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When Does a Conflict of Interest Exist Between an Insurer and Its Insured Under Illinois Law?

Under Illinois law, when a conflict of interest exists between an insurer and its insured, the insurer must decline to defend the insured and, instead of participating in the defense, the insurer must pay for independent counsel for the insured. Stoneridge Development Company, Inc. v. Essex Insurance Company, 382 Ill. App. 3d 731, 742 (2nd Dist. 2008). If, however, the insurer goes ahead and defends its insured without disclosing the conflict of interest in its reservation of rights, the insurer will be estopped from raising coverage defenses. Id.

To determine whether a conflict of interest exists, Illinois courts compare the allegations of the underlying complaint against the insured to the terms of the policy at issue. Id. If, after comparing the complaint to the insurance policy, it appears that factual issues will be resolved in the underlying suit that would allow insurer-retained counsel to “lay the groundwork” for a later denial of coverage, then there is a conflict between the interests of the insurer and those of the insured.Id. Put another way, if, in the underlying suit, insurer-retained counsel would have the opportunity to shift facts in a way that takes the case outside the scope of policy coverage, then the insured is not required to defend the underlying suit with insurer-retained counsel. Id. Rather, the insured is entitled to defend the suit with counsel of its choosing at the insurer’s expense. Id.

Wegman v. Admiral Insurance: The Seventh Circuit’s Take on Illinois Conflicts of Interest Law

Last year, the Seventh Circuit interpreted Illinois conflict of interest law in a unique way. In R.G. Wegman Construction Co. v. Admiral Insurance Co., 629 F.3d 724 (7th Cir. 2011), the Seventh Circuit held that, under Illinois law, a conflict of interest exists and an insured is entitled to independent counsel whenever there is a “nontrivial probability” that the verdict in the case will exceed the insurer’s policy limits. The rule articulated by the Seventh Circuit in Wegman goes further than any Illinois state court previously had gone with respect to determining whether a conflict of interest exists between an insurer and its insured.

Recent Northern District Decision Confirms that Insureds Can Gain Access to the Federal Court and the Wegman Holding

In a recent decision from the Northern District of Illinois, Addus Healthcare, Inc. v. Auto-Owners Insurance Company, 2011 U.S. Dist. LEXIS 124938 (N.D.Ill. 2011), the insured brought a declaratory judgment action against Auto-Owners in federal court. Auto-Owners had been defending the insured in an Illinois state court case. In the underlying case, one of the insured’s employees was involved in an automobile accident. Two passengers in the vehicle the employee was driving were seriously injured, one fatally. The surviving passenger, the deceased passenger’s estate and the deceased passenger’s widow filed suit against the insured and its employee.

The Auto-Owners policy had limits of $100,000. According to the insured, the potential for a verdict or settlement in the underlyingcase far exceeded the Auto-Owners’ $100,000 policy limit. Since there was a “nontrivial probability” of an excess verdict, the insured contended that a conflict of interest existed and demanded that Auto-Owners provide it with independent counsel of its own choice. Auto-Owners refused and stated that if the insured wanted independent counsel in the underlying case, it would have to pay for it itself. As a result, the insured filed a declaratory judgment action against Auto-Owners in federal court, relying on the Wegman decision.

In an effort to avoid the effects of the Wegman holding, Auto-Owners filed a Motion to Dismiss, claiming that the insured had failed to meet the “amount in controversy” requirement for diversity jurisdiction under 28 U.S.C. § 1332. Pursuant to 28 U.S.C. § 1332, the amount in controversy in diversity cases must exceed $75,000. Auto-Owners claimed that there was no pecuniary component to the insured’s request for a declaration from the court that a conflict of interest existed with respect to the insured’s defense in the underlying case.

The insured claimed that the fees that it was forced to pay to its retained attorneys because Auto-Owners refused to acknowledge the conflict of interest, and appoint independent counsel on its behalf satisfied the amount in controversy requirement. The insured’s proof came in the form of an affidavit provided by one of its attorneys working on the underlying suit, stating that the amount billed, plus the amount likely to be billed would exceed $75,000.

Auto-Owners responded that even if there was a pecuniary component to the insured’s declaratory action, if the insured prevailed in the declaratory action, Auto-Owners would discharge the law firm that was currently defending the insured in the underlying suit. Auto-Owners would also turn over the defense to the insured’s independent counsel, and the difference between what Auto-Owners is paying the current defense firm and what it would pay independent counsel did not exceed $75,000.

The court held that the amount in controversy requirement can be assessed from either the defendant’s or the plaintiff’s viewpoint. As such, even if it were true that the difference between what Auto-Owners would pay the two law firms did not exceed $75,000, the point was moot because the amount in controversy requirement can be assessed from solely the insured’s viewpoint. The court further held that the insured can satisfy its burden of proving the “amount in controversy” requirement if it shows, by a preponderance of the evidence, that regardless of how much a declaratory judgment in its favor would cost Auto-Owners, it is worth more than $75,000 to the insured.

The court stated that the fees attested to by the insured’s retained counsel were “eminently reasonable” given that the state lawsuit was an accident case involving one fatality and one serious injury. Therefore, since a declaration in the insured’s favor would result in Auto-Owners rather than the insured paying the independent counsel’s fees, the pecuniary consequences to the insured $75,000.

Finally, Auto-Owners argued that the fees that were incurred (or were to be incurred) by independent counsel in the state case after the federal declaratory judgment action was filed should not be counted toward the jurisdictional minimum. The court rejected Auto-Owners’ argument by confirming that “in a suit seeking a declaration regarding insurance coverage in an underlying lawsuit, the expense of providing legal defense in the underlying lawsuit counts for purposes of § 1332.”

Conclusion

As long as Wegman stands without being challenged by an Illinois appellate court, insurers must be aware of the risk they face if they fail to appoint independent counsel when there is a substantial risk of an excess judgment.

Further, the Addus Healthcare v. Auto-Owners Insurance case is important because it shows that in cases where (a) an insured claims that a conflict of interest exists under Wegman, (b) the insurer refuses to appoint independent counsel, and (c) there is diversity of citizenship between the insurer and the insured, an insured can base the “amount in controversy” requirement solely on independent counsel attorneys fees that have been (or will be) incurred in the underlying case. In cases where the limits of the policy are relatively low, this is not a difficult hurdle for the insured to clear to gain access to the federal court and avail itself of the Wegman holding.