Seventh Circuit Finds Policy Limits Cap Insurer’s Exposure On An Excess Verdict Despite Improperly Denying A Duty To Defend

In Hyland v. Liberty Mut. Fire Ins. Co., 2018 U.S. App. LEXIS 6460 (7th Cir. March 15, 2018), the United States Court of Appeals for the Seventh Circuit considered whether a liability insurer could be saddled with the full amount of an excess verdict against its insured when it improperly failed to defend the insured in an underlying suit.  Liberty Mutual issued an automobile policy that covered a vehicle driven by Michiah Risby as well as anyone driving the vehicle with Risby’s permission.  The vehicle was involved in an accident while Miquasha Smith was driving and passenger Monteil Hyland was injured.  Smith asserted that Risby gave her permission to drive the vehicle and therefore claimed insured status under the Liberty Mutual policy, but Risby denied giving her permission to drive. 

Hyland sued Smith, but Liberty refused to provide a defense or indemnify Smith because she was not driving the car with permission and therefore did not qualify as an insured.  Smith defaulted and a judgment was entered for $4.6 million, which was assigned to Hyland to pursue against Liberty Mutual.  Hyland then filed suit against Liberty Mutual in the U.S. District Court for the Central District of Illinois to collect the full judgment.  The district court concluded that Liberty Mutual’s failure to either defend Smith or file a declaratory judgment action violated Illinois law and made it liable for the entire $4.6 million judgment, even though the policy limits were $25,000 per person.  Liberty Mutual appealed.

The Seventh Circuit reversed.  The court first acknowledged that the estoppel theory cited by the district court could not be the basis to impose the excess judgment on Liberty Mutual, as no Illinois court endorsed that result through estoppel.  This was true even though Liberty Mutual conceded that it should have provided a defense to Smith.

The court then evaluated Hyland’s alternative argument that her $4.6 million in damages were approximately caused by Liberty Mutual’s neglect in failing to defend its insured, Smith.  Liberty Mutual argued that such a theory would only be viable if there was a finding of bad faith, as Illinois law is clear that an insurer’s exposure is limited to the policy limits plus $60,000 under Illinois’ bad faith statute (215 ILCS 5/155).  Hyland argued that bad faith was not required, and it could recover from Liberty Mutual simply by showing the underlying judgment was caused by the failure to defend.

The Seventh Circuit recognized that no Illinois court had squarely addressed whether bad faith was a necessary element of the claim for recovery in excess of policy limits, but ruled that it did not need to answer that question as Liberty Mutual’s neglect could not have caused the judgment.  The court found that the facts of the underlying suit made clear that Smith was liable for the accident, and a defense attorney could not have avoided that result.  With respect to the damages awarded in the underlying suit, Hyland did not argue that a defense attorney assigned to Smith could have achieved a result for less than $4.6 million, and in fact argued that was the correct judgment for her injuries.  The court therefore held that because Smith did not have a plausible defense to liability or damages, the $4.6 million judgment was not caused by Liberty Mutual’s failure to defend and the maximum loss caused by the failure to defend was the policy’s $25,000 limit.  The district court’s decision was vacated and remanded.