Right To Defend Bests Duty To Defend

By Don R. Sampen, published, Chicago Daily Law Bulletin

The 1st District Appellate Court recently held that an insurer denying coverage to an insured by letter on certain grounds was not later precluded from raising additional grounds for denial once coverage litigation commenced.

The insured in FHP Tectonics Corp. v. American Home Assurance Co., 2016 IL App (1st) 130291 (1st Dist., June 24), was represented by Brady, Connolly & Masuda P.C. Sedgwick LLP represented the insurer, American Home Assurance.

FHP Tectonics was a highway contractor that entered into a subcontract with NES Rentals Holdings Inc. The subcontract required that NES procure insurance coverage that included FHP as an additional insured with primary coverage along with other requirements.

NES procured a commercial general liability policy from American Home. The policy, among other things, by endorsement provided for a $500,000 self-insured retention to be maintained by NES, provided coverage in excess of the self-insured retention for damages “that the insured becomes legally obligated to pay” up to the specified limit and gave American Home “the right but not the duty to defend any suit seeking those damages.”

The policy also contained a blanket additional insured endorsement by which FHP became an additional insured for “liability arising out of [NES’] operations.” In addition, the policy contained an endorsement modifying the policy’s “other insurance” condition and making the policy’s coverage “primary” for any additional insured “where required by contract.”

The estate of an employee of one of FHP’s subcontractors fatally injured on the job brought suit against FHP, and FHP tendered to American Home. American Home, however, denied coverage in a letter to FHP on two grounds, namely, that the injury did not arise out of NES’ operations, and that the $500,000 self-insured retention had not been exhausted.

Twenty-eight months later FHP brought a declaratory action seeking a determination of coverage. The complaint included allegations that American Home was estopped from denying coverage because too much time had elapsed since FHP had tendered to American Home, and the insurer neither filed a declaratory judgment action nor defended FHP under a reservation.

American Home moved to dismiss raising several grounds, including for the first time that the policy gave the insurer “the right but not the duty to defend.” In its response to the motion, FHP argued that American Home was estopped from raising that defense.

But the trial court granted the motion, dismissed the duty-to-defend counts with prejudice and dismissed the duty-to-indemnify claim without prejudice on the ground that indemnification issues were premature. Following the denial of its motions to amend and reconsider, FHP took this appeal.

Duty to defend

In an opinion by Justice Eileen O’Neill Burke, the 1st District Appellate Court affirmed. She first addressed FHP’s argument that it should have been allowed the opportunity to amend its complaint and agreed with the trial court that it should not.

She noted that the liberal pre-final-judgment-pleading-amendment rules of 735 ILCS 5/2-616(a), did not apply because the trial court had entered final judgment prior to FHP’s attempted amendment. And under the more restrictive post-final-judgment requirements of Section 2-616(c), the motion came too late, and the proposed amendment would not have established a viable cause of action in any event.

Burke then turned to FHP’s estoppel arguments. She said that the requirement that an insurer either file a timely declaratory action or defend under a reservation, at the peril of being estopped from raising coverage defenses, all as pleaded in FHP’s complaint, only applied where the insurer had a duty to defend.

As to that duty, FHP argued that the policy terms were ambiguous and should be construed in its favor. Part of the argument was based on the fact that certain portions of the self-insurance retention endorsement made use of the term “you,” which the policy defined as the named insured, i.e., NES. FHP thus contended that the self-insurance retention endorsement, and the language giving American Home “the right but not the duty to defend,” did not apply to FHP as an additional insured.

Burke disagreed. She noted that the key right-but-not-duty language, was not phrased in terms of “you” but rather applied to “any suit” seeking damages. It therefore was not restricted to applying only to the named insured, but also applied to an additional insured.

FHP also argued that the self-insurance retention endorsement’s right-but-not-duty provision was inconsistent with the endorsement making the policy’s coverage “primary” for any additional insured “where required by contract,” thereby giving rise to another ambiguity.

Again Burke disagreed. Initially she pointed out that the primary-insurance endorsement modified only the “other insurance” condition of the policy, which was not a grant of coverage. One thus had to look elsewhere in the policy to determine if there was a duty to defend. She also observed that, even if the endorsement were construed as a grant of coverage, the mere fact that an insurer is primary does not mean that it has a duty to defend. The cases relied on by FHP did not show otherwise.

Mend the hold

FHP’s final argument was that American Home should be prohibited from relying on the “right but not the duty to defend” language under the “mend the hold” doctrine, because American Home had not raised that provision in its initial denial-of-coverage letter. Burke explained that the mend-the-hold doctrine is one that sometimes applies to prevent a party from giving one reason for its conduct and then later trying to justify its conduct based on a different consideration.

In the insurance context, however, Burke said that the doctrine does not apply in the absence of unfair surprise, detriment or prejudice. Here, moreover, FHP demonstrated no prejudice.

American Home’s letter put FHP on notice that the insurer was denying coverage, and regardless of the rationale, FHP’s recourse at that point was to file a declaratory action challenging that decision. The mend-the-hold doctrine therefore did not apply.

The court therefore affirmed the dismissal in favor of American Home.

Key points

• A plaintiff seeking to amend its complaint under the liberal standards of Section 2-616(a) must file its motion prior to the entry of final judgment.
• Use of the term “you” in an endorsement giving the insurer the right but not duty to defend “any suit,” does not necessarily restrict the endorsement’s application to named insureds.
• An insurer providing primary coverage is not necessarily obligated by the policy to defend the insured.
• An insurer denying coverage on one ground is not prohibited from later changing the basis for its denial, at least so long as the insured does not demonstrate detriment, unfair surprise or prejudice.