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May 28, 2019 Articles

The Burden to Allocate Settlement Funds

As social engineering schemes have grown and evolved, so too has the body of case law addressing whether crime coverage policies provide coverage to insureds who fall victim to email fraud

by Christina Culver and Cy Haralson

A common issue that can arise in contentious coverage disputes—especially those with multiple parties and multiple underlying claims—is what to do with settlements that the insured recovers from other parties for the claimed loss or settlements that the insured enters into without the insurer’s participation. A recent case out of the Fifth Circuit, Satterfield & Pontikes Construction, Inc. v. U.S. Fire Insurance Co., showcases a number of issues and arguments regarding a general contractor’s burden to allocate settlements it received from subcontractors between covered and uncovered damages owed to a plaintiff property owner. A number of other recent cases from around the nation highlight basic principles of allocation jurisprudence in the context of an insured seeking indemnity for settlements it has entered into with injured third parties.

Satterfield & Pontikes Construction, Inc. v. U.S. Fire Insurance Co.

In this recent Fifth Circuit case, Satterfield & Pontikes Construction, Inc. (S&P) served as general contractor for the construction of a courthouse for Zapata County, Texas. After construction, Zapata County brought a construction defect suit against S&P that ultimately went to arbitration. The arbitration panel found in favor of the county, finding that S&P failed to build the courthouse in a good and workmanlike manner, in accordance with the proper standards of care and in accordance with the plans and specifications, and failed to properly supervise its subcontractors. The total award, including post-judgment interest, was $8,063,641.78.

S&P initially intended to satisfy $4,492,500 of the award with settlements from its subcontractors and then turn to two primary carriers and an excess carrier, U.S. Fire, to fund the remainder. U.S. Fire objected to that proposed allocation of the subcontractor settlements. As set out in the district court[1] and Fifth Circuit[2] opinions, U.S. Fire argued as follows: Starting with the approximately $8 million award, the insured needed to subtract the uncovered portions of the award, including attorney fees, arbitration fees, prejudgment interest, and excluded mold damage. This left roughly $3,240,000 of potentially covered claims. Because the potentially covered damages were well less than the $4,492,500 in subcontractor settlements plus the $1,000,000 of the primary layer of insurance directly below U.S. Fire’s excess tier, there was no covered loss that implicated U.S. Fire’s policy.

S&P ultimately satisfied the arbitration award judgment with a combination of the $4,492,500 in subcontractor settlements, about $3.1 million from primary carriers, and about $440,000 from S&P itself. S&P and the primaries then sued for reimbursement.

The need for allocation. Applying similar analyses, both the district court and the Fifth Circuit found in favor of U.S. Fire, rejecting S&P’s allocation of the subcontractor settlements. The first question for both courts was whether the settlements had to be allocated at all or whether, as S&P argued, the settlements could be allocated unilaterally to uncovered portions of the award alone.

At the district court, S&P’s core argument against the need for allocation was that the settlements “have no bearing on the retained limit above which the US Fire coverage is triggered. Thus, the retained limit remains at the $1,000,000 limit of the . . . [primary] policy that was exhausted.” S&P relied on the Texas Supreme Court case Lennar Corp. v. Markel America Insurance Co.,[3] which stated that it is “the insured that is in the best position to select coverage among multiple insurers.” Extending that reasoning, S&P argued that “[l]ikewise, if an insured such as S&P is in the best position to allocate damages among its own insurance policies, it is logical for it to allocate those damages among recoveries from other parties.”

The district court rejected this line of argument, finding that S&P’s “offset” theory was not supported by Texas case law. Regarding S&P’s reliance on Lennar, the court stated that the rule allowing an insured to select which policy period to activate was simply not applicable. Rather, the district court explained, “the issue here is whether an insured can round up general settlements from its subcontractors, unilaterally decide that they will be allocated to uncovered damages, and then go after the insurers that would cover the damages if the loss was properly allocated to that policy.” The court summarized its view as follows:

S&P chose not to insure a substantial portion of the risk it carried as the general contractor for this large construction project. Now, after it has suffered an adverse judgment that encompassed both covered and uncovered risks, S&P seeks to leave its insurers on the hook for risks they did not agree to insure. This theory is not only lacking in case support, it would produce an unfair result.

On appeal, S&P argued against the need for allocation on slightly different grounds. S&P’s fundamental argument was that because the subcontractor settlements were not the product of insurance coverage, U.S. Fire was not entitled to use them to offset amounts covered by its own policy to prevent double recovery. Generally speaking, U.S. Fire’s policy provided excess coverage over certain “Underlying Insurance” and “Other Insurance,” the latter of which included “any type of Self-Insurance or other mechanism by which an Insured arranges for funding of legal liability for which this policy also provides coverage.”

S&P characterized the subcontractor settlements as the products of “contractual risk transfer mechanisms” intended to “shore up leaks or gaps in insurance coverage.” For that reason, S&P argued that U.S. Fire had no right to use the settlements to avoid paying a portion of the judgment because the subcontractor indemnity payments were meant to be applied to the gaps in the U.S. Fire coverage.

Rejecting S&P’s argument, the Fifth Circuit found that the “plain language of the policy allows us to affirm the district court’s summary judgment order.” First, the court found that indemnity agreements fall under the plain language of the broad “Other Insurance” provision as a “mechanism by which an Insured arranges for funding of legal liabilities for which [U.S. Fire’s] policy also provides coverage.” Second, the court found that “S&P provides no persuasive authority supporting its contention that subcontractor indemnification agreements are, by their nature, meant principally to fill gaps in insurance coverage (and therefore do not fall into the policy language here because the indemnity agreements would cover legal liabilities that U.S. Fire’s coverage did not).” The court dismissed S&P’s reliance on a case from the Florida Supreme Court[4] suggesting that an indemnity clause is a hedge against risk retained by the insured contractor, explaining that the case stood simply for the proposition that a general contractor can apply proceeds obtained from subcontractor indemnification settlements to satisfy a “self-insured retention” clause, instead of having to use its own money to pay the self-insured retention. Finally, the Fifth Circuit found that S&P had “offered no good reason to think that these particular indemnity agreements were meant first and foremost to fill gaps in its excess insurance coverage.”

The insured’s burden to allocate. Having determined that allocation was necessary, the next question was who had the burden to make the allocation. At oral argument, the district court indicated that it was relying heavily on a case styled RSR Corp. v. International Insurance Co.:[5]

RSR is closely analogous to the current facts. As in the present case, the insured was liable for a variety of damages, some covered under an excess policy and some not covered. The insured entered into general-release settlement agreements for more than the potentially covered damages under the policy. The insured then sought coverage from its excess insurer for the covered amount. The insurer refused to pay, on the ground that the insured had already received more money in settlements than it could have recovered under the policy. The Fifth Circuit sided with the insurer, reasoning that it was the insured’s responsibility to demonstrate what portions of the settlements were for covered liabilities and which were not. Absent that showing, the settlements were presumptively for covered claims, meaning that the plaintiff could not recover.

In supplemental briefing, S&P attempted to distinguish RSR, on the grounds that, unlike the insurer in RSR, U.S. Fire was not at a disadvantage due to lack of information about the settlement processes and that U.S. Fire had consented to “any reasonable settlement.” The district court rejected this argument, explaining that “even if it is true that, in this case, US Fire had relatively more information about the underlying litigation and settlement process than [the insurer] did in RSR, S&P did, and US Fire did not, have the power to structure its subcontractor settlements to ensure a clear allocation of the settlement proceeds.” For that reason, the district court found that it is the insured’s responsibility to demonstrate what portions of the settlements were for covered liabilities and which were not. Because S&P had not done so, U.S. Fire’s motion for summary judgment was granted.

On appeal, the Fifth Circuit agreed with the district court’s reliance on RSR and the reasoning from that case, finding that “S&P bears the burden to show that the subcontractor settlement proceeds were properly allocated to either covered or noncovered damages” and that if it could not, “then we must assume that all of the settlement proceeds went first to satisfy the covered damages under U.S. Fire’s policy.”

The Fifth Circuit stressed several points. First, it reaffirmed RSR’s general reading of the Texas Supreme Court case Mobil Oil Corp. v. Ellender,[6] finding that the Texas court’s “core concern” was that “[n]onsettling parties should not be penalized for events over which they have no control.” Second, as the district court had done, the Fifth Circuit made it clear that just because “U.S. Fire agreed that S&P could reasonably settle its claims with the subcontractors, that does not mean U.S. Fire granted S&P permission to allocate all of those settlement proceeds to noncovered damages.” Third, the court highlighted the fact that, as the district court noted, “U.S. Fire did not have power to structure the settlements to attribute the proceeds to one kind of damages or another.” For those reasons, and the reasoning of RSR, the Fifth Circuit found that the allocation burden was properly placed on S&P.

Recent Case Law on Allocation of Settlement Amounts

In addition to Satterfield, other recent cases highlight and reaffirm some basic principles of allocation jurisprudence in the more common context of an insured seeking indemnity for settlements it has entered into with injured third parties. The cases discussed below demonstrate the default principle of placing the burden to allocate on the insured and justifications for that rule, when the burden might switch to the insurer, and the types of evidence and information that are appropriate for making a reasonable allocation.

The insured’s burden to allocate. Recent cases from Massachusetts and Oregon affirm placing the allocation burden on the insured. In the Massachusetts case Rass Corp. v. Travelers Cos., Inc.,[7] the appellate court affirmed that, absent a breach of the duty to defend, the insured bears the initial burden to prove “the compromise of claims that were covered by the general insuring clause.” In Rass, the underlying plaintiff and the insured together manufactured and distributed a sauce to grocery stores. The insured then notified a buyer by email that it had entered into negotiations to make and bottle the sauces with another manufacturer. When the original manufacturer learned of the email, she sued the insured, alleging misappropriation of trade secrets, tortious interference with present and prospective economic advantage, and trade libel. Travelers accepted the insured’s defense pursuant to a reservation of rights but disclaimed coverage for the manufacturer’s trade secrets claim. The insured rejected Travelers’ $20,000 contribution to settlement and settled the case for $175,000 without any contribution from Travelers. The insured then brought suit against Travelers, and the trial court allocated 80 percent of the $175,000 settlement to the manufacturer’s covered email-related claims, with the remainder to the uncovered trade secrets claim.

The insured appealed the allocation, and the appeals court held that the allocation was proper. Because Travelers’ duty to indemnify the distributor for covered losses had not been determined on the record in the underlying lawsuit, the trial court was “left to determine . . . whether any portion of the settlement had been made in compensation for the acts alleged in the underlying complaint and, if so, whether those acts are covered under the policy language.” The court noted that, “if any part of a settlement is for covered claims, the court is then charged with allocating the settlement between covered and noncovered claims.” The court further noted that the insured bore the burden of proof to prove “the compromise of claims that were covered by the general insuring clause.” Because the parties agreed on appeal that the claim for misappropriation of claim secrets was not covered, “Travelers has no duty to indemnify whatever portion of the settlement is attributable to that claim.”

As in Rass, in a case under Oregon law, American Medical Response NW, Inc. v. ACE American Insurance Co.,[8] the federal court made an Erie guess and determined that, absent wrongdoing by the insurer, the insured bears the initial burden to allocate. In American Medical, 16 underlying plaintiff patients filed suits against the insured and its employee alleging multiple causes of action arising from alleged sexual assaults committed by the insured’s employee while providing emergency ambulance services. ACE denied coverage for the lawsuits. One of the underlying cases proceeded to trial, and the jury awarded $2.25 million in damages. The insured then settled six of the underlying suits, while the remaining suits were pending in Oregon state courts. The insured sued ACE for breach of the insurance contract, seeking indemnification for the full amount of the settlements.

The U.S. District Court for the District of Oregon ultimately held that the insured bore the burden to prove that the underlying settlements were for covered claims. Although Oregon courts had not yet addressed which party bears the burden to prove apportionment of a settlement that encompasses both covered and noncovered claims, the court noted that plaintiffs generally bear the burden to prove damages in a breach of contract action. The court reasoned that “[the insured] is in the best position to know the bases for the settlements in the underlying cases. Therefore, [the insured] has the burden to prove the underlying settlements were for covered claims.”

Justification for putting the burden on the insured. As American Medical noted, a straightforward justification for placing the burden to allocate on the insured is its role in the settlement process. In the Pennsylvania case Executive Risk Indemnity, Inc. v. Cigna Corp.,[9] the Pennsylvania Superior Court considered in more detail why the burden to allocate is properly placed on the insured, relying on the sophistication of the insured and the control it had over its defense in finding that “the insured is the party that should bear the burden of proof for apportionment of claims.” After Cigna settled class action claims for breach of contract and violations of the Racketeer Influenced and Corrupt Organizations Act (RICO), it submitted a claim to its excess insurer, Executive Risk, for indemnification of the settlement costs. The trial court held a hearing to determine the proper allocation of indemnity payments between the covered RICO claims and the uncovered breach of contract claims, and placed the burden on Cigna to prove the allocation of settlement.

The Pennsylvania Superior Court held that the trial court reasonably allocated $3,827,287 each for the parties’ contract claims. “However, there was insufficient evidence to prove what percentage of those . . . costs went toward defending solely covered claims and what portion of attorneys’ fees were being paid on which class of claims.” The court therefore affirmed the trial court’s holding that Cigna failed to carry its burden to differentiate between the covered and noncovered claims. Because the insured had controlled the underlying litigation and defense, and “had better access to the relevant information and intentions of the parties in the deliberative settlement process,” it was “not only reasonable, but logical, that the insured bears the burden to allocate.” In particular, the court noted that the insured and insurer were equally sophisticated entities, that the insured had drafted the settlement agreement under which it sought indemnification, that the insured chose the counsel to participate in the settlement negotiations, that the insured controlled the underlying litigation and defense, and that the insured had better access to the relevant information and intentions of the parties in the deliberative settlement process.

Shifting the burden to the insurer. In another case under Massachusetts law, Scottsdale Insurance Co. v. United Rentals (North America), Inc.,[10] the federal district court found that because the insurer had in fact wrongfully denied the duty to defend, the burden to allocate settlement amounts switched to the insurer. United Rentals involved a personal injury action resulting from a trade show accident in which the underlying plaintiff was struck by an electric boom lift rented from United Rentals. United Rentals tendered a claim to its liability insurer, Scottsdale, for defense and indemnity in the underlying lawsuit. Scottsdale then filed a declaratory judgment action seeking a determination that it owed United Rentals no duty of defense or indemnity in the underlying lawsuit. The federal district court held that Scottsdale had a duty to defend, but the duty to indemnify was not ripe for adjudication.

United Rentals paid to settle the underlying personal injury suit and retendered the claim for indemnity to Scottsdale. Ultimately, the district court held that, because Scottsdale wrongfully declined to defend United Rentals, even if it did so in good faith, Scottsdale bore the burden of showing that United Rentals’ settlement costs were not covered by the policy and that if it could show that only some claims were not covered, it bore the further burden of reliably establishing allocation of settlement costs between covered and uncovered claims.

Proper evidence and information in support of allocation. In a case under Minnesota law, UnitedHealth Group Inc. v. Executive Risk Specialty Insurance Co.,[11] the Eighth Circuit highlighted the type of evidence and information that may inform the allocation analyses. UnitedHealth Group sued several of its professional liability excess insurers for defense and indemnity regarding two underlying health care administration actions. Before the coverage action was resolved, UnitedHealth Group entered into a settlement agreement to resolve both of the underlying lawsuits for payment of $350 million. After executing the agreement, UnitedHealth Group amended its pleadings in the coverage action, seeking damages for the insurers’ failure to indemnify it, in part, for covered claims that were resolved by the settlement agreement. In predicting how the Minnesota Supreme Court would resolve the issue, the Eighth Circuit held that UnitedHealth Group bore the burden to allocate the settlement between potentially covered and noncovered claims with sufficient specificity to permit a reasoned judgment regarding liability. To make this showing, UnitedHealth Group was entitled to rely on, for example, testimony from attorneys involved in underlying lawsuits, evidence from those lawsuits, expert testimony evaluating the lawsuits, and underlying transcripts. The Eighth Circuit stressed, however, that courts must look to what parties knew at the time of settlement. Post-settlement events may be relevant, but only if they reflect how a “reasonable party” would have valued and allocated claims at the time of settlement. For example, UnitedHealth Group could not rely on post-settlement rulings and testimony in the lawsuits because it obviously could not have relied on those later events if it had attempted to make an allocation during the earlier settlement.

Christina Culver and Cy Haralson are partners with Thompson, Coe, Cousins & Irons in Houston, Texas.

[1] Am. Guarantee & Liab. Ins. Co. v. U.S. Fire Ins. Co., 255 F. Supp. 3d 677 (S.D. Tex. 2017), aff’d sub nom. Satterfield & Pontikes Constr., Inc. v. U.S. Fire Ins. Co., 898 F.3d 574 (5th Cir. 2018).

[2] Satterfield & Pontikes Constr., Inc. v. U.S. Fire Ins. Co., 898 F.3d 574 (5th Cir. 2018).

[3] Lennar Corp. v. Markel Am. Ins. Co., 413 S.W.3d 750 (Tex. 2013).

[4] Intervest Constr. of Jax, Inc. v. Gen. Fid. Ins. Co., 133 So. 3d 494, 503 (Fla. 2014).

[5] RSR Corp. v. Int’l Ins. Co., 612 F.3d 851 (5th Cir. 2010).

[6] Mobil Oil Corp. v. Ellender, 968 S.W.2d 917 (Tex. 1998).

[7] Rass Corp. v. Travelers Cos., Inc., 90 Mass. App. Ct. 643, 645, 63 N.E.3d 40 (2016), review denied, 75 N.E.3d 1131 (Mass. 2017).

[8] Am. Med. Response NW, Inc. v. ACE Am. Ins. Co., 31 F. Supp. 3d 1087 (D. Or. 2014).

[9] Exec. Risk Indem., Inc. v. Cigna Corp., 74 A.3d 179, 183 (Pa. Super. Ct. 2013).

[10] Scottsdale Ins. Co. v. United Rentals (N. Am.), Inc., 305 F. Supp. 3d 223 (D. Mass. 2018) (on appeal).

[11] UnitedHealth Grp. Inc. v. Exec. Risk Specialty Ins. Co., 870 F.3d 856 (8th Cir. 2017).


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