Gates Formed Fibre v. IMPERIAL CAS & INDEM. CO.

• Decision Date: 02 December 1988
• Docket Number: Civ. No. 87-0222-P.
• Citation: 702 F. Supp. 343
• Parties: GATES FORMED FIBRE PRODUCTS, INC., Plaintiff, v. IMPERIAL CASUALTY AND INDEMNITY COMPANY and Plasti-Vac, Inc., Defendants.
• Court: U.S. District Court — District of Maine

702 F. Supp. 343

GATES FORMED FIBRE PRODUCTS, INC., Plaintiff, v. IMPERIAL CASUALTY AND INDEMNITY COMPANY and Plasti-Vac, Inc., Defendants.

Civ. No. 87-0222-P.

United States District Court, D. Maine.

December 2, 1988.

Stephen B. Wade, Charles H. Abbott, Auburn, Me., for plaintiff.

John S. Whitman, William W. McCandless, Jr., Portland, Me., for defendant Imperial Cas. and Idem. Co.

Robert E. Mullen, Auburn, Me., for defendant Plasti-Vac, Inc.

MEMORANDUM OF DECISION AND ORDER DENYING PLAINTIFF'S MOTION TO STRIKE AFFIRMATIVE DEFENSE THAT A SETTLEMENT TERMINATED THE OBLIGATION TO INDEMNIFY UNDER THE POLICY

GENE CARTER, District Judge.

Gates Formed Fibre Products, Inc. ("Gates") is a Colorado corporation with a plant located in Maine. In 1985, Gates purchased from Plasti-Vac, Inc. ("PVI") a thermoforming machine to be used in Gates's manufacturing facility in Maine. In April 1986, Gates sued PVI for damages it suffered as a result of the thermoforming machine's failure to perform satisfactorily. Gates claimed damages totaling just over $1 million, including $200,000 as the machine's purchase price, $750,000 in lost profits, and about $45,000 in air freight charges.

In December 1986, PVI gave notice of the pending lawsuit to an agent of Imperial Casualty and Indemnity Company ("Imperial"), with whom PVI had a general insurance policy with a products liability endorsement. In February 1987 Imperial agreed to defend PVI in the lawsuit under a reservation of its rights to contest PVI's assertion that the Imperial policy covered this claim.

The jury trial began on July 13, 1987. Settlement negotiations among the three parties (including Imperial) took place before trial started, and continued into the trial, without success. No settlement had been reached when the case was committed to the jury on July 22, 1987.

On July 24, 1987, before the jury returned its verdict on that day, Gates and PVI entered into separate negotiations that culminated in a settlement agreement. Imperial was neither notified of nor invited to participate in these negotiations. It was not informed of the agreement until after it was finalized. Under the settlement agreement,¹ Gates agreed not to enforce against PVI personally any judgment obtained except to the extent of $200,000. In return, PVI agreed that, the actual jury verdict notwithstanding, a judgment of not less than $200,000 would be entered for Gates. If the actual jury verdict exceeded $200,000, the judgment was to be entered in the amount of the actual jury verdict. The agreement called for PVI to make two $100,000 payments to Gates and to cooperate fully with Gates in pursuing any claim for any excess over that amount against PVI's insurer. The agreement stated that it was not intended to release or indemnify PVI from liability, and included language intended to preserve claims against PVI's available insurance coverage.

On the same day that Gates and PVI reached their settlement agreement, the jury completed its deliberations and returned a verdict for Plaintiff in the amount of $661,189.99. The Court entered judgment in that amount, plus interests and costs.

In the present action, Gates seeks a declaration of "what amount, if any, of the judgment, Imperial is obligated to pay" under the insurance policy.² Amended Complaint at 2 (Docket Item # 5) (emphasis added). PVI answered Gates's complaint and filed a cross-claim against Imperial in three counts. Count I of this cross-claim also seeks construction of the Imperial contract, not as to Imperial's duty to indemnify PVI, but as to "what amount, if any, of the defense costs incurred by PVI that Imperial is obligated to be responsible for." Cross-claim, unnumbered page three (emphasis added). That count also seeks an award of costs and attorney's fees. Count II of the cross-claim asserts a claim against Imperial for breach of contract, seeking damages of $250,000 and statutory interest and attorney's fees pursuant to 24-A M.R. S.A. § 2436. Count III asserts against Imperial a claim for damages in the amount of $500,000 for alleged bad faith breach of Imperial's contractual obligations and other conduct. The cross-claim of PVI seeks no declaration of Imperial's duty to indemnify PVI under the insurance policy as to the amount of the judgment in the underlying case.

Imperial has denied any obligation to pay either Gates or PVI and has pleaded, inter alia, as an affirmative defense that the settlement agreement between Gates and PVI released Imperial from liability or, in the alternative, that the settlement limits Imperial's liability on the policy to $200,000, the amount which PVI is obligated to pay to Gates under the settlement agreement.

On July 15, 1988, after a second pretrial conference of counsel, the Court issued an order calling for motions and supporting materials addressing, inter alia,³ the legal effect of the settlement in the underlying case on the extent of Imperial's liability exposure. Accordingly, on August 1, 1988, Gates filed the motion in limine now under consideration, requesting that the Court strike Imperial's affirmative defense which asserts that the settlement agreement releases or limits Imperial's liability to indemnify. In response, Imperial filed a memorandum in opposition to Gates's motion, arguing that the Gates-PVI settlement agreement releases Imperial from any obligation under the policy or, in the alternative, that the effect of the agreement limits Imperial's liability to a maximum of $200,000.⁴ PVI has never filed any papers on the issue generated by Gates's motion in limine.

The Court denies Plaintiff's motion to strike the affirmative defense.⁵ On the undisputed facts as they now exist in the record, PVI settled the claim of Gates without either giving notice to Imperial of the specific negotiations leading to the actual settlement agreement or obtaining Imperial's consent to the settlement. Thereby, PVI violated the terms of the policy issued by Imperial. Accordingly, Defendant Imperial was thereby relieved of any obligation to indemnify PVI under the insurance policy, and the affirmative defense of Imperial is viable.

ANALYSIS

Imperial's Claim That The Settlement Agreement Releases Imperial From Its Duty To Indemnify

An insurance company's refusal to defend its insured against a covered claim generally constitutes breach of the insurance contract. Arizona Property and Casualty Insurance Guaranty Fund v. Helme, 153 Ariz. 129, 137, 735 P.2d 451, 459 (1987); Appleman, 7C Insurance Law and Practice § 4714 (1979). It is well settled that once an insurer breaches its duty to defend, the insured is free to proceed as he sees fit. Ideal Mutual Insurance Co. v. Myers, 789 F.2d 1196, 1200 (5th Cir. 1986). Thus, if an insurer wrongfully refuses to defend an action against an insured, as required by the policy, the insured is entitled to settle without jeopardizing his right to coverage otherwise available to him. Appleman, 7C Insurance Law and Practice § 4714 at 526; Navlyt v. State Farm Fire and Casualty Co., 62 Ill.App.3d 387, 19 Ill.Dec. 353, 378 N.E.2d 1228 (1978), citing Elas v. State Farm Mutual Automobile Insurance Co., 39 Ill. App.3d 944, 948, 352 N.E.2d 60, 63 (1976). Because the insurer's refusal to defend leaves the insured exposed, it makes sense to permit the insured to protect himself, without penalty of loss of his coverage, through settlement.

Where the insurer does not refuse to defend, but rather agrees to defend under a reservation of rights, a slightly different analysis applies. Unlike an outright refusal to defend, defense under a reservation of rights does not constitute a breach of the insurance agreement. The insurer's duties to defend and to indemnify are distinct. United Services Automobile Association v. Morris, 154 Ariz. 113, 119, 741 P.2d 246, 252 (1987). It is possible to satisfy the former while preserving the right to dispute the latter, without breaching the insurance agreement. See American Policyholders' Insurance Co. v. Cumberland Cold Storage Co., 373 A.2d 247, 250 (Me. 1977) ("it is not uncommon that an insurer will have a duty to defend based on the allegations in the complaint, yet have no subsequent duty to indemnify the insured"). The Court of Appeals for the Eighth Circuit, holding that a defense under a reservation of rights is not a breach, noted:

Does a liability insurer which is affording its insured a defense to a pending action for damages breach its contract of insurance by disputing with its insured the amount of coverage that is available for the claim? ... Two aspects of the insurer's obligation are to be considered. The first is the duty to defend. It cannot be questioned that the insurer was affording a defense to the insured. The other duty is one to pay or settle. The time for performance of that duty has not been reached.

Sargent v. Johnson, 551 F.2d 221, 230-31 (8th Cir.1977). By agreeing to defend while preserving the right to contest coverage, the insurer satisfied its duty to defend without breaching its duty to indemnify.

Even absent actual breach of the insurance contract, however, an insurer's reservation of right to assert a policy defense may still leave the insured in the precarious position of having to satisfy an uninsured judgment. See Arizona Property and Casualty Insurance Fund v. Helme, 153 Ariz. at 138, 735 P.2d at 460. Thus, where the insurer defends the insured but disputes coverage, courts have permitted an insured to protect itself by settling the claim against it without jeopardizing its right to whatever insurance coverage is subsequently adjudicated to exist. Eureka Investment Corp. v. Chicago Title Insurance Co., 530 F.Supp. 1110 (D.D.C.1982), aff'd in part, rev'd in part on other grounds, 743 F.2d 932 (D.C.Cir.1984) ("it is well established that if an insurer wrongfully denies liability when its insured submits a claim, the insurer may be held liable for the costs of a reasonable settlement...