The Montana Supreme Court issued a decision Thanksgiving week clarifying that when a
policyholder is owed a defense by multiple general liability insurers, all of those insurers must participate in the defense, or risk severe penalties for breaching the duty to defend.  In J&C Moodie Properties LLC v. Scottsdale Insurance Company the court held that Scottsdale Insurance breached the duty to defend its insured in an underlying construction defect action, and was therefore exposed to extra-contractual remedies, despite the fact that the policyholder was defended by another insurer.  In so doing the court clarified precedent that had seemed to suggest that a co-insurer could escape liability for breach of the duty to defend in such situations, and strengthened the hand of policyholders in Montana.

Factual Background:  The insured, Haynie Construction, completed construction work on land owned by J&C Moodie Properties in 2009, during Scottsdale’s policy period.  However, the work had begun in 2008, during the period of a policy issued by Farm Bureau Insurance.  In 2013 Moodie sued Haynie.  Haynie tendered both to Farm Bureau and Scottsdale.  Farm Bureau accepted the defense, but under a full reservation of rights and denial of any indemnity obligation.  Scottsdale denied coverage on the basis of a “designated operations exclusion” that precluded coverage for damage “arising out of operations prior to the inception” of the policy.

The defect litigation evidently did not go well.  In 2015, Haynie and Moodie entered into a stipulated settlement/judgment for over $5 million, with a covenant by Moodie not to execute against Haynie’s personal assets, and an assignment of Haynie’s claims against Scottsdale.  Moodie then sued Scottsdale to collect on the judgment.

Scottsdale responded by admitting that it had a defense obligation, but argued that it had not breached its duty to defend because Farm Bureau had defended Haynie, meaning that Scottsdale’s policy was excess only.  Scottsdale also raised procedural objections to the trial court’s failure to hold a reasonableness hearing on the amount of the settlement and denial of Scottsdale’s request for discovery into the reasonableness of the settlement.

The Montana Supreme Court’s Decision:  On the duty to defend question the court had to deal with precedent that suggested that Scottsdale should suffer no penalty for not picking up the defense.  The court distinguished those prior cases, because in those cases the insured was not demonstrably harmed or “abandoned” when the insurer failing to defend.  By contrast, said the court, Haynie had truly been abandoned by Scottsdale, because Scottsdale did nothing to understand Farm Bureau’s coverage position and played absolutely no role in the underlying case.  If Scottsdale had checked in during the litigation, it would have learned that Farm Bureau was defending under a reservation of rights, was denying any obligation to fund a settlement or pay a judgment, and that the litigation was not going well.  What Scottsdale should have done, according to the court, was participated in the defense and filed a declaratory judgment action to resolve any disputed coverage issues.  Having failed to do that, Scottsdale breached the duty to defend.  As the court put it: “When an insurer defends the insured, it also defends itself against a duty to defend claim.  Scottsdale’s decision to ‘roll the dice’ on its opinion that Haynie was not insured under the policy exposed Haynie, and itself, to great risk.”

Because Scottsdale breached the duty to defend, under Montana law it lost the ability to enforce any contractual limitations on its liability, including exclusions or policy limits, and the amount of the settlement between Haynie and Moodie became the presumptive measure of damages, and that Scottsdale had the burden of proving that it should not have to pay that amount.  (This is what is known as “coverage by estoppel,” which is a feature of Washington law and the law of some other states, but has so far not been accepted in Oregon).

On the procedural objections, however, the court held that Scottsdale was entitled to a hearing on the reasonableness of the settlement, because it had shown that there was at least one factual issue as to the amount of the judgment, and that it was entitled to discovery of evidence that is “relevant to an assessment of the reasonableness of the stipulated settlement” including facts about the “liability and damage aspects of the plaintiff’s claim” and the risks to the policyholder created by Scottsdale’s breach.

In that part of the holding the court relied on another recent case, Tidyman’s Management Services v. Davis (Tidyman’s II), from August 2016, in which the court ordered the trial court to conduct a second reasonableness hearing because the trial court had used what the Supreme Court considered the wrong standard for “reasonableness.”  In Tidyman’s the trial had refused to consider the insurer’s challenges to the merits of the underling case, instead only assessing whether the settlement was based on subjectively reasonable information, in the eyes of the insured and the claimant.  In Tidyman’s II the court rejected that standard, instructing the trial court to evaluate the objective reasonableness of the settlement, but taking into account that the policyholder has been left unprotected by its insurer.  The court also instructed that the trial court must consider all material and relevant evidence, including that introduced by the insurer, even if the insured did not have that information at the time of settlement.  Last week’s Moodie decision provides an important refinement on Tidyman’s II concerning procedural aspects of reasonableness hearings in Montana.

Take-Away:  The Moodie decision further expands on Montana’s already broad duty-to-defend standard, which protects policyholders from unreasonable denials of coverage because of the threat of “coverage by estoppel” if an insurer makes the wrong assessment on coverage.  For example, earlier this year the Ninth Circuit (applying Montana law) held that an insurer who denies coverage via letter based on policy exclusions, but fails to explain in the letter why the exclusions applied, will be deemed to have unreasonably breached the duty to defend even if the denial was based on a good-faith interpretation of the law.  See Dowson v. Scottsdale Insurance, Ninth Circuit No. 12-00015 (unpublished). Overall, Montana law is increasingly coming to resemble Washington law, and diverge from Oregon law, on important principles of liability coverage.  That makes it even more important for companies that do business in multiple states to pay attention to choice-of-law issues, and attempt to apply the law most favorable to coverage, whether through contract language, choice of forum, or litigation strategy.