Opinion ID: 1209086
Heading Depth: 2
Heading Rank: 3

Heading: B & R's Refusal to Accept a Conditional Defense

Text: Continental contends that the trial court should have granted its motion for summary judgment on the ground that, as a matter of law, B & R breached the policy by refusing to accept Continental's offer to defend under a reservation of rights. Continental contends that it should be able to conduct the insured's defense without giving up its right to refuse to pay an adverse judgment if it can later establish that the insured breached a condition of the policy. B & R's position is that Continental cannot have it both ways. B & R contends that Continental must either (1) affirm the policy, defend the suit, and pay any resulting adverse judgment, thus waiving both the alleged breach by the insured and any possible coverage defenses, or (2) repudiate the policy and withdraw from the defense, taking its chances that its claim of a breach by the insured would stand up in a subsequent suit on the policy. Continental acknowledges that the general rule is that, if an insured refuses to accede to the insurer's reservation of rights, the carrier must either accept liability under the policy and defend unconditionally or surrender control of the defense and be held liable if it guessed wrong on the coverage issue. See Boise Motor Car Co. v. St. Paul Mercury Indemnity Co., 62 Idaho 438, 112 P.2d 1011, 1016 (1941). Continental, however, urges us to reject that rule and adopt the approach of the Oregon Supreme Court in Ferguson v. Birmingham Fire Insurance Co., 254 Or. 496, 460 P.2d 342 (1969). Under Ferguson, where the insurer defends and there is a conflict of interest between the insurance company and the insured in the original litigation, a judgment in that action does not operate as an estoppel to prevent the insurance company from contesting coverage in a later action. The Ferguson court therefore found that it was unreasonable for the insured to insist that the insurance company either withdraw from the case or defend and waive its right to later litigate the question of coverage. Id. at 349. Both Boise and Ferguson, however, are distinguishable from the case at bar. In Boise and Ferguson the insurance company refused to defend because it believed that the claim was not covered by the policy. In the case at bar, Continental is not contesting coverage in that sense. Continental's contention is that the policy is unenforceable because of the insured's breach of the cooperation clause. [11] While Continental was willing to proceed with B & R's defense, it insisted on reserving its right to later challenge B & R's right to claim the protection of the policy, by asserting the insured's alleged breach as a defense in a later action to enforce the policy. Applying traditional principles of contract law, we perceive a substantial distinction between the two situations. In the first, where the insurer asserts a coverage defense, the insurer admits the validity of the policy but contends that a particular claim does not come within the coverage provided by the policy. In the second situation, where the insurer asserts a policy defense, [12] the insurer admits that the claim comes within the coverage provided by the policy but contends that the policy itself is unenforceable because of the insured's breach of a condition of the policy. In short, the insurer repudiates the contract and refuses to perform because of a prior breach by the other party. Boise and Ferguson represent two possible approaches to the coverage defense situation. The case at bar, however, involves an asserted policy defense, and we do not believe that the two situations necessarily involve the same considerations. In reaching our decision, therefore, we consider only the policy defense situation. We leave open the question whether the insurer has the same obligations and liabilities in the coverage defense situation. [13] The purpose of the Boise rule  that an insured need not accept the insurance company's offer of a conditional defense under a reservation of rights  is to avoid conflicts of interest between the company and its insured. Two types of conflicts are foreseeable in the reservation of rights situation. The first conflict which may arise, if the insurer knows it can later assert non-coverage, is that it may offer only a token defense of its insured. If the insurer does not think that the loss on which it is defending will be covered under the policy, it may not be motivated to achieve the lowest possible settlement or in other ways treat the interests of its insured as its own. The second conflict arises when success on a particular theory of recovery in the case against the insured would result in the denial of coverage under the policy. In that case, the insurance company would have an interest in seeing the plaintiff obtain a verdict based on the theory under which no coverage would result. For example, if a plaintiff alleged both negligence and an intentional tort as alternative theories of recovery, an insurer operating under a reservation of rights might covertly frame its defense to achieve a verdict based upon commission of the intentional tort, so that it could later assert that the defendant was not covered, since the policy provided no coverage for intentional torts. In the absence of a reservation of rights agreement, however, the insurer would be liable for indemnification regardless of whether the verdict established negligence or an intentional tort, and thus would be more likely to defend vigorously on both grounds. See, e.g., Socony-Vacuum Oil Co. v. Continental Casualty Co., 144 Ohio St. 382, 59 N.E.2d 199, 204-05 (1945) (conflict created by alternative theories of recovery, Boise rule applied). The court in Ferguson admitted that the overwhelming weight of authority holds that the two types of conflict described above justify not requiring an insured to accept a defense under a reservation of rights. 460 P.2d at 349. The Ferguson court, however, saw a way around each of the two types of conflict. In the first, more generalized conflict of interest situation, the court reasoned that the insurance company's knowledge of supposed jury sympathy toward an insured in a coverage dispute would prevent the insurer from providing a less than adequate defense on the merits: It is feared that if the insurer knows that it can later assert non-coverage, it may offer only a token defense in the action brought against the insured, or be less prone to effect a settlement advantageous to the insured. We think that this danger is minimal. The insurer knows that when it is the defendant in a lawsuit brought by one of the policy holders the jury's sympathy for the insured frequently produces a plaintiff verdict even when the insurer's case is strong. Knowing this, the insurer is not likely to relax its effort in defending the action against the insured. If the insurer feels certain that it can successfully defend an action brought against it by the insured, it is not likely to accept the insured's tender of the defense in the first place. Id. (footnote omitted). As to the second form of conflict, where a judgment on one theory of the case could affect the coverage issue, the Ferguson court reasoned that, when such a conflict exists, the estoppel by judgment rule should not be applied to the trial on coverage. The court held that the judgment in the original action should operate as an estoppel in the subsequent coverage determination only when the interests of the insurer and insured in defending the original action were identical. Thus, under the Ferguson decision, if a plaintiff's alternative theories of recovery based on negligence and intentional tort posed a potential conflict of interest on the coverage issue, a finding by the jury that an intentional tort had been committed would not be binding in the later action to determine coverage: Where there is a conflict of interest between the insurer and insured and the judgment in the action against the insured can be relied upon as an estoppel by judgment in a subsequent action on the issue of coverage, the control of the action by the insurer could adversely affect the insured if the judgment was based upon conduct of the insured not falling within the coverage of the policy. Likewise, the insurer could be adversely affected by a judgment based upon conduct for which there is coverage. But we see no reason for applying the rule of estoppel by judgment in such cases. The judgment should operate as an estoppel only where the interests of the insurer and insured in defending the original action are identical  not where there is a conflict of interests. If the judgment in the original action is not binding upon the insurer or insured in a subsequent action on the issue of coverage, there would be no conflict of interests between the insurer and the insured in the sense that the insurer could gain any advantage in the original action which would accrue to it in a subsequent action in which coverage is in issue. Id. at 348-49 (footnotes omitted). While the Ferguson approach might be acceptable in the coverage defense situation for which it was developed, [14] we do not believe it is an adequate solution to the policy defense situation. The fact that, under the Ferguson approach, the insurer would not be estopped to assert the insured's breach as a defense in a subsequent action on the policy does not sufficiently eliminate the conflict of interest in the original litigation. Even if the insurer vigorously and properly defended the claim against its insured, it could still take actions which could prejudice the insured's position in a later suit on the policy. If nothing else, the insurer might gain access to information, not otherwise properly available to it, which it could use to its advantage later to establish the insured's breach. Furthermore, if the insurer felt that its chance of prevailing in the later suit was fairly certain, it would not have the same interest in achieving a reasonable settlement that it would otherwise have. [15] Because the application of the Ferguson approach to the policy defense situation would unacceptably compromise the interests of the insured, we reject it. The Boise approach requires the insurer to make a clear choice between defending and withdrawing, and, in the policy defense situation, we believe that approach is necessary to protect the interests of the insured. Thus, we decline to adopt in full the position of either party. It may be that, where the insurance company wishes to contest coverage, the insured is obligated to accept a defense under a reservation of rights. [16] We hold, however, that where, as here, the insurance company challenges the insured's right to enforce the policy on the ground the insured has breached a condition thereof, the insured has a right to demand an unconditional defense. Thus, the insurance company must either affirm the policy and defend unconditionally or repudiate the policy and withdraw from the defense. [17] The insurer may not reserve its right to repudiate the policy, unless the insured consents to a reservation of that right. In the case at bar, therefore, B & R was fully within its rights and did not breach of policy when it insisted that Continental either defend unconditionally or withdraw from the defense. The superior court properly denied Continental's motion for summary judgment.