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November 2012

Ryan v. National Union: Insureds Seek Consequential Damages for Breach of the Duty to Defend

Insurance policies, because they are contracts, are in general subject to a state’s full body of contract law.  Due to the unique character of insurance policies, however, the law governing them has developed a large number of rules and doctrines that differ from, and in some cases supplant, general contract law.  In Connecticut, one of these “insurance only” contract rules is the measure of damages where an insurer breaches its duty to defend.  In such cases, the policyholder is entitled to collect the amount of any settlement or judgment against it up to the limit of the policy, plus attorney’s fees incurred in defending the claim.  Generally, at least in the absence of bad faith, the insured’s claim is thus limited to amounts that, absent the breach of the duty to defend, would have been available under the policy for liability and defense.  The insureds in Ryan v. National Union are seeking to push that limit.

The current state of the law dates back to 1967, when the Connecticut Supreme Court handed down its decision in the seminal case of Missionaries of the Company of Mary, Inc. v. The Aetna Casualty and Surety Co., 155 Conn. 104, 230 A.2d 21 (1967).  In a holding that came to be known as the “rule of the Missionaries case,” the court stated that where an insurer is found to have breached its duty to defend, it may not thereafter rely on the terms of the policy to contest its indemnity obligation.  The court thus found that the insured was entitled to collect the full amount of its settlement, plus attorneys fees and expenses associated with the underlying action.  Shortly after the rule of the Missionaries case was established, it was expanded and clarified to also include “the amount of a judgment obtained against the insured up to the limit of liability fixed by its policy.”  Keithan v. Massachusetts Bonding Ins. Co., 159 Conn. 128, 139, 267 A.2d 660 (1970).

The Missionaries rule means that where a claim is even possibly covered, thus triggering the insurer’s broad duty to defend, an insurer that fails to defend will not be able to later argue that it has no indemnity obligation if the actual facts of the case (as developed at trial, for example) demonstrate that the claim is not covered.  The question of indemnity is foreclosed.  Until recently, insured claimants in Connecticut generally have not explored the issue of whether, by fixing the available categories of damages, the courts have excluded other traditional types of contract damages, including consequential damages.  In several other states, consequential damages – that is, losses that flow indirectly from the breach – are available in connection with an insurer’s breach of the duty to defend.  Such damages are available, for example, in Colorado (Bainbridge, Inc. v. Travelers Cas. Co. of Connecticut, 159 P.3d 748 (Colo.App. 2006) and Kansas (Miller v. Westport Ins. Corp., 200 P.3d 419 (Kan. 2009). 

While Connecticut state courts have yet to address the question, the United States District Court for the District of Connecticut has taken on the issue at least twice.  In the case of City of West Haven v. Liberty Mut. Ins. Co., CIV. No. N-87-68, 1989 WL 190242 (D.Conn. June 1, 1989), the court initially announced that “[d]amages for wrongful refusal to defend a claim include the negotiated or adjudicated amount of the claim, the insured’s expenses in resisting the claim and any additional loss legally traceable to the breach in order that the insured may be made whole.”  Subsequent to that statement, however, the court ultimately decided that additional amounts sought by the insured could only be had on a showing of bad faith – not merely by demonstrating a breach of the duty to defend. 

More recently, in Ryan v. National Union, 03-CV-0644, 2010 U.S. Dist. LEXIS 103563 (Sept. 28, 2010), the insureds alleged that the defendant insurer improperly failed to defend them for certain securities claims brought against them by a former client.  After judgment was entered against the insureds in the underlying case, they brought an action seeking damages for, inter alia, breach of the duty to defend.  The trial court found that the insurer had indeed breached its duty to defend and allowed the jury to consider consequential damages for harm to the insureds’ reputations and for loss of income.  (These claims were based at least in part on the fact that the insurer ultimately had provided a defense, but not before one of the insureds had appeared in the underlying case and allegedly compromised the defense of the case.  The insureds claimed that the resulting negative trial result was caused by the insurer’s refusal to provide counsel from the start and contributed, according to the insureds, to their loss of reputation and income).  

In its decision to allow the jury to consider consequential damages, the district court relied almost exclusively on out of state law, reflecting the unsettled nature of this question in Connecticut.  As of November 2012, the decision was on appeal to the Second Circuit and that court had certified the question of consequential damages to the Connecticut Supreme Court as an important and unresolved issue under Connecticut law. We will continue to monitor developments related to this important question.  Because the issue remains undecided in a number of other jurisdictions as well, a dispositive decision from Connecticut’s highest court could reach far beyond the borders of Connecticut.