Declaratory Actions And Insurance

A declaratory judgment action is essentially a request — typically by the insurer but often by the insured — that a court examine the relevant insurance policy provisions and declare the rights and obligations of the parties under the insurance contract. The declaration can address whether the insurer is obligated to furnish the insured with a defense in a pending lawsuit arising out of a third-party claim under a liability policy, or it can address the substantive issue of coverage under the policy for any first-party or third-party claim.

For a number of reasons, insurers often prefer that the parties’ rights and
obligations under the policy be decided by a federal judge rather than by a state judge. Questions of insurance coverage are, however, typically questions of state law. Because federal courts exist primarily to decide issues of federal law, the jurisdiction of the federal courts to hear cases that present issues of state law is limited.

To establish federal jurisdiction in a declaratory judgment action, two conditions must be satisfied. First, is the constitutional inquiry – the case must be a ‘case or controversy’ pursuant to Article III of the US Constitution. Second is the prudential inquiry – declaratory relief must be appropriate. Relief pursuant to the Declaratory Judgment Act also requires the establishment of standing under the statute.

In determining whether there is a case or controversy, the test is whether the alleged facts demonstrate there is a substantial controversy between parties, with adverse legal interests, of such immediacy and existence so to warrant a declaratory judgment.

In Johnson v. Shree Radhe Corporation, et al 2018 WL 1409973 (March 21, 2018), the United States District Court focused on statutory standing. There, Plaintiff filed an action in state court alleging injury arising from Defendants’ negligence. In addition, he included a claim under the Uniform Declaratory Judgments Act against Defendants, including Auto-Owners Insurance Company, which issued a policy to the remaining Defendants. Auto-Owners removed the case thereby triggering analysis under the Federal Declaratory Judgment Act. Plaintiff moved to remand.

In Johnson, the court reiterated that under federal law, a plaintiff is not precluded from standing to sue an insurer simply because he is not a party to the insurance contract. An actual controversy can exist between an insurance company and a third party in certain circumstances. First, in the event the insurance company joins the third party in a case; a common scenario to those familiar with coverage issues. Insurers can generally establish their stake in the outcome of the underlying controversy based upon the injury they could suffer by having to pay a claim for which there is no valid coverage. Next, the court has also found a plaintiff, not a party to the insurance contract, has standing to sue the insurer in the event the plaintiff has secured a judgment against the carrier’s insured. In Johnson, however, Plaintiff was without a judgment, sought to enforce rights under a policy to which he was not a party, and under which he had no claims pursuant to the policy provisions. As a result of Plaintiff’s inability to establish a concrete injury, in the context of the declaratory judgment action, coupled with his inability to demonstrate a substantial controversy that effected the legal rights of the adverse parties, the court determined Plaintiff lacked standing and remanded the action.

A Declaratory Judgment Example

In the case of insurance contracts, declaratory judgments help determine a policy’s coverage. It helps to define if coverage exists for a particular peril, whether the insurer is required to defend the policyholder from a third party’s claim, and whether the insurer is responsible for a loss when other insurance contracts also cover against the same peril.

For example, a policyholder believes that his denied claim is unjust. As a result, he informs the insurer that he is considering a lawsuit to recover losses. The insurer seeks a declaratory judgment to clarify its rights and obligations with hopes of preventing the lawsuit. If a declaratory judgment indicates that the insurer is not obligated to cover the loss, the insurer will likely avoid litigation. If the judgment indicates that the insurer is responsible, then the policyholder is likely to sue the insurer to recover losses.

Declaratory judgments originated in the early 20th century when states adopted a universal set of standards after the enactment of the Uniform Declaratory Judgments Act of 1922. In 1934, Congress enacted the Declaratory Judgments Act, which granted federal courts the authority to provide declaratory judgments.

In federal court, the Declaratory Judgment Act is designed to afford parties threatened with a liability, but otherwise without a satisfactory remedy, a means of early adjudication of the controversy. The existence of a controversy is crucial, because the “case or controversy” requirement of Article III of the Constitution applies to declaratory judgments.
To show an “actual controversy” as required by 28 USC §2201, the plaintiff in a declaratory action must show he has sustained, or is in immediate danger of sustaining, a direct injury as the result of the defendant’s conduct. Stated differently, there must be a substantial controversy, between parties having adverse legal interests, of sufficient immediacy and reality to warrant the issuance of a declaratory judgment.
But, where an insurer has already made a decision and seeks a court to “approve” its decision, that may not be an appropriate controversy for resolution. The primary purpose of a declaratory judgment is to permit a plaintiff to obtain a declaration of its rights and liabilities before proceeding with a course of conduct for which it might be held liable, not to declare nonliability for past conduct. Declaratory judgment is not available where the judgment cannot guide and protect the petitioner regarding future acts. Declaratory judgment cannot be used solely to adjudicate past conduct and not to affect future behavior.
Following this line of cases, by waiting to file a declaratory judgment action until after it has denied the claim, the insurer is not seeking guidance on future acts, but asking the court to render an advisory opinion on its past conduct, which is not the purpose of a declaratory judgment action and may result in dismissal. Thus, an insured and its counsel should think twice about allowing a declaratory judgment action to proceed where the insurer has already denied the claim.

The Declaratory Judgment Act, 28 U.S.C. § 2201(a) provides a federal declaratory remedy. The exercise of jurisdiction under the Act is not compulsory. There is a four part test for entertaining an insurance coverage action during the pendency of the tort trial in federal court; i.e.:

(i) the strength of the state’s interest in having the issues raised in the federal declaratory action decided in the state courts;

(ii) whether the issues raised in the federal action can more efficiently be resolved in the state court in which the action is pending;

(iii) whether permitting the federal action to go forward would result in unnecessary “entanglement” between the federal and state court systems, because of the presence of “overlapping issues of fact or law”;

(iv) whether the declaratory judgment action is being used merely as a device for “procedural fencing” – that is, to control the choice of forum in a race for res judicata or to obtain a federal hearing in a case otherwise not removed.

Discovery

Discovery in coverage litigation is much different from discovery in tort litigation. The scope of discovery depends upon the issue. In duty to defend cases, generally, no significant discovery is needed by the insurer, since the duty to defend is based upon the allegations of the Complaint. Brohawn v. Transamerica Ins. Co., 276 Md. 396, 347 A.2d 842 (1975). However, since insureds may rely upon extrinsic evidence to bring an action within coverage, discovery may prove helpful to the insured. In duty to indemnify cases, the evidence is generally limited to that produced at the underlying tort trial. In “bad faith” duty to settle within policy limits cases, more extensive discovery is permitted. Whether information as to other claims and lawsuits is discoverable is an issue for the trial court. Most courts find it marginally relevant at best and either not discoverable or subject to limited discovery. North River Ins. Co. v. Mayor and City Council of Baltimore, 343 Md. 34, 67, 680 A.2d 480, 497 (1996)(“[t]he numerical majority of the cases deny any discovery of the records of other insureds, either on the ground that it will not lead to the discovery of relevant evidence, or on the ground that the relevance is so clearly outweighed by the burden of production that production is denied”).

Depositions

As with discovery in general, the purpose and goals of the deposition vary depending upon whether the suit concerns the duty to defend, the duty to indemnify or 5 “bad faith.” In a duty to defend case, policy language and the allegations of the complaint drive the court’s determination of coverage. Hence, it is rarely useful to depose the adjuster in a duty to defend case. The handling of the file and the insurer’s reasons for denying coverage or reserving rights are not relevant to the determination of coverage by the court. The same goes for a duty to indemnify case, where the jury verdict sheet or the evidence adduced at trial – not the reasons the insurer accepted or denied coverage – determines coverage.

Insureds, however, tend to notice the deposition of the claims adjuster as a knee jerk reaction. Of course, in a bad faith case, the issues concerning handling of the file and settlement negotiations make the deposition of the adjuster central. The deposition of the insured is useful in a duty to defend case to flesh out any extrinsic evidence the insured relies upon and the related factual basis of the underlying plaintiffs’ allegations, such as whether the insured intended or expected the plaintiff’s injury or whether the putative insured had permission to drive the insured motor vehicle. Further, it is an opportunity to pin down the insured’s claim that extrinsic evidence brings the case within coverage. Experts generally should not be permitted to testify since the policy is interpreted based upon its plain language as understood by laypersons.

Burden of Proof

you have assembled your evidence, you have to prove your case. The insured has the burden of proving every fact essential to his or her right to recover. The insurer has the burden of proving any exclusion under the policy. The insurer has the burden of proving prejudice from the insured’s violation of a notice provision. The insurer has the burden of proving that the insured made a misrepresentation in the application for the policy. Lost policies require the proponent to establish the fact of loss and terms and conditions of the policy by clear and positive evidence. a. Allocating a verdict between insurer and insured Who has the burden of apportioning the loss between covered and uncovered damages when there is a general verdict? Allocation is simple where the verdict is distinguished between covered and uncovered claims. If there is no specific allocation, the court must determine what portion is allocated to covered claims. Generally, the insured has the burden of proving a loss is within coverage. Where the verdict is mixed, it remains the insured’s obligation. A few courts have shifted the burden to the insurer in some situations, such as where the insurer controlled the defense and failed to request special jury interrogatories to allocate the verdict.

Some Federal Courts have permitted insurers to intervene pursuant to FRCP Rule 24 to request special jury interrogatories or a verdict form.
In the great majority of cases, the duty to defend should be decided by summary judgment. There is no fact issue because the duty to defend is determined by the eight corners test. In other words, the facts are set out in the underlying petition, so there is no need for a jury to make a factual determination. Rather, the court should decide as a matter of law whether the facts fall within the scope of coverage or fit within an exclusion to coverage. Consequently, determining coverage can usually be accomplished much faster than the resolution of the underlying case.

When Do You File a Declaratory Judgment Action

In addition, even if you decide to bring the duty to indemnify as part of the declaratory action, once you have obtained a partial summary judgment on the duty to defend, the carrier will normally feel comfortable in withdrawing from the defense of the underlying case. Certainly, no one can say that the carrier is acting unreasonably if the court has already agreed as a matter of law that there is no duty to defend.

A second consideration is whether it makes business sense to undertake the costs that go along with a declaratory judgment action. Even in a relatively simple case, it may take $10,000 to $20,000 to obtain a summary judgment on the duty to defend. If the claim could be settled for that amount, or if the defense costs in connection with the underlying case are not likely to be substantially more than that, it may make not make sense to file a declaratory judgment action. In other words, are the costs justified by the potential benefit of a ruling on coverage?

On the other hand, where there is a denial of coverage, the analysis is more straightforward. One of the first considerations is whether the insured will agree that there is no coverage and, therefore, will not likely bring a breach of contract or bad faith action. If the correspondence and actions of the insured make it clear that the insured does not dispute the carrier’s position, then a declaratory judgment action may be unnecessary.

However, keep in mind that if the stakes are high enough you’ll need attorneys like those at Ascent Law to help you.

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