The Brief Case: DRI Committee News

Insurance Law: Covered Events

From the Bad Faith Subcommittee: Denial of Duty to Defend – Subsequent Consent Judgment with Covenant Not to Sue/Enforce

By James T. Mellon

Insurance claims professionals make many claims decisions every working day. Some decisions are more consequential than others. Among the most significant decisions made is determining whether or not the insurer owes a defense to its insured. Different individuals will reach different decisions when attempting to discern the meaning of a complaint filed in litigation – judges, attorneys, and claims personnel may all have different backgrounds, experiences and biases. This short article deals with some personal observations regarding the duty to defend made during actual cases, and the overarching concern regarding one possible consequence of a denial of defense, namely, a consent judgment with covenant not to sue/enforce.

In December 2022, my partner and I authored an article in For the Defense, Consent Judgments with Covenant Not to Sue/Enforce. The article provided an overview as to how the courts in each of the 50 states address, accept, and/or reject consent judgments and covenants not to sue/enforce in the context of a breach of the duty to defend.

A case filed in Wayne County Circuit Court in Michigan, Vincent Granatelli, Inc. v Total Petroleum, Inc., alleged injurious falsehood and tortious interference with business relations. Total Petroleum (Total) tendered the defense to its insurer, but the insurer declined to accept the tender. Total had an out-of-pocket, $650,000 self-insured retention, even if the insurer had defended. Total subsequently settled the case for $650,000. Total then brought a declaratory judgment action against its insurer in federal court. We were retained to defend the insurer. The United States District Court judge concluded that the pleadings are malleable and, as reported in the appellate decision “Total would be liable upon the lesser showing that it acted with reckless disregard of the truth.”¹ The trial court went on to hold that the insurer breached its duty to defend, and that the insurer “would be liable for the full extent of the settlement,” even though the settlement was within Total's self-insured retention.²

The case proceeded on appeal to the Sixth Circuit Court of Appeals which concluded, based upon Sixth Circuit precedent (and coincidentally involving the same insurer), that recovery against an insurer breaching the duty to defend is not subject to a retained limit, or self-insured retention, i.e., the recovery is not reduced by the contractual retention.³ The concurring judge recognized that the majority was constrained by the precedent and, therefore, had to affirm. However, he felt the prior Sixth Circuit decision had stretched the Michigan precedent to facts which were clearly distinguishable. The concurrence commented, “The practical effect of this flawed opinion is that it has essentially converted a contractual duty to defend into an absolute duty to defend. That is, after Capitol, any insurance company (as it was in this case) would be foolish to refuse to defend and run the risk of being liable for the entire judgment, attorney fees and all, regardless of prior contractual arrangements between itself and the insured.”⁴ The concurrence did “not buy Total's argument that the insurer's failure to defend prejudiced it in any foreseeable way,” and further commented, “Thus, because of the Capitol decision, Total has received a sizable windfall.”⁵

In another Michigan case, this time in the Oakland County Circuit Court, a psychologist and her professional corporation leased an office suite from a hospital's holding company, which was the lessor. We represented the lessor. The psychologist subsequently claimed that she was exposed to black mold during the term of the leasehold and, thereby, sustained physical and nonphysical injuries. The lease contained an indemnity provision, and the lessor filed a counterclaim against the psychiatrist and the lessee entity. Defense was tendered to the psychiatrist’s liability insurer. The insurer refused to defend. As counsel for the lessor, we advised the insurer in numerous correspondence as to the breadth of the duty to defend and the reasons why defense was owed. The insurer steadfastly persisted in its denial. During the litigation, the claims representative who denied the claim was deposed, and as he was walked through various policy provisions, he ended up conceding that there appeared to be a duty to defend. Still, the lessee’s insurer continued to deny. Days before a scheduled trial, a settlement meeting took place. Though the parties did not even come close to a monetary settlement, they did agree upon a consent judgment with a covenant not to sue/enforce which was entered. Counsel for the lessee demanded the consent judgment be for $450,000, even after being informed by Counsel for the lessor that Michigan law required that the settlement amount be reasonable. With a $450,000 consent judgment in hand, the lessee then garnished the insurer, which had refused to defend.

The lessee’s insurer asserted that the reasonableness of the amount of the consent judgment was a fact question for a jury. During the garnishment proceedings, both parties filed cross-motions for summary disposition, and after oral argument, the court issued a written opinion and order referencing only plaintiff's arguments and concluding the settlement was reasonable. Of particular interest, prior to the scheduled trial, the case had gone through a case evaluation process and the three case evaluators, one plaintiff, one defense, and one neutral, returned an evaluation of just $3,000. However, case evaluation proceedings are not admissible. The court essentially bootstrapped its conclusion, commenting, “Further, evidence of the reasonableness of the settlement was that it was within Defendant's insurance limits.” In other words, the amount was reasonable because it was within insurance limits. The insurer appealed but settled for a substantial portion of the consent judgement amount before oral argument on the appeal.

In a more recent case, a coverage provider denied defense to a municipal employee in a wrongful death case. That individual had pled no contest/nolo contendere to a crime, and the coverage document had a criminal act exclusion, which included pleas of no contest/nolo contendere. Shortly thereafter, the municipal employee, who had been denied defense took an Uber ride to the office of the plaintiff counsel in Detroit. The injured party’s attorney then referred the municipal employee to a friendly “independent” attorney, and within a few weeks the injured party and the municipal employee agreed to a $6.9 million consent judgment with covenant not to sue. The injured party filed a declaratory action against the coverage provider, whom we represented, and a contract action against the municipal employer, alleging a breach of an agreement with the employee’s union that the employer would provide “insurance,” was breached.⁶ However, after the consent judgment was entered, plaintiff went on to allege a different municipal employee was solely liable for the injuries. Plaintiff alleged that numerous calls were made from a nursing home to the local 911 dispatcher and that the calls went unanswered for eight minutes. The elderly patient had been found unresponsive in his bed, and the nursing home staff initiated a code and attempted a resuscitation. When EMS personnel arrived, they took over the code, but the patient never showed any signs of life. The plaintiff argued the breadth of the duty to defend. The litigation occurred during the Covid-19 pandemic, and a motion for summary disposition was adjourned several times. Eventually, the trial judge, following oval argument, took the matter under advisement, and, sometime later, granted summary disposition in favor of the coverage provider, due to the criminal act exclusion, and to the municipality employer on a breach of contract claim. Incidentally, the trial judge ended up retiring shortly thereafter.

Plaintiff filed a claim of appeal but plaintiff’s appellate attorney dropped the appeal as to our client without payment and subsequently settled with the employer. Sometimes claims personnel consult outside counsel before denying a claim. Some claims personnel don’t have the experience to know that many judges have a very expansive view of the duty to defend. Attorneys assigned to respond after a denial of the duty to defend know the pitfalls and risks of not defending after tender. Admittedly, this causes some anxiety on the insurer’s attorney who seeks to explain to a perhaps unsympathetic judge why the defense wasn’t owed. An insurance executive who was a wise experienced person once told me that he would rather be in the room because bad things can happen when you are not. In short, an insurer which outright refuses to defend does so at its own peril.

Denial of defense is a trap for the unwary. An insurer that has refused to defend will not be at the settlement table when a claimant and a defendant, who may be unrepresented and left to his or her own devices, are considering how to best resolve the matter, oftentimes with the defendant lacking the financial wherewithal to pay on a judgment, should one enter. A consent judgment effectively costs the defendant nothing, and it places an insurer in a precarious position of having to be absolutely correct in its decision to decline defense. In fact, in many states, the insurer will have to show that the matter alleged was not even arguably within coverage, not just that the matter ended up actually outside of coverage.⁷ Unless a matter is clearly outside the scope of coverage, the insurer would be better positioned to defend under reservation of rights, and then bringing a declaratory action, rather than risk a consent judgment with covenant not to sue.

¹ Total Petroleum Inc v Hartford Accident & Indm Co, 129 F3d 1265 (6th Cir 1997) (unpublished).
² Id.
³ Id. (examining Capitol Reproduction, Inc v Hartford Ins Co, 800 F2d 617 (6th Cir 1986)). Subsequently, Capitol Reproduction was subsequently abrogated, and that abrogation was recognized in Stryker Corp v XL Ins America, 576 Fed Appx 496, 500-01 (6th Cir 2014)).
⁴ Id. (Surheinrich, J, concurring).
⁵ Id. (Surheinrich, J, concurring).
⁶ The coverage provider in question was not an “insurer,” but a municipal group self-insurance pool, which by statutory decree is “not an insurance company or insurer.” MCL 124.6.
⁷ E.g., Radenbaugh v Farm Bureau Gen Ins Co of Mich, 240 Mich App 134, 137; 610 NW2d 272 (2000).

James T. Mellon is a shareholder and founding member of Mellon Pries Kowalski. He secured the designation of Charter Property Casualty Underwriter (CPCU) and Associate in Risk Management (ARM) from The Institutes. He has served for many years as an adjunct professor at the University of Detroit Mercy School of Law, teaching courses on insurance law and medical malpractice. He has also been an instructor at Lawrence Technological University, where he taught multiple courses, including the Legal Environment of Insurance, Property Loss Adjusting, the Claims Environment, and Liability Claims Practices.

Interested in joining Insurance Law committee? Click here for more information.