The first line of the Seventh Circuit’s opinion says it all: “This case provides a warning for insurance companies who refuse to defend their insureds.” As the court’s admonishment suggests, insurers that improperly refuse to defend an insured do so at their own risk and – if not done through a reservation of rights or a declaratory judgment action – may waive their coverage defenses in the process.

The case, National American Insurance Co. v. Artisan and Truckers Casualty Co., stemmed from a semi-truck accident and the resulting personal injury suit. The plaintiffs in that case, who were seriously injured in the accident, filed suit against: the driver of the truck; the driver’s father, who owned the truck; and Unlimited Carrier, the trucking company whose placards were on the side of the truck.

When the driver of the truck learned of the lawsuit, he contacted his insured, Artisan, which promptly denied coverage. Artisan asserted that its policy excluded coverage because it covered only the driver of the truck and his father, and, at the time of the accident, the driver was operating the truck on behalf of Unlimited Carrier, which was not named as an insured on its policy. The Artisan policy also explicitly excluded claims when the truck was being “operated, maintained or used for or on behalf of anyone else or any organization.” Because the driver’s truck displayed placards for Unlimited Carrier at the time of the accident, and since the plaintiffs’ complaint alleged that “Unlimited Carrier exercised authority and control” over the truck, Artisan asserted that its policy excluded coverage.

Meanwhile, Unlimited Carrier’s insurer, National American Insurance Co. (“NAICO”) defended the drivers’ suit subject to a reservation of rights. NAICO and the plaintiffs settled, then NAICO filed a declaratory judgment action against Artisan to recover what it paid in defending and settling the underlying suit. The district court for the Northern District of Illinois held that Artisan breached its duty to defend and granted summary judgment in favor of NAICO. Artisan then appealed to the Seventh Circuit, which affirmed.

The Seventh Circuit found three facts particularly persuasive. First, despite the Unlimited Carrier placards on the truck, the driver was not actually in the process of picking up a load for Unlimited Carrier. Second, the driver did not sign a lease with Unlimited Carrier until eight days after the accident, meaning that the driver did not even have authority to display Unlimited Carrier’s placards. Third, the plaintiffs in the underlying action alleged vicarious liability not just against Unlimited Carrier, but also against the driver’s father, who was named as an insured under Artisan’s policy.

This third point was particularly important. Artisan argued that Unlimited Carrier was ultimately liable in the underlying case since plaintiffs there alleged that it exercised authority and control over the truck. This allegation, according to Artisan, trumped any liability of the driver’s father as it implicated the federal doctrine of placard liability, which provides that a plaintiff can sue the company whose placard appeared on the truck that struck him.

The Seventh Circuit rejected this argument. While Artisan’s “ultimate liability” argument might apply to its duty to indemnify the driver, the court said, it has no application to its broader duty to defend which is triggered when a cause of action against the insured “potentially fall[s] within the scope of coverage,” even if other causes of action do not. Just because one theory of liability – placard liability – may not trigger coverage, plaintiffs’ claim that the driver’s father was also vicariously liable did trigger Artisan’s duty to defend. Since Artisan breached that duty, it was estopped from raising policy defenses to coverage and must reimburse NAICO for the money NAICO spent defending and settling the underlying suit.

While the Artisan decision is limited to the facts at hand in that case, the warning given by the Seventh Circuit should reverberate with all liability insurers. An insurer refusing coverage faces three courses of action: (1) defend the lawsuit under a reservation of rights; (2) seek a declaratory judgment excluding coverage; or (3) do nothing and refuse to defend. The latter option is done at the insurer’s risk, and an improper refusal may result in the type of estoppel that resulted in the Artisan case. Policyholders dealing with an insurer that refuses to defend should be aware of this.