of noncompliance. See id. at 229; Haynes v. Dairyland Mut. Ins. Co., 199 N.W.2d 83, 86 (Iowa 1972). If it is established that the insured has not substantially complied with the policy conditions, the party claiming coverage bears the burden to prove that performance was excused or waived or that the failure to comply was not prejudicial to the insurer. See Simpson v. U.S. Fid. & Guar. Co., 562 N.W.2d 627, 631 (Iowa 1997)

. Where excuse or waiver is not proved, there is a rebuttable presumption of prejudice. Id. at 631-32.

The estate does not argue that McCarthy complied with the policy conditions, but it does assert that various actions of Iowa Mutual released McCarthy from his obligations under the policy. Specifically, the estate complains of Iowa Mutual's defense of McCarthy under a reservation of rights, its commencement of a declaratory judgment action to litigate coverage, and Iowa Mutual's refusal to approve the settlement between McCarthy and the estate.

"It is a basic principle of contract law that once one party to a contract breaches the agreement, the other party is no longer obligated to continue performing his or her own contractual obligations." 1 Windt § 3.10, at 139; accord Van Oort Constr. Co. v. Nuckoll's Concrete Serv., Inc., 599 N.W.2d 684, 692 (Iowa 1999)

(holding that the breach must be material) (citing Restatement (Second) of Contracts § 237, at 215 (1981)). Our Red Giant case presents an example of this principle in operation. In Red Giant, we held that, where an insurance company refuses to defend the insured against a claim covered by the policy, the insured is free to settle with the injured party by stipulating to the entry of a judgment that is collectible only from the insurer. 528 N.W.2d at 531. The right of the insured in Red Giant to settle the claim against it resulted from the insurance company's refusal to defend. Under such circumstances, the "insurer's unjustified refusal to defend relieves the insured from his or her contract obligations not to settle and the insured is at liberty to make a reasonable settlement or compromise without losing his or her right to recover on the policy." 14 Lee R. Russ & Thomas F. Segalla, Couch on Insurance 3d § 202:7, at 202-32 (1999) [hereinafter "Couch"]; accord Fullerton v. U.S. Cas. Co., 184 Iowa 219, 231-32, 167 N.W. 700, 705 (1918) ("[The insurer] repudiated its obligation to assume and carry the defense to final judgment; and, having abandoned the case, it left the assured at liberty to take up the defense and contest the claim to final judgment, or, if so advised, to make the most favorable settlement possible.").

Unlike the insurer in ...