[J-86-2014] IN THE SUPREME COURT OF PENNSYLVANIA

WESTERN DISTRICT

CASTILLE, C.J., SAYLOR, EAKIN, BAER, TODD, McCAFFER Y, STEVENS, JJ.

THE BABCOCK & WILCOX COMPANY AND B&W NUCLEAR ENVIRONMENTAL SERVICES, INC.

v.

AMERICAN NUCLEAR INSURERS AND MUTUAL ATOMIC ENERGY LIABILITY UNDERWRITERS AND OTHER INTERESTED PARTY: ATLANTIC RICHFIELD COMPANY

AMERICAN NUCLEAR INSURERS AND MUTUAL ATOMIC ENERGY LIABILITY UNDERWRITERS

v.

THE BABCOCK & WILCOX COMPANY AND B&W NUCLEAR ENVIRONMENTAL SERVICES, INC., AND ATLANTIC RICHFIELD COMPANY

APPEAL OF: BABCOCK & WILCOX POWER GENERATION GROUP, INC. (F/K/A THE BABCOCK & WILCOX COMPANY) AND BABCOCK & WILCOX TECHNICAL SERVICES GROUP, INC. (F/K/A B&W NUCLEAR ENVIRONMENTAL SERVICES, INC.), AND ATLANTIC RICHFIELD COMPANY : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : : No. 2 WAP 2014 Appeal from the Order of the Superior Court entered July 10, 2013 at No. 525 WDA 2012, vacating the Judgment of the Court of Common Pleas of Allegheny County entered February 17, 2012 at GD99-11498 and GD99-16227 and remanding. ARGUED: October 7, 2014[J-86-2014] - 2 OPINION

MR. JUSTICE BAER DECIDED: July 21, 2015 We granted review to consider an issue of first impression regarding whether an insured forfeits insurance coverage by settling a tort cla im without the consent of its insurer, when the insurer defends the insured subject to a reservation of rights, asserting that the claims may not be covered by the poli cy. After review, we reverse the decision of the Superior Court and reinstate the judgm ent of the trial court. The case history spans two decades, beginning with the 199 4 filing of a federal class action lawsuit against Appellant-Insureds Babcock & Wil cox Company (B&W) and Atlantic Richfield Company (ARCO) (collectively, Insureds) brought by plaintiffs claiming to have suffered bodily injury and property damage ca used by emissions from nuclear facilities owned by Insureds. 1 Over time, the class action grew to include over 500 named plaintiffs, who lived near the nuclear faciliti es. Insureds denied that the facilities released any emissions or that the harm suffered by plai ntiffs resulted from the facilities. Nevertheless, a 1998 jury trial of eight test cases resul ted in an initial verdict totaling over $36 million or approximately $4.5 million per plaintiff. The federal court, however, granted a new trial due to evidentiary issues. The re trial was never held given the subsequent settlement discussed below. While the underlying tort action was pending in feder al court, disputes arose between Insureds and their insurers, Appellees American N uclear Insurers and Mutual Atomic Energy Liability Underwriters (collectively ANI or Insurer). At the outset of the litigation, Insurer acknowledged that it would defend Insureds but contested whether the policy covered aspects of the claims, and thus defended subj ect to a reservation of

1 The Superior Court’s decision below provides a fuller discussion of the facts. Babcock & Wilcox Co. v. American Nuclear Insurers, 76 A.3 d 1, 3-5 (Pa. Super. 2013).[J-86-2014] - 3

rights. Specifically, in 1994, Insurer, inter alia , asserted that the policy did not cover damages that were not caused by nuclear energy hazard, damages in excess of the policy limits, and claims for injunctive relief and puni tive damages. Letter of June 20, 1994, R.R. at 148a-151a. The 1994 reservation of r ights was supplemented as to B&W in October 1999, by a letter indicating, inter alia , that Insurer reserved its right to disclaim coverage for Insureds’ liability based upon Insur eds’ pressuring of Insurer to settle, which Insurer viewed, in connection with other a ctions, as a breach of Insureds’ duty to cooperate. 2 Letter of October 5, 1999, R.R. at 3206-08. While the details are not relevant to the current disp ute, Insurer filed a declaratory judgment action in state court days after th e 1999 reservation of rights letter, raising challenges relating to the coverage limit, whet her B&W and ARCO were entitled to separate representation, and bad faith and breach o f contract allegations, including the breach of the duty to cooperate, against the Insure ds. The Insureds counter claimed, raising bad faith allegations against Insurer. While staying various claims for future determination, including the breach of the dut y to cooperate claim, the court decided issues regarding the trigger of coverage and he ld that B&W and ARCO were entitled to separate counsel. The Superior Court a ffirmed on appeal, and this Court

denied allocatur. 3

2 The Insureds’ contractual duty to cooperate is set fort h in Condition 6 of the contract, see infra at 4.

3 During this period of time, Insured B&W filed for b ankruptcy, with proceedings spanning 2000-2007. Notably, Insurer did not withdraw its reservation of r ights, although some aspects of the reservation of rights were mooted by interveni ng events. Indeed, Insurer reasserted its allegation that Insureds had not complied with their duty to cooperate in 2008. Letter of September 19, 2008, R.R. at 3385; Letter of Oct. 3, 2008, R.R. at 3397.[J-86-2014] - 4

During the course of the litigation, Insurer refused consent to any settlement offers presented to it due to its conclusion that the case had a strong likelihood of a defense verdict given the lack of medical and scientific sup port for plaintiffs’ claims and decisions by the federal trial court regarding procedura l and evidentiary issues in the pending retrial, which Insurer viewed as highly favora ble to Insureds’ ultimate outcome. Nevertheless, after presenting the settlement offers to Insurer and being denied consent, Insureds ARCO and B&W, respectively in 2008 and 2009, settled with the class action plaintiffs for a total of $80 million, which was substantially less than the $320 million of potential coverage. 4 Insureds then sought reimbursement of the settlement am ount from Insurer in the Allegheny County Court of Common Pleas. Insurer count ered that reimbursement was not permissible because the insurance contract contained a standard consent to settlement clause, also referred to as a cooperation clau se, requiring Insureds to cooperate with Insurer and to obtain Insurer’s consent to settle:

Assistance and cooperation of the Insured. The insured shall cooperate with the companies, and upon the companies’ request, attend hearings and trials and assist i n making settlements, securing and giving evidence, obtai ning the attendance of witnesses and in the conduct of any le gal proceedings in connection with the subject matter of this insurance. The insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense. Insurance Agreement, Condition 6, Reproduced Record ( R.R.) at 59a. Under the insurance policy the decision to settle rested exclusively w ith Insurer which “may make

4 Notably, the policy provided that the policy limits were inclusive of defense costs, such that expenditures on defense reduced the coverage available for liability. Insurer expended $40 million defending Insureds prior to the settlement, apparently leaving $280 million in coverage.[J-86-2014] - 5

such investigation, negotiations and settlement of any claim or suit as they deem expedient.” Id. at I(A)(1), R.R. at 57a. Moreover , the policy expressly did not cover “liability assumed by the insured under contract . . . .” Id. at Exclusion (c), R.R. at 58a. Relevant to the question at bar, the trial court re cognized that the case presented the issue of “under what circumstances will a court require an insurance company, whose policy is found to provide coverage, to reimburse an insured that settled the underlying litigation over the objections of the insur ance company” in a case involving a

standard consent to settlement clause when the insurer ha s defended its insured subject to a reservation of rights. Tr. Ct. Op., July 5 , 2011 at 2. As discussed in more detail below, Insureds asserted that Insurer should reimb urse Insureds for the settlement so long as coverage applies and the settlemen t is fair and reasonable and entered in good faith, a test derived in part from t he seminal case of United Services Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987) (here inafter “Morris fair and reasonable standard”). Insurer, in contrast, argued that the obli gation to pay the settlement could only be imposed on Insurer if it acted in bad faith i n refusing to settle, seeking application of this Court’s test in Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa. 1957), where we held that an insurer must pay a judg ment in excess of policy limits for its bad faith failure to settle below policy limits (her ein after “Cowden bad faith standard”). 5 While initially opining in December 2009 that the C owden bad faith standard should apply, the trial court reconsidered its decision in July 2011 and applied the Morris fair and reasonable standard. Judge R. Stanton Wettick reasoned that while the interests of insurers and insureds generally align when the insurer has accepted

5 Full discussions of Cowden and Morris are set forth infr a at 20 and 23 respectively.[J-86-2014] - 6

responsibility for defense and indemnity, the parties’ interests increasingly diverge the more the insurer believes the policy does not cover the claims, as when the insurer defends under a reservation of rights. He observed tha t, in a reservation of rights case, an insured would prefer to cap the potential liabili ty as it ultimately may be responsible

for the full settlement in the event that insurer is su ccessful in its challenge to coverage,

whereas the insurer does not want to settle as it would relinquish its challenge to coverage. Tr. Ct. Op., July 5, 2011 at 5. Relying u pon Morris and decisions from other jurisdictions, the trial court opined that a reservation of rights case is more akin to a case where an insurer has refused coverage and defense. Id. at 5-6. Accordingly, the court adopted the test forwarded by Insureds under whi ch an insurer, defending subject to a reservation of rights, is required to reimburse an insured for a settlement reached in violation of the consent to settle clause where coverag e is found to exist and the settlement is “fair and reasonable” and made in “good faith and without collusion.” Id. at 6-11(citing in support Insurance Co. of North America v . Spangler, 881 F.Supp. 539 (D. Wyo. 1995); Morris, 741 P.2d 246; Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa 2000); Patrons Oxford Ins. Co. v. Harris, 905 A.2d 81 9 (Me. 2006); and Martin v. Johnson, 170 P.3d 1198 (Wash. Ct. App. 2007)); Tr. Ct . Order, July 5, 2011(providing

that Insurer shall reimburse Insureds if the Insureds esta blish that the settlement was

“fair and reasonable” unless Insurer establishes that “t here is no coverage” under the policies for reasons unrelated to the settlement). 6

6 The court further observed that unlike some other case s discussed below where the insured merely assigned its rights to the plaintiff and removed itself from any potential liability, the insured in this case paid the settlement with its own funds and was now seeking reimbursement, and thus “had a strong inter est to hold out for the best possible deal.” Tr. Ct. Op. at 2.[J-86-2014] - 7

Following the court’s decision, a two-week trial was hel d where a jury determined that Insureds’ settlement with plaintiffs was fair and r easonable. The trial court, then, molded the verdict to include prejudgment and post-ver dict interest. Insurer appealed to the Superior Court seeking application of the Cowden bad faith standard. The Superior Court recognized that this case presents an issue of first impression in Pennsylvania, which has nonetheless been addressed by various state and federal courts. The court further observed that the question is subject to well-set tled basic principles of Pennsylvania insurance law. The court emphasized that i nsurance policies are contracts at heart, controlled by the language of the p olicy, but which include unique policy concerns requiring that any ambiguity be interpr eted in favor of the insured. The court reiterated that Pennsylvania distinguishes be tween the duty to provide coverage and the broader duty to defend, which applie s when the claim may potentially come within the coverage of the policy. The panel acknow ledged that the insurer’s broad duty to defend is balanced by an insurer’s option to defend subject to a reservation of rights. It emphasizes that the utilizat ion of the reservation of rights is not a breach of contract but instead is encouraged, as it pr ovides insureds with a defense in all cases of potential coverage while coverage is being determined. While acknowledging the permissible use of reservation of rights, the Superior Court detailed the potential for a conflict of inter est between an insurer defending under a reservation of rights and an insured, who would be s ubject to full liability if its claim is eventually determined not to be covered. The panel recounted concerns raised in other

courts that insurers will be less zealous in defense and less willing to settle if the insurers believe that they will ultimately not be lia ble for coverage. Acknowledging insureds’ interest in settling reservation of rights cases , the Superior Court noted that allowing insureds to settle seemingly violates the clear language of the policy requiring[J-86-2014] - 8

the insurer’s consent to settlement and presents the pote ntial for collusion between an insured and a plaintiff. The Superior Court categorized judicial responses to these concerns as falling into two broad categories. It contended that a numbe r of courts, like the trial court in this case, follow Morris, 741 P.2d 246, holding that an insurer may be liable to reimburse a settlement that is fair, reasonable, and no n-collusive, if coverage is determined to apply. The second category, which is cham pioned by ANI in the case at bar, includes Vincent Soybean & Grain Co., Inc., v. Ll oyd's Underwriters of London , 246 F.3d 1129 (8th Cir. 2001), and resembles Pennsylvania’ s Cowden bad faith standard, although Pennsylvania cases have not applied the standar d when the insured has settled absent an insurer’s consent. Vincent Soybean and other like cases emphasize that an insured breaches the insurance policy when it set tles without the insurer’s consent. These cases, therefore, have required the insu red to demonstrate that the insurer acted in bad faith in refusing to settle befor e requiring insurer to pay the settlement. The Superior Court opined “that the Mor ris and Vincent Soybean approaches tilt the playing field too much in favor o f, respectively, the insured or the insurer. There is, however, a third approach, an appro ach that we believe best balances

the interests of the insurer and the insured.” Babcock & Wilcox Co. v. American Nuclear Insurers, 76 A.3d 1, 17 (Pa. Super. 2013). The Superior Court utilized Taylor v. Safeco Insuran ce Co., 361 So.2d 743 (Fla. Dist. Ct. App. 1978), as exemplifying the third appro ach, which allows the insured the option of rejecting the insurer’s defense (hereinafter the “Taylor/Insured’s Choice Test”). The Superior Court summarized its test as follows:

[W]e hold that, when an insurer tenders a defense subj ect to a reservation, the insured may choose either of two opt ions. It may accept the defense, in which event it remains[J-86-2014] - 9 unqualifiedly bound to the terms of the consent to set tlement provision of the underlying policy. Should the insur ed choose this option, the insurer retains full control of the litigation, consistently with the policy's terms. In th at event, the insured's sole protection against any injuries arisi ng from the insurer's conduct of the defense lies in the bad fai th standard articulated in Cowden

. Alternatively, the insured may decline the insurer's t ender of a qualified defense and furnish its own defense, eithe r pro se or through independent counsel retained at the insur ed's expense. In this event, the insured retains full contro l of its defense, including the option of settling the underlyi ng claim under terms it believes best. Should the insured select this path, and should coverage be found, the insured may recover from the insurer the insured's defense costs and t he costs of settlement, to the extent that these costs are deemed fair, reasonable, and non-collusive. Id. at 22. Applying this test to the case at bar, the court remanded for a new trial on “1) whether [Insureds] in fact rejected [Insurer’s] defense; and, if not, 2) whether [Insurer] acted in bad faith in declining to settle” or participa te in settlement negotiations. Id. 7 Notably, the Taylor/Insured’s Choice Test approach was not forwarded by either Insurer or Insured, and indeed, both parties vehement ly object to the Superior Court’s adoption of the test because an insured under Pennsylva nia law does not have the option of “rejecting” an insurer’s defense as it would co nstitute a breach of the insurance policy, thereby releasing the insurer from the obligat ion to provide coverage. See American and Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2 A.3d 526, 545 (Pa. 2009) (“[W]here the claim was potentially covered, Insured wo uld have been at risk of breaching the insurance contract if it had rejected [th e insurer’s] defense and it was later determined that the claim was covered.”). Moreover, t he parties observe that most

7 Judge Olsen dissented to the Superior Court’s analysis, concluding that the case was controlled by this Court’s prior decision in Cowden.[J-86-2014] - 10

insureds would be unable to utilize the Taylor/Insured ’s Choice Test approach as they would not have the funds to allow them to employ an independent defense after rejecting the insurer’s defense for which they had paid premiums to obtain. Accordingly, for these reasons, we likewise reject the Superior Court’ s holding as unworkable under Pennsylvania law and turn to the arguments presented b y the parties to determine which approach to adopt. As noted, we granted review to consider as an issue of f irst impression whether an insured forfeits the right to insurance coverage when it settles a lawsuit without the insurer’s consent, where the insurer has defended the sui t subject to a reservation of rights. 8 Insureds advocate adopting the Morris fair and reasona ble standard. They contend that when an insurer defends subject to a reserva tion of rights, an insured must be able to protect itself from the potential of an a dverse and uninsured decision in the underlying tort case, if the insurer is ultimately deem ed correct in concluding that the policy does not cover the claim. Further, Insureds claim that the insurer in a reservation of rights scenario is “in the attractive position of bein g able to avoid exposure either because the insured prevails at trial or because the insu rer’s coverage defense is successfully asserted[.]” Insureds’ Brief at 33. Insureds co ntend that the Morris fair and reasonable standard provides protection for the insured by allowing the insured to

8 Specifically, we granted review of the following qu estion:

Does a policy holder forfeit its right to insurance cove rage by settling an underlying and covered claim without its insurer's consent, where the insurer is defending subject to a reservation of rights to disclaim coverage, the settlemen t is at arm's length, is fair and is reasonable, and the in surer has failed to offer any amounts in settlement?

Babcock & Wilcox Co. v. Am. Nuclear Insurers, 84 A.3d 69 9 (Pa. 2014).[J-86-2014] - 11

accept settlement, while still preserving the insurer’s r ights to contest coverage, challenge the fairness and reasonableness of the settle ment including whether it resulted from fraud or collusion, and maintain control over other aspects of the defense including the choice of counsel and the defense strategy prior to settlement. Delving further into the underpinnings of the Morri s fair and reasonable standard,

Insureds observe that the court in Morris held that a n insurer’s reservation of rights “narrows the reach of the cooperation clause and permit s the insured to take reasonable measures to protect himself against the dange r of personal liability.” Insureds’ Brief at 30 (quoting Morris, 741 P.2d at 252 .) Insureds observe that other courts have adopted similar standards, including Miller v . Shugart, 316 N.W.2d 729 (Minn. 1982), and Patrons Oxford Ins. Co., 905 A.2d 8 19. Insureds, however, recognize that contrary authority exists criticizing the Morris fai r and reasonable standard, but they argue that those cases, including Vincent Soybean, discusse d by the Superior Court, involved factually distinct circumstances, where the insure d’s lack of cooperation extended beyond merely settling the claim without the insurer’s consent and included refusing to inform the insurer about the settlement o ffer or include insurers in any of the

defense.

Insureds insist that the Morris fair and reasonable sta ndard is consistent with Pennsylvania insurance law. They emphasize that the Mo rris fair and reasonable standard acknowledges the propriety of an insurer’s decisio n to defend under a reservation of rights, emphasizing that such act in no wa y breaches the insurer’s duties under the insurance policy. The standard, according to Insureds, recognizes that the insurer’s decision to defend under a reservation of rig hts does not permit the insured to breach the duty to cooperate in the defense, but rath er alters the relative duties. Insureds explain their position:[J-86-2014] - 12 To the contrary, . . . the insured must continue to sat isfy its cooperation duties, such as sharing information with its insurer, responding to insurer requests, permitting an i nsurer to participate in settlement negotiations, and, of co urse, seeking insurer consent prior to entering settlement. U nder the Fair and Reasonable Standard, in one respect, and only one respect, is the insured's "cooperation duty" adjusted in light of the insurer's assertion of its intention to r eserve the right to disclaim coverage. And that is, when the insu rer has reserved its right to disclaim coverage for a settlement or judgment, the insured is no longer duty-bound to refu se to enter into a fair, reasonable and non-collusive settlem ent simply because the insurer refuses consent. For, if the insurer is reserving its right to disclaim, thereby placin g its insured in the "precarious" position widely noted, the n the contours of the insured's duty to cooperate cannot prope rly be considered to extend so far as to include a duty to f orego a fair and reasonable settlement solely because its insu rer wishes to force a trial or to permit a forfeiture of co verage simply because the insured proceeds to enter into such a settlement. Insureds’ Brief at 35-36 (emphasis omitted). In support, Insureds observe that Pennsylvania insuran ce law “prohibits a mechanistic approach to interpretation of insurance pol icy conditions.” Insureds’ Brief at 37 (citing Brakeman v. Potomac Ins. Co., 371 A.2d 193, 196 (Pa. 1977) (requiring an insurer to demonstrate prejudice before deeming the in sured to have forfeited its insurance coverage by failing to satisfy the notice requi rements of the insurance policy)). Insureds also note this Court’s instruction that the “insurer must show that the breach is something more than a mere technical departure from the letter of the [insurance contract. Instead, it must show] that it is a departure that results in a substantial prejudice and injury to its position in the matter.” Insureds’ Brief at 38 (quoting Paxton Nat. Ins. Co. v. Brickajlik, 522 A.2d 5 31, 532 (Pa. 1987) (quoting Conroy v. Commercial Cas. Ins. Co., 140 A. 905, 907 ( Pa. 1928))) (alterations in brief). Insureds further emphasize the “strong, prevailing publ ic policy in Pennsylvania to[J-86-2014] - 13

encourage voluntary settlements.” Insureds’ Brief at 39 (quoting Nationwide Ins. Co. v. Schneider, 960 A.2d 442, 449 (Pa. 2008)). Insureds asse rt that the Morris fair and reasonable standard protects the insured from forfeitu re and promotes settlement in

cases where the insured’s decision to settle in the face of a reservation of rights defense does not constitute a substantial breach, given t hat it requires a fair and

reasonable settlement. 9

Amici Curiae 10

supporting Insureds note that the Morris fair and rea sonable standard provides a corollary to the Cowden bad faith standard, observing that while Cowden involved the grant of damages in excess of policy limits, where an insured abided by an insurer’s bad faith refusal to settle, th e Morris fair and reasonable standard properly imposes only settlement costs up to the policy limits, where an insured agrees

to a fair and reasonable settlement over the insurer’s objection, without any need to

demonstrate the insurer’s bad faith. In response, Insurer urges this Court to affirm the S uperior Court’s decision to the extent it calls for the application of the Cowden bad faith standard, while adamantly rejecting the Superior Court majority’s adoption of t he Taylor/Insured’s Choice Test allowing an insured to reject coverage as discussed above. 11 Insurer contends that this

9 Insureds further argue that even if this Court does n ot adopt the Morris fair and reasonable standard for all cases, it should be applied t o this case given the history of Insurer’s refusal to provide coverage. Insureds finally assert that they would also succeed in proving that Insurer acted in bad faith in re fusing to settle if this Court were to apply Cowden to cases where an insured settled withou t the consent of the insurer.

10 Amici curiae supporting Insureds in the above stated arguments includ e: United Policyholders, Dravo Corporation, E.W. Bowman, Inc., H ajoca Corporation, Kennametal, Matthews International, Mine Safety Appl iances, Saint Joseph's University, Sylvan Incorporated, and Trumbull Corporation.

11 As discussed supra at 9-10, all parties reject the applica tion of the Taylor/Insured’s Choice Test, which allows an insured to d ecide whether to reject (continuedP)[J-86-2014] - 14

Court’s decision in Cowden applies to cases involving an insurer’s refusal to consent to settlement, rejecting the Insureds’ suggestion that an i nsurer’s reservation of rights changes the analysis.

The fact that an insurer defends under a reservation of rights should not change the analysis, according to Insurer. It observes that, un der Pennsylvania law, insurers are permitted and, indeed, encouraged to defend thei r insureds under reservations of rights to provide the insureds with a defense at the ou tset of the underlying tort litigation “if the factual allegations of the complaint on its face encompass an injury that is actually or potentially within the scope of the policy. ” Insurer’s Brief at 35 (quoting Jerry’s Sport Center, 2 A.3d at 541). Insurer indicat es that providing an initial defense under a reservation of rights allows time for the fact ual issues in the underlying tort litigation to clarify so that the parties can determine which claims are covered by the language of the policy. As acknowledged by Insureds, an insurer’s reservation of rights does not constitute a breach of the insurance policy. In contrast to our case law which promotes the use of reservations of rights, Insurer highlights that the plain language of the pol icy forbids an insured “except at his own cost, [from making] any payments, assum[ing] any obl igations or incur[ring] any expense.” Insurance Agreement, Condition 6, supra at 4. Instead, the policy unambiguously grants Insurer the unilateral authority to settle the suit. Accordingly, it contends that the Insureds breached the policy by agreein g to settle without Insurer’s

(Pcontinued) coverage. Under this test, if the insured accepts coverag e, a bad faith standard is applied if the insured settles with the plaintiff wit hout the insurer’s consent. The parties contend that this test is contrary to Pennsylvania law, w hich does not allow insureds the option to reject an insurer’s defense without breaching the policy. Moreover, the facts in this case do not suggest that Insureds rejected coverage. Accordingly, under the Superior Court’s analysis, the Cowden bad faith standar d would most likely apply upon the remand for a new trial.[J-86-2014] - 15

consent, and that Insurer should not be responsible for t he settlement absent a

demonstration that Insurer acted in bad faith in refusi ng to settle under Cowden. Insurer argues that the insureds’ rights are protected by the insurer’s obligation to act in good faith in deciding whether to accept the offered se ttlement, and that the decision to reserve its right to deny coverage does not alter that good faith requirement. Insurer asserts that it acted in good faith in refusing to accept the settlement in

the case at bar. It notes that the interests of the I nsureds and Insurer were aligned as it was very unlikely that the verdict would exceed the pol icy limits given the plaintiffs’ weak evidence and the trial court’s procedural and evidentia ry rulings prior to the retrial. Insurer argues that many of the challenges initially raised in the reservation of rights letter had been mooted during the decades of litigat ion. It further contends that the

Insureds would be unable to demonstrate bad faith as required by Cowden, as the

evidence demonstrated Insurer’s “bona fide belief” “tha t it had a “good possibility” of a defense verdict in the underlying suit and that “the c hance of nonliability” was “real and substantial.” Insurer’s Brief at 41. Moreover, Insurer n otes that its refusal to settle was in part based on the legitimate concern that other plain tiffs would file copycat claims against Insureds if Insureds settled the plaintiffs’ wea k claims. While encouraging our adoption of the Cowden bad fa ith standard in the case at bar, Insurer criticizes the Morris fair and reasonable sta ndard relied upon by the trial

court and Insureds. Insurer contends that the Morris ho lding is “anathema to contract law principles established by this Court because it treat s a performing insurer as though it breached its duty to defend.” Insurer’s Brief at 28. Insurer cites to a litany of decisions and commentators discrediting the Morris decision f or treating an insurer that properly defends subject to a reservation of rights th e same as the law treats an insurer

that refuses to defend. Insurer observes that the Morri s fair and reasonable standard[J-86-2014] - 16

properly applies to an insured’s decision to settle under Pennsylvania law where an insurer wrongfully refuses to defend or indemnify an i nsured, as in the Superior Court’s decision in Alfiero v. Berks Mutual Leasing Co., 500 A.2 d 169 (Pa. Super. 1985), but argues that it should not be extended to cases where an insurer has not breached its duties but, instead, has defended subject to a reservati on of rights. Insurer rejects Insureds’ reliance on Brakeman, Conroy, and Paxton, supra at 12.

It observes that in those cases this Court refused to allo w forfeiture of insurance coverage based upon “technical” breaches by the insured, su ch as failing to provide proper notice. Conversely, Insurer argues that an agr eement to settle without consent

is not a technical breach but rather undermines a funda mental aspect of the bargain

between an insurer and an insured as to who controls th e litigation. Insurer’s Brief at 50. Additionally, Insurer questions the Insureds’ reli ance on Pennsylvania’s public policy favoring settlement. Instead, Insurer asserts th at the Superior Court’s decision below will not encourage settlement but, rather, will lead to protracted litigation regarding whether a settlement is fair and reasonable. Insurer is supported by a number of amici curiae

. 12 Amici maintain that for the last sixty years the Cowden bad faith standard has prope rly accounted for the interests of insurers and insureds facing the potential of uninsur ed exposure (whether it be an excess verdict or claims not covered by the policy). Amici reject the implication that the

Morris fair and reasonable standard is needed to address reservation of rights cases because the insured is in an unusually precarious situation of having the policy not cover losses. They retort that an insured can be placed i n precarious situations even without a reservation of rights, as damages may exceed the policy limits or include

12 The following amici curiae submitted briefs in support of Insurer: The Complex Insurance Claims Litigation Association and the American Insurance Association; The Pennsylvania Defense Institute; and Property Casualty Insurers Association of America.[J-86-2014] - 17

punitive damages which are non-insurable. Instead, th ey contend that this risk is part of the bargain assumed by the parties to a liability insura nce contract, which defines what losses are covered and the limits of the coverage, along with the applicable premiums necessary to provide the agreed upon coverage. They a rgue that while the Morris line of cases attempts to rebalance the bargain agreed to by the parties, the Cowden bad faith standard properly balances the parties’ interests w ithout doing violence to the clear language. Moreover, Amici maintain that allowing insured to violate the policy language by agreeing to settle without the insurer’s consent so long as the settlement is “reasonable” will result in settlements in nearly all cases as “it seems there would always be some settlement figure, however slight, which would be ‘rea sonable’ to accept,” even if the underlying claim is frivolous. Pa. Defense Institute Bri ef at 7 (emphasis omitted). Amici explain that “a relatively small percentage of reserva tion[s] of rights actually create types of conflicts of interest that truly expose an insur ed to uninsured losses.” Id. at 7. Instead, they contend that most reservations of rights resolve during the course of the litigation and are merely a “reminder of the terms o f the contract as applied to the facts in the lawsuit”, which cannot be deemed to constitute a breach of the contract. Id. at

12. 13

13 As an example, Amici note that in a water damage case resulting from a ru ptured water line, an insurer would likely issue a reservation of rights in regard to any claims for mold damage which would be subject to a mold exclusion, even though the bulk of the claims would be fully covered and no mold claims would l ikely be advanced by the plaintiff. It notes that the Morris fair and reasonab le standard fails to take into account the difference between this type of “soft” reservation of rights, which is unlikely to alter the interests of the parties, and a “hard” reservatio n of rights. With a “hard” reservation of rights, the insurer views the claims as possibly covered, requiring a defense, but ultimately unlikely to be covered by the policy, such as when intentional actions are also pled in negligence. Brief of Pa. Defense Institute at 25-27.[J-86-2014] - 18

In this case, we are faced with a discrete issue of first im pression that is nonetheless informed by longstanding Pennsylvania insur ance law. Specifically, we are asked to decide the appropriate standard to apply in de termining whether an insurer is liable under its insurance policy for a settlement made by its insured without securing the insurer’s consent, when the insurer is defending t he claim subject to a reservation of rights. In deciding whether to extend our Cowden bad faith test to this scenario or to adopt the Morris fair and reasonable standard or a va riant thereof, we first consider our precedent relating generally to the interpretation o f insurance contracts and specifically to an insurer’s reservation of rights. Next, we revie w how Pennsylvania courts, in Cowden and Alfiero, have approached related but disti nguishable questions involving an insured’s decision to accept or forgo a settlement offe r absent the insurer’s consent to settle. Finally, before adopting a variant of th e Morris fair and reasonable standard, we examine how our sister courts have approached this spe cific issue of an insured’s decision to accept a settlement offer over the insurer’ s objection, where the insurer has provided a defense subject to a reservation of rights. General Insurance Policy Interpretation and Reservat ion of Rights in Pennsylvania “The interpretation of an insurance contract is a ques tion of law, [and] our standard of review is de novo.” Donegal Mut. Ins. Co. v. Baumhammers , 938 A.2d 286, 290 (Pa. 2007) (internal citations and quotation marks omitted). “Our purpose in interpreting insurance contracts is to ascertain the inte nt of the parties as manifested by the terms used in the written insurance policy. When th e language of the policy is clear and unambiguous, we must give effect to that language .” Id. However, “[i]f doubt or ambiguity exists it should be resolved in insured's favo r.” Jerry's Sport Center, 2 A.3d at

540.[J-86-2014] - 19

Relating to the propriety of an insurer’s defense subj ect to a reservation of rights, the parties and Amici observe that an insurer’s duty to defend is distinct fro m and broader than its duty to indemnify. Id. at 540, 543 -44. “An insurer is obligated to defend its insured if the factual allegations of the complaint on its face encompass an injury that is actually or potentially within the scope of the pol icy.” Id. at 541. The insurer must defend the insured even in an action that is groundless or likely to later be deemed not covered by the policy. The insurer refuses to defend “ at its own peril,” as it can be subject to bad faith damages if it fails to defend with out good cause. Id. at 542. This broad duty to defend is mutually beneficial as it prot ects the insured “from the cost of defense” while allowing the insurer “to control the d efense to protect itself against potential indemnity exposure.” Id. at 545. Where an insurer provides a defense, the insured is “at risk of breaching the insurance contract” if it rejects the insurer’s defense. I d. We have emphasized that an insured is “obliged to cooperate” with the insurer de fending the action. Id. Further, our precedent allows the insurer to defend subject to a reser vation of rights, which permits the insurer to control the defense from the beginning of the litigation while still alerting the insured to the potential lack of coverage. Id. We observed, however, that where the insurer believes that coverage does not exist, the insure r should deny coverage to

“allow the insured to control its own defense without breaching its contractual obligation to be defended by the insurer.” Id. at 542. We fur ther encourage insurers to seek declaratory relief to eliminate the uncertainty rega rding its responsibility for continued defense and ultimately for indemnity coverage. With this understanding of the burdens and benefits to both parties resulting from the broad duty to defend and the reservation of rights procedure, we next review how Pennsylvania co urts have addressed related disputes between insurers and insureds pertaining to pre- trial settlement offers.[J-86-2014] - 20

Pennsylvania’s Approach in Related Scenarios of Cowden a nd Alfiero As discussed by the parties, this Court, in Cowden, consider ed a case involving an insurer’s refusal to settle. The issue presented was w hether an insurer acted in bad faith in refusing to settle, when the ultimate verdict far exceeded policy limits, thus subjecting the insured to substantial costs that could have been avoided had insurer agreed to settle pretrial. We recognized that the w eight of authority supported the conclusion that an insurer may be liable for the entire judgment against an insured “regardless of any limitation in the policy, if the in surer's handling of the claim, including a failure to accept a proffered settlement, was done in such a manner as to evidence bad faith on the part of the insurer in the discharge of its contractual duty.” Cowden,

134 A.2d at 227. In regard to the decision to settle, we observed, that the interests of the parties are “substantially hostile” where there is little or n o likelihood of a verdict or settlement within policy limits. Id. at 228. “In such circumstances, it becomes all the more apparent that the insurer must act with the utmost go od faith toward the insured in disposing of claims against the latter.” Id. We acknowle dged, however, that there is “no absolute duty on the insurer to settle a claim when a p ossible judgment against the insured may exceed the amount of the insurance coverag e.” Id. After considering how other courts had weighed the competing interests, we se t forth the insurer’s proper

consideration of the insured’s interests:

It means that when there is little possibility of a ve rdict or settlement within the limits of the policy, the decision to expose the insured to personal pecuniary loss must be based on a bona fide belief by the insurer, predicate d upon all of the circumstances of the case, that it has a good possibility of winning the suit. While it is the insure r's right under the policy to make the decision as to whether a cla im against the insured should be litigated or settled, it is not a[J-86-2014] - 21 right of the insurer to hazard the insured's financia l wellbeing. Good faith requires that the chance of a find ing of nonliability be real and substantial and that the deci sion to litigate be made honestly. Id. Although no bad faith was found in Cowden, the Court suggested that in the event of a bad faith determination, the insurer would be subject to the entire judgment, even the amount in excess of the policy limits. Id. at 227. While instructive, Cowden does not control in the case at bar because, in Cowden, the insured did not settle but rather allowed the insurer to continue its defense, whereas In sureds in the case at bar accepted the settlement without Insurer’s consent. In contrast, in Alfiero, our Superior Court addressed a case where the insured

entered into a settlement without the consent of its e xcess insurer, where, unlike the case at bar, the excess insurer breached the insurance policy by refusing to defend or indemnify the insured, even after a declaratory judgm ent that the insurer had a duty to defend. Notably, the settlement had been presented to the excess insurer and was less than the excess insurance policy limits. The court held th at, given that the excess insurer had breached the duty to defend, the insured w as free to “negotiate a settlement according to terms intended to preserve its assets from exe cution.” Alfiero, 500 A.2d at

172. The court noted that there was no evidence of c ollusion on the part of the insured. Accordingly, it held that the settlement could be impose d upon the breaching excess insurer “so long as it was done in good faith and the s ettlement was fair and reasonable.” Id. As noted, Alfiero is distinguishable from the case at bar because here Insurer did not breach the policy by refusing to defend but instead offered a defense subject to a reservation of rights. Other Jurisdictions’ Approaches to Settlement Absent Insur er’s Consent in Reservation of Rights Cases[J-86-2014] - 22

Absent Pennsylvania caselaw addressing an insured's decision to settle without an insurer's consent where an insurer is defending subj ect to a reservation of rights, we

consider the decisions of our sister courts faced with simila r dilemmas. 14 We observe that Insurer claims that a majority of courts have reject ed Morris while the Insureds claim that most courts have adopted tests consistent with Mo rris. Rather than attempting to tally the votes, we recognize that well -intentioned, thoughtful jurists have

found themselves on both sides of the Morris divide. Mo reover, our review of other court's decisions on this question reveals that courts are of ten swayed by the facts of the case to either adopt a test protective of the insur er or the insured based on which party acted in an arguably improper manner in that p eculiar case. After consideration, like many of our sister courts, we adopt a variant of th e Morris fair and reasonable

standard limited to those cases where an insurer de fends subject to a reservation of rights and breaches its duty to settle, as describe d herein, in a case where the policy is ultimately found to cover the relevant claims. As f ully developed infra, in such cases an insured may accept a settlement over the insurer’s refusal where the settlement is fair, reasonable, and non-collusive.

14 The issues presented in this case only arise in a subset of reservation of rights cases where the interests are not aligned in consid ering settlement. Indeed, the parties in the case at bar recognize that insureds' and ins urers' interests are generally aligned even in many reservation of rights cases where sett lement is in the best interest of both insurer and insured. Where the interests are not a ligned, both parties are often acting with substantial uncertainty as they consider settl ement. There is uncertainty whether the insurance policy covers the claim, whether the i nsured will be determined to be liable to the plaintiff for the damages, and, if the insur ed is liable, whether the damages will exceed the policy's coverage limits. While an insure r must act as a fiduciary toward its insured, it is obligated only to provide coverage f or which the insured paid premiums.[J-86-2014] - 23

We first address the seminal case of Morris. The Arizona Supreme Court aptly summarized the conflicting interests of an insurer and an insured where questions are raised regarding whether the policy covers the claims. Wh ile acknowledging the propriety of a reservation of rights defense, the cour t observed that an insured is "placed in a precarious situation" because the insured f aces the potential of paying a verdict in excess of policy limits or the entire verdict i f it is ultimately determined that the policy does not cover the claim. The court rejected the insurer's argument that the policy's "cooperation clause gave it a right to force the insureds to reject any settlement, no matter how reasonable, risk trial, and place themsel ves at danger of a judgment larger than the policy limits or one that might not b e covered." Morris, 741 P.2d at 251. It concluded that "such an interpretation of the cooper ation clause hamstrings insureds while granting the insurer a double bite at escaping liability" by being able to contest the insured's liability and the coverage defense. Id. In contrast, the court also recognized the danger in no t allowing an insurer to defend under a reservation of rights and instead forcin g it to choose whether to defend

without reservation or refuse its defense. In an oft-ci ted passage, the court explained

the insurer’s dilemma:

This solution puts an insurer honestly attempting to p erform its duties between Scylla and Charybdis. The insurer m ust either give up its right to raise tenable coverage de fenses or its right to insist on full application of the cooperati on clause. Id. at 251-52. The Arizona court opined that, rather than forcing this choice, the better solution “would permit the insurer to raise the coverage defen se, and also permit an insured to protect himself from the risk of noncoverage or excess jud gment, while at the same time protecting the insurer from unreasonable agreements bet ween the claimant and the[J-86-2014] - 24

insured.” Id. at 252. The court concluded that the in surer who “reserves the right to deny the duty to pay should not be allowed to control the conditions of payment." Id. Instead, it opined that the reservation of rights "nar rows the reach of the cooperation

clause" to allow the insured to settle in certain cases a bsent the insurer’s consent. Id. In a somewhat problematic statement, the court hel d that that "the cooperation clause prohibition against settling without the insurer' s consent forbids an insured from settling only claims for which the insurer unconditionall y assumes liability under the policy.” 15 Id. The court, however, required the “agreements m ust be made fairly, with notice to the insurer, and without fraud or collusion on the insurer.” Id. Again arguably overstating its holding, the court further opined, “Th e insurer's reservation of the privilege to deny the duty to pay relinquishes to the insured control of the litigation, almost as if the insured had objected to being defended under a reservation.” 16 Id. In speaking to the question of the reasonableness of the insured’s settlement, the court relied heavily on the decision of the Minnesota S upreme Court’s in Miller, 316 N.W. 729, and observed that an “insured being defend ed under a reservation might settle for an inflated amount or capitulate to a friv olous case merely to escape exposure or further annoyance.” Morris, 741 P.2d at 253. To protect the insurer, the court held

15 This sentence broadly suggests that the insured can s ettle any claim for which the insurer defends subject to a reservation of rights. We agree with Amici , however, that not all reservations of rights are equal, see su pra at 17 n.13. The mere fact that an insurer restates that it will not cover what the insuran ce policy does not cover, where it arguably might be part of the damages sought, does not automatically result in allowing the insured to settle the entire suit. Parties and cour ts may need to consider whether a particular reservation of rights justifies diverging fro m the contract’s cooperation clause, a question which is not squarely before this Court.

16 Notably, Insureds in this case argue that the reservati on of rights does not entirely relinquish the insurer’s control over the defe nse to the insured, but rather only allows the insured the limited discretion to accept a fai r and reasonable settlement, while maintaining the insurer’s control over all other aspects of the defense.[J-86-2014] - 25

that the insurer would only be responsible for paying the settlement if coverage is eventually determined to apply and the insured demon strates that the settlement was

“not fraudulent or collusive and was fair and reasonabl e under the circumstances,” as viewed by “what a reasonably prudent person in the in sureds' position would have

settled for on the merits of the claimant's case.” Id. at 254 (emphasis omitted). 17

A number of courts and commenters have criticized the Mo rris decision as an improper attempt to rewrite an insurance policy for t he insured’s benefit. Several courts have cited Windt’s treatise, Insurance Claims and Dispute s, critiquing the Morris

17 An analysis similar to the Morris decision has been adop ted in the following cases: Cay Divers, Inc. v. Raven, 812 F.2d 866 (3d Cir. 1987) (holding, similar to Morris, that a reasonable settlement effectuated by th e insured does not bar the insured’s action for indemnification against the insur er where a complaint is arguably within the scope of insurance coverage and the insurer d ischarged its duty to defend by providing independent counsel, but reserved its right to contest coverage); Midwestern Indemnity Company v. Laikin, 119 F.Supp. 2d 831, 842 (S.D. Ind. 2000) (following Morris and holding that a “consent judgment with a cove nant not to execute would bind the insurer on issues of the insured’s liability and the extent of injured parties’ damages” if: coverage is shown; the consent judgment did not resu lt from bad faith; and the consent judgment was a reasonable settlement of the disp ute); Spangler, 881 F.Supp. at 544 (following Morris and holding that “where the insurer was defending under a reservation of rights and had filed a declaratory judg ment action contesting coverage, the insured’s assignee is not barred from recovery from the insurer for a stipulated liability to which the insurer did not consent and the insured is not personally liable”); Great Divide Insurance v. Carpenter, 79 P.3d 599, 60 9 (Alaska 2003) (citing Morris for the proposition that a covenant settlement agreement is enforceable against an insurance company who defends an insured under a reserva tion of rights if the settlement agreement is reasonable); Patrons Oxford Ins ., 905 A.2d 819, 827 (Me. 2006) (following Morris and holding that where an i nsurer defends an action against the insured under a reservation of rights, the insurer is bo und by the settlement entered into by its insured to the extent that the settlement is re asonable and that coverage is deemed to exist); and Gainsco Ins. Company v. Amoco Prod uction Co., 53 P.3d 1051, 1071 (Wy. 2002) (following Morris and holding that “when the insured and the claimant settle a case that is being defended by the insurer, ev en under a reservation of rights, the insured and the claimant should bear the burden of proving that the settlement was reasonable”).[J-86-2014] - 26

decision's failure to apply the plain language of the insurance contracts which "unambiguously state that the insurer will not pay a settlement that is entered into

without the insurer's authorization. Courts cannot re write the contract to reach the opposite conclusion simply because they believe that it w ould have been 'fairer' if the contract had so provided." Am. Family Mut. Ins. Co. v . C.M.A. Mortgage, Inc., 682 F. Supp. 2d 879, 892 (S.D. Ind. 2010) (quoting Allen D . Windt, 1 Insurance Claims and Disputes 5th § 3.9 at 3-56)). The analysis further provided:

An insured should not be allowed to enter into an unauthorized settlement simply because it is being defe nded pursuant to a reservation of rights. If it does so, and the settlement is not one that the insurer would have been dutybound to accept, the insured should not be able to re cover anything . . . . As long as the insurer complies with i ts contractual obligations, it should have the benefit of its contract, and should not be subjected to such disputes wit h its insured. Id. Other courts, recognizing some of Morris's shortcomi ngs, have instead adopted a modified version, limiting the cases to which the f air and reasonable standard applies. Specifically, we look to the Supreme Court of Iowa, which addressed issues of law and fact similar to those before this Court. In Kelly v . Iowa Mut. Ins. Co., 620 N.W.2d 637, 639 (Iowa 2000), the insurer, faced with a wrongful death claim brought against its insured, defended its insured subject to a reservat ion of rights, asserting that the employee exclusion provision of the policy resulted in a lack of coverage because the victim was alleged to be an employee of the insured . The insurer properly provided independent counsel to the insured, while contestin g its coverage obligations. The insurer, however, refused to engage in settlement n egotiations because it contended that the tort defense would be successful. Nonetheless, the insured ultimately settled with[J-86-2014] - 27

the victim's estate for $507,500, where the insured agreed to pay $7,500 and the estate agreed not to make further claims against insured b ut to seek the additional $500,000 from insurer, which constituted the policy limits. When victim sought to recover the $500,000 from insurer, insurer defended claiming th at the insured had breached the policy by settling. In response, insured claimed th at insurer breached the policy by reserving its rights and by refusing to approve the settlement. The Iowa Supreme Court recognized its prior case law, si milar to our Superior Court’s decision in Alfiero, holding that when an insu rer refuses to provide a defense outright, it breaches the insurance policy (assuming the p olicy is later determined to apply), releasing the insured from its contractual obli gations and setting it free to settle as it sees fit. However, the court observed that in t he case before it, as in the case at bar, the insurer had provided a defense, even though it also reserved its rights to contest coverage. The Iowa Supreme Court emphasized t hat Morris and other decisions have held that an insured may settle without obtain ing the insurer's consent in a reservation of rights case as if the insurer had br eached the policy by reserving its rights. Kelly, 620 N.W.2d at 642 (citing Cay Divers, Inc. v. Raven, 812 F.2d 866, 870 (3d Cir. 1987); Spangler, 881 F.Supp. at 545; Morris, 741 P. 2d at 252)). The court rejected this aspect of the Morris line of cases, observing that "the reasoning of these cases is flawed because they permit an insured to breach his duties under the policy without losing coverage, even though there has not been a breach o f the contract by the insurance company.” Id. at 642. Instead, the Iowa Supreme Court applied a more nuance d analysis based upon its observation that an insurer breaches its duty to its i nsured when it refuses to settle in the appropriate case. It recognized its prior caselaw, similar to our analysis in Cowden, finding that the insurer can commit bad faith by refu sing to settle in an appropriate case. It extended this analysis to cases where an insurer defend s its insured subject to a[J-86-2014] - 28

reservation of rights and denies consent to a reasonable settlement offer. The court recognized that the insurer does not breach its duty by denying consent because the policy provides that the insurer has control over the def ense and any settlement. Instead, the court, similar to Insureds’ argument i n the case at bar, held that the denial of

consent to a reasonable settlement offer releases t he insured from its duty not to settle

absent the insurer's consent. The court explained its holding:

Certainly under these circumstances, where the insured ma y ultimately be responsible for a judgment if coverage is found not to exist, it is extremely important that the insur ance company, who is controlling the defense, fulfill its con tractual obligation to settle where appropriate. One comment ator has observed that an insurer may breach the contract by failing to settle an appropriate case, even though it s failure to settle is attributable solely to the company's negligence . See 1 Windt § 5.14, at 329. This commentator suggests that, [‘]recognizing that the company has, despite the absence of bad faith, breached the insurance contract, the compa ny should be precluded from enforcing the provisions in the policy inuring to its benefit, such as the one prohibit ing unauthorized settlements by the insured.[’] Id. Kelly, 620 N.W.2d at 644. Given that the duty of good faith includes a duty t o settle in appropriate cases,

the court held that when faced with a reasonable settl ement demand in a reservation of rights case, an insurer “must either abandon its coverage defense and pay the demand or lose its right to control the conditions of settlement .” Id. The court held “that when an insurer provides a defense under a reservation of rights and rejects a fair and reasonable settlement demand that a reasonable and pru dent insurer would pay, the

insured is free to consummate the settlement on terms t hat protect the insured from any[J-86-2014] - 29

personal exposure.” Id. at 645. If coverage is later found to apply, the insurer will be liable for the insured's settlement up to policy limit s. Id. at 644-45 n.6.

Other courts have likewise considered reasonablene ss of a settlement to encompass consideration of "facts bearing on the li ability and damage aspects of plaintiffs’ claim, as well as the risks of going to trial." Miller, 316 N.W.2d at 735; see also

Guillen ex rel. Guillen v. Potomac Ins. Co. of Illi nois, 785 N.E.2d 1, 14 (Ill. 2003) (same). Moreover, courts place the burden of demonstrating the reasonableness of settlement on the insured or its plaintiff. Miller, 316 N.W.2d a t 735 ("The burden of proof is on the claimant, the plaintiff judgment creditor, to show that the settlement is reasonable and prudent."). Considering our prior decisions in Cowden and the Superior Court’s decision in Alfiero, along with the line of cases following Mor ris, we adopt a variation on the Morris

fair and reasonable standard limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rig hts and, thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims. Like our sister states, we observe that a determination of

whether the settlement is fair and reasonable necessaril y entails consideration of the terms of the settlement, the strength of the insured’s d efense against the asserted claims, and whether there is any evidence of fraud or col lusion on the part of the insured. See e.g., Miller, 316 N.W.2d at 735 (requi ring consideration of the risks of going to trial)). We recognize that the test in the case at bar has attri butes of the Cowden bad faith test, where an insurer’s decision not to settle ha d to be supported by the conclusion “that the chance of a finding of nonliability be real and substantial and that the decision to litigate be made honestly.” Cowden, 1 34 A.2d at 228. Under the[J-86-2014] - 30

Cowden bad faith test, however, if the insured establ ishes that the insurer breached its duty of good faith by failing to settle, the insurer is held responsible for the entire verdict, which resulted from the bad faith decision not to settle, even if it far exceeds policy limits. In contrast, if an insurer breaches its dut y to settle while defending subject to a reservation of rights and the insured accept s a reasonable settlement offer, the insured need only demonstrate that the in surer breached its duty by failing to consent to a settlement that is fair, reasonable, and n on-collusive, as described above, rather than demonstrating bad faith by the insurer, as the damages sought are subject to the policy limits to which the insurer originally co ntracted. 18 See Kelly, 620 N.W.2d at 645 (“The bad faith standard is simply not appropri ate here, where the issue is one of contractual

liability as opposed to extra-contractual liability”) (emphasis in original). In this case, after an extensive trial where the ju ry was presented with voluminous evidence relating to the strength of the underlying action and the settlement offer, the jury determined that the settlement was “fair and r easonable from the perspective of a reasonably prudent person in the same position of [ Insureds] and in light of the totality of the circumstances,” a standard which we adopt herein as the proper standard to apply in a reservation of rights case where an insured settle s following the insurers’ refusal to consent to settlement. Notes of Testimony, Sept. 19, 2011, at 2009. We conclude that

18 The dissent opines that we distinguish the case at bar f rom Cowden based on the fact that Cowden did not involve an unauthorized settlement, which the dissent contends is a “distinction without a difference.” Dissent ing Op. at 4. Respectfully, we disagree with this simplification which focuses solely on the immediate facts without acknowledging the consequences resulting from the factual differences. As explained more fully above, we conclude that it is reasonable to require an insured to demonstrate the higher burden of bad faith in order to recover from the insurer an excess verdict, an amount which exceeds the coverage limits for which the in sured paid premiums. Conversely, the lower standard of proof of a reasonabl e settlement is proper where the insurer’s liability is confined to the previously contracte d policy limits. Accordingly, we find Cowden, substantively distinguishable.[J-86-2014] - 31

the Superior Court erred by requiring an insured to demonstrate bad faith when the insured accepts a settlement offer in a reservation of rights case. 19 Accordingly, we reverse the decision of the Superior Court and reinstat e the judgment of the trial court.

Former Chief Justice Castille and former Justice M cCaffery did not participate in

the decision of this case. Madame Justice Todd and Mr. Justice Stevens join t he opinion. Mr. Justice Eakin files a concurring and dissenting opinion in which Mr. Chief Justice Saylor joins.

19 As noted supra at 10, we reject the Superior Court’s adoption of the Taylor/Insured’s Choice test.