A Michigan Federal District Court Significantly Limits the Scope of a Coverage Settlement Agreement

Pitfalls associated with drafting settlement agreements, particularly as to coverage matters, are illustrated by the recent decision in Harvard Drug Group, LLC v. Twin City Fire Insurance Co., 2011 U.S. Dist. Lexis 86556 (E.D. Mich. Aug. 5, 2011).  The insurer in that case issued a claims-made policy to the insured, which provided employment practices liability coverage.  During the term of the policy, the insured tendered a harassment claim and discrimination lawsuit by one of its employees to the insurer.  The insurer and the insured eventually reached a settlement as to coverage for the underlying action, which was memorialized in an agreement.  After the settlement was finalized and the policy terminated, and apparently was not renewed, the employee filed a second lawsuit against the insured, based on the same facts, but this time alleging wrongful termination.  The insurer denied coverage for the second action, on the grounds that it was not made during the policy period, as required by the insuring agreements, and was included in the terms of the settlement agreement.  The insured did not accept this position, and commenced a coverage action against the insurer.

The insurer filed a motion to dismiss the action, which the insured opposed.  The insured also filed a cross motion for summary judgment.  The court denied the insurer’s motion, and granted the insured’s cross motion.  In reaching this decision, the court first considered whether the second action by the same employee was covered under the policy’s insuring agreements, which mandated that claims be first made during the policy period.  The court determined that, although the second claim was first made after the policy terminated, it arose from “interrelated wrongful acts,” and hence was deemed a single claim with the prior one that was made during the policy period. The court relied on provisions contained in the policy which stated that claims arising from the same or interrelated wrongful acts represent single claims. Despite holding that the two actions were essentially one, the court determined that the settlement agreement did not apply to the second action. According to the court, the policy’s interrelated wrongful act provisions could not be read into the settlement agreement.  The court also found that the unambiguous language of the settlement agreement did not support the insurer’s position. The agreement contained standard provisions which stated that the insured released any and all rights and claims under the policy, “whether known or unknown, suspected or unsuspected, fixed or contingent,” arising out of or related to the first action.  The court determined that these provisions could not be read to apply to a claim that was not yet in existence at the time of the settlement. They were instead construed to apply to unknown liabilities and damages only, which were associated with the first action filed by the employee against the insured.  The court, therefore, determined that the insurer had to provide coverage for the second action.

The court’s holdings in this case are highly questionable, and appear to be based on pro-insured inclinations.  The insurer, however, could have avoided this outcome by the inclusion of more specific language in the settlement agreement, which would have applied to any future claims, whether in existence or not, that arose from the same or related facts as the first action.