Opinion ID: 2010567
Heading Depth: 1
Heading Rank: 4

Heading: Insurer's Right to Litigate Coverage

Text: ¶ Generally, an insurer who defends an insured waives the right to assert policy defenses unless it first notifies the insured that it disclaims liability under the policy. See 7 C.J. Appleman, Insurance Law & Practice § 4694 p. 336 (Bendal ed. 1979) [hereinafter Appleman]. [4] Under South Dakota law, if an insurer has a duty to defend its insured, it is bound  absent a reservation of rights  under the doctrine of collateral estoppel by those facts decided in the action against the insured that are essential to the judgment of liability, whether the insurer elects or refuses to defend. Ziegler v. Ryan, 66 S.D. 491, 285 N.W. 875, 880 (S.D.1939). [5] ¶ On the other hand, if the insurer's interest in defending the claim while restricting its obligation to the terms of the policy creates a conflict of interest between the insured and the insurer, there can be no estoppel from litigating in a later proceeding those issues on which there was a conflict of interest. As the California Supreme Court explained, if the insurer adequately reserves its right to assert the noncoverage defense later, it will not be bound by the judgment against the insured. Gray v. Zurich Ins. Co., 65 Cal.2d 263, 279, 419 P.2d 168, 178, 54 Cal.Rptr. 104, 114 (1966). By reserving the noncoverage issue, a conflict of interest will be avoided and the interests of the insured and the insurer in defending against the injured claimant will be identical. [6] Likewise, the Arizona Supreme Court, declaring it the better rule, held that where there is a conflict of interest between an insured and [an] insurer, the parties will not be estopped [to] litigat[e] in a subsequent proceeding those issues as to which there was a conflict of interest.... Farmers Ins. Co. of Ariz. v. Vagnozzi, 138 Ariz. 443, 675 P.2d 703, 708 (1983) (faced with a potential coverage defense, the insurer properly reserved its right to later assert the policy's intentional act exclusion); see also Restatement (Second) of Judgments § 58 (1982); St. Paul Fire & Marine Ins. Co. v. Crosetti Bros., Inc., 256 Or. 576, 475 P.2d 69, 71 (1970). ¶ Insurers are obliged to keep separate the independent duty to defend from the obligation to indemnify their insureds. [7] A conflict of interest exists when the injured person's claim against the [insured] is such that it could be sustained on different grounds, one of which is within the [insurer's] obligation to indemnify and another of which is not. Restatement, Judgments § 58. These principles and the problems they create are explained in the comment to the Restatement, Judgments § 58: On the one hand, the [insurer] has a duty to defend the [insured] even if the claim advanced in the action by the injured party is outside the scope of the indemnity obligation. In carrying out this duty, the [insurer] must seek to protect the [insured] even though in doing so it must take positions on the [insured]'s behalf that are contrary to its own interest. For example, the [insured] may be charged alternatively with having acted negligently and intentionally. In such a situation, it is to the [insured]'s interest that the claim, if sustained at all, be sustained on the basis of negligence because the loss will then fall on the [insurer], but it is to the [insurer]'s interest that the claim of negligent wrongdoing be resisted because liability on that basis would fall with the obligation to indemnify. On the other hand, the [insurer] has a right to its day in court on whether the [insured]'s liability is within the scope of the indemnity obligation. A corollary of this right is that the [insurer] should not be estopped by steps or positions that the [insurer] may have taken in the course of performing its duty to defend the [insured]. Hence, the usual rule that an [insurer] is precluded by the determination of issues which he litigates on behalf of an [insured], stated in § 57, should not apply to an [insurer] who defends, under the compulsion of an independent duty to defend, an [insured] with whom he has a conflict of interest. The only way to reconcile these duties is to recognize that an [insurer] who has an independent duty to defend the [insured] in effect has two legal capacities with regard to the [insured]. In his capacity as insurer against the [insured]'s risk of being sued on claims that might be found to be within the indemnity obligation, the [insurer] has a responsibility to provide counsel and supporting assistance to defend the [insured] without regard to the [insurer]'s interests, essentially as a guardian for a ward. In his capacity as [insurer], he has a responsibility to indemnify for such liability as may be within the indemnity obligation. In the latter capacity, he should not be bound by determinations in an action in which he participated in the former capacity if there is conflict of interest between the two. See § 36. The [insurer] may be required to manifest this differentiation by a reservation of its right qua [insurer] when it assumes the defense of the [insured]. ¶ As Engelmann's insurer, St. Paul defended him under a reservation of rights. A reservation of rights is a notice to the insured that the insurer will defend the insured but that the insurer is not waiving any defenses it may have under the policy. By this method, insurers can provide the insured a defense to liability and reserve for later the question whether the policy provides coverage. As in most jurisdictions, acting under a reservation of rights is an established procedure in South Dakota. An insurer is not estopped notwithstanding participation in defense of an action against insured to assert noncoverage if timely notice was given to the insured that it has not waived benefit of its defense under the policy. [8] Connolly v. Standard Cas. Co., 76 S.D. 95, 73 N.W.2d 119, 122 (S.D.1955). See also Appleman § 4692 at 297. ¶ St. Paul provided Engelmann with a splendid defense in his malpractice trial. Indeed, the jury's verdict is so structured as to create at least an arguable issue whether the judgment is within the scope of insurance coverage. [9] Counsel for Engelmann could have breached the obligation of fealty to the insured if he had advocated for special interrogatories or separate verdicts on the rape and sex abuse allegations. We must reflect now, though, that the insurer's right to challenge coverage for Engelmann's sexual misconduct was not decided in the tort trial and could not have been decided there. St. Paul cannot be foreclosed from proceeding with its challenge to coverage in this declaratory action. ¶ Because the insurer is entitled to contest the noncoverage question, we remand this case for the parties to litigate the factual issue of what part of the victims' damages, if any, are allocable to the covered second negligence theory. [10] We affirm the circuit court's denial of the insurer's motion for summary judgment on the issue of providing a defense to Engelmann and the Clinic in Baloun's malpractice suit. Correspondingly, we agree with the circuit court that a ruling on summary judgment on the indemnity issue in Baloun's case is premature. As with the others, she may be able to establish a theory equivalent to the second theory offered in the earlier malpractice trial. ¶ Affirmed in part, reversed in part, and remanded for trial. ¶ AMUNDSON, Justice, concurs in part and concurs specially in part. ¶ DOBBERPUHL, Circuit Judge, concurs specially.