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Coverage Disputes: The Procedurally Safe Method (And The Method Preferred By Georgia Appellate Courts) Is For The Insurer To Defend Its Insured Under A Reservation Of Rights, And Seek Declaration Of Coverage In Separate Action

Volume 19, No. 111 May 2007

Anthony Procacci
aprocacci@deflaw.com

            In its Southern Guaranty Insurance Company v. Dowse, 278 Ga. 674, 605 S.E. 2d. 27 (2004) decision, the Supreme Court of Georgia expressed to insurers that where coverage is in question, the preferred and procedurally safe method of resolving the dispute is for the insurer to defend its insured under a reservation of rights until the coverage dispute has been resolved.  In the Dowse case, the insurer denied coverage and a defense to its insured.  In light of the denial, the insured defendant allowed the plaintiff to take a stipulated default judgment against it in exchange for the plaintiff’s promise to refrain from pursuing collection efforts against the defendant’s assets, except for any proceeds available under the insurance policy.  The agreement between the insured defendant and plaintiff made clear that the intent was to allow the plaintiff to obtain a judgment, and pursue collection efforts solely against the defendant’s insurer.  After obtaining the judgment, the plaintiff initiated a garnishment proceeding against the insurer, claiming that the policy was a garnishable asset. 

            The insurer claimed that because its insured was released of any obligation to pay damages, that it, too, was relieved of that obligation.  The Georgia Supreme Court rejected the insurer’s argument, noting that the insured’s agreement with the plaintiff specifically permitted plaintiff to seek collection of the judgment against the insured defendant to the extent coverage was provided under the insured’s policy. 

            The insurer also claimed that under the terms of the policy, the insured’s settlement with the plaintiff without the insurer’s consent relieved the insurer of any payment obligation.  The Georgia Supreme Court again rejected the insurer’s argument, noting:

“[l]iability policies generally include provisions that prohibit an insured from settling claims without the insurer's approval.  These provisions enable insurers to control the course of litigation concerning such claims, and also serve to prevent potential fraud, collusion and bad faith on the part of insureds.    

Dowse at 676. (emphasis added).  

            The Court went on to state that:

“. . .an insurer that refuses to indemnify or defend based upon a belief that a claim against its insured is excluded from a policy’s scope of coverage does so at its peril, and if the insurer guesses wrong, it must bear the consequences, legal or otherwise, of its breach of contract. . . (and that) an insurer that denies coverage and refuses to defend an action against its insured, when it could have done so with a reservation of rights as to coverage, waives the provisions of the policy against a settlement by the insured and becomes bound to pay the amount of any settlement within a policy’s limits made in good faith, plus expenses and attorney’s fees.”

 Dowse at 676. (emphasis added).    

            Although the Court noted that an insurer retains its right to assert its policy defenses to coverage where it denies a defense to its insured, this right is not as strong as it may seem, in light of the Court’s holding that: 1) the insurer may not contest its insured’s liability; 2) the insurer may not contest the plaintiff’s right to recover; and 3) the insurer may not contest its obligation to pay to the extent the policy provides coverage.  Furthermore, the Court’s reference to the typical liability policy provision which enables the insurer to direct the litigation, and to prevent fraud, collusion and bad faith on the part of insured suggests that where coverage and a defense are absolutely denied, the insurer may have a difficulty obtaining relief from what appears to be an inequitable result. 

            This may be especially problematic for insurers where the insured and plaintiff join forces to settle the matter with the intent that the plaintiff will collect the judgment solely from the insurer, and immunize the insured’s personal assets from collection efforts.  In such a scenario, the parties will likely stipulate to facts in the underlying litigation tending to establish coverage for the plaintiff’s injuries.  Additionally, the insurer, may be estopped, or legally prevented from challenging and re-litigating the accuracy of the stipulated “facts” during subsequent coverage dispute litigation.  Therefore, with respect to coverage disputes, the message from the Georgia Supreme Court seems to suggest that insurers should defend under a reservation of rights, if, for no other reason than to create an evidentiary record of facts supporting non-coverage, and prevent their insureds from colluding with plaintiffs to fashion an agreement establishing the plaintiff’s stipulated judgment as a “covered loss” under the policy. 

            The potentially devastating ramifications of an insurer’s failure the defend its insured under reservation of rights, and its consequential loss of control over the litigation is demonstrated in the case of Yeomans & Associates Agency, Inc. v. Bowen Tree Surgeons, Inc., 274 Ga. App. 738, 618 S.E. 2d. 673 (2005).  In Yeomans, the insured company held a general liability policy which specifically excluded coverage for bodily injury caused by any automobile owned or operated by the insured.  The policy defined “insured” to include the named insured’s employees acting within the scope of their employment.  The plaintiff was injured in an automobile collision with an off-duty employee of the insured.  The plaintiff sued the insured employer, inaccurately alleging that the employer was liable under a master/servant theory because the employee was in the scope of his employment while operating the vehicle.  No defense was provided to the insured, and following the entry of a default judgment against the insured employer, suit was brought against the insurer.  The insurer’s defenses against coverage were: 1) that the policy contained a specific exclusion for claims arising out of the insured’s use of an automobile, and 2) that there could be no master/servant liability because the employee was not within the scope of his employment when the accident occurred.

            Notwithstanding the policy defenses, the Georgia Court of Appeals determined that there was coverage under the policy.  The Court explained that because the evidentiary record in the coverage litigation contained undisputed proof that the employee was not acting within the scope of his employment, he could not be considered an “insured” for purposes of the policy’s automobile exclusion, which exclusion only applied to employees acting within the scope of their employment. 

            In dismissing the insurer’s second defense, the Court noted the distinction between an insurer’s duty to pay and its duty to defend, and held that “the issue of whether (the insured) was actually liable to (plaintiff) for (the employee’s) negligence under respondeat superior is irrelevant to the question of whether (the insurer) was obligated to defend (the insured) . . .” Therefore, the fact that the evidentiary record in the coverage litigation contained undisputed proof that the employee was not acting within the scope of his employment was irrelevant to the issue of the insurer’s liability to the insured, since the judgment had already been entered and liability fixed against the insured in the underlying litigation.  The Court noted that if the insurer provided a defense, it could have shown that the employee was not acting within the scope of his employment, and that the insured therefore bore no liability to the plaintiff.  Thus, the Court held that “it was (the insurer’s) duty to seek a favorable decision on its insured’s behalf.” 

            In essence, the Court rejected the insurer’s arguments, reasoning that had the insurer defended the insured under a reservation of rights in the suit against the insured, it could have controlled the litigation and created a record of evidence either proving that the employee was not acting within the scope of his employment (in which case there would have been no liability or judgment against the insured), or that he was acting within the scope of his employment (in which case the policy exclusion would have been applicable).  The insurer’s failure to participate in its insured’s defense resulted in its inability to prevail on its policy defenses, and its liability for a judgment entered against its insured, where its insured was not actually liable to the plaintiff.

            These two relatively recent cases demonstrate the Georgia appellate courts’ message that where a potential coverage dispute exists, insurers should err on the side of caution, defend under a reservation of rights, and seek declaratory relief regarding the coverage dispute.  This method is obviously preferred by the courts, and is safer for insurers because it allows them to control the litigation, and allows them to prevent themselves from being a victim of fraud, collusion and bad faith.