Seventh Circuit Fills Gap in Case Law Regarding Settlement Apportionment in Insurance Coverage Claims

On July 1, 2010, in the case of Santa’s Best Craft, LLC v. St. Paul Fire and Marine Ins. Co., 611 F.3d 339 (7th Cir. 2010), the U.S. Court of Appeals for the Seventh Circuit rendered a decision establishing Illinois precedent on allocation of insurers’ liability based on covered and uncovered claims in cases in which it is possible that none of the settlement was attributable to the dismissal of claims for damage covered by the insurer’s policy.  The court held that “the proper inquiry is whether the claims were not even potentially covered by the insurance policy.”  The Seventh Circuit predicted that Illinois courts would determine whether a “primary focus” of the settled claims was a potentially covered loss, the burden of which is on the insured.  On the other hand, the court found that if the insurer can establish that the claims were not even potentially covered, then the insurer would not be required to reimburse the insured for the settlement.

In Santa’s Best, the insured was sued for allegedly copying another company’s Christmas light packaging and using false and deceptive advertising language.  Following this lawsuit, the insureds requested that their insurer, St. Paul Fire, provide a defense.  St. Paul Fire argued that there was no coverage and subsequently filed a counterclaim for declaratory judgment.  The U.S. district court held that the insurer had a duty to defend, causing St. Paul Fire to tender substantial funds to the insured for its litigation expenses.  The court agreed, however, with St. Paul Fire in that it was not obliged to cover the insured’s contract indemnitee’s defense costs or to reimburse the insured for settlement funds that resolved the underlying action.  The court also denied the insured’s request for prejudgment interest.  Each party appealed.

On appeal, the Seventh Circuit reversed the district court in part, finding that based on the substance of the allegations of the underlying complaint against the insured, the suit included at least one covered claim.  It agreed with the district court that the insurer had a duty to defend but failed to meet its burden to prove that certain exclusions applied.  The court also agreed that the district court properly refused to require St. Paul Fire to reimburse the insured for its third party indemnitee’s expenses, but remanded for further proceedings to determine whether the primary focus of the underlying action was a covered loss, and to resolve whether St. Paul Fire owed prejudgment interest on litigation expenses and reimbursement for the settlement expenses.  To access the Seventh Circuit’s opinion, please visit:

http://www.ca7.uscourts.gov/tmp/1C0SC2UV.pdf

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