A recently decided First District Appellate case has provided clarity in regards to an insurance company’s ability to challenge settlements, particularly when an insurance company has already forfeited its right to control the litigation by reserving its right to deny coverage. In particular, Central Mutual Insurance Co. v. Tracy’s Treasures, Inc., 385 Ill. Dec. 904 (1st Dist. 2014), which was decided last year has opened the door for an insurance company to challenge a settlement despite its limited (or non-existent roll) in the litigation.
In Tracy, the insured, Tracy’s, was sued in a Telephone Consumer Protection Act (“TCPA”) class-action claim. Tracy’s promptly notified its insurance provider, Central Mutual, of the claim. Having received the claim, Central Mutual reserved its rights to deny coverage and sued Tracy’s for declaratory relief, seeking a finding that it did not owe Tracy’s a duty to defend or indemnify Tracy’s under the policy at issue. Meanwhile, Central Mutual continued to provide defense coverage until a court ruled it had no duty to defend the litigation.
In response, Tracy’s informed Central Mutual that the act of disclaiming coverage while providing a defense created a conflict of interest, and Tracy’s was therefore entitled to select its own counsel and control its defense of the TCPA class-action. Central Mutual agreed to substitute Tracy’s selected counsel for the “courtesy counsel” Central Mutual originally provided despite its position that it had no duty to indemnify or defend Tracy’s. Additionally, Central Mutual also agreed to pay the attorneys’ fees for Tracy’s selected counsel. Following this substitution, Tracy’s negotiated a settlement with the TCPA plaintiffs for $14 million to be paid from the insurance proceeds. Central Mutual disapproved of this settlement amount and moved for summary judgment in its declaratory judgment action against Tracy’s on the grounds that the $14 million settlement was unreasonable and the product of collusion.
The first issue the Tracy’s court addressed, which was also an argument Tracy’s asserted, was whether or to what extent Central Mutual could even challenge the settlement amount. Central Mutual ceded its rights to control the litigation when it sued for declaratory relief against Tracy’s; therefore, Tracy’s did not need the consent of Central Mutual before agreeing to the settlement. In light of these facts as well as Illinois legal precedent on this issue, Tracy’s argued that Central Mutual was legally barred from contesting the settlement.
While the Tracy’s court agreed that Tracy’s did not need the consent of Central Mutual before agreeing to the settlement the court ultimately held that “the fact that an insured is not required to obtain the insurer’s consent to a settlement does not necessarily preclude the insurer from later contesting the reasonableness of the settlement.” In other words, Tracy’s ability to control its own litigation did not also bar Central Mutual from being heard on whether the settlement amount was reasonable or the result of collusion.
In reaching its conclusion, the court relied on the Illinois Supreme Court’s opinion in Guillen ex. rel. Guillen v. Potomac Insurance Co. of Illinois[1]. In Guillen, the Illinois Supreme Court held that, if an insurer has not breached its duty to defend (i.e. has not “abandoned” the insured) and has properly reserved its rights to deny coverage by filing for declaratory relief, then that insured may not only challenge the reasonableness of any settlement amount reached in the underlying litigation but it may also challenge whether coverage existed in the first place. On the other hand, if an insured breached its duty to defend by “abandoning” the insured, the insured may still challenge the settlement amount’s reasonableness; however, it cannot challenge whether it has an obligation to provide coverage because it already had breached the policy agreement. In sum, under either circumstance, an insured that has ceded its right to control the litigation may still challenge the settlement amount.
Applying these legal principles to the facts in Tracy’s, the court determined that it could consider the challenge by Central Mutual to the settlement amount as well as its claim that no coverage existed. Central Mutual had not breached its duty to defend; in fact, it provided Tracy’s “courtesy counsel” before Tracy’s ultimately selected its own lawyer. Additionally, there was no prejudice to Tracy’s because Central Mutual – from the very onset of the litigation – informed Tracy’s of its position that no coverage existed for the underlying TCPA class-action. In other words, the court distinguished Tracy’s from other Illinois cases in which the insured was prejudiced when – after months or years of litigating – the insurer suddenly claimed no coverage existed. As a result, the appellate court concluded that Central Mutual retained the ability to contest both the reasonableness of the settlement and insurance coverage of the claim.
Relying once again on Guillen, the court outlined two tests for whether a settlement is “reasonable.” The first test is whether, under the totality of the circumstances, the insured’s decision to settle “conformed to the standard of a prudent uninsured.” The second test asks, with respect to the settlement amount, “what a reasonably prudent person in the position of the insured would have settled for on the merits of [the] claim.” This second test involves a common sense consideration of the facts bearing on liability and damages, including the risk of going to trial. Under either test, the plaintiff in the underlying case has the burden of proving reasonableness because the plaintiff was the one who agreed to the settlement and necessarily has more knowledge of the facts surrounding settlement. Finally, the insurer may “rebut any preliminary showing of reasonableness with affirmative evidence bearing on the issue.”
Turning specifically to the facts of Tracy’s, the court first found that the trial court’s hearing providing the TCPA class members and opportunity to be heard on the settlement was not determinative of the issues before it because the court during that hearing did not make findings regarding either of the two tests outlined in Guillen and Central Mutual was not offered a chance to voice its position on the settlement. Second, the court dismissed the argument that the settlement was unreasonable because Central Mutual was never provided notice of the settlement before it was agreed to. The court reasoned this argument lacked merit because Central Mutual had forfeited its right to control the litigation and therefore was not entitled to notice of the settlement.
Having resolved these two preliminary issues, the court then turned to the two tests outlined in Guillen; however, the court did not ultimately rule on whether Tracy’s and the underlying plaintiff had satisfied their burden of showing reasonableness under either test. Instead, the court remanded the matter back to the trial court for hearing on whether either reasonableness test has been satisfied.
Finally, the Tracy’s court addressed Central Mutual’s claim that the settlement was the product of collusion. The trial court determined there were genuine issues of material fact as to whether the settlement was the result of collusion. The appellate court in Tracy’s affirmed the trial court’s decision, and remanded the matter for hearing on the issue of collusion in addition to the settlement’s reasonableness.
Noting that any settlement agreement necessarily requires an element of cooperation between the parties, the Tracy’s court stated that a settlement “becomes collusive when the purpose is to injure the interests of an absent or nonparticipating party, such as an insurer or non-settling defendant.” The court also listed the factors favoring a finding of collusion, including misrepresentation, concealment, and lack of serious negotiations on damages, attempts to affect the insurance coverage, profit to the insured, and attempts to harm the insurer’s interests. In sum, the common vein of all these factors is an unfairness to the insurer, which is “probably the bottom line” in cases where a court finds collusion existed.
The Tracy’s court remarked that, under this standard, it would appear Central Mutual has a strong claim that Tracy’s and the TCPA plaintiffs’ attorney colluded in agreeing to the settlement and remanded the matter for hearing on this issue as well.
Although the facts in Tracy’s are somewhat unusual and case-specific, the practical import of the court’s decision is that – even though an insurer has ceded its right to control the litigation – an insured, its selected counsel, and the plaintiff in the underlying case should all bear in mind that the insurer can still challenge any settlement reached on the grounds that it is unreasonable or the product of collusion. The parties to all settlement negotiations should keep this consideration in mind when crafting the agreement and amount.
[1] 203 Ill. 2d 141 (2003)
[2] Id.