The court in Perma-Pipe, Inc. v. Liberty Surplus Insurance Corporation, Case No. 13 C 2989, 2014 U.S. Dist. LEXIS 54867 (N.D. Ill. April 21, 2014), held that a CGL insurer breached its duty to defend by refusing to pay for independent defense counsel selected by the insured when the insured faced "a nontrivial probability" of a judgment in the underlying litigation in excess of its policy limits.  

In the underlying action, the University of California sent a demand to the insured seeking damages caused by the “catastrophic failure” of pipes manufactured by the insured.  The insured’s CGL insurer initially agreed to defend the insured, subject to a reservation of rights.  When the insured subsequently was named in two lawsuits arising out of the pipe failure--one filed by the University seeking $35 million and the other filed by a subrogated insurer seeking more than $5 million--the insurer withdrew its reservation of rights, agreed to provide coverage up to the $1 million per occurrence policy limit, and retained counsel to defend the insured.  The insured informed its insurer that it wanted to be defended by the insured’s long-time counsel rather than defense counsel retained by the insurer.  The insurer refused, and the insured filed suit alleging that the insurer had breached its duty to defend and acted in bad faith.

Applying Illinois law, and citing R.C. Wegman Constr. Co. v. Admiral Ins. Co., 629 F.3d 724 (7th Cir. 2011) as authority, the court held that the insurer was obligated to pay for the insured to be defended by counsel selected by the insured due to a conflict of interest between the insurer and insured.  As the court explained, on one hand, because the insurer’s potential liability was capped by its $1 million policy limit, it faced little risk in deciding to try the underlying cases, hoping that the resulting liability, if any, would be less than the $1 million policy limit. The insured, on the other hand, was facing potential liability well in excess of the $1 million policy limit and, therefore, had a greater incentive to settle before trial to avoid uncovered liability.  According to the court, this “nontrivial probability” of an excess judgment in the underlying suit created a conflict of interest, and the insurer breached its duty to defend when it refused to pay for defense counsel selected and controlled by the insured.