The Potential Liability Rule Inapplicable in a Priest Molestation Case

By Steven Plitt
Claims Journal
April 16, 2014

http://www.claimsjournal.com/news/midwest/2014/04/16/247451.htm

Some courts have adopted the so-called “potential liability standard” in determining whether an insurance company is obligated to indemnify the insured for a settled claim. As an example, the Second Circuit Court of Appeals in Luria Bros. & Co. v. Alliance Assur. Co., 780 F.2d 1082, 1091 (2nd Cir. 1986) explained the  potential liability standard as follows:

In order to recover the amount of the settlement from the insurer, the insured need not establish actual liability to the party with whom it has “settled so long as  … a potential liability on the facts known to the [insured is] shown to exist, culminating in a settlement in an amount reasonable in view of the size of possible recovery and degree of probability of claimants success against the [insured].”

Under the potential liability standard, “[i]f an insured settles an underlying claim prior to verdict, it must show that it settled an otherwise covered loss in ‘reasonable anticipation of liability.’”  Federal Ins. Co. v. Binney & Smith, Inc., 393 Ill.App.3d 277, 332 Ill.Dec. 448, 913 N.E.2d 43, 48 (2009); Hyatt Corp. v. Occidental Fire & Cas. Co. of North Carolina, 801 S.W.2d 382, 388 (Mo. App. W.D. 1990).

Without finding that Missouri jurisprudence adopted the potential liability standard for settlement indemnification, the Eighth Circuit U.S. Court of Appeals, recently used that analysis to reject an insured’s claim for indemnification. In Chicago Ins. Co. v. Archdiocese of St. Louis, 740 F.3d 1197 (8th Cir. 2014), a secondary excess liability insurer brought a declaratory judgment action against the St. Louis Archdiocese of the Roman Catholic Church, seeking a judicial declaration that its policy did not cover a settlement paid to a family of an alleged victim of sexual abuse perpetrated by one of the Diocese’s priests. The District Court had granted the insurer’s motion for summary judgment against the Arch Diocese, which was affirmed by the Eighth Circuit Court of Appeals.

At the time of the settlement, the Archdiocese was insured through an excess liability policy issued by Certain Underwriters at Lloyd’s London (Lloyd’s). Chicago Insurance Company (CIC) was a second layer excess insurer above the Lloyd’s policy. Lloyd’s agreed “to indemnify the insured for all sums which the insured shall be obligated to pay by reason of the liability imposed upon the insured by law or assumed by the named insured under contract or agreement … on account of personal injury … arising out of any occurrence.” The CIC policy incorporated the terms of the Lloyd’s policy but contained additional relevant language by defining the term “loss” as “the sums paid as damages in settlement of the claim or in satisfaction of a judgment for which the insured is legally liable.”

The underlying case involved a sexually molested victim who subsequently committed suicide. At the time of the settlement, three viable claims remained:  one wrongful death and two additional claims alleging intentional misconduct on the part of the Archdiocese. The parties entered a settlement which released the Archdiocese from any future liability associated with the alleged misconduct. After settling the claim, the Archdiocese turned to its insurers for indemnification. CIC denied the Archdiocese’s request for indemnification and sought declaratory judgment relief. In resolving the indemnification/coverage issue in favor of CIC, the District Court determined that because the wrongful death claim in the underlying complaint alleged a form of negligence against a religious organization, there was no cause of action against the Archdiocese under existing Missouri Supreme Court precedent. Because the Archdiocese could not be held legally liable, the District Court found that the Archdiocese had failed to establish that a defined “loss” had occurred under the CIC policy. The wrongful death claim in the underlying complaint alleged a form of negligence for which no cause of action was allowed and the remaining underlying claims against the Archdiocese alleged intentional conduct, and therefore, did not qualify as a policy defined “occurrence.”

The Eighth Circuit Court of Appeals began its analysis of the “legal liability” question by citing the Missouri Supreme Court’s decision in Gibson v. Brewer. See, Gibson v. Brewer, 952 S.W.2d 239, 249-50 (Mo. 1997). In the Gibson case, the Missouri Supreme Court held that negligence-based actions against a religious organization that required a court to evaluate the reasonableness of religious doctrine, policy and administration offended the First Amendment and could not be prosecuted. Next, the Eighth Circuit Court of Appeals in Chicago Ins. Co. v. Archdiocese turned to the language of the CIC policy and recognized that the term “legal liability” was not defined by the policy. Nevertheless, the term “legal liability” was generally understood to mean a liability that a court of competent jurisdiction would recognize and enforce between parties. 740 F.3d at 1199 citing Steven Plitt, et. al, 7A Couch on Insurance, §103:14 (2013 rev. ed.). Elaborating on §103:14 of Couch on Insurance, the Court noted that the term “legal liability” served to limit the insuring clause such that “the fact that a loss is occasioned through the fault of the insured [insured] does not long trigger the insurer’s liability.”  As such, the insured was required to be legally liable for the claim before the insurer was obligated to pay the loss. These general principles were consistent with Missouri law which required that for an insured to recover under a pure indemnity policy, the insured needed to show that it was legally liable to the injured claimant and that the amount of the settlement was reasonable.

The Eighth Circuit Court of Appeals in Chicago Ins. Co. v. Archdiocese of St. Louis then turned to the Archdiocese other argument for coverage. The principal argument made by the Archdiocese was that the District Court had required it to establish actual liability for coverage to be triggered when Missouri law only required that it show potential liability to trigger insured indemnification. Addressing this argument, the Eighth Circuit Court noted that even if Missouri followed a potential liability standard–the question that the Court stated that it would not decide–the Archdiocese was unable to show that it faced potential liability. Citing to the Gibson case, where the Missouri Supreme Court rejected several negligence-based claims against a Catholic Diocese stemming from the alleged sexual misconduct of a priest, see, Gibson, 952 S.W.2d at 249-50, the Court found that in order to determine how a “reasonably prudent Diocese” would act would require the Court to excessively entangle itself in religious doctrine, policy and administration. Given the Gibson Court’s rejection of liability under the First Amendment, the Eight Circuit Court found that the Archdiocese failed to show that the settlement was in reasonable anticipation of liability. As such, the Archdiocese did not affirmatively establish that it was legally liable–potentially or otherwise–for the conduct alleged in the wrongful death action.

Based upon the Gibson case and its application of the First Amendment, the Eighth Circuit Court of Appeals concluded that the Archdiocese had failed to show that the settlement was in reasonable anticipation of litigation. Although Missouri law did not require the insured, as a condition of reimbursement, to prove that it was ultimately liable for the settled claims, Missouri courts had not specifically dealt with coverage situations where the insured was unable to show that it faced potential liability in the underlying action. In resolving that issue, the question of whether the negligence existed in any particular situation depended on whether or not a reasonably prudent person would have anticipated danger and provided against it. Utilizing the case specific facts, the Court noted that in order to determine how a “reasonably prudent Diocese” would act, any court would have to excessively entangle itself in religious doctrine, policy and administration.

In reviewing the case law, the Court could not find any authority which permitted a settling insured to recover under an indemnity policy where the governing law did not permit the claimants underlying cause of action against the insured. Under the potential liability standard, the governing law affecting the settling insured’s underlying liability remained significant for coverage purposes. When the Court moved past the specific context of the settlement in question, the Court noted that Missouri case law confirmed that if governing rules preclude the underlying action against the insured, the insured is not entitled to coverage.

In a footnote, the Court also rejected the Archdiocese argument that the Gibson decision was a minority view that was subject to possible reversal and changes in the law. The Eighth Circuit Court of Appeals rejected this argument stating: “[a]lthough Gibson has been challenged, we think the point is irrelevant as virtually every law is subject to possible change or reconsideration at some unknown time. Ultimately, Gibson remained the law of Missouri when the Archdiocese settled.”