Insurer to Pay Up After Leaving Client in Lurch

CHICAGO (CN) - The 7th Circuit rapped an insurance company for its "unreasonable and vexatious treatment" of an Illinois city that owes $9 million for malicious prosecution and concealment of evidence.

Although the city of Waukegan was covered under law-enforcement misconduct insurance by Scottsdale Insurance from 1989 to 1990 and American Safety Casualty in 2002, neither carrier stepped forward to defend or indemnify it.

Each company claimed it was the other's responsibility to indemnify, leaving Waukegan to its own devices. And, neither carrier bothered to seek a declaratory judgment for noncoverage until after a jury held the city liable for $9 million.

S. Alejandro Dominguez had sued the city in 2004 after DNA evidence exonerated him of a 1990 conviction for home invasion and sexual assault.

A federal judge found that American Safety's policy applied, and ordered it to pay the award to Dominguez and reimburse Waukegan's legal expenses.

Although the city was dismissed as a party to Dominguez's lawsuit, it was still held liable for the judgment against Officer Paul Hendley.

The 7th Circuit affirmed March 16.

"Instead of doing the sensible thing - providing the city with a defense while deciding among themselves, perhaps through arbitration, which was responsible - all of the carriers left Waukegan to its own devices," Chief Judge Frank Easterbrook wrote for three-judge panel.

"American Safety began this proceeding in 2007 under the diversity jurisdiction - against its customer, the city, and rather than against the other carriers to work out which policy or policies applied," the 22-page ruling states.

"Dominguez was arrested in 1989 and prosecuted in 1990; those must be the years of the 'occurrences' under this definition, American Safety and Interstate Indemnity insist," Easterbrook wrote. "But how could 'malicious prosecution' have occurred in 1990 when, as a matter of state law, exoneration is an element of the tort? Hendley's misconduct occurred in 1989 and 1990, but the policy does not define the 'occurrence' as misconduct by a law-enforcement officer. It defines 'occurrence' as the tort under state or federal law - and, in both bodies of law, the tort occurs when its last element comes into being. For misconduct that causes imprisonment, that final element is exoneration, which happened in 2002."

Delay harms both the insurers and their customers, the court noted.

It also rejected American Safety's claims that it did not have to defend the city until legal expenses exceeded the $100,000 deductible.

"Waukegan's legal bill in the Dominguez suit exceeded $1 million, so it must have incurred $100,000 in fees long before the trial, yet American Safety still refused to defend it," Easterbrook wrote, adding: "Doubtless a policy could be written to postpone the defense obligation until the deductible has been paid out."

"What sense would it make for an insurer to put defense off until the insured has retained and paid a team of lawyers to undertake the tasks?"

American Safety argued that its policy did not apply because Waukegan's legal team flubbed the defense.

"It comes with ill grace for an insurer that steadfastly refused to defend its customer to insist that it is relieved of liability because the insured erred in conducting a defense that was thrust upon it," the court noted.

The federal appeals court affirmed dismissal of the claim against Scottsdale Insurance. Waukegan was required to notify Scottsdale immediately after a claim was made, but it did so two years later, which is the time it took for the city to locate the policy.

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