Insurer not equitably estopped from denying indemnity coverage despite defending without ROR

A federal court for the Northern District of Illinois, applying Illinois law, held that an insurer was not estopped from denying indemnity coverage where the claim arose outside of the policy period because the insured could not demonstrate any “clear, concise, and unequivocal evidence” of control of the underlying case by the insurer or any actual prejudice.

In 2009, Blue Moon Lofts Condominium Association (“Blue Moon”) obtained a default judgment against The Structural Shop, LTD (“TSS”) in the Circuit Court of Cook County for $1,356,435 plus costs for a case that was originally filed in 2002.  In 2012, Blue Moon contacted Douglas Palandech, TSS’s attorney and registered agent at the time, to discuss collection of the default judgment.  Before being informed by Palandech, TSS’s principal had no knowledge of the underlying suit, default order, or default judgment.  TSS moved in the Circuit Court of Cook County to vacate the default judgment because according to TSS they had never been served in the underlying litigation.  The court granted the motion and vacated the default judgment.  TSS then notified its professional liability insurer for the policy period of May 10, 2012 to May 10, 2013, Essex Insurance Company (“Essex”), of the litigation proceedings.  Essex agreed to defend TSS in the Circuit Court case and agreed to Palandech’s continued representation of TSS.  Palandech informed Essex that that the issue of the original service was still be investigated and that the judge could revisit his order vacating the default judgment.

Before a settlement was reached, the court ruled that service had indeed been proper on TSS back when the case was first filed in 2002.  Essex then hired new counsel for TSS and informed TSS that it would continue to defend through the appeal, but that it did not owe TSS any indemnity coverage because the claim was first made before its policy period.

Essex then filed a declaratory judgment action against TSS and Blue Moon (who had since been assigned TSS’s rights under the Essex policy) in federal court seeking a declaration that it had no duty to indemnify TSS for the Circuit Court default judgment.  Blue Moon filed affirmative defenses asserting that Essex should be estopped from denying coverage, that Essex waived its right to assert coverage defenses, and that Essex refused in bad faith to settle Blue Moon’s claims with TSS.  Essex and Blue Moon both moved for summary judgment.

Blue Moon argued that Essex was estopped from raising coverage defenses because it neither timely reserved its rights nor timely filed a declaratory judgment action.  Illinois law recognizes two distinct forms of estoppel when analyzing an insurer’s duty to defend: contractual estoppel and equitable estoppel.  Contractual estoppel prevents an insurer from raising policy defenses to coverage where an insurer fails to defend a suit under a reservation of rights or seek a declaration that there is no coverage and is later determined to have wrongfully denied coverage.  Under Illinois law, the general rule is that it “cannot be used to create primary liability or to increase coverage provided under an insurance policy.”

Equitable estoppel applies “if the insurer initially undertakes the duty to defend without reserving its rights, but later reserves rights or files a declaratory-judgment action.”  Under equitable estoppel, “if an insurer undertakes the defense of an action, and that undertaking results in some prejudice to the insured, an insurer may be estopped from asserting a defense that the policy did not cover the claim.”  Equitable estoppel can even be applied to hold the insurer responsible where coverage did not originally exist.  To invoke equitable estoppel, “the insured must demonstrate that the insurer was actually or constructively aware of the facts or circumstances indicating noncoverage … and must establish … that he was misled by an act or statement of [the insurer], he reasonably relied on the document or representation, and he was prejudiced thereby.”  “Prejudice will be found if the insurer’s assumption of the defense induces the insured to surrender her right to control her own defense.”

Because Essex defended the action from the beginning without a reservation of rights, the court analyzed equitable estoppel and held that it did not apply because Blue Moon failed to identify any “clear, concise, and unequivocal evidence” of control by Essex.  The court rejected Blue Moon’s argument that by defending the action for more than two years, Essex effectively misled TSS into believing it had coverage.

The court held that Blue Moon could not sustain an affirmative defense of waiver because under Illinois law, “waiver cannot apply to extend coverage to TSS for a claim made long before the policy took effect.”  Ultimately, the court ruled that Essex did not have a duty to indemnify TSS for the underlying claim.  Essex Ins. Co. v. The Structural Shop, LTD, No. 15 C 2896 (N.D. Ill. Mar. 21, 2018).