Characteristic signs of plaintiff-insured collusion, which may work to extinguish an insurer’s obligation to indemnify the insured

When an insurer denies policy coverage for a suit or even issues a reservation of rights and files a declaratory judgment action, the insured occasionally settles directly with the third-party claimant or plaintiff for a specified amount that may only be collected from the insurance proceeds if coverage is found.  Two recent Illinois appellate court actions, discussing an insurer’s duty to defend an insured in separate Telephone Consumer Protection Act (“TCPA”) suits, have addressed the issue of plaintiff-insured collusion as a bar to indemnification under a policy of insurance.  In short, both courts agree on a common sense conclusion: if an insured’s settlement with a third-party plaintiff is more than what a reasonable uninsured would agree to settle for, an insurer may not be required to indemnify the insured.

Central Mutual Insurance Company v. Tracy’s Treasures, Inc.

In Central Mutual Insurance Company, the trial court in a declaratory judgment action denied an insurer’s motion for summary judgment, which alleged that coverage was barred by collusion and fraud in a settlement between the TCPA class action plaintiff and the insured.  The First District Appellate Court affirmed the denial of summary judgment in favor of the insurer, Central Mutual Insurance Company, but noted that pursuant to the Illinois Supreme Court’s decision in Guillen v. Potomac Insurance Co. of Illinois, the settlement may be deemed unreasonable if there is evidence of bad faith, collusion, or fraud by insured. The Court noted that there are no Illinois state court decisions addressing the circumstances under which a settlement will be deemed collusive, but cited to foreign authority as persuasive on the topic:

We recognize that collusion and fraud in the context of settlements negotiated by an insured and an underlying plaintiff are broadbrush concepts and that ‘[a]ny negotiated settlement involves cooperation to a degree.’[…] But a settlement ‘becomes collusive when the purpose is to injure the interests of an absent or nonparticipating party, such as an insurer or nonsettling defendant.  Among the indicators of bad faith and collusion are unreasonableness, misrepresentation, concealment, secretiveness, lack of serious negotiations on damages, attempts to affect the insurance coverage, profit to the insured, and attempts to harm the interest of the insurer. They have in common unfairness to the insurer, which is probably the bottom line in cases in which collusion is found.

 Collusion occurs when ‘the insured and a third party claimant work together to inflate the third party’s recovery to artificially increase damages flowing from the insurer’s breach’ of the duty to defend.

Several factors are relevant to a determination whether a settlement is collusive, including ‘the amount of the overall settlement in light of the value of the case; a comparison with awards or verdicts in similar cases involving similar injuries; the facts known to the settling insured at the time of the settlement;  the presence of a covenant not to execute as part of the settlement; and the failure of the settling insured to consider viable available defenses.

Due to fact questions, the First District Appellate Court in Central Mutual Insurance Company declined to find that the plaintiff and insured colluded, that the settlement was therefore unreasonable and that Central Mutual Insurance Company was not required to indemnify the insured for the settlement amount as a matter of law.  However, the Court noted that “certain facts on the record before us certainly point to a finding that there was not even the illusion of adversity or arms’-length negotiations between counsel for [the class action plaintiff] and counsel for [the insured].”

 G.M. Sign, Inc. v. State Farm Fire & Casualty Co.

In G.M. Sign, Inc. v. State Farm Fire & Casualty Co., the Second District Appellate Court reversed the trial court and ordered summary judgment in favor of an insurer, finding that a policy exclusion precluded coverage under the policy for a TCPA claim.  While it avoided specific reference to “collusion,” the Court chided the reasonableness of the plaintiff-insured settlement and attempts to “plead into possible insurance coverage:”

We doubt whether, under these circumstances, any amended complaint could have triggered State Farm’s duty to defend. In essence, [the plaintiff] was attempting to recharacterize, at the eleventh hour, the class action that it had already litigated and negotiated to settlement, for purposes of obtaining insurance coverage. This is not a strategy that courts should condone. […] Moreover, [the plaintiff] was attempting to trigger State Farm’s duty to defend even though, under the terms of the settlement agreement, [the insured] was guaranteed not to be personally responsible for paying the judgment. Thus, when [the plaintiff] filed the amended complaint, State Farm’s duty to defend was moot. Perhaps this explains why [the insured’s] attorney tendered the amended complaint to State Farm at [the plaintiff’s] suggestion only six days before final approval of the settlement, conspicuously neglecting to attach a copy of the settlement agreement.

Characteristic Signs of Plaintiff-Insured Collusion

Because the facts and potential damages associated with each suit and the settlement negotiations for the same differ significantly, “collusion” is a very fact-specific concept and there is no bright-line test for it.  However, some of the characteristic signs of plaintiff-insured collusion that an insurer may consider are:

  • Settlement agreements predicated upon a release of personal liability against the insured and a settlement that is only collectable from insurance proceeds;
  • Settlement amounts far outside the reasonable or pled damages in a case, and unsupported by jury verdict analysis in the jurisdiction and venue of the underlying complaint;
  • Settlement terms that an insured would normally fight if they were personally liable for the settlement, such as unclaimed funds in a class action settlement automatically converting to cy pres funds rather than reverting back to the insured or exorbitant attorney’s fees for the plaintiff’s counsel;
  • An insured’s decision not to plead or assert through dispositive motion fundamental defenses that could negate all or part of the plaintiff’s allegations or damages;
  • An insured’s decision not to sue or interplead third-parties responsible for the plaintiff’s alleged damages; or
  • Settlement between the plaintiff and insured prior to early and rudimentary discovery in the suit establishing liability against the insured.