Pro Rata Allocation Applies To Settlement
August 11, 2009
The 1st District Appellate Court recently held that, although an insurer is entitled to challenge the reasonableness of an underlying settlement reached by an insured, the settlement here was reached in reasonable anticipation of liability; but that the insurer's obligation to indemnify the insured for the settlement, which applied to both covered and non-covered policy periods, would be determined on a pro rata basis. Federal Insurance Co. v. Binney & Smith, Inc., 2009 WL 1905284 (June 30).
The insurer, Federal, was represented by Fred Allen Smith III and Kirk C. Jenkins of Sedgwick, Detert Moran & Arnold LLP. Parl L. Langer and Matthew J. Morris of Proskauer, Rose LLP represented the insured, Binney.
Class actions were brought against Binney, maker of Crayola brand crayons, alleging that Binney's labeling on the crayons during the period 1969 through 1986, representing that the crayons were "certified non-toxic," breached implied and express warranties and violated the Illinois Consumer Fraud Act and Uniform Deceptive Trade Practices Act. The basis for the lawsuits was a study showing that the crayons contained trace levels of asbestos fibers as part of the binding agent in the crayons.
Within a few months after the lawsuits were filed, Binney reached a settlement of the litigation which, with out-of-pocket costs, caused Binney to incur about $1 million. The settlement, among other things, required Binney to provide $0.75 coupons to consumers, and to pay attorneys fees and expenses of $600,000.
Federal provided CGL coverage to Binney for three relevant years during the early and mid-1980s. It brought suit in 2000 seeking a declaration that it had no duty to defend or indemnify Binney. Binney in turn filed a counterclaim seeking coverage, and in addition filed a third-party action for coverage against another insurer, Royal, which it settled for an undisclosed sum. Binney nevertheless sought the full amount of its settlement obligation from Federal.
Following a bench trial, the trial court found in Binney's favor on the duty to indemnify, the duty to defend no longer being in issue. The court used an "all sums" approach to allocate coverage to Federal, and it declined to allow a setoff based on the Royal settlement. Federal filed this appeal, and Binney cross-appealed for prejudgment interest.
In an opinion by Justice Warren D. Wolfson, the 1st District affirmed in part and reversed in part. Wolfson first reviewed the case law with respect to insurance coverage for settlements reached by an insured. He indicated that the insured, to obtain coverage, must show that it settled a covered loss in reasonable anticipation of liability.
In addition, while the insured need not establish its actual liability, it must show that the settlement amount is reasonable in light of the size of possible recovery and the probability of the claimant's success. Wolfson said that the burden of proving reasonableness falls on the insured since it has better access to the facts bearing upon the settlement.
Binney here attempted to establish the reasonableness of the settlement through affidavits of its in-house counsel. The affidavits indicated that, while Binney believed the underlying allegations were without merit, Binney nevertheless recognized the risk of proceeding with the litigation.
Federal contended, however, that Binney could not have reasonably anticipated liability because its compliance with federal law created an absolute defense to the consumer fraud type claims that had been raised. It relied on a section in the Illinois Consumer Fraud Act stating that actions "specifically authorized" by law provided a defense. 815 ILCS 505/10b(1).
It also relied on communications Binney had with the Consumer Product Safety Commission concerning the adequacy of Binney's labeling of the crayons under the federal Labeling of Hazardous Material Act. The communications indicated that, as the result of testing, the crayons did not present a risk of toxicity. Federal argued that the language of the letter provided an absolute defense to the class plaintiffs' claims attacking the "certified non-toxic" labeling on the crayons.
Wolfson disagreed. In his view, the CPSC communications did not "specifically authorize" the "certified non-toxic" labeling, and mere compliance with the rules applicable to labeling and advertising was not sufficient to trigger the defense.
Federal further argued that the settlement was improper because the claimants presented no evidence that their potential damages were the result of Binney's advertising or labeling. Wolfson again disagreed, finding that the allegedly false advertising could have supported claims for damages and for coverage. He concluded that there was no reason to disturb the trial court's decisions that Binney settled in reasonable anticipation of potential liability.
Federal next argued that the settlement amount must be allocated between the covered consumer fraud-related claims and the non-covered warranty claims. Wolfson rejected this position on the ground that allocation among claims is unnecessary where the primary focus of the underlying litigation was a covered loss and the insured settled in reasonable anticipation of that litigation. Allocation here, moreover, would require a mini-trial and no allocation therefore would be required.
With respect to allocation among policy periods, rather than among claims, Federal contended that Binney was required to show what portion of the settlement related to advertising injuries arising from offenses committed during the effective periods of coverage under the Federal policies. It also argued that if Binney were unable to specifically allocate individual claims to the relevant policy period, the entire loss had to be allocated on a pro rata basis according to each insurer's time on the risk.
Binney on the other hand argued, and the trial court held, that the "all sums" allocation approach should apply, so that Federal was liable for coverage up to the extent of the limits of each policy triggered. This position was based in part on the language of the Federal policies, which provided coverage for "all sums" Binney became legally obligated to pay because of advertising injury.
Wolfson found that, despite the "all sums" language in the policies, the policies limited coverage to offenses committed during the policy period, and that nothing the policies indicated that Federal intended to provide coverage past the finite policy periods.
He therefore found it was error for the trial court to apply the "all sums" approach, and that settlement damages should be apportioned using a pro rata time-on-the-risk formula.
Federal further argued that the trial court erred when it declined to reduce Binney's judgment to account for money already recovered by Binney from Royal. Binney countered that the trial court properly denied contribution to Federal.
Wolfson again agreed with Federal, holding that Federal was not requesting contribution but a setoff, and that a setoff was appropriate because of the principle limiting damages to one recovery and disallowing windfall recoveries. Failure to account for the Royal settlement would give Binney a windfall.
Finally, Wolfson upheld the trial court's denial of prejudgment interest for Binney.
Based on these determinations, the court affirmed in part and reversed in part and remanded for further proceedings.
