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Illinois Appellate Court Addresses When Punitive Damages Create a Conflict of Interest

In Xtreme Protection Services, LLC v. Steadfast Ins. Co., 2019 IL App (1st) 181501 (May 3, 2019) the Illinois Appellate court considered when punitive damages give rise to a conflict of interest entitling the insured to independent counsel.

David Isreal filed suit against Michael Bucon, James Adams, and Xtreme Protection Services, LLC, alleging assault and intentional infliction of emotion distress. In Mr. Isreal’s complaint, he alleged that Mr. Bucon, as an agent of Xtreme and Adams, placed listening devices in Mr. Isreal’s office, attached GPS devices to his vehicles, and sent him harassing text messages. He sought compensatory damages of $120,000 and $2.1 million in punitive damages.

Xtreme was insured under an “armed security services” liability policy issued by Steadfast. The policy excluded covered for punitive damages. Xtreme’s counsel tendered the underlying complaint to Steadfast, which advised that it would retain counsel to defend Xtreme. Xtreme’s counsel responded that the allegations of the complaint created a conflict requiring independent counsel. Steadfast retained counsel for Xtreme under a reservation of rights based on the punitive damages exclusion and on the basis that the underlying complaint alleged intentional conduct.

Xtreme filed suit against Steadfast seeking a declaration that Xtreme was entitled to select its own counsel because of a conflict of interest arising from Steadfast’s right to deny coverage for punitive damages. Steadfast counterclaimed for a declaration that it no longer had a duty to defend because Xtreme breached its duty to cooperate. Both parties filed motions for judgement on the pleadings. The trial court determined that Xtreme was entitled to select its own counsel as a result of Steadfast’s reservation related to punitive damages and denied Steadfast’s motion. Steadfast appealed.

In affirming, the Court reasoned that a conflict of interest arises when the facts to be resolved in the underlying case would allow the insurer to “lay the groundwork” for a subsequent denial of coverage. Citing Nandorf, Inc., v. CNA Ins. Cos., 134 Ill. App. 3d 134 (1st Dist. 1985), the Court noted that an insured may have a right to independent counsel where the potential punitive damages far outweigh the compensatory damages sought; the insurer’s interest would be as well served by an award of minimal compensatory damages and substantial punitive damages as it would be by a finding of no liability. However, the Court cautioned that this did not mean an insured was always entitled to independent counsel whenever punitive damages are sought.

The Court was persuaded by the fact that the compensatory damages claims were within the policy limits, whereas the punitive damages were well in excess of the limits: Steadfast lost nothing in letting the case go to trial, whereas Xtreme would have more of an interest in settling the case prior to trial. Therefore, there was a conflict of interest entitling Xtreme to select its counsel. The Court rejected Steadfast’s argument that there was no disproportion between the damages sought following the fifth amended complaint—to the extent compensatory damages were increased in recent pleadings, so too were punitive damages. As a result, there was no basis for Steadfast’s argument that Xtreme breached its duty to cooperate.

Accordingly, the Court affirmed the judgment of the circuit court.