Legal commentators and court watchers rightly complain about activist judges who make laws rather than interpret them.  Last month’s decision in the The Babcock & Wilcox Co. et al. v. American Nuclear Insurers, et al., is deserving of such criticism.  The Pennsylvania Supreme Court fashioned a new and dramatic rule favoring policy holders and harming insurers, and it did so while openly disregarding clear policy language.

The dispute in Babcock began in 1994 with a class action lawsuit by plaintiffs claiming bodily injury and property damage.  They alleged that their harm resulted from emissions at nuclear facilities operated by Babcock and Atlantic Richfield Company.  The facility operators denied that their facilities released any emissions, and they also denied that the plaintiffs’ harm resulted from the facilities.

At the outset of the litigation, insurers for Babcock and Atlantic Richfield agreed to defend the class action but reserved their rights to contest coverage for certain aspects of the plaintiffs’ claims.  The insurers paid $40 million in defense costs but refused to consent to settlement because they believed the facility operators were likely to prevail due to a lack of medical and scientific support for the plaintiffs’ claims.  Notwithstanding the insurers’ views, Atlantic Richfield and Babcock settled the lawsuit for a total of $80 million and then looked to their insurers for reimbursement.  The insurers denied indemnity because the decision to settle rested exclusively with the insurers.

Relying on a decision from Arizona, the Pennsylvania Supreme Court ultimately found in favor of Babcock and Atlantic Richfield.  The court noted that an insurer’s reservation of rights may place the policy holder in a “precarious situation.”  While the insurer makes the decision to decline a reasonable settlement offer, it is the insured that may ultimately bear the cost of a judgment if the claims are outside the scope of coverage.  The court reasoned that insurers should not be able to assert coverage defenses and at the same time control the conditions of settlement.  Instead, the court held that when an insurer defends under a reservation of rights, it must provide indemnity for settlements that are “fair, reasonable and non-collusive.”

Reasonable attorneys may disagree over the merits of the rule created in Babcock. Insurers will likely conclude that it is not only wrong but completely unnecessary. With a potent array of existing bad faith remedies – i.e., liability for excess judgments, consequential damages, interest, attorneys’ fees, and punitive damages – there was no need to place yet another heavy finger on the scale for policy holders.  The most disappointing aspect of Babcock, however, was not the result but the damage done to the rule of law.

Quoting the policy, the court candidly acknowledged that the policy did not cover unauthorized settlements:

Under the insurance policy the decision to settle rested exclusively with Insurer which “may make such investigation, negotiations and settlement of any claim or suit as they deem expedient.”  Moreover, the policy expressly did not cover “liability assumed by the insured under contract....”

The court also acknowledged that when the language of an insurance “policy is clear and unambiguous, we must give effect to that language.”

Notwithstanding clear policy language and a clear rule of construction, the court simply disregarded the insurer’s right to control settlement and the standard CGL consent to settle clauses.  The court did not strain to find an ambiguity, or wax philosophical about the insured’s reasonable expectations, or reach for some other jurisprudential fig leaf.  Indeed, without any pretense of interpretation the court simply read an explicit, bargained-for term out of the policy.  And in the process it dramatically altered the relationship between policy holder and insurer.  

The Babcock decision is bad for insurers, to be sure.  It is also bad for policy holders because it will undoubtedly lead to increased litigation and potentially higher premiums.  But make no mistake: the biggest loser in the wake of Babcock is the rule of law.