Court Opinion

ID: 9543813
Source: CourtListenerOpinion
Date Created: 2023-08-07 16:49:28.646297+00
Date Added: 2024-06-11T15:11:13.384873
License: Public Domain

*224LANDAU, J.
Defendant petitions for reconsideration of our opinion, 141 Or App 210, 917 P2d 1025 (1996), in which we (1) held that defendant had wrongfully refused to defend plaintiff, its insured, against a claim brought by a third party, (2) held that, as a result, defendant is liable for the amount that plaintiff agreed to pay the third party in settlement of the claim brought by the third party, to the extent that the settlement was reasonable, and (3) remanded for a determination of the reasonableness of the settlement that plaintiff actually negotiated with the third party. Defendant does not challenge the first holding but does challenge the second and third. According to defendant, an insurer that wrongfully refuses to defend is liable for a reasonable settlement between an insured and a third party only if the underlying event that gave rise to the third-party action was covered under the policy of insurance. Defendant argues that, if the underlying event in this case fell within its pollution exclusion clause, then it cannot be held liable even if the settlement was otherwise reasonable, because insurers cannot be penalized for failing to defend by being required, in effect, to provide coverage they never agreed to provide. We agree and modify our opinion, adhering to it as modified.
No Oregon decision defines precisely the consequences of an insurer’s wrongful refusal to defend. Courts in other jurisdictions have taken various approaches. A substantial number hold that an insurer that has wrongfully refused to defend is estopped from denying coverage. See, e.g., Joslyn Mfg. Co. v. Liberty Mut. Ins. Co., 23 F3d 1212, 1214 (7th Cir 1994) (“[b]y violating its duty to defend, under Illinois law the insurer is estopped to deny policy coverage in a subsequent lawsuit”); Qualman v. Bruckmoser, 163 Wis 2d 361, 368, 471 NW2d 282, 285 (1991) (“[i]f the insurance company breaches its duty to defend its insured in the underlying action against the insured, the company cannot later challenge any coverage issues”). That rule is generally supported by the rationale that, because the insurer has breached the insurance policy, it is no longer entitled to claim any of its protective provisions. See, e.g., Clemmons v. Travelers Ins. Co., 88 Ill 2d 469, 479, 430 NE2d 1104, 1109 (1981) (the *225“roots [of the rule] lie in the theory that because the insurer breached one of its duties under the contract of insurance * * *, the insurer cannot later turn around and enforce another clause of the contract, to its complete protection”).
Other courts reject the extension of coverage by estoppel and hold that an insurer that wrongfully fails to defend is responsible for settlement costs only to the extent that the underlying claim is covered. See, e.g., Polaroid Corp. v. Travelers Indem. Co., 414 Mass 747, 762-63, 610 NE2d 912, 921 (1993) (“[i]f an underlying claim * * * is not within the coverage of an insurance policy, an insurer’s improper failure to defend that claim would not ordinarily be a cause of any payment that the insured made in settlement of that claim”); Hirst v. St. Paul Fire & Marine Ins. Co., 106 Idaho 792, 799, 683 P2d 440, 447 (1984) (“where an insurance company has wrongfully refused to defend, it may nevertheless in a subsequent action on the policy attempt to show that the liability is not covered by the policy”) (quoting Afean v. Mutual Fire, Marine and Inland Ins. Co., 595 P2d 638, 647 (Alaska 1979)); Keller Industries v. Emp. Mut. Liab. Ins. Co., 429 So 2d 779, 780 (Fla Dist Ct App 1983) (“an unjustified failure to defend does not require the insurer to pay a settlement where no coverage exists”); Alabama Farm Bur. Mut. Cas. Ins. Co. v. Moore, 349 So 2d 1113, 1116 (Ala 1977) (“[W]e reject the proposition that an insurer’s liability to pay for damages may stem from a breach of its duty to defend. The two duties are to that extent independent.”); see also R. Long, 1A The Law of Liability Insurance § 5A.18 at 5A-107 (1966 & Cumm Supp 1994) (“[T]he insured must prove that the amount paid in settlement was reasonable in order to be able to recover those amounts, and that the claim was within the policy coverage.”). The principal underpinning of that rule is the idea that policy holders are entitled to receive the benefit of their bargains and no more. As one commentator has explained:
“The insurer’s breach [of the duty to defend] should not * * * be used as a method of obtaining coverage for the insured that the insured did not purchase. When a contract is breached, the injured party is entitled to receive what would have been obtained if there had been no breach; the injured party is not entitled to receive more.”
*226Allan D. Windt, 1 Insurance Claims and Disputes § 4.37 at 268 (3d ed 1995).
Oregon is among the jurisdictions that have rejected the rule that insurers that wrongfully fail to defend are estopped from contesting coverage as to settlement costs. In Timberline Equip, v. St. Paul Fire and Mar. Ins., 281 Or 639, 576 P2d 1244 (1978), the insurer had breached its duty to defend, the insured had settled claims asserted by a third party, and the insured sued the insurer for recovery of all settlement costs. The insured argued that, by failing properly to defend, the insurer had waived any right to contest coverage and was, consequently, liable for the entire settlement. The Supreme Court disagreed:
“That argument is incorrect. When a contract is breached the injured party is entitled to receive what he would have if there had been no breach; he is not entitled to receive more.”
Id. at 646. Timberline, however, did not address the question of what other consequences, if any, attend an insurer’s wrongful failure to defend. More precisely, Timberline did not address whether Oregon follows the decisions of other states holding that an insurer that wrongfully fails to defend generally will not be liable for settlement costs unless the underlying claim is covered. To answer that question we work from more fundamental principles of Oregon contract and insurance law. Three such principles are pertinent to the disposition of this matter.
 First, the duty to defend is a contractual duty, and, under general principles of contract law, the breach of that duty gives rise to a claim for damages. Georgetown Realty v. The Home Ins. Co., 102 Or App 611, 615, 796 P2d 651 (1990), rev’d on other grounds 313 Or 97, 831 P2d 7 (1992). The measure of those damages is generally stated in terms of the “benefit of the bargain,” Corder v. A&J Lumber Co, Inc., 223 Or 443, 449, 354 P2d 807 (1960), subject to a limitation of foreseeability. Foreseeability, it should be emphasized, is determined from the time of execution of the agreement, not from the time of the breach. Cont. Plants v. Measured Mkt., 274 Or 621, 625-26, 547 P2d 1368 (1976).
*227Second, the duty to defend is different from the duty to indemnify, and the breach of one does not, in and of itself, establish the breach of the other. See, e.g., Ledford v. Gutoski, 319 Or 397, 403, 877 P2d 80 (1994) (“[t]he duty to indemnify is independent of the duty to defend”). That only makes sense. The duty to defend is triggered by the bare allegations of a pleading. In contrast, the duty to indemnify is established by proof of actual facts demonstrating a right to coverage.
Third, the duty to indemnify cannot be extended by estoppel. The scope of an insurer’s risk is determined by the terms of the policy, not by the conduct of the parties subsequent to execution. See, e.g., ABCD...Vision v. Fireman’s Fund Ins. Companies, 304 Or 301, 307, 744 P2d 998 (1987) (“[e]stoppel cannot be invoked to expand insurance coverage or the scope of an insurance contract”).
Application of those three principles leads to the conclusion that an insurer’s breach of the duty to defend does not give rise to a duty to indemnify unless the underlying claim is covered. That conclusion is the only one consistent with the general rule that an insured is entitled to the benefit of its bargain, and no more. The policy contains provisions specifying the conditions of coverage, exclusions and exceptions to the exclusions. To allow coverage beyond those terms — for example, to require an insurer to cover a loss that is otherwise subject to an exclusion — would be to allow the insured to obtain more than it bargained for: coverage for a noncovered claim. The foregoing conclusion also is the only one that maintains the distinction between the duty to defend, which is established by the allegations of a complaint compared with the terms of a policy, and the duty to indemnify, which is established by the actual facts demonstrating a right to recover under the policy. Finally, it is the only conclusion that is faithful to the principle that coverage may not be extended by waiver or estoppel.
The dissent does not propose the adoption of an outright rule of estoppel. But neither does it propose that an insurer’s obligation to pay settlement costs depends on whether the underlying claim is covered. The dissent stakes out something of a middle position, which would require the *228insurer to pay the insured’s settlement costs to the extent that they are reasonable. What constitutes a “reasonable” settlement depends on what a hypothetical insurer would have done under the circumstances. Whether the claim actually is subject to coverage is irrelevant, however, if it can be shown that a reasonable insurer would have settled anyway, either because a reasonable insurer would not have known at the time of the hypothetical settlement that a policy exclusion applied or because the reasonable insurer would have assessed the risks in such a way that it would have settled notwithstanding the applicability of the exclusion. The dissent’s proposed rule is apparently borne of concern that insurers not be allowed to take advantage of information as to the applicability of a policy exclusion that the insurer obtained only after having lost the battle over its duty to defend. That concern is perhaps meritorious (although it is uncertain precisely how often, in the real world, insurers will not know the facts as to the event underlying the coverage dispute only after the litigation over the duty to defend). The problem is that the legal theory cannot be reconciled with Oregon contract and insurance law.
First, the dissent’s proposed rule is at odds with the traditional measure of contract damages. It does not give the insured what it bargained for, which is coverage in accordance with the terms of the policy. It gives the insured more, namely, the possibility of coverage for a noncovered event. The dissent does not explain by what legal theory it arrives at that result. It appears that the dissent relies on a variation of consequential damages theory, but such an analogy is inapt.
Consequential damages are, by definition, those that the parties to a contract reasonably contemplate at the time of execution, not at some later date. See, e.g., Siegner v. Interstate Production Credit Assn., 109 Or App 417, 436, 820 P2d 20 (1991) (consequential damages available if the defendant “knew of facts making the loss foreseeable at the time the contract was made”); Bixler v. First National Bank, 49 Or App 195, 200, 619 P2d 895 (1980) (consequential damages “would not be recoverable for breach of a contract to loan money unless the lender knew of facts making the loss foreseeable when the contract was made”). Thus, whether it is reasonable to include as consequential damages settlement *229costs in excess of the provisions of an insurance policy must be examined by reference to what was reasonably contemplated by the parties at the time of the execution of the policy. As in any contract, the intentions of the parties are expressed in the terms of the insurance policy itself, which contains express limitations on coverage. See generally Hoffman Construction Co. v. Fred S. James & Co., 313 Or 464, 469-71, 836 P2d 703 (1992) (describing methodology for ascertaining intention of parties to insurance policy). Those limitations do not say that the policy is limited, for example, by a pollution exclusion clause “unless the insurer reasonably determines that it is in its interest to cover otherwise excluded damages.” They express limitations on coverage without qualification by reference to a later risk assessment on the part of the insurer. Thus, awarding an insured the costs of settlement for an event that otherwise would not be subject to coverage cannot be justified by reliance on the rule of consequential damages.
Second, to the extent that the dissent’s proposed rule limits the evidence on which an insurer may rely in determining its duty to indemnify, it punishes an insurer for having failed properly to defend by preventing it to assert the applicability of a policy exclusion. Thus, the consequence for violating the duty to defend is the expansion of the duty to indemnify. That improperly conflates the two independent duties of defense and indemnification. It also effectively extends coverage by estoppel by limiting the extent to which an insurer can rely on an exclusion solely because of its wrongful conduct.
The dissent cites no Oregon authority for its proposal to so punish insurers that wrongfully fail to defend. It relies instead on a judgment that it is better policy to punish insurers for their wrongful conduct than to punish insureds for entering into settlements without the benefit of the defense to which they were entitled. What is before us, however, is not a policy judgment. The dissent’s complaint that it is innocent insureds who are being “punished” for an insured’s breach, moreover, begs the question of whether a plaintiff that claims coverage for an event that may not, in fact, be a covered event is really being “punished.”
*230The dissent further takes us to task for our insistence that the duties to indemnify and to defend are distinct. According to the dissent “[w]hen an insurance company fails to undertake its duty to defend it leaves the insured with less than the bargained-for protection of the insured’s interests against a third party.” 144 Or App at 233. Assuming that is so, it does not follow that the proper remedy is to create an obligation to indemnify that goes beyond the terms of the policy. The authority cited by the dissent itself bears out the point. In Maine Bonding v. Centennial Ins. Co., 298 Or 514, 693 P2d 1296 (1985), for example, the court held that an insured may be held liable for failing to exercise due diligence in defending claims against its insured by failing unreasonably to settle the claims. Id. at 518-19. Nevertheless, the court took care to caution that the insurer’s liability is subject to the limits stated in the policy. Id. at 519. Significantly, the court held that, even when an insurer has an obligation to settle a claim in excess of its policy limits, “the insured alone has the responsibility to pay claims above the limits of liability.” Id. The breach of a duty to defend, in other words, does not itself expand the duty to indemnify beyond the express terms of the policy.
With the foregoing principles in mind, we return to the facts of this case. Defendant declined to provide a defense as to claims brought against plaintiff, its insured. Plaintiff proceeded with a defense at its own expense and ultimately settled those claims. Plaintiff then sued for recovery of its settlement costs, which included both the costs of providing the defense and the cost of the liability itself. Defendant breached its duty to defend, and, as defendant itself concedes, it is liable for the costs of defense. As to the settlement, however, defendant asserts that it is not liable, because the underlying event that gave rise to the claim is subject to an exclusion clause in the insurance policy. Defendant is entitled to assert the applicability of the exclusion provision. If the provision applies, it is not liable for the settlement costs. If not, then it will be liable for those settlement costs to the extent that they are reasonable. On remand, therefore, the case should proceed on the merits as to coverage.
*231Petition for reconsideration allowed; opinion modified; reversed and remanded for further proceedings consistent with the court’s opinion of May 22,1996, as modified by this opinion.