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Allocating Insurance Coverage Between Covered And Uncovered Claims

Lawsuits often involve legal claims that are or may be covered under the terms of an insurance policy and claims that are clearly not covered or which might ultimately be determined to fall outside the scope of coverage. Policyholders are entitled to all the coverage provided by their policy, but may not obligate their insurer to pay claims that are not covered. When a lawsuit goes to trial and the facts of a loss are established, an insurer is only obligated to pay if those facts establish that its policy actually covers the loss. See, e.g., Newell-Blais Post No. 443 v. Shelby Mut. Ins. Co., 396 Mass. 633 (1986). Most lawsuits, however, are settled well before trial. In such situation, how can the policyholder and the insurer fairly allocate responsibility between them for the covered and uncovered claims? This is an issue which policyholders and insurers should contemplate and discuss early in the litigation process.

In Massachusetts, an insurance company has a duty to defend all claims made in a lawsuit if a complaint raises the possibility that at least one claim may be covered. Sometimes a policyholder will demand that an insurer settle an entire lawsuit even though it involves some claims which are not covered rationalizing that because the insurer must defend the entire case, it is also obligated to settle the entire case. But the rules governing an insurer’s duty to defend cannot fairly be applied to impose a duty to settle a case involving uncovered claims. An insurer may not be held liable for the settlement of claims not covered by the policy. See, e.g., American Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986). 

Where facts have not been established by a trial, the policyholder generally has the burden to prove that claims underlying a settlement are covered, and to allocate the settlement amount between covered and uncovered claims. See, e.g., Continental Cas. Co. v. Canadian Universal Ins. Co., 924 F.2d 370 (1st Cir. 1991). This burden of allocation can shift to an insurer if it breaches its duty to defend. Where the party with the burden of proof cannot satisfy its burden without resort to speculation or arbitrary characterizations, it may be held responsible for paying the entire settlement.  See, e..g, Liquor Liability Joint Underwriting Ass'n of Massachusetts v. Hermitage Ins. Co.,419 Mass. 316 (1995).  Policyholders and insurers should be motivated by these rules to cooperate in cases involving covered and uncovered claims in order to avoid coverage litigation.

In coverage litigation about allocation of responsibility for the costs of a settlement, the law requires some proof of the facts underlying the settlement. This may include consideration of complaint allegations, arguments advanced by parties in legal memoranda during the course of the case, particulars of claimed damages, or evidence of how the settling parties and their counsel viewed the relative merits of all the claims. A court is empowered to accept whatever evidence is available regarding the intent behind the settlement decision. Because the insurer’s obligation to pay will be based upon the facts inherent in the settlement, it makes great sense for policyholders and insurers to cooperate and freely share this information during a case so that if an opportunity to settle presents they can reach mutual agreement on a fair allocation. This is far better means of resolution than facing the expense and problems inherent in a post facto analysis of a settlement.

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