Umbrella Insurer Not Obliged to Cover Defense, Court Says

By Don R. Sampen, published, Chicago Daily Law Bulletin, July 23, 2024

The 7th U.S. Circuit Court of Appeals recently held that an umbrella insurer had no duty to defend its insured where the insured also had coverage under a primary policy that contained, not a duty to defend, but a duty to pay legal fees as part of an insured’s total net loss.

The case is Great American Insurance Co v. State Farm Fire and Casualty Co., 2024 U.S. App. Lexis 15244, (7th Cir., June 24). The primary insurer, Great American as assignee of the Community College Risk Management Consortium, was represented by BatesCarey LLP of Chicago. Riley Safer Holmes & Cancila LLP of Chicago represented the umbrella carrier, State Farm.

In 2015, Robert Breuder, the former president of the Community College District No. 502, DuPage County, sued the board of trustees and members for alleged defamatory statements and civil rights violations in connection with his termination. While some claims were dismissed, certain defamation claims made against the board members in their personal capacity were not.

The underlying defendants were covered by a policy issued by the Illinois Community College Risk Management Consortium. That policy required that the consortium pay the “ultimate net loss” covered under the policy, which included defense costs.

The consortium thus had no actual duty to defend, but only a duty to pay legal fees, which it could advance before the ultimate net loss was determined, and which the consortium did advance.

One of the board defendants was Kathy Hamilton, who also was insured under a personal liability umbrella policy issued by State Farm. The policy included coverage for defamation and contained an “other insurance clause” stating that the coverage was excess over all other insurance available to the insured.

The State Farm policy’s defense clause further stated that the insurer would defend the insured but only “when the basis for the suit is a loss that is not covered by any other insurance policy but is covered by this policy.”

The litigation spanned several years and ultimately resulted in a settlement amounting to $4 million. While the consortium provided a defense, State Farm informed Hamilton that, in light of the consortium’s involvement, State Farm’s obligations were not triggered.

The consortium subsequently assigned all its rights against State Farm to Great American, which brought this action against State Farm. It alleged that State Farm breached its duty to defend Hamilton. Great American sought recovery of a proportionate share of the defense costs and also contended that State Farm was estopped from raising defenses to coverage because it never defended.

The district court dismissed the lawsuit, finding that State Farm had no liability for the costs of defense. Great American took this appeal.

Analysis

In an opinion by Judge Ilana Diamond Rovner, the 7th Circuit affirmed. Focusing her attention on the language of the State Farm policy defense clause, she asked: “was there another insurance company potentially on the hook” for the claim asserted by Breuder? She answered that question in the affirmative, identifying the consortium as the other insurance company because it conceded it was responsible for indemnifying board members for the loss.

While suggesting that such an interpretation “should be the end of the story,” Rovner noted Great American’s objection that injecting the word “potential” as part of the analysis — a word not used in the policy — made the State Farm policy ambiguous. Rovner disagreed, stating that a defense obligation always depends on an analysis of “potential” loss.

It does so because at the time the duty to defend is assessed at the outset of the lawsuit, the insurer cannot know whether its insured will suffer an actual covered loss. This, Rovner wrote, “is the very premise of insurance. It is based on potentialities.”

She also pointed out that State Farm’s potential defense obligation depended, not on whether the consortium was obligated to defend, but on the consortium’s potential indemnity coverage. The fact that the consortium did not have a duty to defend therefore was irrelevant to the assessment of whether State Farm had a duty to defend.

On a related point, Rovner rejected Great American’s argument that, at the start of the Breuder suit when State Farm was obligated to assess its duty to defend, there was no “other insurance” covering the loss because, according to Great American, the consortium’s duty to indemnify did not arise until the settlement occurred.

Once again, Rovner observed that when assessing the duty to defend, one looks to potentialities. Here, at all times the consortium had a potential indemnity obligation. It was that potential, not the ultimate determination of the indemnity obligation, that was relevant in determining that State Farm had no defense obligation.

The court therefore affirmed in favor of State Farm.

Key Point

Where an umbrella insurer’s defense obligation is triggered by the absence of indemnity coverage provided by another insurer, a court will look to the other insurer’s potential for indemnity coverage in determining the umbrella insurer’s duty to defend.