In a case of first impression, the state Superior Court has ruled that when an insurer agrees to defend an insured subject to a reservation of rights, the insured may either accept the insurer's defense and remain bound by a consent-to-settlement clause while allowing the insurer to control the litigation, or furnish its own defense and retain control of the litigation, the costs of which may or may not be covered by the insurer depending on whether those costs are deemed fair, reasonable and non-collusive.

In arriving at this holding, a three-judge panel in Babcock & Wilcox v. American Nuclear Insurers ruled unanimously to reverse an Allegheny County trial judge's ruling that two insurers — American Nuclear Insurers and Mutual Atomic Energy Liability Underwriters, referred to collectively in the court's opinion as "ANI" — must indemnify Babcock & Wilcox Co. for the $80 million plus prejudgment interest it paid to plaintiffs to settle claims over radiation exposure against ANI's protests.

The panel instead ordered a new trial, directing the lower court to determine whether B&W rejected its insurers' defense and whether the insurers' refusal to settle the case or participate in the settlement talks constituted bad faith.

The court was split 2-1, however, on which approach the trial court should apply on remand.

Noting the dearth of Pennsylvania precedent regarding an insurer's obligation to honor a consent-to-settlement clause in an insurance contract when it has agreed to defend an insured subject to a reservation of rights, the majority adopted the approach set forth in the Florida Court of Appeal's 1978 ruling in Taylor v. Safeco Insurance, which held that when an insured settles after rejecting an insurer's defense, the insurer is only obligated to cover the amount of the settlement up to the policy limits if the settlement was "'reasonable'" and not entered into "'in bad faith, fraudulently, collusively, or without any effort to minimize his liability.'"

Writing for the majority in B&W, Judge David N. Wecht said Taylor "provides the standard most consistent with Pennsylvania law."

"We find that the Taylor approach, in providing an insured the option to decline a defense tendered subject to a reservation of rights, but protecting an insurer's right to control the defense when it is accepted by the insured, best balances the interests of insurer and insured, and better honors the binding nature of the insurance contract," Wecht said. "By granting the insured a basis upon which to eliminate the risk of a conflict of interest at the outset of a claim, it does not consign the insured solely to the protection of our strictly-construed bad-faith standard. At the same time, our approach protects an insurer's right to control litigation when it provides a defense."

Wecht was joined by Judge John L. Musmanno.

But Judge Judith Ference Olson penned a concurring and dissenting opinion, stating that while she agreed the case should be remanded for a new trial, she disagreed with the application of Taylor.

"In my view, established and controlling Pennsylvania law compels the conclusion that since ANI tendered a defense subject to a reservation of its rights to contest coverage, B&W remained committed to observe its obligations under the consent-to-settlement clause in the parties' insurance contract unless B&W could establish bad faith on the part of ANI pursuant to our Supreme Court's decision in Cowden v. Aetna Casualty and Surety," Olson said.

The state Supreme Court held in Cowden that an insurer is obligated to accept a settlement within the policy limits when a verdict or settlement within the policy limits is unlikely.

According to Wecht, the B&W case came before the Superior Court once before, in 2002.

At that time, Wecht said, the trial court had ruled, and the Superior Court affirmed, that ANI had a duty to pay for separate counsel to defend the separate interests of B&W and its predecessor Atlantic Richfield Co. against suits alleging injury and property damage caused by radiation emissions from Pennsylvania's Apollo and Parks facilities, referred to in Wecht's opinion as "the Hall action."

B&W eventually settled the Hall action for $80 million over ANI's objection and, in 2009, Allegheny County Court of Common Pleas Judge R. Stanton Wettick Jr. ruled that ANI had no duty to indemnify B&W because B&W was not able to meet its burden under Cowden, according to Wecht.

But in 2011, according to Wecht, Wettick revisited the coverage issue and reversed course on his previous holding, instead finding that the applicable standard was the Superior Court's 1985 ruling in Alfiero v. Berks Mutual Leasing, which held that an insurer has a duty to indemnify an insured for a settlement as long as the settlement was fair, reasonable and non-collusive.

Following a trial in February 2012, according to Wecht, an Allegheny County jury found that the $80 million settlement was fair, reasonable and non-collusive and Wettick subsequently issued an order requiring ANI to indemnify B&W for the settlement.

Wecht, however, ruled that Wettick had erred in ordering a trial focused solely on whether the settlement B&W entered into over ANI's objections was fair, reasonable and non-collusive.

"Instead, the trial should have been directed at determining (1) whether B&W in fact rejected ANI's defense; and, if so, (2) whether ANI acted in bad faith in declining to settle, or, as alleged by B&W, to participate in settlement negotiations with the Hall plaintiffs," Wecht said.

Wecht said that while it appears to be undisputed that B&W did not reject ANI's defense, the case is too complex to determine that without developing more of a record.

With regard to whether ANI acted in bad faith, Wecht said the court would not rule out the possibility that it did.

"Given the exposure to B&W in the ongoing litigation, as amplified by ANI's insistence that it had one or more viable coverage defenses, we leave open the possibility that ANI's refusal to participate in settlement negotiations or accept the $80 million settlement constituted bad faith," Wecht said.

ANI's attorney, Jon J. Hogue of Murray, Hogue & Lannis in Pittsburgh, could not be reached for comment at press time.

Counsel for B&W, Neal Brendel of K&L Gates in Pittsburgh, also could not be reached.

Zack Needles can be contacted at 215-557-2493 or zneedles@alm.com. Follow him on Twitter @ZNeedlesTLI.

(Copies of the 46-page opinion in Babcock & Wilcox v. American Nuclear Insurers, PICS No. 13-1591, are available from The Legal Intelligencer. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.)