Insurance policyholders have for years had the ability under Illinois common law to point to one insurer and demand that the selected insurer provide a defense to it and to indemnify it for claims made against it. This rule is known as the "exclusive tender" or "targeted tender" rule, and it allows policyholders that have coverage under policies issued by more than one insurer to choose which of the insurers must defend and indemnify it. The result of such a selection by the policyholder is that all other insurers that may have owed the policyholder coverage are fully released from all obligations those insurers had under their policies. A second result of such a selection by the policyholder is that the selected insurer is barred from seeking equitable contribution from any other insurer to whom the policyholder did not make a tender.
One issue not yet addressed by Illinois courts, or by the United States Supreme Court, is whether the exclusive tender rule withstands constitutional scrutiny under both the Illinois Constitution and the Constitution of the United States. An insurance contract is a private contract between a policyholder and his or her insurance company. The policyholder seeks to shift certain insurable risks to the insurance company, which in turn charges the policyholder a fee, or premium, to undertake these risks. The duties and obligations of both the policyholder and the insurer are memorialized in the insurance contract, as are the terms and conditions of the coverage afforded to the policyholder. The policyholder may expand or limit the scope of coverage afforded under the insurance contract through the use of endorsements and riders. The insurance contract and any endorsements attached thereto constitute the entirety of the agreement between the parties.
The Illinois Constitution and Constitution of the United States afford Illinois citizens, including policyholders and insurance companies, the guarantee that their private contracts will be free from legislative and judicial interference except in certain limited circumstances. The question remains unanswered whether the "exclusive tender" rule in Illinois passes constitutional muster.
The "exclusive tender" rule was first recognized by the Illinois Appellate Court in the case of Institute of London Underwriters v. Hartford Fire Insurance Co.1 In that case, a contractor’s insurer brought an action against a comprehensive general liability (CGL) insurer for a project owner, seeking a declaration that the CGL insurer was liable to pay 50% of a settlement procured by the contractor’s insurer involving a claim by the contractor’s employee against the project owner which had been named as an additional insured under the contractor’s policy. The Appellate Court held that when two insurance policies potentially apply to a loss, the insured may elect which insurer is to defend and indemnify the claim by tendering its defense to one insurer and not the other, thereby foreclosing the settling insurer from obtaining contribution from the non-settling insurer. The court reasoned:
Great Lakes had bargained with Thatcher to be an additional insured in its liability policy for the construction project Thatcher was to perform on Great Lakes’ premises. Great Lakes did not tender its defense to Hartford because it concluded it was not responsible for the accident resulting in the death of Thatcher’s employee, Garcia, and that Thatcher’s insurer, the Institute, was the appropriate carrier to respond to the Garcia claim. Great Lakes may well have feared that if the loss were attributed to its policy with Hartford the result might be a rise in premiums or cancellation of its policy. This factor alone suggests the insured ought to have the right to seek or not to seek an insurer’s participation in a claim as the insured chooses when more than one carrier’s policy covers the loss.2
To support its holding that the policyholder has the right not to seek an insurer’s participation in a claim, the court looked to a decision by the United States Court of Appeals for the Seventh Circuit in Hartford Accident & Indemnity Co. v. Gulf Insurance Co.3 In that case, the court held that an insurer’s defense obligation was triggered only when the insurer had knowledge that its assistance was desired. The court reasoned as follows:
Mere knowledge that an insured is sued does not constitute a tender of a claim. What is required is knowledge that the suit is potentially within the policy’s coverage coupled with knowledge that the insurer’s assistance is desired. An insurance company is not required to intermeddle officiously where its services have not been rendered.4
More recent Illinois cases have held the same view. For example, in Bituminous Casualty Corp. v. Royal Insurance Co.,5 the Illinois Appellate Court upheld the insured’s right to target one insurance policy over another for its defense. The court held the targeted insurer, Bituminous Casualty, could not seek equitable contribution from the other insurer, Royal Insurance, which was not designated by the insured.6 The court rejected Bituminous Casualty’s argument that the "other insurance" clauses found in both policies preserved Bituminous Casualty’s right of equitable contribution against Royal Insurance. To support its ruling, the court reasoned as follows:
It is only when an insurer’s policy is triggered that the insurer becomes liable for the defense and indemnity costs of a claim and it becomes necessary to allocate the loss among co-insurers. The loss will be allocated according to the terms of the "other insurance" clauses, if any, in the policies that have been triggered. As discussed above, Royal’s policy was not triggered and its obligation to defend and indemnify Johnson Construction… was excused by the targeted tender to Bituminous.7
In a more recent ruling, the First District afforded policyholders an additional extra-contractual benefit. In Alcan United, Inc. v. West Bend Mutual Insurance Co.,8 the court held that the policyholder could withdraw its exclusive tender to one insurer and then make an exclusive tender to another insurer. It follows under the Alcan court’s ruling that the first insurance company was relieved of its obligation to the policyholder and that the insurer to which the second exclusive tender was made was now precluded from asserting an equitable contribution claim against any other insurance policy that otherwise would have afforded the policyholder coverage. The court concluded that it could do so:
Under the reasoning and policy considerations of… Institute of London… giving the insured the option to choose coverage, the insured also should be permitted to deactivate coverage with a carrier previously selected for purposes of invoking exclusive coverage with another carrier. This should be true, particularly, when the deactivation occurs upon the discovery of other coverage not known to have been in existence at the time the first tender took place. Thus, as Alcan never chose contemporaneous coverage under the policies issued by West Bend and Reliance, and as coverage under Reliance’s policy was deactivated before coverage under West Bend’s policy was sought, there was no "other insurance" upon which West Bend could seek contribution.9
In John Burns Construction Co. v. Indiana Insurance Co.,10 the Illinois Supreme Court concluded that an insured could make a selective tender for defense, as expressed in a written letter, thereby precluding contribution rights of the selected insurer. And in Richard Marker Associates v. Pekin Insurance Co.,11 the Second District made clear that an insured can effectively withdraw a tender of defense from one insurer and thereby preclude the purported contribution rights of the selected insurer. Where a defendant is insured by more than one insurance company, it can choose which policy it wishes to respond to the claim or lawsuit. Thus, once an insured has instructed an insurer not to involve itself in the defense or indemnification of a claim, that insurer is relieved of its obligation to the insured with regard to that claim.
The benefit of these cases to policyholders is that they have gained certain rights not afforded to them in the terms and conditions of the policy itself. These rights include the ability to target one policy over another to respond to a claim or loss and the ability to withdraw that exclusive tender made to one insurer and then to make an exclusive tender to a second insurer. The impact of these cases to insurers is that they are unable to enforce certain provisions in the insurance contract, specifically the "other insurance" clause and provisions permitting insurers to seek equitable contribution from other insurers.
III. The Exclusive Tender Rule’s Potential Conflict With The Constitution
For nearly a century, the Illinois Supreme Court has prohibited any governmental act impairing the contractual rights of private citizens. In 1911, in the case of Walker v. Lovitt,12 the court clearly stated that the Illinois Constitution provides a constitutional right to enter into private contracts without interference from Illinois governmental bodies:
Any unilateral alteration of a private contract by an Illinois court would deny to the parties to the contract the equal protection of the laws and abridge their privileges as citizens of the United States, and deprive them, without due process of law, of the liberty of making contracts outside of the state in regard to their property.. 13
The United States and Illinois Constitutions guarantee that persons and corporations are free to enter into contracts and to be subject only to those terms and conditions that they contemplate and accept. Any unilateral alteration of this contractual relationship violates the Constitution’s guarantees of freedom to contract.
Article I, section 10, of the United States Constitution provides that no state shall pass any bill or law that impairs the obligations of parties to contracts.14 Although no explicit constitutional language protects the sanctity of contract against federal legislation, the United States Supreme Court has held that the Due Process Clause in the Fifth Amendment has essentially the same effect.15 Both federal and state constitutions prohibit the enactment or enforcement of laws impairing the obligations of contracts.16 Article 1, Section 16 of the Illinois Constitution contains the following specific prohibition against any law impairing the obligations of private contracts:
SECTION 16. EX POST FACTO LAWS AND IMPAIRING CONTRACTS
No ex post facto law, or law impairing the obligation of contracts or making an irrevocable grant of special privileges or immunities, shall be passed.
For nearly two centuries, the United States Supreme Court has routinely declared invalid governmental acts that substantially impair or affect the contractual rights of parties.17
Generally, any judicial or legislative act that attempts to make material alterations of the character, terms or legal effect of existing contracts is clearly void.18 Of this character are acts that attempt to add a material condition or provision to a contract and those which attempt to release stipulations therein.19 It may be said that an act impairs the obligations of a contract when it attempts to take from a party a right that he is entitled to by its terms.20 Thus, judicial action or legislation which attempts to make material alterations in the character, terms or legal effect of an existing contract impairs the obligations of that contract.21 Furthermore, all judicial and legislative acts that impose added conditions or duties on parties to a contract are void if they produce a change in the obligations or substantial rights of the parties.22 Other material alterations that would impair the obligations of contracts are those that alter the extent of liability under a contract or which empower courts to rewrite contractual agreements substantially.23
A basic and cherished principle in this nation is that the right of parties to structure contracts in accordance with their wishes and expectations is protected under our Constitution.24 If the freedom to contract under the Constitution is to retain any meaning at all, it must be understood that it does impose limitations upon the power of legislatures, and courts for that matter, to abridge existing contractual relationships.25 This constitutional guarantee is not limited to individuals. Commercial parties are also afforded constitutional protections to enter into contracts freely and to accept only those terms and conditions that they desire to undertake.26
A mixed message may be sent to insurance companies and their policyholders in Illinois about how far courts may go to re-write an otherwise unambiguous private insurance contract. Furthermore, should the exclusive tender continue to be the law in Illinois, individuals and corporations in Illinois will be forced to enter into private contracts with a significant degree of uncertainty as to whether their duties and obligations under their contracts will be changed without warning at some point by the courts in Illinois.
The right to contract freely is not absolute. There are certain limited and exceptional circumstances where a legislature or court may alter private contracts and such alterations will withstand constitutional challenge. The first exceptional circumstance where a private contract’s terms and conditions may be altered is where the parties to the contract affected by the modification give their consent to such alteration.27 In each case discussed above, there were no facts to suggest that the policyholders or insurers consented to the wholesale modifications to the policies effectuated by the trial and appellate courts to create and exclusive tender.
During periods of emergency, alterations are sometimes authorized and held not unconstitutional as an impairment of the contractual obligation.28 Again, the records of the cases discussed above contain no evidence that any pressing emergency warranted any narrowing of the "other insurance" provisions in each of the policies at issue. In the absence of any such exigent circumstances, the "emergency" exception clearly did not appear to apply so as to constitutionally justify the trial and appellate courts’ rulings in those cases.
Private contracts may also be altered where the interests of the public welfare are at stake. Again, the record is completely devoid of any allegation that the trial and appellate courts’ rulings were based on the interests of preserving and protecting the public interest and welfare.
The exclusive tender rule must be examined in the context of constitutional guarantees of the right of policyholders and insurers to contract freely. If courts are permitted to unilaterally modify the rights and obligations of parties to private contracts, a mixed message will be sent to policyholders and insurers in Illinois about how far a court may go to re-write an otherwise unambiguous private insurance contract. Furthermore, individuals and corporations in Illinois and across the nation are now forced to enter into private contracts with a significant degree of uncertainty as to whether their duties and obligations under their contracts will be changed without warning at some point in the future by a court.
1 234 Ill.App.3d 70, 599 N.E.2d 1311 (1st Dist. 1992).
2 Id. at 78-79, 599 N.E.2d at 1316.
3 776 F.2d 1380 (7th Cir. 1985).
4 Id. at 1383.
5 301 Ill.App.3d 720, 704 N.E.2d 74 (3rd Dist. 1998).
6 Id. at 723, 704 N.E.2d at 76-77.
7 Id. at 726, 704 N.E.2d at 79.
8 303 Ill.App.3d 72, 707 N.E.2d 687 (1st Dist. 1999).
9 Id. at 83, 707 N.E.2d at 695.
10 189 Ill.2d 570, 727 N.E.2d 211 (2000).
11 318 Ill. App. 3d 1137, 743 N.E.2d 1078 (2nd Dist. 2001).
12 250 Ill. 543, 549, 95 N.E.2d 631 (1911).
13 See, e.g., Allgeyer v. State of Louisiana , 165 U. S. 578 (1897).
14 U.S. Const. art. I. See also Tidal Oil v. Flanagan, 263 U.S. 444 (1924).
15 Lynch v. United States, 292 U.S. 571 (1934)(invalidating Congressional attempts to cancel certain types of insurance policies).
16 Superior Motors, Inc. v. Winnebago Indus., Inc., 359 F.Supp. 773, 777 (D.S.C. 1973).
17 See generally Perry v. United States, 294 U.S. 330 (1935); New Jersey v. Wilson, 11 U.S. 164 (1834); College v. Woodward, 17 U.S. 518 (1819); Fletcher v. Peck, 10 U.S. 87 (1810).
18 16A C.J.S. Constitutional Law § 353 et seq.
20 Superior Motors, Inc., 359 F.Supp. at 773.
21 Id. at 777.
22 Id. See also 16A C.J.S. Constitutional Law § 353 et seq.
24 See generally Hedge v. Evans Financial Corp., 707 F.2d 1566 (D.C.Cir. 1983).
25 See generally Allied Structural Steel v. Spannaus, 438 U.S. 234 (1978).
26 Mellon Bank, N.A. v. Aetna Business Credit, Inc., 619 F.2d 1001 (3rd. Cir. 1980).
27 See generally 16A C.J.S. Constitutional Law §344.
Richard Hodyl, Jr. is a partner with the law firm of Williams Montgomery & John Ltd. and has a national insurance coverage and appellate practice. He regularly represents insurers, policyholders, and national insurance trade associations in complex insurance coverage cases and matters involving cutting edge insurance-related issues.