Extrinsic Evidence Can Play Role for Insurer

By Don R. Sampen, published, Chicago Daily Law Bulletin [November 15, 2016]

The 7th U.S. Circuit Court of Appeals, construing Illinois law, recently held that an insurer, in a declaratory judgment setting, may rely on evidence beyond the allegations of the underlying complaint to deny coverage to an insured.

The insurer in Landmark American Insurance Co. v. Hilger, 2016 U.S. App. Lexis 17343 (7th Cir., Sept. 22, 2016), was represented by Walker Wilcox Matousek LLP. Bingham Greenebaum Doll LLP of Indianapolis represented the prospective insured, Peter Hilger.

Hilger was the president of a company that provided customized products to financial institutions. He was named as one of several co-defendants in two separate lawsuits brought by credit unions in Michigan and Tennessee.

The credit unions alleged that Hilger and his co-defendants persuaded them to fund loans used to pay life insurance premiums by overstating the value of the policies that would serve as collateral for the loans. The causes of action alleged included fraud, negligent misrepresentation, unjust enrichment, breach of contract and others.

Hilger tendered his defense to Landmark under a professional liability policy held by one of his co-defendants, claiming to be an additional insured. The Landmark policy provided additional insured coverage for independent contractors of the named insured, for professional services rendered on behalf of the named insured.

Landmark denied coverage and filed this declaratory action claiming that it had no duty to defend. Hilger filed a counterclaim and moved for judgment on the pleadings, which the U.S. District Court allowed. The court reasoned that the allegations of the underlying complaints were ambiguous as to Hilger’s status, some suggesting that he acted as an agent of the named insured, others that he was an independent contractor.

The district court concluded that this ambiguity should be resolved in favor of Hilger, that Landmark therefore had a duty to defend, and that evidence outside the pleadings was inappropriate for consideration. Landmark took this appeal.

Analysis

In an opinion by Judge Diane S. Sykes, the 7th Circuit reversed. She began by noting Hilger’s argument that in duty-to-defend disputes, the court is limited to a review of the allegations in the underlying complaint. She said that is true but only when an insurer tries to deny coverage without seeking a declaratory judgment or defending under a reservation.

The reason for the rule where there is no declaratory action or defense under reservation, according to Sykes, is that, in their absence, the court’s inquiry is necessarily limited to the complaint’s allegations in determining whether the refusal to defend is justified.

Here, however, Landmark did seek a declaratory judgment, so Sykes said the limitation does not apply. Under these circumstances, the insurer may present evidence beyond the underlying complaint, so long as the evidence does not tend to determine an ultimate issue in the underlying proceeding.

An “ultimate issue” is one that would collaterally estop the plaintiff in the underlying lawsuit from raising a theory of recovery or be crucial to the insured’s liability. In this case, Sykes found that evidence outside the complaint going to Hilger’s status as an independent contractor was unlikely to decide any ultimate issue.

She noted that the district judge relied heavily on Old Republic Insurance Co. v. Chuhak & Tecson P.C., 84 F.3d 998 (7th Cir. 1996), for the proposition that a court should look only to the underlying complaint in a declaratory action for determining the defense obligation.

That case, however, predated the Illinois Supreme Court’s decision in Pekin Insurance Co. v. Wilson, 237 Ill.2d 446 (2010), in which the state high court clarified the law on this point. The Old Republic decision, therefore, no longer reflects Illinois insurance law.

Accordingly, the court reversed and held that Landmark could offer evidence outside the underlying complaints going to Hilger’s independent contractor status and, therefore, his status as an additional insured.

Key Point

Evidence extrinsic to the underlying complaint is admissible in a declaratory judgment action in determining an insurer’s duty to defend, so long as the evidence does not tend to determine an ultimate issue in the underlying case.