Douglas v. Allied American Insurance, No. 5-99-0040

5th District, 16 March 2000

PRESIDING JUSTICE GOLDENHERSH delivered the opinion of the court:

Plaintiff, Catherine Douglas, assignee of Patricia Cowsert, appeals from an order of the Circuit Court of Madison Countygranting summary judgment in favor of defendant, Allied American Insurance Company, also known as Gallant InsuranceCompany (hereinafter Allied). Allied had filed a third-party complaint against attorney Randall Kelley. The trial courtfound in favor of Kelley on Allied's third-party complaint for contribution, and that finding was not appealed by Allied.Therefore, the issue before this court is whether the trial court erred in granting summary judgment in favor of Allied. Wereverse and remand.

I. BACKGROUND

On January 19, 1993, plaintiff was involved in an automobile accident with Patricia Cowsert near Medora in MacoupinCounty. At the time of the accident, Cowsert was 20 years old and insured under a policy issued by Allied. The insurancepolicy had limits of $20,000 per person and $40,000 per accident.

As a result of the accident, plaintiff filed suit against Cowsert. Three other individuals also filed suit against Cowsert,including Mary Susan Watts, a passenger in the Douglas vehicle, and Laura Hose and Misty Parkerson, passengers in theCowsert vehicle. Allied hired attorney Randall Kelley to represent Cowsert in the underlying litigation. On July 5, 1994,Allied tendered the policy limits of $40,000 to the court for disbursement to the plaintiffs. On July 14, 1994, Kelleywithdrew as counsel for Cowsert. Cowsert was without funds to hire an attorney to defend her in the pending actions, soCowsert was unrepresented during trial. On August 30, 1994, the trial court entered summary judgment in favor of theplaintiffs and against Cowsert on the issue of liability. On September 7, 1994, the cases were called for hearing on the issueof damages, after which the trial court entered judgment in favor of Parkerson, Hose, Watts, and plaintiff and againstCowsert in the amount of $320,108, $60,917, $654,695, and $404,335, respectively.

On September 28, 1995, plaintiff herein received an assignment from Cowsert for any claim Cowsert might have againstAllied for breach of duty to defend. On November 6, 1995, plaintiff filed a declaratory judgment action against Alliedpursuant to the assignment from Cowsert. Count I alleged breach of contract and count II alleged bad faith. The parties thenengaged in discovery.

During discovery, Allied admitted that it hired Kelley to represent Cowsert and that Kelley filed a motion to withdraw fromCowsert's case; however, Allied denied "that any such motion to withdraw was filed at the instruction, or with theknowledge or approval, of [Allied]." Allied also denied that it had authorized or instructed Kelley not to represent Cowsertat the hearings on plaintiff's motions for summary judgment and damages. Kelley testified contrary to Allied's assertionsduring his deposition on July 22, 1997.

According to Kelley, Allied "generally" told him what to do concerning the representation of Cowsert. For example, theytold him how far they wanted him to go in terms of working up the file, what depositions they wanted him to attend, whatdiscovery they wanted him to engage in, and what court appearances they wanted him to make. Kelley explained that oncethe check was accepted into the court file, Allied told him not to participate in distribution of the funds or do anything elseon the file because Allied believed it had fulfilled its contractual obligations to Cowsert. Kelley testified that Allied neverasked his opinion about whether or not it was a good idea to withdraw, nor did they ever ask him to review the policy todetermine whether it would be proper to withdraw at that time.

After written discovery and depositions, all parties moved for summary judgment in the declaratory judgment action. Thetrial court held that Kelley was an agent of Allied, and the court entered summary judgment in favor of Allied and againstplaintiff. The trial court also entered summary judgment in favor of Kelley on the third-party complaint. Plaintiff nowappeals. Allied did not appeal the trial court's finding in favor of Kelley on the third-party complaint.

II. STANDARD OF REVIEW

It is well-settled in Illinois that a reviewing court will conduct a de novo review of an appeal from the grant of a summaryjudgment. See Espinoza v. Elgin, Joliet & Eastern Ry. Co., 165 Ill. 2d 107, 113, 649 N.E.2d 1323, 1326 (1995). Thedetermination of the rights and obligations under an insurance policy is a question of law that is appropriate for dispositionby way of summary judgment. See Crum & Forster Managers Corp. v. Resolution Trust Corp., 156 Ill. 2d 384, 391, 620N.E.2d 1073, 1077 (1993). A court must construe the policy as a whole and determine the intentions of the parties based onthe policy's express terms, taking into account the type of insurance for which the parties have contracted, the risksundertaken and purchased, and the subject matter that is insured, along with the purposes of the entire contract. See Crum &Forster Managers Corp., 156 Ill. 2d at 391, 620 N.E.2d at 1078. The interpretation of insurance contracts is governed bythe rules for interpreting contracts generally, and whether a policy is ambiguous is a question of law for the court. If thecourt decides the contract is ambiguous, the construction of the contract becomes a question of fact. See Dash v. MessengerService, Inc. v. Hartford Insurance Co., 221 Ill. App. 3d 1007, 582 N.E.2d 1257, 1260 (1991). With these principles inmind, we begin an analysis of the issue presented.

III. ANALYSIS

Plaintiff contends that the trial court erred in entering summary judgment against her because there was a genuine issue oflaw whether Allied breached its duty to defend its insured when it tendered the policy limits to the court without obtaining arelease or settlement and withdrew representation of its insured. Plaintiff asserts there is an ambiguity created by thecontract language and that Allied had a duty to defend Cowsert until the policy limits were exhausted by payment of ajudgment or a settlement. We agree.

The general rule in Illinois is that an insurer's duty to defend and its duty to indemnify are separate and distinct, with theduty to defend being broader than the duty to indemnify. See Crum & Forster Managers Corp., 156 Ill. 2d at 393-94, 620N.E.2d at 1080. To determine whether the insurer had a duty to defend an insured, a court must look to the allegations in theunderlying complaint and compare those allegations to relevant provisions of the insurance policy. See Outboard MarineCorp. v. Liberty Mutual Insurance Co., 154 Ill. 2d 90, 107-08, 607 N.E.2d 1204, 1212 (1992). If the facts alleged in theunderlying complaint fall within, or even potentially within, the policy's coverage, the insurer's duty to defend arises. SeeOutboard Marine Corp., 154 Ill. 2d at 108, 607 N.E.2d at 1212. A refusal to defend is unjustifiable unless the face of theunderlying complaint clearly indicates that the facts alleged do not fall potentially within the policy's coverage. SeeOutboard Marine Corp., 154 Ill. 2d at 108, 607 N.E.2d 1204.

In making its determination that Allied had no duty to continue to defend Cowsert after it had paid the bodily injury policylimits to the court but before any judgment or settlement was reached, the trial court relied on language found in "Part I -Liability, Coverage A, Coverage B," of the policy, which states:

"To pay on behalf of the insured, but only to the extent of the applicable policy limits, all sums which the insuredshall become legally obligated to pay as damages because of:

A. bodily injury, or

B. property damage,

arising out of the ownership, maintenance, or use of the owned automobile or any non[]owned automobile, and thecompany shall defend any suit alleging such bodily injury or property damage and seeking damages which arepayable under the terms of this policy, even if any of the allegations of the suit are groundless, false[,] or fraudulent;but the company may make such investigation and settlement of any claim or suit as it deems expedient.

It is understood and agreed that the company has no obligation to any insured

after the applicable limits of the policy have been exhausted by payment ***."

The trial court found that the last sentence quoted above controlled the issue that and its plain meaning established thatAllied had no further obligation once it paid its entire liability limits. The term "exhausted by payment" was not defined inthe contract.

As previously set forth, a court must construe the policy as a whole. A court is not to read provisions in isolation but isrequired to read the provisions of a contract in light of each other to determine whether an ambiguity exists. See DashMessenger Service, Inc. v. Hartford Insurance Co. of Illinois, 221 Ill. App. 3d 1007, 582 N.E.2d 1257, 1260 (1991). Ifwords in the policy are susceptible to more than one reasonable interpretation, they are ambiguous. Any ambiguity in apolicy must be construed against the insurance company and in favor of the insured. See Outboard Marine Corp., 154 Ill.2d at 108-109, 607 N.E.2d at 1212. A review of the policy language found in Allied's contract of insurance with Cowsertindicates that an ambiguity exists.

Allied focuses on use of the words "exhausted by payment" to conclude that the payment of liability limits to the courtterminated Allied's obligation to defend under the policy. The trial court adopted Allied's approach and concentrated onlyon the last sentence of the provision. However, in interpreting the provision, we cannot disassociate the last sentence in theprovision from its context. When the final sentence containing the words "exhausted by payment" is read together with theprior sentences, the entire provision's ambiguity becomes apparent.

The pertinent provision provides that the insurer will pay on behalf of the insured only those "sums which the insured shallbecome legally obligated to pay." (Emphasis added.) The term "legally obligated" is not defined in the policy, but its plainmeaning suggests an obligation due to judgment or settlement. In support of our interpretation, we note that Black's LawDictionary states that a legal obligation forms the basis for a judgment in a court of competent jurisdiction. Black's LawDictionary 806 (5th ed. 1971). Merely because Allied tendered its policy limits to the court does not mean that Allied waslegally obligated to pay that amount, since neither a settlement had been reached nor a judgment had been entered.

Zurich Insurance Co. v. Raymark Industries, Inc., 118 Ill. 2d 23, 514 N.E.2d 150 (1987), supports our interpretation of thephrase "legally obligated." In that case, the trial court declared that under the terms of the policies issued to RaymarkIndustries, Inc. (Raymark), the primary insurers were obligated to defend new claims and continue to defend the claimspending against Raymark up until the time the liability limits of those policies were exhausted by "payment of judgmentsand/or settlements." Zurich Insurance Co., 118 Ill. 2d at 53, 514 N.E.2d at 163. The underlying actions had been filed byindividuals alleging personal injuries and wrongful death resulting from exposure to asbestos products manufactured byRaymark. Our supreme court found that a defending insurer which had exhausted its policy limits was no longer obligatedto defend the insured and that the insured must tender the case to another insurer. The court in that case specifically statedas follows:

"The duty to indemnify arises only when the insured becomes legally obligated to pay damages in the underlyingaction that gives rise to a claim under the policy. The duty to defend an action brought against the insured, on theother hand, is determined solely by reference to the allegations of the complaint. If the complaint alleges facts whichbring the claim within the potential indemnity coverage of the policy, the insurer is obligated to defend the action."(Emphasis added.) 118 Ill. 2d at 52, 514 N.E.2d at 163.

It is clear that in a lawsuit one does not become "legally obligated" until a judgment or settlement is reached between theparties.

Moreover, a review of the contract shows that the term "exhausted by payment" is not defined by the policy and is subjectto more than one interpretation. For example, Allied could have paid the policy limits to the court and interpleaded theconflicting claimants in a declaratory judgment action. It could have paid the policy limits to any one of four claimants inthe underlying actions. It could have paid the policy limits in full or partial satisfaction of a judgment. It could have paid thepolicy limits directly to Cowsert in lieu of investigating whatever defenses might be available and let Cowsert decide whatto do. Or, it could have paid the limits in return for a release for itself and its insured. See Brown v. Lumbermens MutualCasualty Co., 326 N.C. 387, 394, 390 S.E.2d 150, 154 (1990). Certainly, several different methods of effectuating the term"exhausted by payment" exist.

Other jurisdictions that have considered similar language in an insurance contract have determined that the word "exhaust"means only payment either by settlement or judgment wholly depleting the policy amount, not simply paying the policylimits to the court. There are numerous cases from other jurisdictions which hold that an insurer cannot discharge its duty todefend by unilaterally tendering its policy limits to the court or the claimant. When an insurer merely tenders its limits,without obtaining a settlement of any claim for its insured, a strong argument exists that it has not exhausted its policylimits.

In a case from North Carolina, Brown v. Lumbermens Mutual Casualty Co., 326 N.C. 387, 390 S.E.2d 150 (1990), the duty-to-defend provision of an automobile policy that stated, "Our duty to settle or defend ends when our limit of liability for thiscoverage has been exhausted," was found to be ambiguous because it did not specify in what manner the limits would haveto be exhausted before its duty to defend was discharged. Brown is factually similar to the case at bar. In that case, Brown,the insured, was involved in an automobile accident with a car driven by Joan Hinson. Hinson filed suit against the insured.The insurer employed counsel to defend Brown. Prior to trial, the insurer paid its policy limit of $25,000 to Hinson inpartial satisfaction of Hinson's claim and stopped defending Brown. Hinson obtained a verdict against Brown for $45,000.The trial court entered judgment on that amount and credited Brown with the $25,000 payment made by the insurer. Brownthen filed suit against the insurer for breach of duty to defend. The trial court entered summary judgment in favor of Brown,finding that the insurer's unilateral tender to Hinson and Hinson's acceptance of the policy limit without effectuating asettlement of Hinson's claim against Brown did not relieve the insurer of its duty to defend.

In Anderson v. United States Fidelity & Guaranty Co., 177 Ga. App. 520, 339 S.E.2d 660 (1986), similar policy languagewas in question. The Georgia court did not agree with the insurer that the term "exhaust" encompassed the paying of policylimits to the court but interpreted it to mean the payment by way of either a settlement or a judgment wholly depleting thepolicy amount. See also Samply v. Integrity Insurance Co., 476 So. 2d 79 (Ala. 1985).

As previously observed, the policy in question contains the words "exhausted by payment" but does not define what type ofpayment is necessary in order to relieve Allied of its duty to defend. One reasonable interpretation is that the insurer willdefend any claim and the insurer's obligation to defend will terminate only if and when the insurer's policy limits areexhausted by judgment or settlement. In support of this interpretation, we rely on Conway v. Country Casualty InsuranceCo., 92 Ill. 2d 388, 442 N.E.2d 245 (1982). In that case, our supreme court specifically stated, "[S]ince the insurer's duty todefend its insured is not dependent upon a duty to indemnify[] but arises from the undertaking to defend stated in thepolicy, an insurer's payment to its policy limits, without more, does not excuse it from its duty to defend." Conway, 92 Ill.2d at 394, 442 N.E.2d at 247. In making its determination that an insurer cannot discharge its duty to defend its insuredsimply by making payments to the claimant to the extent of its policy's limits, the Conway court looked to the language ofthe policy in issue, which provided in pertinent part, "The Company shall not be obligated to pay any claim or judgment orto defend any suit or prosecute or maintain any appeal after the applicable limits of the Company's liability have beenexhausted by payment of any judgments or settlements." Conway, 92 Ill. 2d at 393, 442 N.E.2d at 246-47. The Conwaycourt found that since the insurer could terminate its obligation to defend only by payments made pursuant to a judgment orsettlement, the insurer's voluntary payments to a claimant, without a release, did not discharge the insurer of its duty todefend. Conway, 92 Ill. 2d at 395-96, 442 N.E.2d at 248.

While the inclusion of the language that exhaustion of the policy limit must be by payment of "judgments or settlements"was important to the Conway court's determination that the company's payments to the claimant did not discharge its dutyto defend, the absence of such language here is not fatal to the insured's case because the relevant provision is ambiguous,and such ambiguity must be construed in the insured's favor. Moreover, a liberal reading of Conway supports theproposition that regardless of the specific language of the policy, a liability insurer may not absolve itself of its duty todefend the insured by tendering its policy limits to the court. An insurance company has a fiduciary duty to defend itsinsured and to consider the insured's interest. "[A]n insurer cannot simply discharge its duty to its insured simply by makingpayments to the claimant to the extent of its policy's limits." Conway, 92 Ill. 2d at 395, 442 N.E.2d at 248.

There are strong public policy arguments against allowing insurers to discharge their duty to defend by paying policy limitsand then leaving the insured to fend for himself. "[A] most significant protection afforded by the policy--that of defense--isrendered a near nullity" if the duty to defend would terminate upon unilateral tender of policy limits. Simmons v. Jeffords,260 F. Supp. 641, 642 (E.D. Pa. 1966).

"'[T]he insurer's duty is both to defend actions and to pay judgment against the insured. Otherwise where the damagesexceed the policy coverage, the insurer could walk into court, toss the amount of the policy on the table, and blithelyinform the insured that the rest was up to him. This would obviously constitute a breach of the insurer's contract todefend actions against the insured, for which premiums had been paid, and should not be tolerated by the courts.'"(Emphasis omitted.) National Casualty Co. v. Insurance Co. of North America, 230 F. Supp. 617, 622 (N.D. Ohio1964), quoting 8 Appleman, Insurance Law & Practice,