Estoppel Doesn’t Apply Where Insurer is Not Controlling Defense

By Don R. Sampen, published, Chicago Daily Law Bulletin September 9, 2019

The 7th U.S. Circuit Court of Appeals recently held that an insurer was not estopped from denying coverage even though it had participated in the defense of an insured without a reservation, where it did so through counsel appointed by the insured.

The insuer in Essex Insurance Co. v. Blue Moon Lofts Condominium Association, 2019 U.S. App. Lexis 19174 (7th Cir., April 16. 2019), was represented by Cozen O’Connor. Law Offices of Scott A. Kogen & Associates P.C. represented Blue Moon, the claimant and assignee of the insured’s rights.

Blue Moon sued The Structural Shop in state court for construction defects in 2002. Blue Moon caused service of process to be made on Structural Shop’s agent, but Structural Shop never responded and a default was entered. The state court entered a default judgment against Structural Shop in 2009 for about $1.3 million.

Blue Moon appears not to have commenced collection proceedings until 2012. At that time, Structural Shop was insured by Essex under a policy that provided coverage for claims first made against Structural Shop between May 2012 and May 2013. Believing that it had not been earlier served with process, Structural Shop moved to vacate the default judgment, which was allowed, and then tendered the defense of the claim to Essex.

Essex agreed to participate in the defense of the claim through outside counsel retained by Structural Shop. Thereafter, however, Blue Moon’s counsel provided evidence that Structural Shop had, in fact, been properly served with process in 2002, and the default judgment was reinstated. Structural Shop petitioned for relief from the judgment, which was denied, and then took an appeal.

Essex thereupon sent Structural Shop a reservation letter advising that Essex would continue its defense but under a reservation of rights, to the extent of continuing the appeal of the state court order denying relief from the default judgment. At that point Essex hired a new law firm to handle the appeal.

During pendency of the underlying appeal, Blue Moon and Structural Shop settled for $550,000, plus an assignment of Structural Shop’s insurance rights to Blue Moon.

Essex then brought the instant declaratory action for a determination of its insurance obligations. Blue Moon counterclaimed, contending that Essex was estopped from denying coverage and was liable for the default judgment.

The U.S. District Court found in favor of Essex and Blue Moon took this appeal.

Analysis

In an opinion by Judge Michael Y. Scudder Jr., the 7th Circuit affirmed. He initially described what he referred to as “general estoppel,” which requires that the insurer issue a reservation of rights when it undertakes to defend or risk later being estopped from raising policy defenses to coverage.

Scudder said that this form of estoppel would not apply here because it would apply only where the allegations of the underlying complaint fall within coverage. Here, the claim against Structural Shop, which was first made in 2002, fell clearly outside of coverage under the Essex policy.

A second form of estoppel, Scudder said, equitable estoppel, requires that the insured show that by the insurer taking control of the insured’s defense, the insured has been misled into thinking that the insurer will pay for the judgment entered against the insured. The question under this form of estoppel is whether the insurer has actually taken control.

Scudder found that Essex never took control because Structural Shop-appointed outside counsel controlled the litigation strategy from the start. This was so even after Structural Shop informed Essex of Blue Moon’s claim for outside counsel continued to act to protect Structural Shop’s interest by working to prove that service never occurred. Essex’s participation was nothing more than passive.

Scudder acknowledged that Essex did eventually replace Structural Shop’s outside counsel and took over the appeal, but that was only after Essex issued a reservation of rights. That reservation defeated the application of estoppel based on control of the litigation.

Blue Moon also argued waiver by Essex due to its continued defense of Structural Shop despite its knowledge of the lack of coverage. Unlike a policy defense, such as late notice, however, Scudder said that waiver cannot be used to create coverage where none exists. Here, everyone agreed that the policy’s terms did not cover Blue Moon’s 2002 claim.

Finally, Blue Moon argued that Essex acted in bad faith in refusing to settle the underlying litigation when it had the opportunity. According to Scudder, however, such a claim can be made only when the insurer has taken control of the insured’s defense, and Essex never did.

The court, therefore, affirmed the judgment in favor of Essex.

Key points

Estoppel arising by virtue of an insurer defending an insured in the absence of a reservation arises only where the insurer has actually assumed control of the insured’s defense, not where the insured is defending through counsel it has selected.

Waiver cannot be used to create or extend coverage where none exists.