Insurer’s Attempt To Withdraw Reservation Of Rights And Assume Defense Rejected.

An Illinois federal district court found that withdrawal of all coverage defenses by a primary insurer does not vitiate a conflict of interest and the policyholder’s right to independent counsel where potential liability exceeds the primary insurer’s limits. 

The district court, applying Illinois law, determined that Liberty Surplus Insurance Company breached its duty to defend Perma-Pipe Inc. by refusing to pay for counsel of the company’s choosing in a $40 million property damage dispute.  Liberty, who had issued a CGL policy with $1 million per occurrence limits/$2 million aggregate limits, agreed to defend Perma-Pipe under a reservation of rights.  Because the reservation created a conflict of interest between the parties, Perma-Pipe was allowed to select independent counsel to defend itself at Liberty’s expense.  Liberty subsequently withdrew all of its coverage defenses, agreed to defend Perma-Pipe, and advised Perma-Pipe that it would no longer pay its independent counsel.  Perma-Pipe filed a breach of contract action, arguing Liberty must continue to pay Perma-Pipe’s chosen counsel.  According to Perma-Pipe, a conflict of interest still remained because the claim for damages exceeded Liberty’s policy limits.  The court agreed, holding that because an insurer’s exposure is capped by the policy limit, it may decide to try claims exceeding the limit, hoping that liability, if any, will be less, despite the risk that the insured could be found liable for an amount far greater than that limit.  Thus, a conflict still exists when there is a “nontrivial probability” of an excess judgment in the underlying suit.  In reaching this decision, the court rejected Liberty’s argument that the existence of excess coverage vitiates the conflict between the primary insurer and the policyholder.  The case is Perma-Pipe, Inc. v. Liberty Surplus Insurance Corporation, No. 1:13-cv-02898 (N.D. IL April 21, 2014).

The so-called Peppers doctrine, a/k/a the right to Cumis counsel, is being increasingly utilized by Illinois policyholders.  This case is an important reminder to policyholders to be aware of their potential right to independent counsel.  It also demonstrates that Illinois courts generally broadly interpret a policyholder’s right to independent counsel.

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