No. 2--05--0063 filed: 2/6/06 

______________________________________________________________________

________ 

IN THE 

APPELLATE COURT OF ILLINOIS 

SECOND DISTRICT 

______________________________________________________________________

________ 

AMERICAN FAMILY MUTUAL ) Appeal from the Circuit Court 

INSURANCE COMPANY, ) of Du Page County. 

 ) 

Plaintiff-Appellee, ) 

 ) 

v. ) No. 04--MR--1212 

 ) 

W.H. McNAUGHTON BUILDERS, ) 

INC., a/ka/ W.H. McNaughton Builders, ) 

LLC, ) Honorable 

 ) Bonnie M. Wheaton, 

Defendant-Appellant. ) Judge, Presiding. 

_________________________________________________________________________

_____ 

JUSTICE McLAREN delivered the opinion of the court: 

In 2004, defendant, W.H. McNaughton Builders, Inc., a/k/a W.H. McNaughton Builders, 

LLC (McNaughton), was sued by Fred and Marianne Begy (the Begy Suit), whose home 

McNaughton had built in 1991. McNaughton turned the Begy Suit over to its insurer, plaintiff, 

American Family Mutual Insurance Company (American Family), which, pursuant to its policy with 

McNaughton, had a duty to defend the suit. American Family agreed to comply with its duty to 

defend, but reserved the right to later deny coverage if McNaughton were found liable for damage 

occurring before the inception of the policy in 1994. In response, McNaughton argued that 

American Family and McNaughton had a conflict of interest, because American Family's interests 
would be protected if McNaughton were found liable in the Begy Suit for damage occurring before 

1994. 

Because American Family's interests would be protected if McNaughton were found liable, 

McNaughton argued that it should not be forced to defend the Begy Suit with an attorney retained by 

American Family. Rather, McNaughton argued that it should be permitted to select its own attorney 

at American Family's expense in accordance with well-settled law. American Family disagreed. It 

filed a declaratory judgment action in which it argued that there was no conflict and sought a 

determination that it had the right to select McNaughton's attorney. The trial court found that there 

was no current conflict, and accordingly it granted declaratory judgment for American Family. 

McNaughton appeals, and we reverse and remand. 

I. BACKGROUND 

American Family issued a commercial general liability policy (the Policy) to McNaughton in 

1994. As part of the Policy, American Family agreed that, in exchange for McNaughton's payment 

of annual premiums, American Family would cover expenses for which McNaughton became liable 

because of "property damage" covered by the Policy. According to the Policy, covered property 

damage was damage that, among other restrictions, occurred during the Policy period and of which 

the insured was unaware prior to the Policy's inception. Additionally, in order to be covered by the 

Policy, the damage had to come within the Policy's definition of "property damage," which, in 

relevant part, was as follows: 

 "a. Physical Injury to tangible property, including all resulting loss of use of that 

property. All such loss of use shall be deemed to occur at the time of the physical injury that 

caused it; or 
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b. Loss of use of tangible property that is not physically injured. All such loss of use 

shall be deemed to occur at the time of the 'occurrence' that caused it." 

In turn, the Policy defined "occurrence" as "an accident, including continuous or repeated 

exposure to substantially the same general harmful conditions." 

American Family added another policy exclusion, effective December 31, 2002. 

Specifically, as of that time, the Policy excluded from coverage, among other things, "direct or 

indirect losses resulting from" "property damage *** includ[ing] any claim for diminution of value 

of real or personal property due to its contamination with 'mold' in any form." The Policy remained 

current through 2004. 

In July of that year, the Begys sued McNaughton. In their two-count complaint, the Begys 

alleged breach of implied warranty and breach of implied warranty of habitability. Count I alleged 

that, in building the Begys' home, McNaughton breached an implied warranty requiring it to install 

in a good and workmanlike manner an exterior insulation and finish system (EIFS).1

 Count II 

alleged, among other things, that, as a result of McNaughton's failings, the Begys' home suffered 

mold damage. Although the complaint did not allege any dates, the agreement between the Begys 

 1

An EIFS is a multilayered exterior wall system that wraps the exterior of a home. It is intended to 

reduce air infiltration and energy consumption, and to stabilize the interior environment. See 

http://www.eima.com/eima/eifs.htm (last visited January 3, 2006). 
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and McNaughton was attached to it, and, according to that agreement, construction of the home was 

to begin in September 1991 and be "substantial[ly]" completed by June 1992. 

McNaughton informed American Family of the Begy Suit, and American Family retained 

counsel to defend McNaughton. Shortly after doing so, however, American Family advised 

McNaughton that American Family would be defending the Begy Suit under a complete reservation 

of rights to later deny coverage. In reserving its rights, American Family pointed out that: (1) the 

Policy did not cover property damage occurring prior to the Policy's inception in 1994; (2) the Policy 

did not cover property damage that resulted from mold and occurred after December 31, 2002; and 

(3) the Policy did not cover property damage that McNaughton knew about before the Policy's 

inception in 1994. 

After receiving notice of American Family's reservation of rights, McNaughton advised 

American Family that, due to a conflict of interest, McNaughton was entitled to hire independent 

counsel to represent it in the Begy Suit. According to McNaughton, a conflict existed because, 

although both McNaughton and American Family had a mutual interest in McNaughton's being 

found not liable in the Begy Suit, American Family's interests would be equally protected if 

McNaughton were found liable for damages not covered by the Policy. McNaughton noted that the 

Policy did not cover damage that occurred before 1994 or damage that McNaughton knew about 

before 1994 or damage that was due to mold and that occurred after 2002. McNaughton also noted 

that the Begys' claims dealt both with mold damage and with breaches of warranties occurring prior 

to 1994, that is, when the Begys' home was built in 1991 and 1992. Finally, McNaughton noted that 

issues as to the timing of the alleged damage--issues, that is, that McNaughton said would be 

resolved in the Begy Suit--could determine whether McNaughton had coverage under its policy with 

American Family. For these reasons, McNaughton argued, a conflict of interest existed between 
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McNaugton and American Family, and, therefore, it was improper for American Family to control 

McNaughton's defense in the Begy Suit. McNaughton asked American Family to allow 

McNaughton to retain independent counsel to defend it against the Begys' allegations. 

American Family responded to McNaughton's request by filing a declaratory judgment action 

against McNaughton. In its complaint, American Family asked the trial court to declare that there 

was no conflict and that, accordingly, American Family should be permitted to select the attorney to 

control McNaughton's defense in the Begy Suit. 

The parties filed cross-motions for judgment on the pleadings. In support of its motion, 

American Family argued, inter alia, that there was no conflict because there would be no opportunity 

in the Begy Suit for counsel retained by American Family to shift facts to lay the basis for American 

Family to later deny coverage to McNaughton. To this end, American Family pointed out that it had 

reserved the right to deny coverage on the basis of, among other things, the timing of the damage to 

the Begys' home. American Family also pointed out that the Begys claimed that McNaughton had 

failed to properly construct their home and that, as a result, their home had suffered mold damage. 

This being the case, American Family argued that the Begys' claims did not raise an issue of when 

the damage occurred. Thus, American Family argued that there was no conflict, and, consequently, 

it should be permitted to appoint its own attorney to defend McNaughton in the Begy Suit. 

In response, McNaughton argued that the Begys' claims did raise an issue of timing, which 

would be the subject of discovery in the Begy Suit. McNaughton argued that, if American Family 

were permitted to control the defense of the Begy Suit, then this discovery would be controlled by 

attorneys retained by American Family--attorneys, that is, with a long-standing financial relationship 

with American Family. Because, depending on what the discovery revealed as to timing, 

McNaughton could lose coverage under the Policy, McNaughton argued that there was a conflict. 
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Consequently, McNaughton argued, American Family should not be allowed to use its own 

attorneys to control McNaughton's defense in the Begy Suit. 

The trial court rejected McNaughton's argument. Specifically, at a hearing on the parties' 

motions, the trial court found that there was no "clear conflict of interest," only a "possible or 

potential conflict of interest depending on what the discovery shows." The trial court explained: 

"[A]t this point in time, it is clearly within the mutual interest of both W.H. McNaughton and 

American Family to find that *** there was no property damage of the type that is alleged; 

only if that question is *** answered in the affirmative would it possibly come into *** the 

issue of when the damage took place ***. 

But at this point in time, [the court] do[es]n't think that there is a conflict of interest 

which would require or even permit the court to allow the appointment of independent 

counsel ***." 

Having concluded that there was no present conflict, the trial court granted American 

Family's motion for judgment on the pleadings. McNaughton appeals. 

II. ANALYSIS 

We begin with the standard of review. A motion for judgment on the pleadings is 

properly granted only if there is no genuine issue of material fact and the moving party is 

entitled to judgment as a matter of law. Gillen v. State Farm Mutual Automobile Insurance 

Co., 215 Ill. 2d 381, 385 (2005). Our review of the trial court's decision on a motion for 

judgment on the pleadings is de novo. M.A.K. v. Rush-Presbyterian-St.Luke's Medical 

Center, 198 Ill. 2d 249, 255 (2001). 

The sole issue in this appeal is whether a conflict of interest exists between 

McNaughton and American Family that entitles McNaughton to be defended against the 
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Begys' allegations by an attorney of McNaughton's choosing. Before turning to that issue, 

however, it is helpful to begin our analysis with a word about an insurer's duty to defend its 

insured. 

An insurer's duty to defend its insured is much broader than its duty to indemnify its 

insured. General Agents Insurance Co. of America, Inc. v. Midwest Sporting Goods Co., 

215 Ill. 2d 146, 154 (2005). If a complaint against an insured contains allegations that are 

even potentially within policy coverage, the insurer is obligated to defend the insured. See 

Guillen v. Potomac Insurance Co. of Illinois, 203 Ill. 2d 141, 150 (2003). Stated another 

way, an insurer may not justifiably refuse to defend its insured unless it is clear from the 

face of the complaint that the complaint has failed to allege facts potentially within the 

insured's policy coverage. Dixon Distributing Co. v. Hanover Insurance Co., 161 Ill. 2d 433, 

439 (1994). In making this determination, the allegations of the complaint must be liberally 

construed in favor of coverage. Midwest Sporting Goods Co., 215 Ill. 2d at 155. 

Here, the Begys allege in the underlying suit that McNaughton failed to properly 

apply an EIFS to their home (which McNaughton apparently built during 1991 and 1992) 

and that, as a result, their home suffered mold damage. Although the Begys' home was 

apparently built prior to the 1994 inception of the Policy, American Family has not alleged 

here that it does not have a duty to defend McNaughton. Rather, American Family argues 

that it should get to control McNaughton's defense. McNaughton, as noted, responds that 

there is a conflict of interest, and, because there is, McNaughton should be permitted to 

control its own defense by using its own attorney. 

The conflict situation is an exception to the rule that the insurer, being charged with 

the duty of defending its insured, should be permitted to control the insured's defense. 
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Illinois Masonic Medical Center v. Turegum Insurance Co., 168 Ill. App. 3d 158, 163 (1988). 

 Permitting the insurer to control the insured's defense allows the insurer to protect its 

financial interests and to minimize unwarranted liability. Turegum, 168 Ill. App. 3d at 163. 

At the same time, however, permitting the insurer to control the insured's defense may lead 

to problems. This is because, although an attorney retained by an insurer to represent its 

insured has ethical obligations to both parties, realistically he or she may have closer ties to 

the insurer and, consequently, a greater desire to protect the insurer's interests. Turegum, 

168 Ill. App. 3d at 163. Of course, this is of no concern when the interests of the insurer 

and the insured are completely aligned. See, e.g., Clemmons v. Travelers Insurance Co., 

88 Ill. 2d 469 (1981). But when those interests diverge, a problem arises. See, e.g., 

Murphy v. Urso, 88 Ill. 2d 444 (1981); Turegum, 168 Ill. App. 3d 158. 

To determine whether there is a conflict, we must compare the allegations of the 

underlying complaint against the insured to the terms of the insurance policy at issue. 

Turegum, 168 Ill. App. 3d at 163. That complaint includes exhibits, such as contracts, 

which are attached to it. See Bianchi v. Savino Del Bene International Freight Forwarders, 

Inc., 329 Ill. App. 3d 908, 921 (2002). If, after comparing the complaint to the insurance 

policy, it appears that factual issues will be resolved in the underlying suit that would allow 

insurer-retained counsel to "lay the groundwork" for a later denial of coverage, then there is 

a conflict between the interests of the insurer and those of the insured. See Clemmons, 88 

Ill. 2d at 479. Put another way, if, in the underlying suit, insurer-retained counsel would 

have the opportunity to shift facts in a way that takes the case outside the scope of policy 

coverage, then the insured is not required to defend the underlying suit with insurerretained counsel. See Clemmons, 88 Ill. 2d at 475; Nandorf, Inc. v. CNA Insurance Cos., 
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134 Ill. App. 3d 134, 137 (1985). Rather, the insured is entitled to defend the suit with 

counsel of its choosing at the insurer's expense. See Nandorf, 134 Ill. App. 3d at 137 

(noting that in conflict situations, "the insurer's obligation to defend is satisfied by 

reimbursing the insured for the costs of independent counsel"). 

Here, McNaughton argues, among other things, that there is a conflict because 

American Family's interests will be served if McNaughton is found liable in the Begy Suit for 

damage occurring prior to the inception of the Policy. The trial court rejected this argument, 

reasoning that (1) there was only a potential conflict, depending on what discovery in the 

Begy Suit showed; and (2) at this point, the interests of McNaughton and American Family 

are aligned, and they will diverge only if McNaughton is found liable. We take these points 

in reverse order. 

With regard to the trial court's second point, it is not dispositive that McNaughton and 

American Family would both benefit from McNaughton's being found not liable in the Begy 

Suit. Indeed, an insurer and its insured will always have a shared interest in the insured's 

being absolved of liability. After all, if the insured is found not liable, then the insurer avoids 

the possibility of paying indemnification expenses down the road. But this is not the end of 

the inquiry. Instead, granting that the insurer and the insured have a shared interest in a 

finding of no liability, the question becomes whether the insurer's interest would be equally 

protected by a finding that would not be in the interest of the insured. If so, there is a 

conflict. See Murphy, 88 Ill. 2d at 453-54; Nandorf, 134 Ill. App. 3d at 138. 

This is the lesson of the supreme court's decision in Murphy. There, a bus crashed, 

injuring a passenger. Murphy, 88 Ill. 2d at 448. The passenger sued both the bus driver 

and the bus owner. The passenger alleged that the owner was liable because the driver 
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was using the bus with the owner's permission. Murphy, 88 Ill. 2d at 449. If that was the 

case, then the driver would be covered as a permissive user under the owner's insurance 

policy. If, however, the driver was using the bus without permission, the driver would not 

be covered. Because coverage potentially extended to the driver, the owner's insurer had 

a duty to defend the driver. Murphy, 88 Ill. 2d at 453. 

The supreme court found that the situation involved a conflict. Murphy, 88 Ill. 2d at 

453-54. Specifically, the court pointed out that both the driver and the insurer shared an 

interest in the driver's being found not liable, but that the insurer's interests would be 

equally protected if the driver were found to have used the bus without permission. 

Murphy, 88 Ill. 2d at 453-54. If he had, then the policy would not extend to the driver; in 

other words, the insurer could not be liable for any damages resulting from the driver's 

conduct. 

Similarly, in the present case, both American Family and McNaughton share an 

interest in McNaughton's being found not liable for any damage to the Begys' home. But 

American Family's interests would be equally served if McNaughton were found liable for 

damage that occurred prior to the Policy's inception in 1994. Thus, here, as in Murphy, 

although the insurer and the insured share an interest, their interests also diverge. 

Therefore, there is a conflict. 

American Family argues that Murphy is distinguishable from the present case. To 

this end, American Family points out that, in Murphy, the issue of permission would be 

resolved in the underlying suit against the owner and the driver, because the driver's 

alleged permission to use the bus was the basis on which the passenger sought to hold the 

owner liable for the driver's conduct. Conversely, American Family argues, in the present 
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case the issue of the timing of the alleged damage to the Begys' home will not be resolved 

in the Begys' suit against McNaughton. Thus, American Family argues, Murphy does not 

support the conclusion that there is a conflict here. 

There are two serious flaws in American Family's argument. First, the argument is 

inconsistent with the facts of this case. Although the Begys' complaint contains no dates (it 

alleges only poor workmanship and damages), the construction agreement between the 

Begys and McNaughton does contain dates (it states that work on the Begys' home was to 

occur during 1991 and 1992), and that agreement is attached to the Begys' complaint. As 

noted, exhibits attached to a complaint are considered to be part of that complaint. See 

Bianchi, 329 Ill. App. 3d at 921. Thus, American Family's argument that dates are not 

relevant to the underlying suit is factually inaccurate. 

Second, American Family's argument makes no sense. According to American 

Family, the issues to be decided in the Begy Suit are limited to whether McNaughton 

performed work poorly and whether, as a result, the Begys' home was damaged. American 

Family argues that the question of when the alleged damage occurred is not relevant to the 

resolution of those issues. In other words, American Family argues that the Begys can 

prevail in a suit against McNaughton--a suit in which they allege that McNaughton's poor 

workmanship caused damage to their home--without establishing that the damage to their 

home stems from the time when McNaughton worked on their home. By that reasoning, a 

plaintiff could prevail in a suit claiming that he or she suffered injuries in a car crash, without 

having to establish that his or her injuries were related in time to the car crash. Put simply, 

that is absurd. Thus, for this reason too, we reject American Family's argument that dates 

are irrelevant in the Begy Suit. 
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Turegum further supports the conclusion that the trial court's reasoning on this point 

was mistaken. There, a patient was admitted to a hospital on three occasions, and she 

sued the hospital, alleging that, on one or more of those occasions, she received negligent 

treatment that caused her injury. Turegum, 168 Ill. App. 3d at 161. At the time of the 

patient's first admission, the hospital was covered by an insurance policy with Turegum. 

However, that policy lapsed prior to the patient's second and third admissions. Turegum, 

168 Ill. App. 3d at 161. Nevertheless, because the policy potentially covered the hospital, 

Turegum had a duty to defend the hospital. At the same time, however, the court found 

that the situation involved a conflict. This was because Turegum's interest would be 

equally protected whether the hospital was found not liable or found liable for negligence 

occurring during the patient's second or third admission (that is, after the policy expired). 

Turegum, 168 Ill. App. 3d at 167-68. 

Similarly, in this case, although McNaughton and American Family share an interest in 

McNaughton's being found not liable, American Family would do just as well if McNaughton 

were found liable for damage occurring before the inception of the Policy. Consequently, 

here, as in Turegum, there is a conflict. 

Thus, the trial court erred in concluding that, because American Family and 

McNaughton shared some interests, there is no conflict. Having established as much, we 

turn to the trial court's first point, i.e., that there is no present conflict, but only a potential 

one depending on what is shown by discovery in the Begy Suit. 

We disagree with that conclusion. A conflict already exists here. A conflict does not 

arise at the time a lack of coverage is unequivocally established. A conflict arises when the 

divergent interests of the insurer and insured are apparent and the attorney representing 
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the insured can no longer represent both clients' interests without prejudice to either client. 

A conflict already exists here because American Family's interests would be served by 

fleshing out in discovery facts showing that the damage to the Begys' home occurred prior 

to the inception of the Policy, while McNaughton's interests would be served by fleshing out 

facts showing that the damage occurred after the inception of the Policy. In this regard, an 

attorney representing American Family's interests would be the enemy of McNaughton. As 

the supreme court has said, "[a] ruling that required an insured to be defended by what 

amounted to his enemy in the litigation would be foolish." Murphy, 88 Ill. 2d at 454-55. 

Thus, McNaughton should not be forced to use American Family's attorneys to defend 

against the Begys' claims. 

American Family attempts to undermine this conclusion by characterizing the above 

conflict as merely "hypothetical." Such a hypothetical conflict, American Family says, 

cannot form the basis for a finding that there exists a conflict between an insurer and its 

insured entitling the latter to retain independent counsel at the expense of the former. 

American Family finds support for this position in Shelter Mutual Insurance Co. v. Bailey, 

160 Ill. App. 3d 146 (1987). 

In Shelter Mutual, the insured's policy excluded intentional acts. Shelter Mutual, 160 

Ill. App. 3d at 155. The insured was sued for negligence only. The court noted that 

conflicts of interest have been found when a complaint alleged multiple theories of recovery 

against an insured, only some of which were covered by an insurance policy. Shelter 

Mutual, 160 Ill. App. 3d at 153-54. In those cases, the court explained, a conflict stemmed 

from the fact that the insurer's interest would be served if the insured were found liable 

under a noncovered theory. Shelter Mutual, 160 Ill. App. 3d at 155. However, the court 
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found that the case before it did not fall into that category. This was because only one 

theory of recovery was alleged and liability based on that theory was covered by the policy. 

 Shelter Mutual, 160 Ill. App. 3d at 155. The court rejected the idea that a conflict existed 

because the complaint, at least in theory, could be amended to include a claim that the 

insured acted intentionally (a claim, that is, that would not be covered by the policy). In 

doing so, the court reasoned that if, even though the complaint against the insured alleged 

only negligence, a potential conflict existed entitling the insured to hire his own attorney, 

"then in any negligence action an insured could claim that an intentional or wilful and 

wanton count could be added to the complaint at any time, thereby requiring the insurance 

company to turn the defense over to another attorney." Shelter Mutual, 160 Ill. App. 3d at 

155. 

Shelter Mutual is easily distinguished from the present case. Here, the 

"hypothetical" discovery to which American Family refers likely includes, among other 

things, questions relating to the timing of the alleged damage to the Begys' home. As 

discussed above, the question of the timing of the damage to the home will almost certainly 

come up in the underlying suit. Thus, there is no merit to American Family's suggestion 

that discovery relating to the theory of recovery alleged in the complaint is analogous to 

unpled, hypothetical theories of recovery. Accordingly, its reliance on Shelter Mutual is 

misplaced. 

In sum, the trial court erred in finding that there was no conflict. Therefore, the trial 

court erred in finding that McNaughton was not permitted to retain its own legal counsel to 

defend it against the Begys' allegations at American Family's expense.2

 

 2

McNaughton raises several additional arguments. For example, McNaughton notes that, 
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after the record in this case was certified on appeal, the Begys amended their complaint to allege that 

they did not discover the problems with their home until September 2001. McNaughton argues that 

we can take judicial notice of the amended complaint, and that the Begys' allegation as to the date of 

discovery provides further support for McNaughton's position that the timing of the alleged damage 

is in issue in the Begy Suit, and, therefore, a conflict exists. Shifting gears, McNaughton argues 

that, in addition to the timing-of-the-damage issue, the Begy Suit involves questions of when 

McNaughton knew of the alleged damage to the Begy home and whether that damage was caused by 

mold after 2002. For these reasons, too, McNaughton argues that there is a conflict. Our conclusion 

that a conflict exists based on the timing-of-the-damage issue, and that this is so based on the Begys' 

initial complaint, makes it unnecessary to consider these additional arguments.
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III. CONCLUSION 

For the reasons stated, the judgment of the circuit court of Du Page County is 

reversed, and the cause is remanded. 

Reversed and remanded. 

CALLUM and GILLERAN JOHNSON, JJ., concur