Insurance Coverage Quarterly: Summer 2007

We are pleased to present another issue of the Momkus McCluskey Insurance Coverage Quarterly newsletter. The purpose of this newsletter is to provide a summary of some recent significant Illinois decisions addressing insurance coverage issues. As only a brief summary can be set forth herein, the reader is urged to seek legal advice on insurance coverage issues. Please feel free to distribute this newsletter to others in your company and retain it for future reference. We hope you find this newsletter useful for your insurance coverage needs, and encourage you to contact us with any questions.

630-434-0400 Ext. 120, jmarsh@momlaw.com

New Twist by Car Dealers and Their Insurers - Calling a "Loaner Car" a "Rental" Car.
We recently assisted an insurer in a claim involving a car dealer, which included a new twist.

In order to attempt to avoid providing any coverage to customers provided a "loaner car" while their vehicle is being repaired, car dealers are now using a "rental" agreement. The vehicle is "rented" at no charge and there is no reference to the "rental" vehicle being a "loaner" car. In this way, car dealers are attempting to avoid the requirement to provide the sole primary liability coverage where the customer's liability limits are less than the 100/300/50 minimums required for new and used car dealers.

Comment. This new tactic should not prevail. The car dealer can call a loaner car a rental car, but that does not make it so. Simply, if the car fits within the statutory definition of a loaner car it is a "loaner" car. If the customer's limits are less than 100/300/50 the car dealer's auto policy should still be solely primary.

Update on "Step-Downs" - State Farm v. Farmers Argued in the Illinois Supreme Court and Senate Bill 1208

In State Farm v. Farmers, the Circuit Court of Cook County found that "step-downs," which attempt to reduce the liability limits to the Illinois minimums (20/40/15) from the actual policy limits are void and unenforceable under Illinois law. The First District Appellate Court reversed, holding that step-downs do not violate Illinois public policy. State Farm Mut. Auto. Ins. Co. v. Illinois Farmers Ins. Co., et al, 368 Ill.App.3d 914, 925-26 (1^st Dist. 2006). On behalf of State Farm, we sought and were granted leave to appeal to the Illinois Supreme Court.

The appeal to the Supreme Court was briefed, including the Illinois Trial Lawyers Association (ITLA) filing an amicus brief in support of State Farm's position that step-downs violate public policy. On May 24, 2007 oral argument was held before the Illinois Supreme Court. Mark Monroe argued on behalf of State Farm that step-downs violate public policy, based upon a line of cases beginning with State Farm v. Universal Underwriters, 182 Ill.2d 240 (1998), and the Illinois legislature acquiescing to this line of decisions and previously rejecting step-downs. Mark Monroe elicited chuckles from the Justices when he stated this is likely the first time ITLA and State Farm agreed on any point of law. Farmers continued to argue step-downs do not violate public policy. In response Edward Psenicka argued in rebuttal on behalf of State Farm. A decision is expected from the Illinois Supreme Court in September.

In the meantime Senate Bill 1208 was introduced in the Illinois Senate, which states:

Section 5. The Illinois Insurance Code is amended by adding Section 143.13a as follows:

(215 ILCS 5/143.13a new)

Sec. 143.13a. Coverage for permissive drivers. Any policy of private passenger automobile insurance must provide the same limits of bodily injury liability, property damage liability, uninsured and underinsured motorist bodily injury, and medical payments coverage to all persons insured under that policy, whether or not an insured person is a named insured or permissive user under the policy. If the policy insures more than one private passenger automobile, the limits available to the permissive user shall be the limits associated with the vehicle used by the permissive user when the loss occurs. (Emphasis supplied).

Section 99. Effective date. This Act takes effect January 1, 2008.

Comments. SB 1208 goes well beyond the arguments advanced in State Farm v. Farmers, as that case is limited to requiring the same liability limits only. SB 1208 also includes property damage, UM and UIM, and medical payments coverages. SB 1208 passed unanimously in both the Senate and House, and is expected to be signed into law by the Governor in August 2007. However, SB 1208 is effective on January 1, 2008, and therefore will not be applied retroactively to void step-downs before January 1, 2008. Whether or not step-downs are found void and unenforceable before January 1, 2008 will be decided by the Illinois Supreme Court.

Horizontal Exhaustion v. Targeted Tender - Which Doctrine Prevails?

The Targeted Tender Doctrine. In Illinois, an insured under multiple policies may select which insurer will defend and indemnify it in a claim or suit by selecting one or more insurer to exclusively provide the defense and indemnity and deselecting other insurer(s). Normally, the doctrine of equitable contribution would permit one who has paid the entire loss to be reimbursed from other insurers who are also liable for the loss. See, e.g., Inst. of London Underwriters v. Hartford Fire Ins. Co., 234 III. App. 3d 70, 73 (1st Dist. 1992). However, a proper targeted tender entirely prevents an insurer from obtaining contribution from other insurance policies covering the same loss by designating one insurer to respond to the loss and deselecting other insurers. Id. When an insured deselects another insurer the insurer is then relieved of its obligation to the insured with regard to that claim. Cincinnati Cos. v. West Am. Ins. Co., 183 Ill.2d 317, 326 (1998). Illinois courts have noted that an insured's right to choose which insurer will defend and indemnify it with respect to a specific claim is a "paramount" right. Kajima Constr. Servs., Inc., v. St. Paul Fire & Marine Ins. Co., 368 III.App.3d 665, 669 (1st Dist. 2006); Legion Ins. Co v. Empire Fire & Marine Ins. Co., 354 Ill.App.3d 699 (1st Dist. 2004).

The Horizontal Exhaustion Doctrine. The horizontal exhaustion doctrine, on the other hand, is a principle of Illinois law that "requires the insured to exhaust all primary policy limits before invoking" "true" excess coverage. Kajima, 368 Ill.App.3d at 669, citing Ill. Emcasco Ins. Co v. Continental Cas. Co., 139 III.App.3d 130 (1st Dist. 1985). To the contrary, the vertical exhaustion doctrine "allows an insured to seek coverage from an excess insurer as long as the insurance policies immediately beneath that excess policy ... have been exhausted, regardless of whether other primary insurance may apply." Kajima, 368 Ill.App.3d at 669-70.

Which Doctrine Prevails? The horizontal exhaustion doctrine is at complete odds with the targeted tender doctrine. The Kajima case answered the question of whether the targeted tender doctrine supersedes the horizontal exhaustion doctrine. Id. at 456. According to the Kajima Court the answer is no, at least for now.

In Kajima, Kajima Construction Services was a general contractor that was insured by Tokio Marine & Fire Insurance Company for a building project. Kajima's subcontractor, Midwestern Steel Fabricators, Inc., obtained a commercial general liability ("CGL") insurance policy from St. Paul Fire & Marine Insurance Company for the building project that provided $2 million of primary coverage and $5 million in excess coverage. Kajima was named as an additional insured on Midwestern's CGL policy. During the building project, one of Midwestern's employees, Thomas Jones, was seriously injured. Jones filed a personal injury action against Kajima and Midwestern alleging that his injuries were caused by their negligence. Kajima made a "targeted tender" to St. Paul and notified them that it expected St. Paul to defend and indemnify it in the Jones case. The Jones case settled during trial for $3 million. St. Paul paid its primary policy limit of $2 million and Tokio contributed its primary limit of $1 million to satisfy the settlement.

Kajima and Tokio ("Tokio") filed a declaratory judgment action against St. Paul seeking reimbursement for Tokio's contribution to the settlement. Tokio argued that it was not responsible for Kajima's defense or indemnification because Kajima made a proper targeted tender to St. Paul. Therefore, Tokio argued that "St. Paul alone must respond to the defense and indemnity with both its primary and excess coverage policy limits before Tokio's primary limits are invoked." St. Paul, on the other hand, argued that although Kajima has the right to selectively tender its defense and indemnification to one of several insurers, the horizontal exhaustion doctrine requires that all primary policies be exhausted prior to reaching any excess policy. Id.

Kajima is the first case in Illinois that has addressed and decided whether an insured can target tender its defense and indemnification to an insurer and require that insurer to reach into its excess coverage if the claim exceeds the primary limits before any other primary insurance policy is invoked. The court agreed with St. Paul's argument that Tokio's application of the targeted tender doctrine would "run afoul of well-established principles of Illinois insurance law recognizing differences between primary and excess coverage." Id. at 671. The court agreed that Kajima's application of the targeted tender rule would be an application of vertical exhaustion rather than horizontal exhaustion, "which would be tantamount to ignoring distinctions that this court has previously recognized between primary and excess insurance." Id. The court noted that an excess policy "is unique in that it always remains excess over and above other contracts...and thus [cannot] be activated until all primary coverage is exhausted." Id. (Emphasis supplied), citing Ill. Emcasco Ins. Co. v. Continental Cas. Co., 139 III. App. 3d 130, 487 N.E.2d 110 (1st Dist.1985). Therefore, the Kajima court held that an excess policy cannot be activated through a targeted tender prior to exhausting the insured's other primary coverage first. Kajima, 856 N.E.2d at 458. In other words, the horizontal exhaustion doctrine prevails over the targeted tender doctrine.

Tokio sought and was granted leave to appeal to the Supreme Court of Illinois. Oral argument in the Supreme Court was scheduled on May 24, 2007. However, the oral argument has been rescheduled to September 2007.

Comments. Until the Illinois Supreme Court decides the issue, an insured will be forced to exhaust all of its primary policy limits (horizontal exhaustion) before it can invoke excess coverage, regardless of whether it "target tenders" its defense and indemnification to a particular insurer and regardless of whether it deselects other insurers.

While the horizontal exhaustion doctrine is well-settled in Illinois, so is the targeted tender doctrine, albeit a doctrine unique to Illinois. There are many arguments that the one doctrine should prevail over the other. For example, one issue apparently not considered by the Kajima Court deals with the nature of "true" excess policies and the lesser premiums paid for this excess coverage. The premium in excess policies is based on the liability limits of the primary policy listed in the declarations page. Therefore, the fortuitous event that there is other primary coverage seems to be a "windfall" to the insurer issuing the true excess policy, as the lower premium is based upon exhaustion of the specified policy (vertical exhaustion), not other primary policies.

A second issue the Kajima court seemed not to consider is the effect of the deselection of other primary policies in a proper target tender. A proper target tender involves the complete deselection of some or all other primary policies, rendering those other policies "unavailable". Thus, the "other insurance" provision in the excess policy above the triggered primary policy should not affect the coverage determination. Put another way, the horizontal exhaustion doctrine requires the exhaustion of all "available" primary insurance coverage prior to an excess policy being invoked. If the other primary policies are deselected, they are "unavailable". The Kajima court's failure to recognize this basic principle could result in a conflict between the appellate court districts should another appellate court consider the issue.

The Illinois Supreme Court will clearly decide which doctrine prevails. However, the targeted tender doctrine, which is unique to Illinois and which has been severely criticized in Appellate Court cases and treatises may be revisited and reassessed in general. Indeed, will the Illinois Supreme Court do away with the targeted tender doctrine?

Illinois Supreme Court Adopts the "Cause Theory" to Determine Number of Occurrences

Liability policies generally provide coverage for an "occurrence," as defined in the policy, each of which triggers the policy's coverage independently. The current ISO definition of an "occurrence" is, "...an accident, including continuous or repeated exposure to substantially the same general harmful conditions." However, most policies do not provide explicit language on how the parties are to determine the number of occurrences that arise under the policy.

In Nicor, Inc. v. Associated Elec. and Gas Ins. Services Ltd., et al., 223 Ill.2d 407 (Ill. 2006), the Supreme Court of Illinois applied the "cause theory" test to determine that each of 195 mercury spills, for which Nicor sought insurance coverage, constituted a separate "occurrence" within the meaning of Nicor's liability policy. As such, the policy was triggered 195 times, meaning that Nicor could not obtain indemnification from its insurer for an occurrence unless the amount of damages for that occurrence exceeded the policy deductible or self-insured retention ("SIR"). Nicor's SIR was $100,000 per occurrence and the costs of investigating and remediating each individual mercury spill did not reach that amount. Had the Court determined that the 195 mercury spills amounted to one occurrence encompassing Nicor's general practice of mismanaging mercury, the SIR amount would have easily been reached by Nicor and its insurer would be obligated to indemnify Nicor for the very substantial remainder of damages above the SIR limit.

The other theory applied to the number of occurrences is the effect theory, under which the number of occurrences is determined by the effect of the accident or injury and the number of individual claims that resulted therefrom. Id. at 418.

In deciding to apply the cause theory to determine the number of occurrences that arise under a policy, the Court in Nicor focused on the underlying circumstances that resulted in the injury, rather than each individual claim. In other words, the number of occurrences is determined by the cause of the damages. In joining the majority view, the Court reasoned that the spills themselves gave rise to the claim and that the initiation of the claim or the resulting legal actions are "not the operative "happening," "event," or "accident" giving rise to liability under the policies." Id. at 435. Under the cause theory, when a single, unbroken cause leads to injuries to multiple claimants, a court will find that a single occurrence triggered the policy. For example, the manufacture and sale of a defective product is decidedly a single occurrence. Id. at 430. A court will find multiple occurrences "where each asserted loss is the result of a separate and intervening human act, whether negligent or intentional, or each act increased the insured's exposure to liability." Id. at 431-32. As an example, the court discusses Mason v. Home Ins. Co. of Illinois, 177 Ill.App.3d 454 (3^rd Dist. 1988), where tainted food was served to customers of a diner for a period of three days. The Appellate Court held that each time a customer was served constituted a separate and distinct occurrence within the policy. Id. at 463.

In Nicor, the Court found that the damages were not caused by Nicor's system wide failure to handle mercury safely, but the spills were separate and independent acts that were a result of different individuals' handling of the mercury at different locations. Thus, it was not a single, unbroken act.

Comment. The determination of the number of occurrences that arise under a liability policy may have a significant effect on the availability and amount of coverage owed to the insured, especially where the policy contains a high deductible self-insured retention. The two potential outcomes in Nicor, for instance, either left the insurers owing no duty to indemnify Nicor or, if the Court found that the spills constituted one single occurrence, the insurers would be required to indemnify Nicor in excess of $10.2 million - a startling disparity!

Please feel free to contact James P. Marsh at 630-434-0400 Ext. 120 or jmarsh@momlaw.com with any questions on these and other insurance coverage issues.

The information presented in this newsletter is general in nature and is not intended to provide legal advice. Please contact an attorney before implementing any of the strategies contained herein. If you have received this newsletter in error, or if you wish to be removed from our mailing list, please contact us. Under the Rules regarding Illinois attorneys, this newsletter may constitute advertising.