Seventh Circuit Finds No Duty to Defend For Liability Insurer When Liability Based on Intentional Wrongs

In an insurance contract dispute, the Seventh U.S. Circuit Court of Appeals ruled April 23 that a liability insurer has no duty to defend a village from litigation alleging intentional misconduct, but not negligence. St. Paul Fire and Marine Insurance Company v. Village of Franklin Park, No. 06-2924 (7th Cir. 4/23/2008) is a contract dispute between an insurer and an Illinois township accused in separate litigation of severely underfunding its mandatory firefighters’ pension fund.

Under Illinois state law, municipalities must establish and administer pension funds for their firefighters. Firefighters in Franklin Park sued under that law, alleging that the village had intentionally underfunded their pension fund for more than 30 years. After the suit was filed in state court in January of 2002, the village asked its liability insurer, St. Paul, to defend it under a policy that covered disputes over employee benefits plans. The insurer declined, and the village disputed this, but did not sue. In late 2004, St. Paul filed in federal court, seeking a declaratory judgment that it had no duty to defend the village. In March of 2006, the district court granted that judgment, ruling that St. Paul’s contract created a duty to defend against negligence, not the intentional wrongdoing alleged by the firefighters. The village appealed both the judgment and the denial of a motion to reconsider. The Seventh Circuit affirmed.

In its opinion, the three-judge panel agreed with St. Paul that the firefighters’ allegations were not a “loss” under the meaning of the policy, pointing to caselaw that distinguishes between loss and money that was illegally or unethically withheld from its rightful owner.

Even if the outcome of the firefighters’ suit required the Village to move amounts earmarked for other uses or collect more taxes, the Village would not suffer a “loss” under the policy because it would still only be paying an amount offset by a benefit it had already received—either having the use of extra tax money or having the ability to collect fewer taxes. See Level 3, 272 F.3d at 911. Were the rule otherwise, Franklin Park could avoid its pension fund obligations entirely by levying no taxes and making no contributions. It would be absurd to think that in such a situation, the effect of a court finally requiring the Village to make the contributions would be a covered “loss” that St. Paul was required to cover.

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