Stay of Consideration of Insurance Policy Exclusions Held Proper

By Don R. Sampen, published, Chicago Daily Law Bulletin
[May 2, 2017]

The 1st District Appellate Court, in an interlocutory appeal, recently held that consideration of policy exclusions in deciding the duty to defend may be stayed pending resolution of the underlying lawsuit because of overlapping factual issues.

The case is Sentry Insurance Co. v. Continental Casualty Co., 2017 IL App (1st) 161785 (March 24, 2017). Continental Casualty was presented by Colliau, Carluccio, Keener, Morrow, Peterson & Parson. Neal, Gerber & Eisenberg LLP represented the insured, Northwestern Medical Faculty Foundation.

Underlying lawsuits were brought against the foundation and Northwestern Memorial Hospital for damage to semen and testicular tissue being stored by the foundation in a cryopreservation storage tank. The matter was destroyed when the preservation vessel broke down and semen and tissue thawed. The foundation tendered the lawsuits to Sentry Insurance Co. for defense.

Sentry accepted the tender under a reservation of rights and then brought the instant declaratory action raising two exclusions, the “care, custody or control” exclusion and the “professional services” exclusion.

Continental, the foundation’s commercial umbrella carrier, was named a defendant in the action. Continental filed an answer and counterclaim raising the same exclusions in its policy.

In 2015, the foundation filed a motion to dismiss or alternatively to stay the declaratory claims against it. As to the stay, it argued that any determination of the duty to defend required the adjudication of facts that overlapped with disputed liability issues in the underlying lawsuits.

In 2016, the trial court granted in part the foundation’s motion. It held that a stay would be entered as to the determination of the duty to indemnify until the duty to defend had been determined. The court further said that it could not determine the applicability of the two exclusions mentioned above because of the overlap of issues with the underlying lawsuits.

The trial court further found that it could go forward to determine whether the lawsuits sought damages for “bodily injury” or “property damage” such as to give rise to the duty to defend.

Sentry and Continental took an interlocutory appeal from the order pursuant to Illinois Supreme Court Rule 307(a)(1), but Sentry ultimately settled with the foundation. Thus, the appeal went forward solely as to Continental.

Care, custody or control exclusion

In an opinion by Justice Robert E. Gordon, the 1st District affirmed. He first addressed the standard of review under a Rule 307(a)(1) appeal and found that an abuse of discretion standard should be applied.

He then took up Continental’s primary argument on appeal, namely, that the trial court erred in staying consideration of the “care, custody or control” and “professional services” exclusions while at the same time going forward to decide the existence of a duty to defend.

Gordon observed that, under Maryland Casualty Co. v. Peppers, 64 Ill.2d 187 (1976), it is generally inappropriate for a court considering a declaratory judgment action addressing insurance coverage to decide issues of ultimate fact that could bind the parties in the underlying litigation.

Applying that principal to the “care, custody or control” exclusion, Gordon said that, to determine its applicability, the trial court would have to decide whether the foundation exercised exclusive control over the specimens at the time they were damaged.

However, a finding that the foundation did exercise exclusive control would contradict the allegations in the underlying complaints that alleged that the hospital exercised control at the same time.

That kind of determination, said Gordon, is prohibited by Peppers. It is prohibited because it could preclude the underlying plaintiffs from recovering under the theories alleged in their complaints against the hospital.

He further rejected Continental’s argument that the foundation had admitted exclusive possessory control in its answers to the pleadings on file against it. At most, according to Gordon, the foundation admitted that it had control over the specimens and did not speak to whether that control was exclusive.

Similarly, Gordon rejected Continental’s argument that a partial summary judgment finding in the underlying case that the foundation had entered into a bailment with respect to the specimens, resolved the issue of exclusive control. Such a finding of bailment, said Gordon, did not establish exclusive control. Thus, the trial court did not err in staying consideration of the “care, custody or control” exclusion.

Professional services exclusion

As to the “professional services” exclusion, Gordon found that its application would necessitate a determination of whether the foundation’s business activities involved specialized knowledge, labor or skill and were predominantly mental or intellectual as opposed to physical or manual in nature. To make that kind of determination, however, the coverage court would have to look to extrinsic evidence outside the underlying pleadings.

Gordon concluded that the trial court did not abuse its discretion in staying consideration of this exclusion for two reasons. One was his acceptance of the foundation’s argument that determining the nature of the foundation’s conduct — specialized knowledge or not — could touch on its liability for negligence in the underlying case.

The second was that consideration of extrinsic evidence would not be appropriate at the current stage of the coverage court’s proceedings. Relying on Fidelity & Casualty Co. of New York v. Environdyne Engineers Inc., 122 Ill.App.3d 301 (1983), and Pekin Insurance Co. v. Wilson, 237 Ill. 2d 446 (2010), he said that reliance on extrinsic evidence would be appropriate at the summary judgment stage, so long as no crucial issue in the underlying litigation was decided. But reliance on such evidence for a matter being decided on the pleadings, as here, would not.

Finally, Gordon said that even though consideration of the two exclusions had to be stayed under Peppers, such a stay did not bar the trial court from considering the rest of the policy and whether the underlying allegations alleged facts potentially within coverage giving rise to a duty to defend.

The reason was that the trial court could decide the defense obligation, in the absence of the exclusions, without deciding any ultimate facts in the underlying litigation.

The 1st District thus affirmed that stay entered by the trial court.

Key points

• Under Peppers, the coverage court cannot decide issues of ultimate fact that could bind the parties in the underlying litigation.
• In applying Peppers, the coverage court can stay consideration of portions of the policy that give rise to fact issues overlapping with the underlying litigation and make its duty-to-defend determination based on the parts of the policy that do not.
• Extrinsic evidence may be used to decide the duty to defend at the summary judgment stage of the coverage action, but its use may be more limited at earlier stages of the coverage action.