Waste Management, Inc. v. International Surplus Lines Insurance

JUSTICE FREEMAN delivered the opinion of the court:

Petitioners, Waste Management, Inc., Chemical Waste Management, Inc., and Matthew Cockrell (collectively, insureds), have petitioned this court for rehearing (134 Ill. 2d R. 367). While we deny the petition, we will, nonetheless, address those points which we deem to have merit.

Initially, insureds assert that this court’s holding that insureds had no expectation of confidentiality with respect to defense counsel’s files is based on a misapprehension of fact. Specifically, insureds maintain that the insurance contract provision which states that the insureds “shall give all such information and assistance as the insurers may reasonably require” is not, in fact, a provision in the Furley insurance contract. Insureds maintain that insurers’ assertion that such a provision is included in the contract is erroneous. Appended to insureds’ petition are documents, not included as part of the record, which they maintain support their belief that this provision was negotiated out of the Furley site contract. Insureds maintain that the only cooperation clause in the Furley site contract provides that “insureds shall cooperate with the company, and upon the company’s request, assist in the conduct of suits and in enforcing any right to contribution or indemnity against persons potentially liable to insured ***.” For purposes of this discussion, but without determining the issue, we accept as true insureds’ version of the contract terms.

Insureds maintain that under the contract the duty to cooperate and to assist exists only when the insurer is actually conducting or participating in the litigation. They state that the contract is silent on “what cooperation is required, if any, when the Insurer merely stands by while the Insured defends himself as was done here” (emphasis added). As a preliminary matter, we note that insureds state in their petition that insurers refused to defend. This statement implies that such a duty existed. In fact, insurers had no duty to defend. The contract provides only that insurers indemnify insureds for defense costs.

The position taken by insureds renders the contract’s cooperation provision as mere surplusage. We reject this position. Even were the express words, “duty to cooperate,” omitted from the contract, such a duty could reasonably be inferred based merely on principles of fairness and good faith.

Having determined that the duty to cooperate exists, we are next faced with the task of determining, in the context of indemnification, its scope. Our review of case law reveals that issues involving the cooperate-and-assist clause urged by insureds have most often arisen in duty-to-defend cases. Within that context, it has been variously stated that the purpose of the provision is to require the insured to cooperate in good faith with the insurer in its defense of a claim. (8 J. Appleman, Insurance Law & Practice §4774, at 231-33 (1981); State Farm Fire & Casualty Co. v. First National Bank & Trust Co. (1972), 2 Ill. App. 3d 768, 772 .) The duty to defend and the duty to indemnify, while separate and distinct (Conway v. Country Casualty Insurance Co. (1982), 92 Ill. 2d 388, 394 ), are corresponding in nature. Thus, though insurers had no duty to defend, we will rely upon the principles applied in duty-to-defend cases to define the scope of the duty of cooperation here.

The duty to defend arises when, based on the pleadings, there is a claim that is potentially covered by the insurance agreement. (Thornton v. Paul (1978), 74 Ill. 2d 132, 144 ; Maryland Casualty Co. v. Peppers (1976), 64 Ill. 2d 187, 193 .) Where the insurer has the duty to defend, that duty includes the right to assume control of the litigation. (Nandorf, Inc. v. CNA Insurance Cos. (1985), 134 Ill. App. 3d 134, 136 .) “The purpose of such right is to allow insurers to protect their financial interest in the outcome of litigation and to minimize unwarranted liability claims.” Parker v. Agricultural Insurance Co. (1981), 109 Misc. 2d 678, 681 , 440 N.Y.S.2d 964, 967 ; 7C J. Appleman, Insurance Law & Practice §4681, at 2-4 (1979).

Unlike the duty to defend, the duty to indemnify cannot be determined simply on the basis of whether the factual allegations of the underlying complaint potentially state a claim against the insurer. (C.H. Heist Caribe Corp. v. American Home Assurance Co. (3d Cir. 1981), 640 F.2d 479, 483 .) “The duty to indemnify arises only when the insured becomes legally obligated to pay damages in the underlying action that gives rise to a claim under the policy.” (Zurich Insurance Co. v. Raymark Industries, Inc. (1987), 118 Ill. 2d 23, 52 ; Maryland Casualty Co. v. Chicago & North Western Transportation Co. (1984), 126 Ill. App. 3d 150, 156 .) It is a necessary prerequisite to recovery upon a policy for the insured to show a claim within the coverage provided by the policy. Great West Steel Industries, Ltd. v. Northbrook Insurance Co. (1985), 138 Ill. App. 3d 84, 97 (Jiganti, P.J., dissenting); Pacific Indemnity Co. v. Linn (E.D. Pa. 1984), 590 F. Supp. 643, 650 .

Typically the insurer has little or no knowledge of the facts surrounding a claimed loss, while the insured has exclusive knowledge of such facts. The insurer is, therefore, dependent on its insured for fair and complete disclosure; hence, the duty to cooperate. While the insured has no obligation to assist the insurer in any effort to defeat recovery of a proper claim, the cooperation clause does obligate the insured to disclose all of the facts within his knowledge and otherwise to aid the insurer in its determination of coverage under the policy. (Freyou v. Marquette Casualty Co. (La. App. 1963), 149 So. 2d 697, 702 .) The insurer is entitled, irrespective of whether its duty is to defend or to indemnify, to gain as much knowledge and information as may aid it in its investigation, or as may otherwise be significant to the insurer in determining its liability under the policy and in protecting against fraudulent claims. To hold otherwise effectively places the insurer at the mercy of the insured and severely handicaps it in contesting a claim. Arton v. Liberty Mutual Insurance Co. (1972), 163 Conn. 127, 134 , 302 A.2d 284, 288 .

Where the insurer provides the defense it is directly involved in the generation of the defense litigation files and, obviously, has access to the whole of them. Where the insurer is bound instead to indemnify for the cost of litigation, it plays a different but no less vulnerable role in the claims process. Thus we do not believe that the insurer, as indemnifier, is relegated to a less secure position with only limited rights to disclosure. The insurerindemnifier is no less interested or entitled to protect its financial interests and to minimize unwarranted liability claims than if it were actually participating in or providing the defense. We conclude that while the insurance contract may not, as insureds assert, expressly state that insureds have a duty to provide all information and assistance, by our interpretation of the clause no less is required.

Insureds next point out that the rationale for our holding, that is, that the materials were generated while the insureds were defending a claim for which the insurers had the ultimate duty to satisfy, ignores the reality that insurers are denying coverage and a duty to indemnify. Insureds state that insurers made “some” decision between 1982 and 1987 not to pay the claims but nothing was specifically communicated to them until 1987.

Insureds seek to characterize insurers’ denial of coverage as a complete surrender of its contractual obligations. We disagree. We note that aside from insurers’ pleadings in the declaratory judgment action, insureds point to nothing and our review of the record reveals no express denial of coverage. Further, it is noteworthy that insureds make no allegation that insurers unreasonably delayed in bringing their complaint for a declaratory judgment.

The mere fact that insurers contest coverage does not abrogate their duty to indemnify. It is the purpose of the declaratory judgment action “ ‘to settle actual controversies before they have ripened into violations of law or legal duty or breach of contractual obligations.’ ” (Heinson v. Porter (1989), 244 Kan. 667, 672 , 772 P.2d 778, 782 , quoting Franklin Life Insurance Co. v. Johnson (10th Cir. 1946), 157 F.2d 653, 658 .) The parties involved in the controversy can then learn the consequences of their action before they act. (Kaske v. City of Rockford (1983), 96 Ill. 2d 298, 306 , quoting Buege v. Lee (1978), 56 Ill. App. 3d 793, 798 .) While an insurer’s statements disclaiming coverage may be couched in terms of denial, such a denial, when alleged in the pleadings or which precedes a promptly filed complaint for declaratory action, is not tantamount to repudiation of the policy obligations. (See Miller v. Shugart (Minn. 1982), 316 N.W.2d 729 .) A contrary conclusion would negate the protections for which the declaratory judgment action is designed and ultimately penalize insurers for conduct which we have previously sanctioned as proper. See Murphy v. Urso (1981), 88 Ill. 2d 444 ; Clemmons v. Travelers Insurance Co. (1981), 88 Ill. 2d 469 . Cf. Ayres v. Bituminous Insurance Co. (1981), 100 Ill. App. 3d 33 ; see also Insurance Co. v. Markogiannakis (1989), 188 Ill. App. 3d 643 (insurer that expressly denied coverage and subsequently filed declaratory judgment action not estopped to raise coverage defense).

Further, our review of the record reveals three letters (May 7, 13, and 19, 1986) from insurers addressed to insureds concerning the Miller litigation. We construe these letters as constituting a reservation of insurers’ rights. Of particular significance is the May 7 letter, wherein insurers reference an earlier letter to insureds in which insurers allegedly stated that they had “originally communicated their reservation of the EIL Policy’s response.” The May 7 letter also states that insurers’ “response not to contest the settlement amount was being made without prejudice of the Underwriter’s continued evaluation of this matter and to their application of defenses to coverage and other options available under the Policy and the law if in fact the continued evaluation indicates the propriety of such contentions as may or may not exist to coverage defenses.” In none of the three letters do insurers deny coverage, but instead, indicate continuing evaluation and concerns about defense coverage.

Here, insurers indicated their concerns about coverage, proceeded to evaluate insureds’ claims under an express reservation of rights, and subsequently sought a declaratory judgment. By their conduct insurers have demonstrated no intent to abandon insureds. We conclude that on these facts, insurers’ “denial” of coverage does not amount to a repudiation of the insurance contract.

Insureds further assert that courts have previously held that an insured need not comply with contract terms once the insurer has “breached the contract or denies coverage.” In support of this contention they invite our attention to the following cases: Mayfair Construction Co. v. Security Insurance Co. (1977), 51 Ill. App. 3d 588 ; Crest v. State Farm Mutual Automobile Insurance Co. (1974), 20 Ill. App. 3d 382 ; Sims v. Illinois National Casualty Co. (1963), 43 Ill. App. 2d 184 ; Luria Brothers & Co. v. Alliance Assurance Co. (2d Cir. 1986), 780 F.2d 1082 .

In each of these cases the insurers wrongfully denied coverage, and without resort to the courts for a declaration of their rights and obligations under the terms of the insurance agreements, totally abandoned their insureds. In that regard, the cases are distinguishable from the case now before us. In each case, though perhaps not expressly stated, the insurers were estopped from asserting coverage defenses.

The estoppel principle, properly stated, provides that an insurer which takes the position that a complaint potentially alleging coverage is not covered under a policy which includes a duty to defend may not simply refuse to defend the insured. Such insurer must defend the suit under a reservation of rights or seek a declaratory judgment that there is no coverage. If the insurer fails to do this, and is subsequently found to have wrongfully denied coverage, it is estopped from later raising policy defenses to coverage. (Murphy v. Urso (1981), 88 Ill. 2d 444, 451 ; Sims v. Illinois National Casualty Co. (1963), 43 Ill. App. 2d 184 .) The rule is likewise applicable to cases where the insurer’s duty is to indemnify. Cf. United States Fidelity & Guaranty Co. v. Wilkin Insulation Co. (1989), 193 Ill. App. 3d 1087 (declaratory judgment action to determine duty to indemnify brought prior to determination of insured’s liability is premature); see also Auto-Owners Insurance Co. v. Milwaukee Mutual Insurance Co. (1987), 165 Ill. App. 3d 734 ; Maryland Casualty Co. v. Chicago & North Western Transportation Co. (1984), 126 Ill. App. 3d 150 .

Other than insureds’ assertion, there has been no determination that insurers have breached the contract. It is significant that insurers have not completely abandoned insureds; they instead reserved their rights and seek a declaration that there is no coverage. The estoppel rule has no application in the context of this declaratory judgment action; insureds’ attempted invocation of it at this juncture is premature. We express no opinion as to its later availability.

We note that as a practical matter, since the parties are adverse for purposes of the declaratory judgment proceedings, each may have suspended performance of their contractual obligations. However, the fact that the request for the defense litigation files now arises in the context of discovery during a declaratory judgment action neither narrows nor extinguishes the contractual obligations of the parties. The contractual duties are continuing.

Further, we caution that a party who fails to perform his contractual obligations, because he believes the other party to be in breach, does so at his own peril. In making this determination we are mindful that where an insurer erroneously believes that there is no coverage and therefore wrongfully denies a claim, it may be estopped to assert the insured’s lack of performance in defense and may, in addition, be liable for damages. (Thornton v. Paul (1978), 74 Ill. 2d 132, 144-45 .) It seems to us a correct corollary that where an insured, because he believes that the insurer is in breach, fails to perform his contractual duties and there is a subsequent finding to the contrary, the insured risks losing the benefit of his bargain.

Insureds next argue that this court’s opinion should make it clear that the common interest doctrine ceases to apply when the parties become adverse. It is their contention that, here, the parties became adverse at the point when insurers “denied” coverage.

While we agree with the soundness of the general proposition, it is of no avail to insureds. It is essential to note that, until there is a declaration to the contrary, insurers continue to bear potential responsibility for settlement and litigation costs in the underlying action. The underlying defense litigation documents were generated in anticipation of minimizing liability, an interest common to both insurers and insureds. As we have previously stated, these documents may enjoy privileged status as to party opponents in the underlying litigation, but they cannot be privileged from insurers who may bear the ultimate burden of payment. While the parties are now adverse concerning the issue of coverage, no such adversity exists as to the underlying litigation. See Independent Petrochemical Corp. v. Aetna Casualty & Surety Co. (D.D.C. 1986), 654 F. Supp. 1334 .

Finally, insureds assert that this court’s opinion should be modified to provide that the work-product materials need not be produced until coverage is admitted or established. We do agree with insureds that, as a threshold matter, the parties should seek a determination that the site is covered prior to proceeding with production of the defense litigation files. However, to require an admission as to other issues of coverage ignores the very purpose of the declaratory judgment action.

We continue to hold that on these facts insureds may not assert against insurers either the attorney-client privilege or the work-product doctrine as a bar to discovery.