Opinion ID: 2029842
Heading Depth: 1
Heading Rank: 4

Heading: Validity of the Assignment

Text: Potomac next argues that, even if it breached its duty to defend the Ortizes, it is entitled to summary judgment because the assignment given by the Ortizes to Guillen is invalid. The settlement agreement between Guillen and the Ortizes contains the following provisions relating to the assignment: 1. Payment. Subject to paragraph 10 below [requiring court approval of the settlement], Defendants will pay Plaintiff the sum of $600,000.00, to be satisfied solely through the assignment to Plaintiff reflected in Paragraph 2 below. 2. Assignment. Defendant hereby assigns to Plaintiff, to the fullest extent permitted by law or otherwise, all of their rights to payment if any, from General Accident Insurance (General) under that certain Business Owners Policy of insurance [ ] issued to Defendants MARIA G. ORTIZ AND EZEQUIEL B. ORTIZ, by General, arising out of the claims asserted against Defendants in the Action or the settlement thereof. (Emphasis in original.) As it did in the lower courts, Potomac notes before this court that an assignee stands in the shoes of the assignor and can have no greater rights than those possessed by the assignor. Thus, Potomac observes, for Guillen to state a prima facie claim for indemnification against Potomac, she must first establish that the Ortizes themselves possessed a right to indemnification. Potomac contends that Guillen cannot meet this burden. Potomac points out that, under the terms of the Ortizes' insurance policy, Potomac was required to indemnify the Ortizes for those sums which they were legally obligated to pay as damages. Potomac does not dispute that, generally speaking, once an insurer breaches its duty to defend, the insured may enter into a reasonable settlement agreement without foregoing its right to seek indemnification. See Outboard Marine, 154 Ill.2d at 128, 180 Ill.Dec. 691, 607 N.E.2d 1204. Potomac concedes that, in such a case, if the payment obligation of the insured is not limited by an assignment, the settlement agreement would create a legal obligation on the part of the insured to pay damages. Potomac argues, however, that in this case, the Ortizes were never legally obligated to pay damages under the terms of their settlement agreement with Guillen because their payment obligation was limited solely to an assignment of the Ortizes' right to recover under their insurance policy. Potomac observes that, because of the assignment, the Ortizes were never personally obligated to pay any money and were never placed in any personal financial risk. This is in contrast, Potomac notes, with a settlement that does not contain such an assignment. In that situation, the insured is placed in financial risk because, unless the insured can prove the insurer breached the duty to defend, the insured will be personally responsible for the amount of the settlement. Potomac contends, however, that in this case, the assignment effectively extinguished the Ortizes' legal obligation to pay damages. Potomac maintains, therefore, that the Oritzes were not legally obligated to pay damages in any real or practical sense of those words, that they suffered no insurable loss, and that they had no right to indemnification. Thus, since Guillen stands in the shoes of the Ortizes, Potomac argues that she cannot state a prima facie claim for indemnification. Potomac's argument regarding the validity of the Ortizes' assignment presents a question: How should the legally obligated to pay language be interpreted when an insurer breaches its duty to defend? Although this is a question of first impression in this court, numerous courts in other jurisdiction have considered it, albeit in a somewhat different context from that presented here. Most often, the interpretation of the legally obligated to pay language has arisen when the insured and the injured plaintiff enter into a settlement agreement consisting of a stipulated judgment or consent judgment joined with a covenant not to execute and an assignment of the insured's rights against the insurer to the injured plaintiff. See generally C. Wood, Assignments of Rights and Covenants Not to Execute in Insurance Litigation, 75 Tex. L.Rev. 1373 (1997); J. Harris, Judicial Approaches to Stipulated Judgments, Assignments of Rights, and Covenants not to Execute in Insurance Litigation, 47 Drake L.Rev. 853 (1999). When confronted by a settlement agreement consisting of a stipulated judgment, an assignment and a covenant not to execute, insurers have maintained, as Potomac does here, that the covenant not to execute effectively extinguishes the insured's legal obligation to pay since the insured has no compelling obligation to pay any sum to the injured party. Freeman v. Schmidt Real Estate & Insurance, Inc., 755 F.2d 135, 138 (8th Cir.1985). The majority of courts, however, have rejected this argument. See, e.g., 47 Drake L.Rev. at 858 (the trend leans overwhelmingly to the rule that the insured remains legally obligated to pay when the settlement consists of a stipulated judgment, an assignment, and a covenant not to execute); 75 Tex. L.Rev. 1373; Gainsco Insurance Co. v. Amoco Production Co., 53 P.3d 1051, 1060-61 (Wyo.2002) (collecting cases). The construction of the legally obligated to pay language adopted by the majority of courts is a technical, rather than practical, one. Courts accepting the conclusion that the insured remains legally obligated to pay when the settlement consists of a judgment, covenant not to execute, and an assignment hold that a covenant not to execute is a contract and not a release. The insured still remains liable in tort and a breach of contract action lies if the injured party seeks to collect on the judgment. 47 Drake L.Rev. at 858. Thus, under this construction, the insured is still legally obligated to the injured plaintiff, and the insured retains the right to indemnification from the insurer. The rationale supporting this technical construction of the legally obligated to pay language is that an insurer who has abandoned the insured by refusing to defend a claim should not be allowed to `hide behind' the policy language. Gainsco, 53 P.3d at 1060-61 (and cases cited therein). Further, some courts have observed that if the legally obligated to pay language were construed in favor of the insurers, it would defeat the very purpose of the settlement agreement entered into by the insured. See, e.g., State Farm Mutual Automobile Insurance Co. v. Paynter, 122 Ariz. 198, 593 P.2d 948, 953 (Ariz.App. 1979). And, since the insured has the right to protect itself after the insurer breaches its duty to defend, public policy generally supports giving a technical construction to the legally obligated to pay language. See, e.g., 75 Tex. L.Rev. at 1384. Thus, the prevailing view is that a liberal construction of the words legally obligated to pay in favor of the insured is appropriate, once the insurer has breached its duty to defend. We agree with the majority view regarding the construction given the legally obligated to pay language. Once the insurer has breached its duty to defend, it is in no position to demand that the insured be held to a strict accounting under the policy language. Fairness requires that the insured, having been wrongfully abandoned by the insurer, be afforded a liberal construction of the legally obligated to pay language. In the case at bar, the Ortizes agreed to pay Guillen the sum of $600,000 to be paid solely from an assignment of the Ortizes' rights against Potomac given to Guillen. Technically speaking, the assignment did not release the Ortizes' from their obligation to pay Guillen $600,000. Instead, it simply limited the assets against which Guillen could collect the $600,000. The assignment did not negate the payment obligation itself. It is true that, in practical terms, the Ortizes never faced any personal financial risk under the settlement agreement. However, because Potomac breached its duty to defend, the Ortizes are entitled to have the legally obligated to pay language liberally construed in their favor. Applying that construction here, the Ortizes remained legally obligated to pay under the terms of the insurance policy. Accordingly, Potomac's argument that it has no duty to indemnify the Ortizes, because the Ortizes had no legal obligation to pay, fails. Potomac also attacks the validity of Ortizes' settlement with Guillen based on public policy. Potomac argues that, in settlement agreements such as the one at issue in the case at bar, the insured's own money is never at risk and, therefore, the insured has no incentive to contest liability or damages with the injured plaintiff. According to Potomac, since the insured is essentially paying with the insurer's money, the insured can, and will, agree to any amount of damages the injured plaintiff requests. For this reason, Potomac contends that settlements such as those at issue here create an environment that fosters collusion and fraud. Thus, Potomac maintains that the agreement between the Ortizes and Guillen should be invalidated as against public policy. In deciding whether an agreement violates public policy, courts determine whether the agreement is so capable of producing harm that its enforcement would be contrary to the public interest. [Citation.] The courts apply a strict test in determining when an agreement violates public policy. J & K Cement Construction, Inc. v. Montalbano Builders, Inc., 119 Ill.App.3d 663, 683, 75 Ill.Dec. 68, 456 N.E.2d 889 (1983). The power to invalidate part or all of an agreement on the basis of public policy is used sparingly because private parties should not be needlessly hampered in their freedom to contract between themselves. First National Bank v. Malpractice Research, Inc., 179 Ill.2d 353, 359, 228 Ill. Dec. 202, 688 N.E.2d 1179 (1997). Whether an agreement is contrary to public policy depends on the particular facts and circumstances of the case. Kleinwort Benson of North America, Inc. v. Quantum Financial Services, Inc., 181 Ill.2d 214, 226, 229 Ill.Dec. 496, 692 N.E.2d 269 (1998). Potomac's concern regarding the possibility of collusion in the type of settlement agreement at issue in the case at bar is well taken. See generally 75 Tex. L.Rev. at 1385-87 (neither party [to the settlement agreement] is motivated to seriously negotiate over issues of damages and liability because the end goal is to structure the deal so that the carrier, a nonparty to the agreement, pays); State Farm Fire & Casualty Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996). Nevertheless, we do not find the concern regarding the possibility of collusion compelling enough to warrant voiding the instant settlement agreement. As a majority of courts have recognized, the risk of collusion and fraud can be lessened in cases such as those at bar, if not avoided altogether, by placing a requirement upon the plaintiff to prove that the settlement it reached with the insured was reasonable before that settlement can have any binding effect upon the insurer. See generally 75 Tex. L.Rev. 1373; 47 Drake L.Rev. 853. The criteria for establishing the reasonableness of a settlement agreement in the present context varies somewhat among jurisdictions. Ultimately, however, with respect to the insured's decision to settle, the litmus test must be whether, considering the totality of the circumstances, the insured's decision conformed to the standard of a prudent uninsured.  (Emphasis added.) Rhodes v. Chicago Insurance Co., 719 F.2d 116, 120 (5th Cir. 1983). Similarly, with respect to the amount of damages agreed to, the test is what a reasonably prudent person in the position of the [insured] would have settled for on the merits of plaintiff's claim. Miller v. Shugart, 316 N.W.2d 729, 735 (Minn. 1982). This involves a commonsense consideration of the totality of facts bearing on the liability and damage aspects of plaintiff's claim, as well as the risks of going to trial. Miller, 316 N.W.2d at 735. We note that the burden of proving reasonableness is properly placed upon the plaintiff both out of fairness, since the plaintiff was the one who agreed to the settlement, and out of practicality, since, as between the plaintiff and the insurer, the plaintiff will have better access to the facts bearing upon the reasonableness of the settlement. Further, we note that the insurer retains the right to rebut any preliminary showing of reasonableness with its own affirmative evidence bearing on the reasonableness of the settlement agreement. Like the appellate court, we agree that the matter at bar must be remanded to the circuit court for further proceedings bearing on whether the settlement agreement between the Ortizes and Guillen was reasonable under the circumstances. However, in certain respects, we depart from the appellate court's holding regarding the remand hearing. As noted, the appellate court in the case at bar, looking primarily at the face of the complaint filed by Guillen against the Ortizes, concluded that the Ortizes' decision to settle with Guillen was reasonable as a matter of law and was not subject to challenge by Potomac. Unlike the appellate court, we cannot conclude that the face of the complaint filed by Guillen is sufficient to establish, as a matter of law, that the Ortizes acted as a prudent uninsured when they decided to settle with Guillen. We note, too, that Potomac has not had an opportunity to present any evidence on the issue of the reasonableness of the Ortizes' decision to settle. Accordingly, we order that the judgment of the appellate court is to be modified. On remand, the circuit court shall consider both whether the Ortizes' decision to settle and whether the amount of damages were reasonable. Finally, with respect to the reasonableness of the amount of damages, we note that the appellate court below stated, as a general proposition of law, that if the settlement amount falls below the policy limits, the settlement amount is upheld as reasonable. 323 Ill.App.3d at 137, 256 Ill.Dec. 51, 751 N.E.2d 104. This is too broad a standard to apply in the context of settlement agreements such as those at bar. The fact that the amount of damages agreed to is within the policy limits does not, by itself, establish that the damages are what a reasonably prudent person in the position of the insured would have settled for on the merits of the plaintiff's claim.