Insurer cannot pay insured's adversary to replead covered claims as uncovered.

Addressing a "novel but potentially quite important issue of insurance law," the Seventh Circuit Court of Appeals has ruled that an insurer acted in bad faith when it paid a company that sued its insured to replead covered claims as uncovered. (Lockwood Int'l, B. V. v. Volm Bag Co., 273 F.3d 741 (7th Cir. 2001), reh'g denied (Jan. 11, 2002).)

"The case is an important precedent for reining in rogue insurer practices and [safeguarding] the basic rights of insureds to receive more than illusory protections when they buy insurance," said Robert Gegios, a Milwaukee attorney who represented the insured.

The case involved a product-disparagement suit brought by a foreign manufacturer, Lockwood International, against its North American distributor, Volm Bag Co. Volm's commercial liability policy with North River Insurance Co. covered some of the claims in the complaint but not others.

Four years into the suit, North River paid Lockwood $1.5 million to amend its complaint to convert covered claims to uncovered claims. The trial court then ruled that North River had no further duty to defend Volm.

Reversing, the Seventh Circuit found that the insurer "tried to shuck off its responsibility to pay for its insured's defense." Writing for the court, Judge Richard Posner said the insurer "sat down with its insured's adversary to contrive a complaint that would eliminate any remaining contractual obligation of the insurance company to defend the insured."

The court acknowledged that limits on the types of claims an insurance policy covers create a conflict of interest between an insurer and an insured. While the insured seeks to maximize coverage under the policy, the insurer wants to minimize it. Here, the court found, "the insurer yielded to this conflict, in effect paying its insured's adversary to eliminate the insured's remaining insurance coverage."

Posner noted that an insurer can legitimately terminate its duty to defend by settling covered claims with the insured's adversary. However, he emphasized, "North River did not merely settle covered claims; as part of the settlement, it paid Lockwood to convert some of the covered claims to uncovered claims. That was not dealing in good faith with its insured."

Posner said, "We have difficulty imagining a more conspicuous betrayal of the insurer's fiduciary duty to its insured than for its lawyers to plot with the insured's adversary a repleading that will enable the adversary to maximize his recovery of uninsured damages from the insured while stripping the insured of its right to a defense by the insurance company."

Gegios and his cocounsel, Christopher Mammel and Michael Childress, both of Chicago, believe that the court used such strong language in rebuking the insurer's conduct to send the message "that such a betrayal of an insured and renunciation of the fundamental duties owed by an insurer will not be condoned," Gegios said.

John Budlong, an Edmonds, Washington, attorney who practices insurance law, also hopes that the court's opinion will deter other insurers from similar actions. "One would hope that this decision makes it less likely that an insurer will try this in the future," he said. "This was an obvious case of collusion between the claimant and the insurer against the insured, and the court predictably found insurer bad faith."

The Seventh Circuit remanded the case to the district court.