Court Assesses Facts Necessary to Decide Insurer Duty to Defend

By Don R. Sampen, published, Chicago Daily Law Bulletin, May 7, 2024

The 1st District Appellate Court recently addressed the limits of “extraneous” facts to be taken into account in deciding whether a complaint against an insured gives rise to a duty to defend.

The case is State Auto Property & Casualty Insurance Co. v. Distinctive Foods, LLC, 2024 IL App (1st) 221396 (April 19). The insurer, State Auto, was represented by Pretzel & Stouffer Chtrd. of Chicago. Taft Stettinius & Hollister LLP of Chicago represented the insured, Distinctive Foods.

The underlying litigation involved a lawsuit RyKrisp LLC filed against Distinctive. Those two entities had entered into an agreement for Distinctive to manufacture crackers for RyKrisp at a specified manufacturing facility. When RyKrisp became concerned about Distinctive’s ability to perform, it moved the manufacturing equipment from the facility to its own warehouse.

RyKrisp alleged that Distinctive’s CEO then entered the warehouse, moved the equipment back to the facility, changed the locks, and refused to return the equipment.

RyKrisp subsequently contracted with another entity, iBake, to manufacture the crackers. At that point the Distinctive CEO contacted iBake and, allegedly out of spite, disparaged RyKrisp and had Distinctive’s attorney send iBake a cease and desist letter. As a result, iBake terminated its agreement with RyKrisp.

RyKrisp’s complaint against Distinctive alleged claims for detinue (wrongful detainment), conversion, replevin and tortious interference. Distinctive filed a counterclaim alleging it was entitled to retain possession of the equipment because it had a lien for improvements and repairs.

Distinctive tendered its defense to State Auto, which had issued a business owners’ liability policy and umbrella policy to Distinctive. Coverage A covered Distinctive for bodily injury and property damage. Coverage B covered personal and advertising injury, including for a publication “that slanders or libels a person … or disparages” a person’s goods or services.

Coverage A contained an exclusion for intentional conduct. Coverage B contained exclusions for injuries caused by the insured “with the knowledge that the act would violate the rights of another” and for a publication made by an insured “with knowledge of its falsity.”

State Auto initially agreed to defend under a reservation of rights, but later informed Distinctive that the policy provided no coverage. The case proceeded to trial, and a jury ended up awarding damages of $8.3 million for RyKrisp.

State Auto then filed the instant declaratory action seeking a determination that it had no duty to defend and also seeking reimbursement of the defense costs it had already paid. On summary judgment, the trial court found that State Auto had no duty to defend or indemnify. Distinctive brought this appeal.

True but Unpleaded Facts

In an opinion by Justice Freddrenna Lyle, the 1st District affirmed. She initially addressed Distinctive’s argument that the trial court erred in refusing to consider facts from the underlying litigation in determining whether State Auto had a duty to defend. Distinctive specifically pointed to the testimony of its CEO that Distinctive mistakenly believed it had the right to withhold RyKrisp’s equipment and had no intention of violating RyKrisp’s rights.

In pursuing that argument, Distinctive relied on Pekin Insurance Co. v. Wilson, 237 Ill. 2d 446 (2010), involving a claim for assault against an insured, where the insured counterclaimed that he had acted in self-defense. The Supreme Court there held that the counterclaim should be considered in determining the insurer’s duty to defend because self-defense provided an exception to the exclusion for intentional acts.

Lyle observed that an insurer’s duty to defend is typically determined by comparing the allegations in the underlying complaint to the terms of the policy. She then noted that, while “true but unpleaded facts” extraneous to the underlying complaint may sometimes be taken into account, the Wilson case itself did not consider testimony from the underlying case.

She further wrote that the “true but unpleaded facts doctrine” is limited to facts discovered during the insurer’s own investigation of the underlying action and is not meant to be applied to facts supplied solely by the insured.

In addition, Lyle found that the exception to the exclusion in Wilson had no parallel exception here for the claims for detinue and conversion. Rather, whether those claims fell within coverage could be determined solely by reference to the underlying allegations.

Similarly, Lyle said Distinctive’s allegations in its counterclaim in this coverage action — which summarized the CEO’s testimony from the trial that Distinctive had not knowingly converted RyKrisp’s property — could not be considered regarding the duty to defend. They could not be considered because these “explanatory allegations” were raised for the first time in the declaratory action.

Detinue and Conversion

Distinctive also argued it was entitled to coverage under Coverage A for property damage for the detinue and conversion claims. It contended the issue was whether it “intended” to cause injury to RyKrisp’s property, which it did not according to Distinctive because it mistakenly thought it had a right to detain the property. The issue therefore should not be regarded as whether Distinctive intended to take the property.

Lyle rejected the argument. She observed that Coverage A was triggered only by an “occurrence,” which was defined as an accident. And here the RyKrisp complaint alleged that Distinctive “wrongfully and without authorization” assumed control over the equipment and refused to return it. This was not an allegation of an accident but rather intentional conduct that unlawfully deprived RyKrisp of the property.

Distinctive also relied on a reference in the RyKrisp complaint to “gross negligence” as a basis for coverage. Lyle found, however, that the language appeared only in the demand for punitive damages and was accompanied by allegations of fraud and actual malice. There was, moreover, no count in the complaint that alleged negligence, and the single reference to “gross negligence” could not trigger the duty to defend.

Tortious Interference

Finally, Distinctive argued it was entitled to a defense under Coverage B in connection with RyKrisp’s claims of tortious interference. Those claims included allegations that Distinctive disparaged RyKrisp to iBake, causing iBake to cancel its agreement with RyKrisp.

Lyle disagreed. She wrote that, while the complaint did allege disparagement, RyKrisp’s theory of recovery was tortious interference, and no relief was sought for disparagement itself.

She likened this case to ISMIE Mutual Insurance Co. v. Michaelis Jackson Associates, LLC, 397 Ill. App. 3d 964 (2009), where former employees of the insured alleged bodily injury to patients in a medical group, but sought recovery for false Medicare claims submitted by the medical group. Under those circumstances the court found no coverage based on bodily injury.

Similarly here, said Lyle, RyKrisp did not seek relief based on disparagement but only for the intentional and unjustifiable interference.

The court therefore affirmed summary judgment in favor of State Auto.

Key Points

• In determining the duty to defend, an insurer or court need not take into account (1) evidence generated in the underlying case, or (2) allegations in an insured’s counterclaim against the insurer in a declaratory judgment action.
  
• An isolated reference to “gross negligence” in a complaint that otherwise alleges intentional conduct does not typically give rise to a duty to defend.
  
• In determining the duty to defend, a court must look to the theories of recovery in the underlying complaint, and a freestanding reference to a fact merely intended to bolster the factual allegations does not trigger the duty to defend if not critical to the theory of recovery.