Pennsylvania Supreme Court Issues Vital Opinion Regarding Change in Insured's Ability to Settle and Retain Coverage Without Insurer's Prior Approval

In a recent opinion by Justice Max Baer, the Pennsylvania Supreme Court held that an insured has the right to accept a settlement offer and retain coverage under the Policy where an insurer is defending under a reservation of rights even absent the insurer's approval, where the insurer has breached its duty by refusing a fair and reasonable settlement. The case arose out of a dispute between Insureds Babcock & Wilcox Company ("B&W") and Atlantic Richfield Company ("ARCO") (collectively, "Insureds") and Insurers American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters (collectively, "Insurers"). 

The Insurers agreed to defend the Insureds subject to reservation of rights, but refused to settle the case based on their assessment that the case presented a strong likelihood of a defense verdict at trial. Despite the Insurers' express opposition to settlement, as well as their ongoing refusal to consent to settlement, the Insureds settled the case with the Plaintiffs and subsequently sought reimbursement from the Insurers. In response, the Insurers maintained that reimbursement was not appropriate as the Policy's Cooperation Clause expressly placed the decision to settle with the Insurers.

The case proceeded to trial, where the Insureds argued that insurers have an obligation to reimburse insureds as long as settlement is fair and reasonable and in good faith, as established in United Services Auto Ass'n v. Morris, 741 P.2d 246 (Ariz 1987). The Insurers maintained that the obligation to pay only applies where an insurer acts in bad faith in refusing to settle, as established in Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa. 1957).  Initially, the Trial Court determined that the Cowden bad faith standard applied; however, the Trial Court later reconsidered its decision, and employed the Morris standard in favor of the Insureds. 

After a jury verdict in the Insureds' favor, the Insurers appealed to the Superior Court of Pennsylvania, which applied a third standard, the Insured's Choice Test, from a Florida decision, Taylor v. Safeco Insurance Co., 361 So.2d 743 (Fla. Dist. Ct. App. 1978). The Insured's Choice Test provides that when an insurer defends under a reservation of rights the insured can either: 1) unconditionally accept defense under the terms of the consent to settle provision of the policy; or 2) decline defense and furnish its own defense, including the right to settle and still have the indemnity protection of the policy should coverage later be found to apply. 

However, the Pennsylvania Supreme Court rejected the Insured's Choice Test used by the Superior Court, finding the test unworkable under Pennsylvania law. The Pennsylvania Supreme Court chose to implement a "variation on the Morris fair and reasonable standard," which allows an insured to accept a settlement over the insurer's refusal when the settlement is fair, reasonable and non-collusive. The Pennsylvania Supreme Court modified the Morris rule to apply only to those situations where the insurer breaches its duty of good faith and fair dealing by refusing a fair and reasonable settlement while maintaining its reservation of rights thus subjecting the insured to potential liability for the judgment.  Determination of whether a settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the defense against asserted claims, and any potential fraud or collusion by the insured. In this case, the Pennsylvania Supreme Court found that the Trial Court's judgment in favor of the Insureds was proper and reinstated it. 

The Pennsylvania Supreme Court based its determination on the standard applied by the jury after an extensive trial and extensive facts presented at trial, opining that in a reservation of rights case where the insured settles despite the insurer's refusal to consent to same, a jury's determination that a settlement is "fair and reasonable from the perspective of a reasonably prudent person in the same position of [Insureds] and in light of the totality of the circumstances" is the proper standard to be applied. Babcock & Wilcox Co. v. American Nuclear Insurers et al., No. 2 WAP 2014.

For more information about this opinion contact Brett O. Strickland at 312.985.5942 or bstrickland@clarkhill.com.