Extraneous Facts Not Considered and Mention of Gross Negligence Not Enough in Determining Whether Insurer Has a Defense Duty

The Appellate Court of Illinois for the First District, in an opinion by Justice Lyle applying Illinois law, held that State Auto Property & Casualty Insurance Company (“State Auto”) had no duty to defend its policyholder, Distinctive Foods, LLC (“Distinctive”), under either its business owners’ liability policy or umbrella policy in an underlying dispute alleging wrongful detainment, conversion, and tortious interference. The appellate court concluded that the insurer did not need to take into account extrinsic evidence or allegations from the coverage case in making its determination. Moreover, the appellate court determined that a blanket assertion about gross negligence in a punitive damages prayer for relief was not enough to trigger the duty to defend.   

A dispute arose between Distinctive and RyKrisp, LLC (“RyKrisp”) stemming from a contract to manufacture crackers. As a result of the dispute, RyKrisp removed certain of its equipment from Distinctive’s facility. However, Distinctive’s CEO unilaterally moved the equipment back to its facility and changed the locks denying RyKrisp access. Rykrisp then contracted with iBake Foods, LLC to manufacture the crackers. Distinctive’s CEO then allegedly disparaged RyKrisp and/or RyKrisp personnel and had its lawyer send a cease and desist letter to it. 

RyKrisp sued Distinctive alleging wrongful detainment, conversion, replevin and tortious interference. Distinctive counterclaimed alleging that it had a right to retain the equipment because it had a lien on it for repairs and improvements. 

Distinctive tendered the matter to State Auto under its business owners’ liability policy and umbrella policy. State Auto agreed to defend under a reservation of rights under Coverage B, personal and advertising injury, but later withdrew the defense, denying the claim. State Auto filed a declaratory judgment seeking a declaration that it had no duty to defend and seeking reimbursement of the defense expenses it had already incurred. State Auto argued that the underlying complaint did not allege “bodily injury” or “property damage” and did not allege any damages caused by an “occurrence” because the underlying complaint sought damages for intentionally tortious conduct. State Auto also contended that the duty to defend did not include prosecuting Distinctive’s counterclaims against RyKrisp. State Auto also argued that it had no duty to indemnify because part of the judgment included punitive damages, which were not coverable and there was no indication that the other part of the award was based on personal and advertising injury. State Auto was granted summary judgment, and Distinctive appealed.  

The appellate court affirmed. It rejected Distinctive’s argument below that the court should have considered facts from the underlying case. Distinctive argued the trial court should have considered its CEO’s testimony that it had a mistaken belief that it had the right to withhold the equipment. Distinctive also asserts that the court should have considered correspondence between Distinctive and State Auto during the underlying litigation. Distinctive maintains that this information was known to State Auto at the time it was making its coverage determination.  

The appellate court agreed with Distinctive that “true but unpleaded facts” extraneous to the underlying complaint may be taken into account. However, the true but unpleaded facts doctrine is typically applied in cases where “the extraneous facts possessed by the insurer and known to be true were facts the insurer discovered during its own investigation of the underlying action, not those offered solely by the policyholder. The appellate court found no exception to the general rule that the coverage was to be determined solely by reference to the allegations in the underlying complaint. Also, the appellate court held that the counterclaim in the insurance declaratory judgment action couldn’t create a duty to defend because those explanatory allegations were first raised in the insurance declaratory judgment action.  Thus, the circuit court did not err in refusing to consider pleadings and testimony outside of the underlying complaint in determining whether State Auto had a duty to defend.  

Distinctive also argued it was entitled to coverage under Coverage A for property damage for the detinue and conversion claims. It contended the issue was whether it “intended” to cause injury to RyKrisp’s property, which it did not according to Distinctive because it mistakenly thought it had a right to detain the property. The appellate court rejected the argument because the allegations were that Distinctive “wrongfully and without authorization” removed and refused to return the equipment which could not be characterized as an “accident” within the meaning of “occurrence” as required by the policy to trigger the duty to defend. 

The appellate court also rejected Distinctive’s reliance on an allegation of “gross negligence” in RyKrisp’s underlying complaint because it was raised only in the punitive damage prayer which included fraud and actual malice allegations. The appellate court noted that the substance of the complaint will control over the form, and even where a complaint alleges an act is negligent, if the allegations show that what is truly alleged can only be characterized as an intentional act, the substance will control. Here, the appellate court concluded that the allegations in RyKrisp’s complaint do not allege anything other than intentional conduct by Distinctive.  

Finally, Distinctive also argued that it was entitled to a defense under Coverage B due to the claims of tortious interference as a result of iBake cancelling its contract with RyKrisp because of Distinctive’s cease and desist demands. The appellate court rejected this argument because RyKrisp did not seek damages for disparagement, but only intentional and unjustifiable interference. State Auto Property & Casualty Insurance Co. v. Distinctive Foods, LLC, 2024 IL App (1st) 221396 (April 19, 2024).