Allocation Between Covered And Uncovered Damages

Coverage disputes frequently arise when claims contain some elements of damage that are covered and some that are not. The general rule in the duty-to-defend context is clear: where some allegations against a policyholder are potentially covered by the policy, the insurer must defend the entire action. This is often called the “in for a penny, in for a pound” rule.

In the duty-to-indemnify context, the outcome is less clear. The Middle District of Florida’s recent decision in Mid-Continent Casualty Co. v. Clean Seas Co., Inc., Case No. No.3:06-cv-518-J-32MCR (M.D. Fla. March 20, 2012) addresses a tricky situation involving covered an uncovered claims. In Clean Seas, the policyholder, a manufacturer of boat paint, was sued in a product defect lawsuit. The plaintiff in the underlying case alleged that the policyholder’s paint was defective and failed, causing physical damage to the plaintiff’s boat. The parties apparently recognized that the “your product” exclusion would exclude coverage for the cost of the defective paint, and so the plaintiff agreed to limit its damages presentation at trial to damage caused to its boat.

After a verdict in favor of the plaintiff, the manufacturer’s insurance company, Mid-Continent, refused to pay the judgment, claiming that the verdict was unclear as to the basis for the damage assessment. Mid-Continent argued that, because the plaintiff’s complaint had alleged damage that was uncovered (i.e., the cost of the defective paint), and because it was not clear how the jury determined the damages, the insurer should have no duty to indemnity Clean Seas for the judgment.

The court rejected Mid-Continent’s argument for several reasons. First, the court in the underlying case had instructed the jury to only consider damages that constituted physical injury to property other than the paint. Although Mid-Continent suggested that the jury disregarded these instructions, there was no evidence in the record to support the allegation.

The court further noted the general rule that an insurer is collaterally estopped from relitigating factual issues determined in the underlying action. In other words, an insurer cannot retry the underlying case in the coverage case. Mid-Continent argued that this general rule did not apply because the insurer and policyholder were not in privity, given Mid-Continent’s reservation of rights.  Rather than working together to defend the case, Mid-Continent argued that its interests were antagonistic to those of its policyholder.

Mid-Continent’s argument on this point is astounding in both its candor and shamelessness. Carriers almost always maintain that they are putting their policyholders’ interests first when they defend under reservation of rights, despite the coverage issues that may cause friction between them. Here, Mid-Continent took the unusual step of admitting what is obvious to all policyholder lawyers: the insurer was not really looking out for its policyholder during the defense of the case, but it was angling to undermine the policyholder’s case to avoid its coverage obligations.  Mid-Continent, of course, was accusing its policyholder of infidelity as well: posturing the case to get the carrier to pay if it suffered an adverse verdict.

The court noted that the policyholder tried to ask for special interrogatories geared towards the coverage issues — interrogatories requested by Mid-Continent to assist Mid-Continent in disclaiming indemnity obligations — but the judge in the underlying case refused to allow the interrogatories on the basis that they were irrelevant to the underlying case.

The judge rejected the insurer’s argument that it owed no indemnity obligations because the policyholder failed to obtain a verdict that would allow the policyholder to prove which damages were covered. The court noted that the insurer could not meet its initial burden of proving that some of the damages were uncovered, since the jury had been charged to consider only covered damages. If the insurer had met its burden, the court suggested (in dicta) that the burden of proof would have shifted to the policyholder to prove what elements of damage were covered.

Florida law on this question of allocation for indemnity purposes is unclear. In the settlement context, Florida courts have held that the insurer has the burden to prove what portions of a settlement are uncovered. Smart policyholders settle claims with an eye towards coverage, and undifferentiated settlements make it very difficult for carriers to meet their burden and disclaim indemnity obligations. Many courts apply the “larger settlement rule” in determining whether an indemnity obligation exists for a settlement involving covered and uncovered elements. Under the “larger settlement rule,” if the exposure on the covered claims is equal to or greater than the amount paid to settle the claims, then the settlement is deemed fully covered.

When a liability case goes to verdict, it is unclear how far a policyholder must go in the underlying case to create a record sufficient to demonstrate which elements of the judgment are covered. Most of the Florida caselaw to address this issue is found in the subrogation or contribution contexts, where the policyholder is no longer the real party in interest, but another insurer is standing in its shoes. In this insurer v. insurer context, courts have generally put the burden on the contributing insurer to prove the obligations of the non-contributing insurer.

Counsel on either side of an underlying case involving covered and uncovered damages, where an insurer is defending under reservation of rights, need to be cognizant of these coverage allocation issues. Carriers are increasingly taking aggressive approaches in underlying litigation, including intervening in the case in an attempt to influence the case in a way that will favor their coverage defenses. Underlying counsel need to counter the insurer’s tactics, while at the same time being cautious not to give the insurer another argument to disclaim indemnity obligations.  In this situation, traps abound for counsel unfamiliar with insurance coverage law.

Although there is no “safe harbor” approach in this difficult situation, the safer approach for underlying counsel is to create a record that precludes the insurer from establishing the existence of uncovered damages. It is clear that the insurer has this initial burden, and if it cannot meet its burden of proving uncovered elements then it will lose the allocation dispute.  Underlying counsel, in particular plaintiffs’ counsel, have it within their power to limit their claims and proofs at trial to ensure that awarded damages are covered damages.  Policyholders or plaintiffs (with Coblentz assignments) who find themselves with a burden to prove what aspects of a verdict are covered may later find that they have an impossible task, particularly if they did not lay a proper foundation during the underlying case.