Most people, including lawyers, do not think about insurance until there has been an accident—either the insured is sued, or makes a claim for a loss. In most instances, the insured notifies the carrier of a loss, and either the insurer defends the insured or pays the insured’s claim. There are, however, occasions when the insurer disputes coverage. If the insurer does so, there are particular steps the insurer must follow so as not to be estopped from raising policy defenses or waive those defenses.
Estoppel in the Context of Third Party Coverage—The Analysis Starts with the Duty to Defend Third party (or liability) insurance coverage provides coverage for claims made by third parties arising from acts of the insured.1 In the context of third party coverage, to determine if an insurer is estopped to deny coverage, it is important to understand the insurer’s duty to defend its insured.
To determine the duty to defend, you must compare the allegations in the complaint with the provisions in the policy.2 The duty to defend is broad. The insurer owes a duty to defend if there are factual allegations in the complaint that even potentially come within the policy’s coverage.3 Furthermore, the insurer must defend the insured even in the allegations against the insured are groundless, false or fraudulent.4 If only one count of a multi-count complaint is covered, the insurer still owes a duty to defend because in Illinois, the duty to defend is not allocated.5
How Estoppel Arises The duty to defend is usually triggered when the insured notifies his insurer of a lawsuit and requests that the insurer defend him, or in other words, tenders the defense to the insurer. In fact, a formal tender is not even necessary since if the insurer has actual notice of the lawsuit, the duty to defend is triggered.6 In the situation where the insurer chooses not to defend due to a defense to coverage, the insurer has two options: defend the insured under a reservation of rights or file a declaratory judgment action to determine coverage.7 If the insurer fails to take either of these steps and is later found to have wrongfully denied coverage, the insurer is estopped to deny coverage.8 The estoppel doctrine “arose out of the recognition that an insurer’s duty to defend under a liability insurance policy is so fundamental an obligation that a breach of that duty constitutes a repudiation of the contract.”9
The very limited exceptions to the estoppel doctrine are: (1) if there is no policy in existence, (2) if the insurer was not given an opportunity to defend, or (3) there clearly was no potential for coverage.10 The first two exceptions are fairly obvious.
The third exception is problematic in that in vast majority of coverage cases, the exact issue to be decided is whether there was a potential for coverage. It is a rare situation where there is no potential for coverage. This is not a risk to take if advising an insurer whether to file a declaratory judgment action to resolve an insurance coverage dispute and avoid estoppel.
The timing of filing a declaratory action is also important. In the context of estoppel, a declaratory judgment action filed after the underlying case has been resolved by settlement or judgment is untimely as a matter of law.11
Peppers Conflict and Estoppel There can be a conflict of interest in the context of the duty to defend when the insurer assigns counsel to defend a case. The Illinois Supreme Court explained this conflict in Maryland Casualty Company v. Peppers, hence the name Peppers conflict.12 A Peppers conflict usually arises where one count of the underling complaint is covered, and one is not. The classic situation is where both negligence and intentional conduct are alleged, since almost all policies exclude from coverage bodily injury intended from the standpoint of the insured.
There is no automatic rule to determine if a Peppers conflict exists. One test is if counsel retained by the insurer would have the opportunity to shift the facts in a way that takes the case outside of the policy’s coverage.13 Another test is when the interest of the insurer would be furthered by a less than vigorous policy defense.14 When a Peppers conflict exists, defense counsel chosen by the insurer has two loyalties: the professional loyalty to the insured, and the business loyalty to the insurer.15 The attorney owes the same professional duties to the insured that would exist if the attorney were privately retained.16 However, the insurer’s chosen attorney may have closer ties to the insurer and a more compelling reason to protect the insurer’s position, thereby creating a conflict of interest.17
In this situation, to avoid estoppel, an insurer has three options: First, the insured could accept the attorney engaged by the insurer after full disclosure by the attorney of the conflicting interests. Second, the insurer could waive its defense of noncoverage under the policy of an intentional injury and defend. Third, absent the first two choices, the insured has the right to be defended by an attorney of his own choice who shall have the right to control the defense of the case.18
The lesson to be learned from all of the above is that if the insurer has a defense to coverage, the insurer cannot simply do nothing and abandon its insured. Illinois law is strict on what steps the insured must take to preserve its policy defenses.
Estoppel and Waiver in the Context of First Party Coverage The concepts of waiver and estoppel are different in the context of first party coverage, which refers to coverage for the insured’s claim against its own insurer. In the context of first party coverage, there is a subtle distinction between waiver and estoppel. As one court explained, “Waiver focuses exclusively on the conduct of the insurer, while estoppel focuses on the conduct of the insured in response to representations made by the insurer.”19
Waiver is a unilateral act by the insurer.20 It can be express or implied. Express waiver is self-explanatory (and an example is cited below). Implied waiver depends on the facts. It has been defined to occur if the insurance company is “advised of the facts bearing on its policy defense and does not then insist on noncoverage but recognizes the continued validity of the policy.”21
To prove waiver, the insured need only show that it would be “unjust, inequitable or unconscionable” to allow the insurer to assert a policy defense.22
Estoppel, on the other hand, requires the insured to show that he was misled by the acts or statements of the insurer or its agent, that he reasonably relied on those representations, and sustained detriment or prejudice based on the reliance.23
The practical difference between waiver and estoppels is prejudice. The insured need not show that he was prejudiced by an insurer’s waiver of policy defences.24
The difference between waiver and estoppel is demonstrated in Lumbermen’s Mutual v. Sykes.25 In that case, Gloria Sykes made a claim to recover for mold damage to her house. The coverage dispute involved whether the mold damage was caused by ice dams on the roof (a covered loss), or by other causes. The court addressed both waiver and estoppel in the context of different conduct by the insurer. In a letter to Sykes, Lumbermen’s stated, “If the cause of the roof damage is due to the ice dams, then there is coverage under the policy to repair the damage to the roof” and that some of the mold was a result of a covered claim. This was express waiver since it was a statement entirely inconsistent with any intention to deny coverage.26 On the other hand, the court held that Lumbermen’s never said anything to indicate that all mold damage was covered, but indicated to the contrary. Nothing in Lumbermen’s conduct suggested an intent to abandon a defense of noncoverage for mold resulting from causes not covered by the policy.
Regarding estoppel, the court held that Lumbermen’s was estopped from raising the defense of noncoverage for a period of time when Lumbermen’s represented that she would be covered and she acted in reliance by authorizing a contractor to begin remediation.27
Reliance, however, must be reasonable, as explained by the Lumbermen’s court. The insured cannot ignore information provided by the insurer which asserts defences to coverage.28
For this reason, the court found that it would be unreasonable for Sykes to conclude that all mold damage was covered when Lumbermen’s made clear in the letter that mold resulting from excluded causes was not covered. In other words, while it may be reasonable for the insured to rely upon a representation of coverage, it would not be reasonable for an insured to continue to believe that a loss is covered when the insurer makes a subsequent representation of noncoverage.
Estoppel Cannot Create Coverage There is one last point to be raised. As a general rule, estoppel and waiver cannot create coverage where no otherwise exists under the policy, or increase policy limits.29 As with every general rule, there is always an exception. The First District of the Appellate Court has held that when an insurer, with actual or constructive knowledge of a defense to coverage defends the insured without a reservation of rights, and later attempts to deny coverage, the insurer is estopped, notwithstanding that coverage for the risk did not exist under the policy.30
Conclusion The concepts of estoppel and waiver are important to consider when an insurer declines to provide coverage to its insured. The lesson to be learned is that the insurer must document coverage defenses and, if required, file a declaratory judgment action to resolve a coverage dispute.
1 Illinois Tool Works, Inc. v. Commerce and Industry Ins. Co., 2011 IL App (1st) 093084, 962 N.E.2d 1042.
2 Stoneridge Development Co. v. Essex Ins. Co., 382 Ill.App.3d 731, 888 N.E.2d 633 (2d Dist. 2008).
3 Stoneridge, 382 Ill.App.3d at 741.
4 United States Fidelity & Guaranty Co. v. Wilkin Insulation Co., 144 Ill.2d 64, 578 N.E.2d 926 (1991).
5 Bedoya v. Illinois Founders Ins. Co., 293 Ill.App.3d 668, 688 N.E.2d 757 (1st Dist. 1997).
6 The Cincinnati Cos. v. West American Ins. Co., 183 Ill.2d 317, 701 N.E.2d 499 (1998).
7 Employers Ins. of Wausau v. Ehlco Liquidating Trust, 186 Ill.2d 127, 708 N.E.2d 1122 (1999).
8 Ehlco, 186 Ill.2d at 150-51.
9 Ehlco, 186 Ill.2d at 151.
10 Ehlco, 186 Ill.2d at 151.
11 Ehlco, 186 Ill.2d at 157. A review of cases discussing the timeliness of a declaratory action filed before the underlying suit was resolved requires another article.
12 64 Ill.2d 187, 355 N.E.2d 24 (1976).
13 American Family Mut. Ins. Co. v. W.H. McNaughton Builders, Inc., 363 Ill.App.3d 505, 843 N.E.2d 492 (2d Dist. 2006).
14 Nandorf v. CNA Ins. Cos., 134 Ill.App.3d 134, 479 N.E.2d 988 (1st Dist. 1985).
15 Nandorf, 134 Ill.App.3d at 137.
16 Nandorf, 134 Ill.2d at 137.
17 Nandorf, 134 Ill.2d at 137.
18 Maryland Cas. Co. v. Peppers, 64 Ill.2d at 198-99.
19 Lumbermen’s Mut. Cas. Co. v. Sykes, 384 Ill.App.3d 207, 890 N.E.2d 1086 (1st Dist. 2008).
20 Lumbermen’s, 384 Ill.App.3d at 219.
23 Lumbermen’s, 384 Ill.App.3d at 224.
24 Chatham Corp v. Dann Ins., 351 Ill.App.3d 353, 812 N.E.2d 483 (1st Dist. 2004).
25 384 Ill.App.3d 207, 890 N.E.2d 1086 (1st Dist. 2008).
26 Lumbermen’s, 384 Ill.App.3d at 221.
27 Lumbermen’s, 384 Ill.App.3d at 225.
28 Lumbermen’s, 384 Ill.App.3d at 228-29.
29 ISMIE Mut. Ins. Co. v. Michaelis Jackson & Assoc., LLC, 397 Ill.App.3d 964, 921 N.E.2d 1156 (5th Dist. 2009); Young v. Allstate, 351 Ill. App.3d 151, 812 N.E.2d 741 (1st Dist. 2004).
30 Nationwide Mut. Ins. Co. v. Filos, 285 Ill.App.3d 528, 673 N.E.2d 1099 (1st Dist. 1996).
Christine McTigue has her office in Wheaton. She concentrates her practice in civil appellate law and insurance coverage matters. Christine is on the panel of neutral commercial arbitrators for the American Arbitration Association, and is a court-certified mediator for the law divisions of DuPage and Cook counties. She received her Bachelor of Arts, magna cum laude, in 1981 from the University of Minnesota; and her J.D. in 1984 from Loyola University of Chicago.