An insurer must indemnify its insured for damages covered by the insured's insurance policy. Typically, the insured has the burden of proving coverage. See e.g.,Colonial Life & Accident Ins. Co. v. Collins, 194 So. 2d 532 (Ala. 1967); Consolidated Edison Co. of N.Y. v. Allstate Ins. Co., 774 N.E.2d 687 (N.Y. 2002). Therefore, "the burden of segregating the damage attributable solely to the covered event is a coverage issue for which the insured carries the burden of proof."Kelly v. Travelers Lloyds of Tex. Ins. Co., 2007 WL 527911, 3 (Tex. App. 2007).
A complaint against the insured that asserts both covered and nonconvered claims, resulting in a judgment or settlement that fails to allocate between the two, creates issues with respect to the burden of proof. Not surprisingly, different jurisdictions resolve these issues differently. In some jurisdictions, the insured's failure to apportion a judgment or settlement between covered and noncovered damages results in no coverage for the insured. In others, the insurer's failure to defend and/or failure to inform the insured that it should allocate the judgment results in the insurer becoming responsible for the entire undifferentiated judgment.
Insured's Burden
In Corn Plus Coop. v. Continental Cas. Co., 2007 WL 107676 (D. Minn. 2007), the plaintiff, Corn Plus, sought to enforce a Miller-Shugart 1 settlement agreement against the defendant-insured's commercial general liability (CGL) insurers. The court granted summary judgment for the insurers, stating that "Minnesota courts do not permit a party to seek reimbursement from an insurer under a Miller-Shugart agreement when the insured fails to allocate between covered and noncovered claims or damages." Corn Plus at 4. The court explained that, because the unallocated settlement amount included noncovered damages, the amount was "not reasonable as a matter of law for the covered damages." Id. at 5.
In Corn Plus, the parties to the settlement agreement had included an addendum allowing the court to determine a reasonable amount in the event the court found the agreed amount unreasonable. However, the court did not apply the addendum based on public policy and because "there [was] no efficient or practical way to determine a reasonable settlement amount for the covered damages due to the parties' failure to allocate." Id. at 6.
In International Commc'n Materials, Inc. v. Employer's Ins. of Wausau, 1996 WL 1044552 (W.D. Pa. 1996), the insured, ICMI, was sued for trademark and trade dress infringement, false advertising, and patent infringement. The false advertising claims triggered the "advertising injury" provisions of the policies while the patent infringement claims were not covered. Wausau initially provided ICMI with a defense under a reservation of rights but withdrew the defense. Travelers, which also insured ICMI, was notified of the litigation 9 months after suit was filed. Seven months later, Travelers issued a letter explaining its coverage position in which it recognized a "potential" duty to defend but did not begin to defend. ICMI treated that "potential" as a denial and settled the underlying litigation for $2,222,222.22.
ICMI then filed a declaratory judgment action against its insurers, asserting that they breached their policies by failing to defend and seeking indemnification for the judgment. Travelers argued, among other things, that ICMI was not entitled to reimbursement because it could not apportion the settlement amount between covered and noncovered damages. The court agreed, reasoning that "as in any breach of contract action, the insured had the burden of proving damages with reasonable certainty." Because the insured "could not allocate the settlement payment among the four counts in the complaint, only one of which was covered," the insured "failed to establish damages and was not entitled to indemnification." ICMI at 10 (citations omitted).
In so holding, the court rejected ICMI's argument that the burden of apportionment shifted to the insurers as a result of the insurers' failure to notify ICMI of their obligation to apportion because the insurers did not defend. The court held that summary judgment was inappropriate because "a genuine issue of material fact exists as to whether ICMI can apportion the settlement payment between covered and noncovered damages." ICMI at 10.
However, in another recent Western District of Pennsylvania decision, Voest Alpine Ind., Inc. v. Zurich Am. Ins. Co., 2007 WL 1175750 (W.D. Pa. 2007), the court held that "[w]here an insured settles liability that is based on covered and noncovered claims without a contemporaneous apportionment between the two, then the proper procedure is for the court to make an equitable apportionment of the settlement." Voest at 3. Although the Voest court recognized that the insured has the burden of apportioning the settlement payment between covered and noncovered claims, the insured's failure to do so was not fatal to recovering under the policy because the "ultimate allocation is a matter that rests with a sound exercise of the court's equitable discretion." Id. The equitable allocation is to be made by the court "on such evidence as was available, despite the potential for testimony colored by hindsight and self-interest." Id.
Insurer's Burden
ICMI distinguishes two lines of caselaw finding that the burden of apportionment between covered and noncovered damages falls on the insurer. In these lines of cases, the insurer either breaches its duty to defend or undertakes the defense of its insured and fails to notify the insured of the need to allocate. In both circumstances, the insurer is responsible for satisfying the entire undifferentiated award.
No Defense Provided
In Liquor Liab. Joint Underwriting Ass'n of Mass. v. Hermitage Ins. Co., 644 N.E.2d 964 (Mass. 1995), the JUA sought recovery from Hermitage for the defense costs and settlement amount from defending their mutual insured. The complaint against the insured alleged negligent serving of alcoholic beverages (within the coverage of the JUA policy) and negligent security (within the coverage of the Hermitage policy). Hermitage denied coverage, and the JUA defended the entire suit. The JUA requested an allocated verdict, but the judge denied the request, and an unallocated verdict was returned. The JUA settled after the verdict was returned, and there was no question that the settlement was "noncollusive and reasonable." Liquor Liability at 969.
The JUA had advised Hermitage of its obligations, but Hermitage nonetheless failed to defend when it could have done so under a reservation of rights. Because Hermitage breached its defense obligation, it had the burden of proving the claim was not within the policy's coverage and, therefore, bore the burden of allocating the underlying judgment between the covered and noncovered claim. Liquor Liability at 968-9. Any attempt by Hermitage to satisfy this burden "would be speculative and arbitrary, essentially amounting to an attempt to determine the particular amount that happened to be in the juror's minds as they returned the verdict," and therefore, Hermitage was responsible to the JUA for the entire unallocated settlement amount. Id. at 969. Cf. Peterson Tractor Co. v. Travelers Indem. Co. of Ill., 156 Fed. Appx. 21 (9th Cir. 2005) (once the insurer breaches the duty to defend, the insured is relieved of its burden to allocate although the insurer can still present any defenses not inconsistent with the judgment), and Welch Foods, Inc. v. Liberty Mut. Fire Ins. Co. (Mass. Super. 2005) (applying the burden to allocate defense costs as well and if unable, the insurer breaching its duty to defend is responsible for both covered and noncovered defense costs).
Defense Provided but No Notification to Insured of Need for Allocation
Courts have characterized shifting the burden to allocate to the insurer who fails to defend as "eminently fair" because the nondefending insurer "could (and should) have participated in the defense of the action ... under a reservation of rights ... and explained to the trial judge" the need to allocate. Palermo v. Fireman's Fund Ins. Co., 676 N.E.2d 1158, 1164 (Mass. Ct. App. 1997). However, some jurisdictions make the insurer responsible for the entire undifferentiated award even when the insurer defends under a reservation of rights.
In Duke v. Hoch, 468 F.2d 973 (5th Cir. 1972), Duke obtained a judgment against the insured and sued its insurer, demanding that the insurer pay the covered portion of a judgment entered in Duke's favor that included covered and uncovered claims. Under Florida law, Duke had the burden of proving which damages included in the judgment pertained to covered losses. Duke was unable to meet this burden because of the unallocated general verdict form. Despite this, the Fifth Circuit excused Duke from his burden of proof because of the conduct of the insurer.
The appeals court noted that because the insured had the burden of proof, the insurer had an interest in the verdict not being allocated. This conflicted with the interest of the insured, who would have been better served by an allocated verdict form in which the segregation of damages would have enabled the insured to prove which damages were covered. The attorney retained by the insurance company to defend Duke had not requested an allocated verdict at trial. Id. at 979.
The Fifth Circuit stressed that the insurer undertaking the defense of a suit against its insured has the right to control the litigation and must meet a high standard of conduct. The right to control the litigation in all of its aspects carries with it the corresponding duty to exercise diligence, intelligence, good faith, and honest and conscientious fidelity to the common interest of the parties. When the insurer undertakes the defense of the claim or suit, it acts as the agent of its insured by virtue of the contract of insurance between the parties. When a conflict of interest arises between the insurer, as agent, and insured, as principal, the insurer's conduct will be subject to closer scrutiny than that of an ordinary agent, because of the insurer's adverse interest. Id. at 978.
Thus, the court found that before trial, the insurer was required to make known to the insured the availability of a special verdict and the divergence of interest between the insured and insurer springing from whether damages were or were not allocated. Id. at 979; see also Doe v. Illinois State Medical Inter-Insurance Exch., 599 N.E.2d 983, 989 (Ill. App. 1992) (reflecting the insurer's obligation to allocate because it is the insurer who is aware of the issue). The court quoted the following provision from Section 4(b) of the Statement of Principles of the ABA and the Conference Committee on Adjusters:
The companies and their representatives, including attorneys, will inform the policyholder of the progress of any suit against the policyholder and its probable results. If any diversity of interest shall appear between the policyholder and the company, the policyholder shall be fully advised of the situation.
The court found that the insurer should not have been allowed to rely on the evidentiary advantage it gained by failing to follow the above principle, and the court accordingly relieved Duke of its burden of proof on the issue of the amount of covered damages. Id. at 979-80.
At least one court has applied this reasoning to an umbrella insurer with respect to an unallocated judgment in excess of the underlying limits. In Valley Bancorp. v. Auto Owners Ins. Co., 569 N.W.2d 345 (Wis. App. 1997), the primary insurer notified the excess insurer, Auto Owners, of the lawsuit 5 months prior to trial. Auto Owners asserted that there was no coverage, with one possible exception. Auto Owners was not notified of a subsequent pretrial strategy meeting and refused to participate in the posttrial settlement negotiations. Because Auto Owners had the opportunity to participate and did nothing to determine coverage or seek a declaratory judgment, the burden to allocate fell on Auto Owners, and because it could not do so, it became responsible "for the entire amount of the settlement in excess of [the primary] limits." Valley at 351.
Duke and Doe describe the notification requirements an insurer bears when defending a mixed complaint under a reservation of rights. In MedMarc Cas. Ins. Co. v. Forest Healthcare, Inc., 199 S.W.3d 58 (Ark. 2004), the insurer defended under a reservation of rights and directed counsel to seek an allocated verdict. The court refused defense counsel's request to allocate among policy periods because it "would confuse the jury." MedMarc at 60.
MedMarc filed suit seeking a declaration that its policy provided no coverage as two insurers were on the risk and the jury failed to allocate. MedMarc argued that allocation was the insured's burden, and the failure to allocate relieved the insurer from paying any amount under the policy. The insured argues that it was the insurer's burden and, further, that the circuit court's allocation was supported by trial testimony.
The MedMarc court concluded, like Duke, that one of the duties inherent in the right to control the litigation is "the duty not to prejudice the insured's rights by failing to request special interrogatories or a special verdict in order to clarify coverage of damages." MedMarc at 62 (citing Gay & Taylor, Inc. v. St. Paul Fire & Marine Ins. Co., 550 F. Supp. 710 (W.D. Okla. 1981)). Requesting allocation, but not receiving it, did not relieve MedMarc of its obligation to pay a portion of the judgment. The court remanded the case to provide "the reasoning and basis for the particular allocation in the form of findings of fact and conclusions of law." Id. at 63.
MedMarc seems anomalous because the insurer defended under a reservation of rights and notified its insured of the ability to seek an allocated verdict apportioning the damages attributable to the covered and noncovered claims. In fact, the MedMarc dissent found that because "MedMarc adequately notified [its insured] of [the] need for an apportioned verdict, ... MedMarc fulfilled its obligations" so that the burden of apportioning the verdict did not shift from insured to insurer. MedMarc at 64 (Thornton, J., dissenting).
Implicit in the MedMarc decision is the majority's reliance on MedMarc's decision to drop its appeal of "the issue of the failure to give the apportionment instruction." MedMarc at 63. Had the trial court's denial of the apportionment instruction been upheld on appeal, it is not clear whether the majority would still have found that MedMarc failed to fulfill its duty with respect to guiding its insured to seek an allocated verdict. Cf. Aetna Ins. Co. v. Borrell-Bigby Elec. Co., Inc., 541 So. 2d 139 (Fla. Dist. Ct. App. 1989) (the insurer is obligated to appeal from an adverse judgment where there is a good faith basis for doing so).
Conclusion
Some jurisdictions find the insured bears the burden of seeking an allocated verdict because the insured bears the burden of proving coverage. Most jurisdictions will find insurers liable for the entirety of an undifferentiated damage that includes covered and noncovered damages when the insurer wrongfully refuses to defend. Many jurisdictions shift the burden of apportionment to the insurer when the insurer defends under a reservation of rights but fails to notify and/or request the insured allocate the verdict.
Contributing author Rebecca C. Appelbaum is a senior associate practicing in the area of third-party coverage at Butler Pappas Weihmuller Katz Craig, LLP.
Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.
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