Reservation of rights on punitive damages does not create Peppers conflict.

An Illinois appellate court in the first district, applying Illinois law, affirmed the trial court’s ruling and held that an insured was not entitled to reimbursement for the fees of its independent counsel, because no conflict of interest existed regarding the defense of the underlying copyright infringement case that entitled the insured to independent counsel.  The court rejected the insured’s argument that the insurer’s reservation of rights created a conflict and found that bad faith sanctions under Section 155 were not warranted.

Bean Products, Inc. (“Bean”) was sued by Ontel Products Corporation for violation of copyright and trademark rights related to home gym products.  Bean tendered the claim to its commercial general liability insurer, Scottsdale Insurance Co. (“Scottsdale”).  Scottsdale represented Bean in the underlying case under a reservation for punitive damages and also reserved its rights to assert “any additional defenses which further investigation will reveal.”  Bean also retained independent counsel throughout the underlying case, arguing that there was a conflict of interest due to Scottsdale’s reservation of rights.  Thus, Bean incurred litigation costs.  The underlying case was ultimately settled.  Bean filed a declaratory judgment action against Scottsdale seeking a declaration that Scottsdale is obligated to reimburse Bean for its independent counsel in the underlying case.  Bean also sought a declaration that Scottsdale’s conduct was vexatious and unreasonable, entitling Bean to $60,000 in sanctions under Section 155.  The parties filed cross-motions for summary judgment and the trial court found in favor of Scottsdale.  The trial court analyzed the claim exclusively under Illinois law even though Bean argued that New York law applied because that is where the underlying case was filed.  Bean appealed the trial court’s ruling.

The appellate court held that the application of Illinois law was proper because Bean conceded at hearing on the motions for summary judgment that Illinois law was applicable to the parties’ dispute.  The appellate court also found that, if Bean had not conceded the issue, a choice-of-law analysis was not necessary because there was no conflict between Illinois and New York law that was significant to the case.

Under Illinois law, a conflict of interest exists if, comparing the claims in the complaint to the terms of the policy, “the insurer’s interests would be furthered by providing a less than vigorous defense to the allegations.”  Bean argued that because the underlying complaint sought “punitive damages in an amount to be determined by the Court,” Scottsdale’s reservation regarding punitive damages created a conflict of interest.  While the court noted that there can be situations where a reservation regarding punitive damages does create a conflict of interest, the appellate court refused to create a bright line rule: “Considering the frequency of general punitive damages demands in litigation, such a trigger would eviscerate an insurer’s right to control the defense of its insured.”  The appellate court held that in the instant case, simply because the underlying complaint sought punitive damages did not create a conflict of interest entitling Bean to independent counsel.

Bean also argued that the “open ended” nature of Scottsdale’s reservation of rights created a conflict of interest because it allowed Scottsdale to “lay the groundwork” for a denial of coverage while still controlling the defense in the underlying suit.  Under Illinois law, a party must show “the divergent interests of the insurer and insured are apparent and the attorney representing the insured can no longer represent both clients’ interests without prejudice to either client.”  Further, Illinois courts are clear that only “actual” and not merely “potential” conflicts entitle an insured to independent counsel.  The appellate court found that Bean had not shown that the parties’ interests had diverged nor had it shown any actual conflict existed.  At most, Bean demonstrated that there was a remote possibility that a conflict could develop, which the court found was not sufficient to infringe on the insurer’s right to control the defense.

With regard to Bean’s claim that Scottsdale’s actions warranted bad faith sanctions under Section 155, the appellate court stated that “[b]ecause we agree with Scottsdale that Bean was not entitled to independent counsel or to reimbursement for independent counsel’s services, at the very least a bona fide dispute existed between the parties over the conflict issue.”  Thus, Section 155 sanctions were inappropriate and the trial court did not abuse its discretion.   Bean Products, Inc. v. Scottsdale Ins. Co., 2018 IL App (1st) 170421-U (Jan. 22, 2018).