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Babcock & Wilcox Co. v. American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters

Supreme Court of Pennsylvania

July 21, 2015

THE BABCOCK & WILCOX COMPANY AND B& W NUCLEAR ENVIRONMENTAL SERVICES, INC.
v.
AMERICAN NUCLEAR INSURERS AND MUTUAL ATOMIC ENERGY LIABILITY UNDERWRITERS AND OTHER INTERESTED PARTY: ATLANTIC RICHFIELD COMPANY; AMERICAN NUCLEAR INSURERS AND MUTUAL ATOMIC ENERGY LIABILITY UNDERWRITERS
v.
THE BABCOCK & WILCOX COMPANY AND B& W NUCLEAR ENVIRONMENTAL SERVICES, INC., AND ATLANTIC RICHFIELD COMPANY. APPEAL OF: BABCOCK & WILCOX POWER GENERATION GROUP, INC. (F/K/A THE BABCOCK & WILCOX COMPANY) AND BABCOCK & WILCOX TECHNICAL SERVICES GROUP, INC. (F/K/A B& W NUCLEAR ENVIRONMENTAL SERVICES, INC.), AND ATLANTIC RICHFIELD COMPANY

         Argued October 7, 2014

          Appeal from the Order of the Superior Court entered July 10, 2013 at No. 525 WDA 2012, vacating the Judgment of the Court of Common Pleas of Allegheny County entered February 17, 2012 at GD99-11498 and GD99-16227 and remanding. Appeal allowed January 24, 2014 at 376 WAL 2013. Trial Court Judge: R. Stanton Wettick, Jr., Senior Judge. Intermediate Court Judges: John L. Musmanno, Judith F. Olson, David N. Wecht, JJ.

         For Atlantic Richfield Company, APPELLANT: James A. Dattilo, Esq., Dattilo & Associated, P.C.

         For Babcock & Wilcox Power Generation Group, Inc.; Babcock & Wilcox Technical Services Group, Inc., APPELLANTS: Thomas More Reiter, Esq., K& L Gates LLP.

         For United Policyholders, et al., APPELLANT AMICUS CURIAE: John Norig Ellison, Esq., Jay M. Levin, Esq., James Christopher Martin, Esq., Traci Sands Rea, Esq., Reed Smith LLP.

         For American Nuclear Insurers; Mutual Atomic Energy Liability Underwriters, APPELLEES: Andrew Amer, Esq.; Jon Geoffrey Hogue, Esq., John Edward Murray, Esq., Murray, Hogue & Lannis.

         For Pennsylvania Defense Institute, APPELLEE AMICUS CURIAE: Nicholas Andrew Cummins, Esq., Bennett, Bricklin & Saltzburg, L.L.P.

         For Property Casualty Insurers Association of America, APPELLEE AMICUS CURIAE: Randy J. Maniloff, Esq., Whte and Williams, L.L.P.

         BEFORE: CASTILLE, C.J., SAYLOR, EAKIN, BAER, TODD, McCAFFERY, STEVENS, JJ. Former Chief Justice Castille and former Justice McCaffery did not participate in the decision of this case. Madame Justice Todd and Mr. Justice Stevens join the opinion. Mr. Justice Eakin files a concurring and dissenting opinion in which Mr. Chief Justice Saylor joins.

          OPINION

Page 446

          MR. BAER, JUSTICE

         We granted review to consider an issue of first impression regarding whether an insured forfeits insurance coverage by settling a tort claim without the consent of its insurer, when the insurer defends the insured

Page 447

subject to a reservation of rights, asserting that the claims may not be covered by the policy. After review, we reverse the decision of the Superior Court and reinstate the judgment of the trial court.

         The case history spans two decades, beginning with the 1994 filing of a federal class action lawsuit against Appellant-Insureds Babcock & Wilcox Company (B& W) and Atlantic Richfield Company (ARCO) (collectively, Insureds) brought by plaintiffs claiming to have suffered bodily injury and property damage caused by emissions from nuclear facilities owned by Insureds.[1] Over time, the class action grew to include over 500 named plaintiffs, who lived near the nuclear facilities. Insureds denied that the facilities released any emissions or that the harm suffered by plaintiffs resulted from the facilities. Nevertheless, a 1998 jury trial of eight test cases resulted in an initial verdict totaling over $36 million or approximately $4.5 million per plaintiff. The federal court, however, granted a new trial due to evidentiary issues. The retrial was never held given the subsequent settlement discussed below.

         While the underlying tort action was pending in federal court, disputes arose between Insureds and their insurers, Appellees American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters (collectively ANI or Insurer). At the outset of the litigation, Insurer acknowledged that it would defend Insureds but contested whether the policy covered aspects of the claims, and thus defended subject to a reservation of rights. Specifically, in 1994, Insurer, inter alia, asserted that the policy did not cover damages that were not caused by nuclear energy hazard, damages in excess of the policy limits, and claims for injunctive relief and punitive damages. Letter of June 20, 1994, R.R. at 148a-151a. The 1994 reservation of rights was supplemented as to B& W in October 1999, by a letter indicating, inter alia, that Insurer reserved its right to disclaim coverage for Insureds' liability based upon Insureds' pressuring of Insurer to settle, which Insurer viewed, in connection with other actions, as a breach of Insureds' duty to cooperate.[2] Letter of October 5, 1999, R.R. at 3206-08.

         While the details are not relevant to the current dispute, Insurer filed a declaratory judgment action in state court days after the 1999 reservation of rights letter, raising challenges relating to the coverage limit, whether B& W and ARCO were entitled to separate representation, and bad faith and breach of contract allegations, including the breach of the duty to cooperate, against the Insureds. The Insureds counter claimed, raising bad faith allegations against Insurer. While staying various claims for future determination, including the breach of the duty to cooperate claim, the court decided issues regarding the trigger of coverage and held that B& W and ARCO were entitled to separate counsel. The Superior Court affirmed on appeal, and this Court denied allocatur.[3]

Page 448

          During the course of the litigation, Insurer refused consent to any settlement offers presented to it due to its conclusion that the case had a strong likelihood of a defense verdict given the lack of medical and scientific support for plaintiffs' claims and decisions by the federal trial court regarding procedural and evidentiary issues in the pending retrial, which Insurer viewed as highly favorable to Insureds' ultimate outcome. Nevertheless, after presenting the settlement offers to Insurer and being denied consent, Insureds ARCO and B& W, respectively in 2008 and 2009, settled with the class action plaintiffs for a total of $80 million, which was substantially less than the $320 million of potential coverage.[4]

         Insureds then sought reimbursement of the settlement amount from Insurer in the Allegheny County Court of Common Pleas. Insurer countered that reimbursement was not permissible because the insurance contract contained a standard consent to settlement clause, also referred to as a cooperation clause, requiring Insureds to cooperate with Insurer and to obtain Insurer's consent to settle:

Assistance and cooperation of the Insured. The insured shall cooperate with the companies, and upon the companies' request, attend hearings and trials and assist in making settlements, securing and giving evidence, obtaining the attendance of witnesses and in the conduct of any legal proceedings in connection with the subject matter of this insurance. The insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense.

         Insurance Agreement, Condition 6, Reproduced Record (R.R.) at 59a. Under the insurance policy the decision to settle rested exclusively with Insurer which " may make such investigation, negotiations and settlement of any claim or suit as they deem expedient." Id. at I(A)(1), R.R. at 57a. Moreover, the policy expressly did not cover " liability assumed by the insured under contract . . . ." Id. at Exclusion (c), R.R. at 58a.

         Relevant to the question at bar, the trial court recognized that the case presented the issue of " under what circumstances will a court require an insurance company, whose policy is found to provide coverage, to reimburse an insured that settled the underlying litigation over the objections of the insurance company" in a case involving a standard consent to settlement clause when the insurer has defended its insured subject to a reservation of rights. Tr. Ct. Op., July 5, 2011 at 2. As discussed in more detail below, Insureds asserted that Insurer should reimburse Insureds for the settlement so long as coverage applies and the settlement is fair and reasonable and entered in good faith, a test derived in part from the seminal case of United Services Auto. Ass'n v. Morris, 154 Ariz. 113, 741 P.2d 246 (Ariz. 1987) (hereinafter " Morris fair and reasonable standard" ). Insurer, in contrast, argued that the obligation to pay the settlement could only be imposed on Insurer if it acted in bad faith in refusing to settle, seeking application of this Court's test in Cowden v. Aetna Cas. and Sur. Co., 389 Pa. 459, 134 A.2d 223 (Pa. 1957), where we held that an insurer must pay a judgment in excess of policy limits for its bad faith failure to settle below policy limits

Page 449

(herein after " Cowden bad faith standard" ).[5]

         While initially opining in December 2009 that the Cowden bad faith standard should apply, the trial court reconsidered its decision in July 2011 and applied the Morris fair and reasonable standard. Judge R. Stanton Wettick reasoned that while the interests of insurers and insureds generally align when the insurer has accepted responsibility for defense and indemnity, the parties' interests increasingly diverge the more the insurer believes the policy does not cover the claims, as when the insurer defends under a reservation of rights. He observed that, in a reservation of rights case, an insured would prefer to cap the potential liability as it ultimately may be responsible for the full settlement in the event that insurer is successful in its challenge to coverage, whereas the insurer does not want to settle as it would relinquish its challenge to coverage. Tr. Ct. Op., July 5, 2011 at 5. Relying upon Morris and decisions from other jurisdictions, the trial court opined that a reservation of rights case is more akin to a case where an insurer has refused coverage and defense. Id. at 5-6. Accordingly, the court adopted the test forwarded by Insureds under which an insurer, defending subject to a reservation of rights, is required to reimburse an insured for a settlement reached in violation of the consent to settle clause where coverage is found to exist and the settlement is " fair and reasonable" and made in " good faith and without collusion." Id. at 6-11(citing in support Insurance Co. of North America v. Spangler, 881 F.Supp. 539 (D. Wyo. 1995); Morris, 154 Ariz. 113, 741 P.2d 246; Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa 2000); Patrons Oxford Ins. Co. v. Harris, 2006 ME 72, 905 A.2d 819 (Me. 2006); and Martin v. Johnson, 141 Wn.App. 611, 170 P.3d 1198 (Wash. Ct.App. 2007)); Tr. Ct. Order, July 5, 2011(providing that Insurer shall reimburse Insureds if the Insureds establish that the settlement was " fair and reasonable" unless Insurer establishes that " there is no coverage" under the policies for reasons unrelated to the settlement).[6]

         Following the court's decision, a two-week trial was held where a jury determined that Insureds' settlement with plaintiffs was fair and reasonable. The trial court, then, molded the verdict to include prejudgment and post-verdict interest. Insurer appealed to the Superior Court seeking application of the Cowden bad faith standard. The Superior Court recognized that this case presents an issue of first impression in Pennsylvania, which has nonetheless been addressed by various state and federal courts. The court further observed that the question is subject to well-settled basic principles of Pennsylvania insurance law. The court emphasized that insurance policies are contracts at heart, controlled by the language of the policy, but which include unique policy concerns requiring that any ambiguity be interpreted in favor of the insured.

         The court reiterated that Pennsylvania distinguishes between the duty to provide coverage and the broader duty to defend, which applies when the claim may potentially come within the coverage of the policy. The panel acknowledged that the insurer's broad duty to defend is balanced

Page 450

by an insurer's option to defend subject to a reservation of rights. It emphasizes that the utilization of the reservation of rights is not a breach of contract but instead is encouraged, as it provides insureds with a defense in all cases of potential coverage while coverage is being determined.

         While acknowledging the permissible use of reservation of rights, the Superior Court detailed the potential for a conflict of interest between an insurer defending under a reservation of rights and an insured, who would be subject to full liability if its claim is eventually determined not to be covered. The panel recounted concerns raised in other courts that insurers will be less zealous in defense and less willing to settle if the insurers believe that they will ultimately not be liable for coverage. Acknowledging insureds' interest in settling reservation of rights cases, the Superior Court noted that allowing insureds to settle seemingly violates the clear language of the policy requiring the insurer's consent to settlement and presents the potential for collusion between an insured and a plaintiff.

         The Superior Court categorized judicial responses to these concerns as falling into two broad categories. It contended that a number of courts, like the trial court in this case, follow Morris, 154 Ariz. 113, 741 P.2d 246, holding that an insurer may be liable to reimburse a settlement that is fair, reasonable, and non-collusive, if coverage is determined to apply. The second category, which is championed by ANI in the case at bar, includes Vincent Soybean & Grain Co., Inc., v. Lloyd's Underwriters of London, 246 F.3d 1129 (8th Cir. 2001), and resembles Pennsylvania's Cowden bad faith standard, although Pennsylvania cases have not applied the standard when the insured has settled absent an insurer's consent. Vincent Soybean and other like cases emphasize that an insured breaches the insurance policy when it settles without the insurer's consent. These cases, therefore, have required the insured to demonstrate that the insurer acted in bad faith in refusing to settle before requiring insurer to pay the settlement. The Superior Court opined " that the Morris and Vincent Soybean approaches tilt the playing field too much in favor of, respectively, the insured or the insurer. There is, however, a third approach, an approach that we believe best balances the interests of the insurer and the insured." Babcock & Wilcox Co. v. American Nuclear Insurers, 2013 PA Super 174, 76 A.3d 1, 17 (Pa. Super. 2013).

         The Superior Court utilized Taylor v. Safeco Insurance Co., 361 So.2d 743 (Fla. Dist. Ct.App. 1978), as exemplifying the third approach, which allows the insured the option of rejecting the insurer's defense (hereinafter the " Taylor/Insured's Choice Test" ). The Superior Court summarized its test as follows:

[W]e hold that, when an insurer tenders a defense subject to a reservation, the insured may choose either of two options. It may accept the defense, in which event it remains unqualifiedly bound to the terms of the consent to settlement provision of the underlying policy. Should the insured choose this option, the insurer retains full control of the litigation, consistently with the policy's terms. In that event, the insured's sole protection against any injuries arising from the insurer's conduct of the defense lies in the bad faith standard articulated in Cowden.
Alternatively, the insured may decline the insurer's tender of a qualified defense and furnish its own defense, either pro se or through independent counsel retained at the insured's expense. In this event, the insured retains full control of its defense, including the option of settling the underlying claim under

Page 451

terms it believes best. Should the insured select this path, and should coverage be found, the insured may recover from the insurer the insured's defense costs and the costs of settlement, to the extent that these costs are deemed fair, reasonable, and non-collusive.

Id. at 22. Applying this test to the case at bar, the court remanded for a new trial on " 1) whether [Insureds] in fact rejected [Insurer's] defense; and, if not, 2) whether [Insurer] acted in bad faith in declining to settle" or participate in settlement negotiations. Id.[7]

         Notably, the Taylor/Insured's Choice Test approach was not forwarded by either Insurer or Insured, and indeed, both parties vehemently object to the Superior Court's adoption of the test because an insured under Pennsylvania law does not have the option of " rejecting" an insurer's defense as it would constitute a breach of the insurance policy, thereby releasing the insurer from the obligation to provide coverage. See American and Foreign Ins. Co. v. Jerry's Sport Center, Inc., 606 Pa. 584, 2 A.3d 526, 545 (Pa. 2009) (" [W]here the claim was potentially covered, Insured would have been at risk of breaching the insurance contract if it had rejected [the insurer's] defense and it was later determined that the claim was covered." ). Moreover, the parties observe that most insureds would be unable to utilize the Taylor/Insured's Choice Test approach as they would not have the funds to allow them to employ an independent defense after rejecting the insurer's defense for which they had paid premiums to obtain. Accordingly, for these reasons, we likewise reject the Superior Court's holding as unworkable under Pennsylvania law and turn to the arguments presented by the parties to determine which approach to adopt.

         As noted, we granted review to consider as an issue of first impression whether an insured forfeits the right to insurance coverage when it settles a lawsuit without the insurer's consent, where the insurer has defended the suit subject to a reservation of rights.[8] Insureds advocate adopting the Morris fair and reasonable standard. They contend that when an insurer defends subject to a reservation of rights, an insured must be able to protect itself from the potential of an adverse and uninsured decision in the underlying tort case, if the insurer is ultimately deemed correct in concluding that the policy does not cover the claim. Further, Insureds claim that the insurer in a reservation of rights scenario is " in the attractive position of being able to avoid exposure either because the insured prevails at trial or because the insurer's coverage defense is successfully asserted[.]" Insureds' Brief at 33. Insureds contend that the Morris fair and reasonable standard provides protection for the insured by allowing the insured to accept settlement, while still preserving the insurer's rights to contest coverage, challenge the fairness and reasonableness of the settlement including whether it resulted from fraud or collusion, and maintain control over other aspects of the defense

Page 452

including the choice of counsel and the defense strategy prior to settlement.

         Delving further into the underpinnings of the Morris fair and reasonable standard, Insureds observe that the court in Morris held that an insurer's reservation of rights " narrows the reach of the cooperation clause and permits the insured to take reasonable measures to protect himself against the danger of personal liability." Insureds' Brief at 30 (quoting Morris, 741 P.2d at 252.) Insureds observe that other courts have adopted similar standards, including Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982), and Patrons Oxford Ins. Co., 2006 ME 72, 905 A.2d 819. Insureds, however, recognize that contrary authority exists criticizing the Morris fair and reasonable standard, but they argue that those cases, including Vincent Soybean, discussed by the Superior Court, involved factually distinct circumstances, where the insured's lack of cooperation extended beyond merely settling the claim without the insurer's consent and included refusing to inform the insurer about the settlement offer or include insurers in any of the defense.

         Insureds insist that the Morris fair and reasonable standard is consistent with Pennsylvania insurance law. They emphasize that the Morris fair and reasonable standard acknowledges the propriety of an insurer's decision to defend under a reservation of rights, emphasizing that such act in no way breaches the insurer's duties under the insurance policy. The standard, according to Insureds, recognizes that the insurer's decision to defend under a reservation of rights does not permit the insured to breach the duty to cooperate in the defense, but rather alters the relative duties. Insureds explain their position:

To the contrary, . . . the insured must continue to satisfy its cooperation duties, such as sharing information with its insurer, responding to insurer requests, permitting an insurer to participate in settlement negotiations, and, of course, seeking insurer consent prior to entering settlement. Under the Fair and Reasonable Standard, in one respect, and only one respect, is the insured's " cooperation duty" adjusted in light of the insurer's assertion of its intention to reserve the right to disclaim coverage. And that is, when the insurer has reserved its right to disclaim coverage for a settlement or judgment, the insured is no longer duty-bound to refuse to enter into a fair, reasonable and non-collusive settlement simply because the insurer refuses consent. For, if the insurer is reserving its right to disclaim, thereby placing its insured in the " precarious" position widely noted, then the contours of the insured's duty to cooperate cannot properly be considered to extend so far as to include a duty to forego a fair and reasonable settlement solely because its insurer wishes to force a trial or to permit a forfeiture of coverage simply because the insured proceeds to enter into such a settlement.

         Insureds' Brief at 35-36 (emphasis omitted).

         In support, Insureds observe that Pennsylvania insurance law " prohibits a mechanistic approach to interpretation of insurance policy conditions." Insureds' Brief at 37 (citing Brakeman v. Potomac Ins. Co., 472 Pa. 66, 371 A.2d 193, 196 (Pa. 1977) (requiring an insurer to demonstrate prejudice before deeming the insured to have forfeited its insurance coverage by failing to satisfy the notice requirements of the insurance policy)). Insureds also note this Court's instruction that the " insurer must show that the breach is something more than a mere technical departure from the letter of the [insurance contract. Instead, it

Page 453

must show] that it is a departure that results in a substantial prejudice and injury to its position in the matter." Insureds' Brief at 38 (quoting Paxton Nat. Ins. Co. v. Brickajlik,513 Pa. 627, 522 A.2d 531, 532 (Pa. 1987) (quoting Conroy v. Commercial Cas. Ins. Co.,292 Pa. 219, 140 A. 905, 907 (Pa. 1928))) (alterations in brief). Insureds further emphasize the " strong, prevailing public policy in Pennsylvania to encourage voluntary settlements." Insureds' Brief at 39 (quoting Nationwide Ins. Co. v. Schneider, 599 Pa. 131, 960 A.2d 442, 449 (Pa. 2008)). Insureds assert that the Morris fair and reasonable standard protects the insured from forfeiture and promotes settlement in cases where the insured's ...


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