Most policyholders that have experience with insurance claims will likely confirm that the mere fact that you have given the insurer timely notice of a claim is no guarantee of a timely response. Consequently, the policyholder may be required to go it alone by funding its own defense while awaiting a response from its insurer. And, of course, there is no guarantee that the insurer will actually provide a defense.

Insurance policies generally include a cooperation clause and exclude coverage for claims settled without the insurer’s agreement. What is a policyholder to do when it has a chance to settle on a reasonable and cost-effective basis before its insurer has agreed to defend or denied coverage? The policyholder is faced with a dilemma. Should it bear the expense and risk associated with the defense of a claim where the insurance carrier has not accepted that risk and the policyholder has a reasonable chance to mitigate the exposure from the claim through settlement?

A January 2016 decision by the Illinois appellate court should encourage policyholders to pursue opportunities to mitigate the risks associated with claims where their insurers have not accepted responsibility for the defense. In United National Insurance Company v. Faure Brothers Corporation, 2016 IL AP (1st) 132419-UB, an Illinois appellate court clarified that a policyholder is not required to incur defense costs and forgo a reasonable settlement opportunity in circumstances where the insurer does not accept its defense.

In Faure Brothers, the insurer rejected the policyholder’s claim, asserting that it did not fall within the policy’s coverage. Before the policyholder received its insurer’s response, the policyholder was presented with an opportunity to settle the claim. Liability on the claim appeared near certain. Faced with certain and significant defense costs and the exposure of a bad claim, the policyholder negotiated a settlement of the lawsuit. It then pursued a claim for the amounts incurred in defense and for the cost of the settlement against its insurer. The insurer responded by suing the policyholder seeking a declaration concerning its duty to provide a defense and to indemnify the policyholder for settlement.

The insurer asserted that the policyholder was obligated to present evidence essentially that it would have lost the lawsuit if it had not settled. The insurer asserted that its policyholder would have to prove the merits of the claim for which it sought coverage in order to get the insurance carrier to fund the settlement. The appellate court rejected that argument. The court held that the burden of proof in the case was with the policyholder in the first instance. But the court found that what the policyholder had to prove to prevail against its insurer was, essentially, the reasonableness of the settlement rather than the merits of the claim. Specifically, the court held that the insurer was required to fund the settlement1 if the policyholder established three things:

  1. that its claim fell within the coverage of the insurance policy;
  2. that the settlement was made in reasonable anticipation of liability; and
  3. that the amount paid in settlement was “reasonable” in light of the quality and quantity of evidence that the policyholder would expect to be offered against it at trial.

What should a policyholder do when it finds itself in the circumstance presented in Faure Brothers? First, a policyholder is well-advised to give its insurers (any insurers who wrote policies that might apply) timely written notice of a claim. Second, there is no reason for a policyholder to sit back and await a decision from an insurer while defense expenses mount, especially if there is an opportunity to bring the case to an early cost-effective resolution. Instead, a communication from counsel, helping the insurer to focus on why the claim is within the coverage as well as potential for early resolution, can expedite the process. Third, if the policyholder is considering settlement, it should provide written notice to the insurer keeping it advised of the settlement negotiations and affording it an opportunity to participate.

Where the policyholder has afforded its insurer a reasonable opportunity to act on the policyholder’s behalf, the policyholder is not required to bypass reasonable settlement opportunities and, assuming the claim is within the coverage, the policyholder will be well-positioned to obtain reimbursement from its insurer.

1 The insurer was obligated to reimburse defense costs as long as at least some claim asserted was potentially within the coverage of the insurance policy.