Possibility of Substantial Punitive Damage Award Justifies Independent Counsel

The Illinois Appellate Court for the First District, applying Illinois law, in an opinion written by Justice Harris, and joined by Justices Cunningham and Connors, held that Xtreme Protections Services LLC (“Xtreme”) was permitted to retain its own defense counsel and recover the costs from its insurer, Steadfast Insurance Company (“Steadfast”), due to a conflict of interest in defending the claim.

In the underlying case, an employee of Xtreme alleged he was assaulted and subjected to intentional infliction of emotional distress by another Xtreme employee who placed listening devices in his office, attached a GPS tracker to his vehicle, and harassed him through text messages. The underlying complaint alleged that the employee was an agent of Xtreme and sought no less than $800,000 in compensatory damages and $4 million in punitive damages.

In response, Xtreme sought coverage under its “armed security services” policy issued by Steadfast. The policy provided that Steadfast would defend Xtreme and indemnify it against “sums that the insured becomes legally obligated to pay as damages resulting from errors or omissions in the conduct of business” and “bodily injury and property damage” of up to $1 million.

Although Steadfast had made no reservation of rights, Xtreme retained its own counsel to defend against the underlying claim because it believed two exclusions in the policy created a conflict of interest. First, the policy did not provide coverage for acts or omissions that were “intentional, criminal, fraudulent, malicious, or dishonest.” Second, the policy did not cover punitive damages. Xtreme notified Steadfast that it had retained its own counsel because of the above concerns. Three months later, in an email, Steadfast noted the policy’s exclusion of coverage for punitive damages and reserved “all rights and defenses available under the Policy and at law to deny coverage.” At the same time, Steadfast notified Xtreme that it was appointing its own attorney to “substitute into the case.”

Xtreme’s attorney, however, continued to defend the underlying suit and Xtreme filed a declaratory judgment action seeking a declaration that it was permitted to retain its own attorney. Xtreme argued that it was authorized to retain its own attorney because of the conflict of interest arising from Steadfast’s reservation of rights letter. In response, Steadfast clarified that it would “defend and indemnify Xtreme, up to the policy limits, for any judgment for compensatory damages . . . [and] will not assert any exclusions or other defense to coverage.” The trial court held that Xtreme was permitted to retain its own counsel because of the risk of a “substantial punitive damages award.”

Steadfast appealed arguing that there was no conflict of interest because it had waived every coverage defense other than noncoverage for punitive damages. While the appeals court acknowledged that Steadfast’s counsel would have the same fiduciary duty to defend Xtreme as if it had been personally retained by Xtreme, it also acknowledged difficulties with that principle in practice. For instance, the court noted that the insurer’s attorney “may have closer ties with the insurer and more compelling interest in protecting the insurer’s position.” Further, the court noted a conflict when there is a significant disparity between the amount of compensatory and punitive damages. Here, the court reasoned the difference between the amount of compensatory and punitive damages was so significant that a conflict almost certainly existed.

Therefore, the court held that it was permissible for Xtreme to retain its own defense counsel and, under the policy, Steadfast was liable to cover Xtreme’s defense costs. Xtreme Protection Servs. LLC v. Steadfast Ins. Co., Ill. App. (1st) 181501 (May 3, 2019).