                             [J-86-2014]
               IN THE SUPREME COURT OF PENNSYLVANIA
                          WESTERN DISTRICT

  CASTILLE, C.J., SAYLOR, EAKIN, BAER, TODD, McCAFFERY, STEVENS, JJ.


THE BABCOCK & WILCOX COMPANY : No. 2 WAP 2014
AND B&W NUCLEAR ENVIRONMENTAL :
SERVICES, INC.                 : Appeal from the Order of the Superior
                               : Court entered July 10, 2013 at No. 525
                               : WDA 2012, vacating the Judgment of the
            v.                 : Court of Common Pleas of Allegheny
                               : County entered February 17, 2012 at
                               : GD99-11498 and GD99-16227 and
AMERICAN NUCLEAR INSURERS AND : remanding.
MUTUAL ATOMIC ENERGY LIABILITY :
UNDERWRITERS AND OTHER         : ARGUED: October 7, 2014
INTERESTED PARTY: ATLANTIC     :
RICHFIELD COMPANY              :
                               :
                               :
AMERICAN NUCLEAR INSURERS AND :
MUTUAL ATOMIC ENERGY LIABILITY :
UNDERWRITERS                   :
                               :
                               :
            v.                 :
                               :
                               :
THE BABCOCK & WILCOX COMPANY :
AND B&W NUCLEAR ENVIRONMENTAL :
SERVICES, INC., AND ATLANTIC   :
RICHFIELD COMPANY              :
                               :
                               :
APPEAL OF: BABCOCK & WILCOX    :
POWER GENERATION GROUP, INC.   :
(F/K/A THE BABCOCK & WILCOX    :
COMPANY) AND BABCOCK & WILCOX :
TECHNICAL SERVICES GROUP, INC. :
(F/K/A B&W NUCLEAR             :
ENVIRONMENTAL SERVICES, INC.), :
AND ATLANTIC RICHFIELD COMPANY :
                                         OPINION


MR. JUSTICE BAER                                               DECIDED: July 21, 2015
       We granted review to consider an issue of first impression regarding whether an

insured forfeits insurance coverage by settling a tort claim without the consent of its

insurer, when the insurer defends the insured subject to a reservation of rights,

asserting that the claims may not be covered by the policy. After review, we reverse the

decision of the Superior Court and reinstate the judgment of the trial court.

       The case history spans two decades, beginning with the 1994 filing of a federal

class action lawsuit against Appellant-Insureds Babcock & Wilcox Company (B&W) and

Atlantic Richfield Company (ARCO) (collectively, Insureds) brought by plaintiffs claiming

to have suffered bodily injury and property damage caused by emissions from nuclear

facilities owned by Insureds.1 Over time, the class action grew to include over 500

named plaintiffs, who lived near the nuclear facilities. Insureds denied that the facilities

released any emissions or that the harm suffered by plaintiffs resulted from the facilities.

Nevertheless, a 1998 jury trial of eight test cases resulted in an initial verdict totaling

over $36 million or approximately $4.5 million per plaintiff. The federal court, however,

granted a new trial due to evidentiary issues. The retrial was never held given the

subsequent settlement discussed below.

       While the underlying tort action was pending in federal court, disputes arose

between Insureds and their insurers, Appellees American Nuclear Insurers and Mutual

Atomic Energy Liability Underwriters (collectively ANI or Insurer). At the outset of the

litigation, Insurer acknowledged that it would defend Insureds but contested whether the

policy covered aspects of the claims, and thus defended subject to a reservation of

1
     The Superior Court’s decision below provides a fuller discussion of the facts.
Babcock & Wilcox Co. v. American Nuclear Insurers, 76 A.3d 1, 3-5 (Pa. Super. 2013).



                                      [J-86-2014] - 2
rights. Specifically, in 1994, Insurer, inter alia, asserted that the policy did not cover

damages that were not caused by nuclear energy hazard, damages in excess of the

policy limits, and claims for injunctive relief and punitive damages. Letter of June 20,

1994, R.R. at 148a-151a. The 1994 reservation of rights was supplemented as to B&W

in October 1999, by a letter indicating, inter alia, that Insurer reserved its right to

disclaim coverage for Insureds’ liability based upon Insureds’ pressuring of Insurer to

settle, which Insurer viewed, in connection with other actions, as a breach of Insureds’

duty to cooperate.2 Letter of October 5, 1999, R.R. at 3206-08.

       While the details are not relevant to the current dispute, Insurer filed a

declaratory judgment action in state court days after the 1999 reservation of rights letter,

raising challenges relating to the coverage limit, whether B&W and ARCO were entitled

to separate representation, and bad faith and breach of contract allegations, including

the breach of the duty to cooperate, against the Insureds.          The Insureds counter

claimed, raising bad faith allegations against Insurer. While staying various claims for

future determination, including the breach of the duty to cooperate claim, the court

decided issues regarding the trigger of coverage and held that B&W and ARCO were

entitled to separate counsel. The Superior Court affirmed on appeal, and this Court

denied allocatur.3




2
      The Insureds’ contractual duty to cooperate is set forth in Condition 6 of the
contract, see infra at 4.

3
      During this period of time, Insured B&W filed for bankruptcy, with proceedings
spanning 2000-2007.
      Notably, Insurer did not withdraw its reservation of rights, although some aspects
of the reservation of rights were mooted by intervening events. Indeed, Insurer
reasserted its allegation that Insureds had not complied with their duty to cooperate in
2008. Letter of September 19, 2008, R.R. at 3385; Letter of Oct. 3, 2008, R.R. at 3397.



                                      [J-86-2014] - 3
      During the course of the litigation, Insurer refused consent to any settlement

offers presented to it due to its conclusion that the case had a strong likelihood of a

defense verdict given the lack of medical and scientific support for plaintiffs’ claims and

decisions by the federal trial court regarding procedural and evidentiary issues in the

pending retrial, which Insurer viewed as highly favorable to Insureds’ ultimate outcome.

Nevertheless, after presenting the settlement offers to Insurer and being denied

consent, Insureds ARCO and B&W, respectively in 2008 and 2009, settled with the

class action plaintiffs for a total of $80 million, which was substantially less than the

$320 million of potential coverage.4

      Insureds then sought reimbursement of the settlement amount from Insurer in the

Allegheny County Court of Common Pleas. Insurer countered that reimbursement was

not permissible because the insurance contract contained a standard consent to

settlement clause, also referred to as a cooperation clause, requiring Insureds to

cooperate with Insurer and to obtain Insurer’s consent to settle:

             Assistance and cooperation of the Insured. The insured
             shall cooperate with the companies, and upon the
             companies’ request, attend hearings and trials and assist in
             making settlements, securing and giving evidence, obtaining
             the attendance of witnesses and in the conduct of any legal
             proceedings in connection with the subject matter of this
             insurance. The insured shall not, except at his own cost,
             make any payments, assume any obligations or incur any
             expense.
Insurance Agreement, Condition 6, Reproduced Record (R.R.) at 59a.              Under the

insurance policy the decision to settle rested exclusively with Insurer which “may make

4
      Notably, the policy provided that the policy limits were inclusive of defense costs,
such that expenditures on defense reduced the coverage available for liability. Insurer
expended $40 million defending Insureds prior to the settlement, apparently leaving
$280 million in coverage.



                                       [J-86-2014] - 4
such investigation, negotiations and settlement of any claim or suit as they deem

expedient.” Id. at I(A)(1), R.R. at 57a. Moreover, the policy expressly did not cover

“liability assumed by the insured under contract . . . .” Id. at Exclusion (c), R.R. at 58a.

       Relevant to the question at bar, the trial court recognized that the case presented

the issue of “under what circumstances will a court require an insurance company,

whose policy is found to provide coverage, to reimburse an insured that settled the

underlying litigation over the objections of the insurance company” in a case involving a

standard consent to settlement clause when the insurer has defended its insured

subject to a reservation of rights. Tr. Ct. Op., July 5, 2011 at 2. As discussed in more

detail below, Insureds asserted that Insurer should reimburse Insureds for the

settlement so long as coverage applies and the settlement is fair and reasonable and

entered in good faith, a test derived in part from the seminal case of United Services

Auto. Ass’n v. Morris, 741 P.2d 246 (Ariz. 1987) (hereinafter “Morris fair and reasonable

standard”). Insurer, in contrast, argued that the obligation to pay the settlement could

only be imposed on Insurer if it acted in bad faith in refusing to settle, seeking

application of this Court’s test in Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa.

1957), where we held that an insurer must pay a judgment in excess of policy limits for

its bad faith failure to settle below policy limits (herein after “Cowden bad faith

standard”).5

       While initially opining in December 2009 that the Cowden bad faith standard

should apply, the trial court reconsidered its decision in July 2011 and applied the

Morris fair and reasonable standard. Judge R. Stanton Wettick reasoned that while the

interests of insurers and insureds generally align when the insurer has accepted


5
      Full discussions of Cowden and Morris are set forth infra at 20 and 23
respectively.



                                       [J-86-2014] - 5
responsibility for defense and indemnity, the parties’ interests increasingly diverge the

more the insurer believes the policy does not cover the claims, as when the insurer

defends under a reservation of rights. He observed that, in a reservation of rights case,

an insured would prefer to cap the potential liability as it ultimately may be responsible

for the full settlement in the event that insurer is successful in its challenge to coverage,

whereas the insurer does not want to settle as it would relinquish its challenge to

coverage. Tr. Ct. Op., July 5, 2011 at 5. Relying upon Morris and decisions from other

jurisdictions, the trial court opined that a reservation of rights case is more akin to a

case where an insurer has refused coverage and defense. Id. at 5-6. Accordingly, the

court adopted the test forwarded by Insureds under which an insurer, defending subject

to a reservation of rights, is required to reimburse an insured for a settlement reached in

violation of the consent to settle clause where coverage is found to exist and the

settlement is “fair and reasonable” and made in “good faith and without collusion.” Id. at

6-11(citing in support Insurance Co. of North America v. Spangler, 881 F.Supp. 539 (D.

Wyo. 1995); Morris, 741 P.2d 246; Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa

2000); Patrons Oxford Ins. Co. v. Harris, 905 A.2d 819 (Me. 2006); and Martin v.

Johnson, 170 P.3d 1198 (Wash. Ct. App. 2007)); Tr. Ct. Order, July 5, 2011(providing

that Insurer shall reimburse Insureds if the Insureds establish that the settlement was

“fair and reasonable” unless Insurer establishes that “there is no coverage” under the

policies for reasons unrelated to the settlement).6




6
       The court further observed that unlike some other cases discussed below where
the insured merely assigned its rights to the plaintiff and removed itself from any
potential liability, the insured in this case paid the settlement with its own funds and was
now seeking reimbursement, and thus “had a strong interest to hold out for the best
possible deal.” Tr. Ct. Op. at 2.



                                      [J-86-2014] - 6
       Following the court’s decision, a two-week trial was held where a jury determined

that Insureds’ settlement with plaintiffs was fair and reasonable. The trial court, then,

molded the verdict to include prejudgment and post-verdict interest. Insurer appealed to

the Superior Court seeking application of the Cowden bad faith standard. The Superior

Court recognized that this case presents an issue of first impression in Pennsylvania,

which has nonetheless been addressed by various state and federal courts. The court

further observed that the question is subject to well-settled basic principles of

Pennsylvania insurance law.        The court emphasized that insurance policies are

contracts at heart, controlled by the language of the policy, but which include unique

policy concerns requiring that any ambiguity be interpreted in favor of the insured.

       The court reiterated that Pennsylvania distinguishes between the duty to provide

coverage and the broader duty to defend, which applies when the claim may potentially

come within the coverage of the policy. The panel acknowledged that the insurer’s

broad duty to defend is balanced by an insurer’s option to defend subject to a

reservation of rights. It emphasizes that the utilization of the reservation of rights is not

a breach of contract but instead is encouraged, as it provides insureds with a defense in

all cases of potential coverage while coverage is being determined.

       While acknowledging the permissible use of reservation of rights, the Superior

Court detailed the potential for a conflict of interest between an insurer defending under

a reservation of rights and an insured, who would be subject to full liability if its claim is

eventually determined not to be covered. The panel recounted concerns raised in other

courts that insurers will be less zealous in defense and less willing to settle if the

insurers believe that they will ultimately not be liable for coverage.       Acknowledging

insureds’ interest in settling reservation of rights cases, the Superior Court noted that

allowing insureds to settle seemingly violates the clear language of the policy requiring




                                       [J-86-2014] - 7
the insurer’s consent to settlement and presents the potential for collusion between an

insured and a plaintiff.

       The Superior Court categorized judicial responses to these concerns as falling

into two broad categories. It contended that a number of courts, like the trial court in

this case, follow Morris, 741 P.2d 246, holding that an insurer may be liable to

reimburse a settlement that is fair, reasonable, and non-collusive, if coverage is

determined to apply. The second category, which is championed by ANI in the case at

bar, includes Vincent Soybean & Grain Co., Inc., v. Lloyd's Underwriters of London, 246

F.3d 1129 (8th Cir. 2001), and resembles Pennsylvania’s Cowden bad faith standard,

although Pennsylvania cases have not applied the standard when the insured has

settled absent an insurer’s consent. Vincent Soybean and other like cases emphasize

that an insured breaches the insurance policy when it settles without the insurer’s

consent. These cases, therefore, have required the insured to demonstrate that the

insurer acted in bad faith in refusing to settle before requiring insurer to pay the

settlement.    The Superior Court opined “that the Morris and Vincent Soybean

approaches tilt the playing field too much in favor of, respectively, the insured or the

insurer. There is, however, a third approach, an approach that we believe best balances

the interests of the insurer and the insured.”     Babcock & Wilcox Co. v. American

Nuclear Insurers, 76 A.3d 1, 17 (Pa. Super. 2013).

       The Superior Court utilized Taylor v. Safeco Insurance Co., 361 So.2d 743 (Fla.

Dist. Ct. App. 1978), as exemplifying the third approach, which allows the insured the

option of rejecting the insurer’s defense (hereinafter the “Taylor/Insured’s Choice Test”).

The Superior Court summarized its test as follows:

              [W]e hold that, when an insurer tenders a defense subject to
              a reservation, the insured may choose either of two options.
              It may accept the defense, in which event it remains



                                     [J-86-2014] - 8
              unqualifiedly bound to the terms of the consent to settlement
              provision of the underlying policy. Should the insured
              choose this option, the insurer retains full control of the
              litigation, consistently with the policy's terms. In that event,
              the insured's sole protection against any injuries arising from
              the insurer's conduct of the defense lies in the bad faith
              standard articulated in Cowden.

              Alternatively, the insured may decline the insurer's tender of
              a qualified defense and furnish its own defense, either pro se
              or through independent counsel retained at the insured's
              expense. In this event, the insured retains full control of its
              defense, including the option of settling the underlying claim
              under terms it believes best. Should the insured select this
              path, and should coverage be found, the insured may
              recover from the insurer the insured's defense costs and the
              costs of settlement, to the extent that these costs are
              deemed fair, reasonable, and non-collusive.
Id. at 22. Applying this test to the case at bar, the court remanded for a new trial on “1)

whether [Insureds] in fact rejected [Insurer’s] defense; and, if not, 2) whether [Insurer]

acted in bad faith in declining to settle” or participate in settlement negotiations. Id.7

       Notably, the Taylor/Insured’s Choice Test approach was not forwarded by either

Insurer or Insured, and indeed, both parties vehemently object to the Superior Court’s

adoption of the test because an insured under Pennsylvania law does not have the

option of “rejecting” an insurer’s defense as it would constitute a breach of the insurance

policy, thereby releasing the insurer from the obligation to provide coverage.               See

American and Foreign Ins. Co. v. Jerry’s Sport Center, Inc., 2 A.3d 526, 545 (Pa. 2009)

(“[W]here the claim was potentially covered, Insured would have been at risk of

breaching the insurance contract if it had rejected [the insurer’s] defense and it was later

determined that the claim was covered.”). Moreover, the parties observe that most


7
      Judge Olsen dissented to the Superior Court’s analysis, concluding that the case
was controlled by this Court’s prior decision in Cowden.



                                       [J-86-2014] - 9
insureds would be unable to utilize the Taylor/Insured’s Choice Test approach as they

would not have the funds to allow them to employ an independent defense after

rejecting the insurer’s defense for which they had paid premiums to obtain. Accordingly,

for these reasons, we likewise reject the Superior Court’s holding as unworkable under

Pennsylvania law and turn to the arguments presented by the parties to determine

which approach to adopt.

      As noted, we granted review to consider as an issue of first impression whether

an insured forfeits the right to insurance coverage when it settles a lawsuit without the

insurer’s consent, where the insurer has defended the suit subject to a reservation of

rights.8 Insureds advocate adopting the Morris fair and reasonable standard. They

contend that when an insurer defends subject to a reservation of rights, an insured must

be able to protect itself from the potential of an adverse and uninsured decision in the

underlying tort case, if the insurer is ultimately deemed correct in concluding that the

policy does not cover the claim. Further, Insureds claim that the insurer in a reservation

of rights scenario is “in the attractive position of being able to avoid exposure either

because the insured prevails at trial or because the insurer’s coverage defense is

successfully asserted[.]” Insureds’ Brief at 33. Insureds contend that the Morris fair and

reasonable standard provides protection for the insured by allowing the insured to


8
      Specifically, we granted review of the following question:

             Does a policy holder forfeit its right to insurance coverage by
             settling an underlying and covered claim without its insurer's
             consent, where the insurer is defending subject to a
             reservation of rights to disclaim coverage, the settlement is
             at arm's length, is fair and is reasonable, and the insurer has
             failed to offer any amounts in settlement?

Babcock & Wilcox Co. v. Am. Nuclear Insurers, 84 A.3d 699 (Pa. 2014).



                                    [J-86-2014] - 10
accept settlement, while still preserving the insurer’s rights to contest coverage,

challenge the fairness and reasonableness of the settlement including whether it

resulted from fraud or collusion, and maintain control over other aspects of the defense

including the choice of counsel and the defense strategy prior to settlement.

       Delving further into the underpinnings of the Morris fair and reasonable standard,

Insureds observe that the court in Morris held that an insurer’s reservation of rights

“narrows the reach of the cooperation clause and permits the insured to take

reasonable measures to protect himself against the danger of personal liability.”

Insureds’ Brief at 30 (quoting Morris, 741 P.2d at 252.) Insureds observe that other

courts have adopted similar standards, including Miller v. Shugart, 316 N.W.2d 729

(Minn. 1982), and Patrons Oxford Ins. Co., 905 A.2d 819. Insureds, however, recognize

that contrary authority exists criticizing the Morris fair and reasonable standard, but they

argue that those cases, including Vincent Soybean, discussed by the Superior Court,

involved factually distinct circumstances, where the insured’s lack of cooperation

extended beyond merely settling the claim without the insurer’s consent and included

refusing to inform the insurer about the settlement offer or include insurers in any of the

defense.

       Insureds insist that the Morris fair and reasonable standard is consistent with

Pennsylvania insurance law.        They emphasize that the Morris fair and reasonable

standard acknowledges the propriety of an insurer’s decision to defend under a

reservation of rights, emphasizing that such act in no way breaches the insurer’s duties

under the insurance policy. The standard, according to Insureds, recognizes that the

insurer’s decision to defend under a reservation of rights does not permit the insured to

breach the duty to cooperate in the defense, but rather alters the relative duties.

Insureds explain their position:




                                      [J-86-2014] - 11
             To the contrary, . . . the insured must continue to satisfy its
             cooperation duties, such as sharing information with its
             insurer, responding to insurer requests, permitting an insurer
             to participate in settlement negotiations, and, of course,
             seeking insurer consent prior to entering settlement. Under
             the Fair and Reasonable Standard, in one respect, and only
             one respect, is the insured's "cooperation duty" adjusted in
             light of the insurer's assertion of its intention to reserve the
             right to disclaim coverage. And that is, when the insurer has
             reserved its right to disclaim coverage for a settlement or
             judgment, the insured is no longer duty-bound to refuse to
             enter into a fair, reasonable and non-collusive settlement
             simply because the insurer refuses consent. For, if the
             insurer is reserving its right to disclaim, thereby placing its
             insured in the "precarious" position widely noted, then the
             contours of the insured's duty to cooperate cannot properly
             be considered to extend so far as to include a duty to forego
             a fair and reasonable settlement solely because its insurer
             wishes to force a trial or to permit a forfeiture of coverage
             simply because the insured proceeds to enter into such a
             settlement.
Insureds’ Brief at 35-36 (emphasis omitted).

      In support, Insureds observe that Pennsylvania insurance law “prohibits a

mechanistic approach to interpretation of insurance policy conditions.” Insureds’ Brief at

37 (citing Brakeman v. Potomac Ins. Co., 371 A.2d 193, 196 (Pa. 1977) (requiring an

insurer to demonstrate prejudice before deeming the insured to have forfeited its

insurance coverage by failing to satisfy the notice requirements of the insurance

policy)). Insureds also note this Court’s instruction that the “insurer must show that the

breach is something more than a mere technical departure from the letter of the

[insurance contract.   Instead, it must show] that it is a departure that results in a

substantial prejudice and injury to its position in the matter.”    Insureds’ Brief at 38

(quoting Paxton Nat. Ins. Co. v. Brickajlik, 522 A.2d 531, 532 (Pa. 1987) (quoting

Conroy v. Commercial Cas. Ins. Co., 140 A. 905, 907 (Pa. 1928))) (alterations in brief).

Insureds further emphasize the “strong, prevailing public policy in Pennsylvania to


                                    [J-86-2014] - 12
encourage voluntary settlements.” Insureds’ Brief at 39 (quoting Nationwide Ins. Co. v.

Schneider, 960 A.2d 442, 449 (Pa. 2008)). Insureds assert that the Morris fair and

reasonable standard protects the insured from forfeiture and promotes settlement in

cases where the insured’s decision to settle in the face of a reservation of rights

defense does not constitute a substantial breach, given that it requires a fair and

reasonable settlement.9

      Amici Curiae10 supporting Insureds note that the Morris fair and reasonable

standard provides a corollary to the Cowden bad faith standard, observing that while

Cowden involved the grant of damages in excess of policy limits, where an insured

abided by an insurer’s bad faith refusal to settle, the Morris fair and reasonable standard

properly imposes only settlement costs up to the policy limits, where an insured agrees

to a fair and reasonable settlement over the insurer’s objection, without any need to

demonstrate the insurer’s bad faith.

      In response, Insurer urges this Court to affirm the Superior Court’s decision to

the extent it calls for the application of the Cowden bad faith standard, while adamantly

rejecting the Superior Court majority’s adoption of the Taylor/Insured’s Choice Test

allowing an insured to reject coverage as discussed above.11 Insurer contends that this

9
       Insureds further argue that even if this Court does not adopt the Morris fair and
reasonable standard for all cases, it should be applied to this case given the history of
Insurer’s refusal to provide coverage. Insureds finally assert that they would also
succeed in proving that Insurer acted in bad faith in refusing to settle if this Court were
to apply Cowden to cases where an insured settled without the consent of the insurer.

10
       Amici curiae supporting Insureds in the above stated arguments include: United
Policyholders, Dravo Corporation, E.W. Bowman, Inc., Hajoca Corporation,
Kennametal, Matthews International, Mine Safety Appliances, Saint Joseph's University,
Sylvan Incorporated, and Trumbull Corporation.

11
       As discussed supra at 9-10, all parties reject the application of the
Taylor/Insured’s Choice Test, which allows an insured to decide whether to reject
(continuedP)

                                       [J-86-2014] - 13
Court’s decision in Cowden applies to cases involving an insurer’s refusal to consent to

settlement, rejecting the Insureds’ suggestion that an insurer’s reservation of rights

changes the analysis.

       The fact that an insurer defends under a reservation of rights should not change

the analysis, according to Insurer. It observes that, under Pennsylvania law, insurers

are permitted and, indeed, encouraged to defend their insureds under reservations of

rights to provide the insureds with a defense at the outset of the underlying tort litigation

“if the factual allegations of the complaint on its face encompass an injury that is

actually or potentially within the scope of the policy.” Insurer’s Brief at 35 (quoting

Jerry’s Sport Center, 2 A.3d at 541). Insurer indicates that providing an initial defense

under a reservation of rights allows time for the factual issues in the underlying tort

litigation to clarify so that the parties can determine which claims are covered by the

language of the policy. As acknowledged by Insureds, an insurer’s reservation of rights

does not constitute a breach of the insurance policy.

       In contrast to our case law which promotes the use of reservations of rights,

Insurer highlights that the plain language of the policy forbids an insured “except at his

own cost, [from making] any payments, assum[ing] any obligations or incur[ring] any

expense.”    Insurance Agreement, Condition 6, supra at 4.             Instead, the policy

unambiguously grants Insurer the unilateral authority to settle the suit. Accordingly, it

contends that the Insureds breached the policy by agreeing to settle without Insurer’s

(Pcontinued)
coverage. Under this test, if the insured accepts coverage, a bad faith standard is
applied if the insured settles with the plaintiff without the insurer’s consent. The parties
contend that this test is contrary to Pennsylvania law, which does not allow insureds the
option to reject an insurer’s defense without breaching the policy. Moreover, the facts in
this case do not suggest that Insureds rejected coverage. Accordingly, under the
Superior Court’s analysis, the Cowden bad faith standard would most likely apply upon
the remand for a new trial.



                                      [J-86-2014] - 14
consent, and that Insurer should not be responsible for the settlement absent a

demonstration that Insurer acted in bad faith in refusing to settle under Cowden.

Insurer argues that the insureds’ rights are protected by the insurer’s obligation to act in

good faith in deciding whether to accept the offered settlement, and that the decision to

reserve its right to deny coverage does not alter that good faith requirement.

       Insurer asserts that it acted in good faith in refusing to accept the settlement in

the case at bar. It notes that the interests of the Insureds and Insurer were aligned as it

was very unlikely that the verdict would exceed the policy limits given the plaintiffs’ weak

evidence and the trial court’s procedural and evidentiary rulings prior to the retrial.

Insurer argues that many of the challenges initially raised in the reservation of rights

letter had been mooted during the decades of litigation. It further contends that the

Insureds would be unable to demonstrate bad faith as required by Cowden, as the

evidence demonstrated Insurer’s “bona fide belief” “that it had a “good possibility” of a

defense verdict in the underlying suit and that “the chance of nonliability” was “real and

substantial.” Insurer’s Brief at 41. Moreover, Insurer notes that its refusal to settle was in

part based on the legitimate concern that other plaintiffs would file copycat claims

against Insureds if Insureds settled the plaintiffs’ weak claims.

       While encouraging our adoption of the Cowden bad faith standard in the case at

bar, Insurer criticizes the Morris fair and reasonable standard relied upon by the trial

court and Insureds. Insurer contends that the Morris holding is “anathema to contract

law principles established by this Court because it treats a performing insurer as though

it breached its duty to defend.”      Insurer’s Brief at 28.    Insurer cites to a litany of

decisions and commentators discrediting the Morris decision for treating an insurer that

properly defends subject to a reservation of rights the same as the law treats an insurer

that refuses to defend. Insurer observes that the Morris fair and reasonable standard




                                      [J-86-2014] - 15
properly applies to an insured’s decision to settle under Pennsylvania law where an

insurer wrongfully refuses to defend or indemnify an insured, as in the Superior Court’s

decision in Alfiero v. Berks Mutual Leasing Co., 500 A.2d 169 (Pa. Super. 1985), but

argues that it should not be extended to cases where an insurer has not breached its

duties but, instead, has defended subject to a reservation of rights.

       Insurer rejects Insureds’ reliance on Brakeman, Conroy, and Paxton, supra at 12.

It observes that in those cases this Court refused to allow forfeiture of insurance

coverage based upon “technical” breaches by the insured, such as failing to provide

proper notice. Conversely, Insurer argues that an agreement to settle without consent

is not a technical breach but rather undermines a fundamental aspect of the bargain

between an insurer and an insured as to who controls the litigation. Insurer’s Brief at

50.   Additionally, Insurer questions the Insureds’ reliance on Pennsylvania’s public

policy favoring settlement. Instead, Insurer asserts that the Superior Court’s decision

below will not encourage settlement but, rather, will lead to protracted litigation

regarding whether a settlement is fair and reasonable.

       Insurer is supported by a number of amici curiae.12 Amici maintain that for the

last sixty years the Cowden bad faith standard has properly accounted for the interests

of insurers and insureds facing the potential of uninsured exposure (whether it be an

excess verdict or claims not covered by the policy). Amici reject the implication that the

Morris fair and reasonable standard is needed to address reservation of rights cases

because the insured is in an unusually precarious situation of having the policy not

cover losses. They retort that an insured can be placed in precarious situations even

without a reservation of rights, as damages may exceed the policy limits or include

12
      The following amici curiae submitted briefs in support of Insurer: The Complex
Insurance Claims Litigation Association and the American Insurance Association; The
Pennsylvania Defense Institute; and Property Casualty Insurers Association of America.



                                     [J-86-2014] - 16
punitive damages which are non-insurable. Instead, they contend that this risk is part of

the bargain assumed by the parties to a liability insurance contract, which defines what

losses are covered and the limits of the coverage, along with the applicable premiums

necessary to provide the agreed upon coverage. They argue that while the Morris line

of cases attempts to rebalance the bargain agreed to by the parties, the Cowden bad

faith standard properly balances the parties’ interests without doing violence to the clear

language.

        Moreover, Amici maintain that allowing insured to violate the policy language by

agreeing to settle without the insurer’s consent so long as the settlement is “reasonable”

will result in settlements in nearly all cases as “it seems there would always be some

settlement figure, however slight, which would be ‘reasonable’ to accept,” even if the

underlying claim is frivolous. Pa. Defense Institute Brief at 7 (emphasis omitted). Amici

explain that “a relatively small percentage of reservation[s] of rights actually create

types of conflicts of interest that truly expose an insured to uninsured losses.” Id. at 7.

Instead, they contend that most reservations of rights resolve during the course of the

litigation and are merely a “reminder of the terms of the contract as applied to the facts

in the lawsuit”, which cannot be deemed to constitute a breach of the contract. Id. at

12.13


13
        As an example, Amici note that in a water damage case resulting from a ruptured
water line, an insurer would likely issue a reservation of rights in regard to any claims for
mold damage which would be subject to a mold exclusion, even though the bulk of the
claims would be fully covered and no mold claims would likely be advanced by the
plaintiff. It notes that the Morris fair and reasonable standard fails to take into account
the difference between this type of “soft” reservation of rights, which is unlikely to alter
the interests of the parties, and a “hard” reservation of rights. With a “hard” reservation
of rights, the insurer views the claims as possibly covered, requiring a defense, but
ultimately unlikely to be covered by the policy, such as when intentional actions are also
pled in negligence. Brief of Pa. Defense Institute at 25-27.



                                      [J-86-2014] - 17
       In this case, we are faced with a discrete issue of first impression that is

nonetheless informed by longstanding Pennsylvania insurance law. Specifically, we are

asked to decide the appropriate standard to apply in determining whether an insurer is

liable under its insurance policy for a settlement made by its insured without securing

the insurer’s consent, when the insurer is defending the claim subject to a reservation of

rights. In deciding whether to extend our Cowden bad faith test to this scenario or to

adopt the Morris fair and reasonable standard or a variant thereof, we first consider our

precedent relating generally to the interpretation of insurance contracts and specifically

to an insurer’s reservation of rights.     Next, we review how Pennsylvania courts, in

Cowden and Alfiero, have approached related but distinguishable questions involving

an insured’s decision to accept or forgo a settlement offer absent the insurer’s consent

to settle. Finally, before adopting a variant of the Morris fair and reasonable standard,

we examine how our sister courts have approached this specific issue of an insured’s

decision to accept a settlement offer over the insurer’s objection, where the insurer has

provided a defense subject to a reservation of rights.

       General Insurance      Policy    Interpretation    and   Reservation   of   Rights   in

Pennsylvania

       “The interpretation of an insurance contract is a question of law, [and] our

standard of review is de novo.” Donegal Mut. Ins. Co. v. Baumhammers, 938 A.2d 286,

290 (Pa. 2007) (internal citations and quotation marks omitted).          “Our purpose in

interpreting insurance contracts is to ascertain the intent of the parties as manifested by

the terms used in the written insurance policy. When the language of the policy is clear

and unambiguous, we must give effect to that language.” Id. However, “[i]f doubt or

ambiguity exists it should be resolved in insured's favor.” Jerry's Sport Center, 2 A.3d at

540.




                                       [J-86-2014] - 18
       Relating to the propriety of an insurer’s defense subject to a reservation of rights,

the parties and Amici observe that an insurer’s duty to defend is distinct from and

broader than its duty to indemnify. Id. at 540, 543-44. “An insurer is obligated to defend

its insured if the factual allegations of the complaint on its face encompass an injury that

is actually or potentially within the scope of the policy.” Id. at 541. The insurer must

defend the insured even in an action that is groundless or likely to later be deemed not

covered by the policy. The insurer refuses to defend “at its own peril,” as it can be

subject to bad faith damages if it fails to defend without good cause. Id. at 542. This

broad duty to defend is mutually beneficial as it protects the insured “from the cost of

defense” while allowing the insurer “to control the defense to protect itself against

potential indemnity exposure.” Id. at 545.

       Where an insurer provides a defense, the insured is “at risk of breaching the

insurance contract” if it rejects the insurer’s defense. Id. We have emphasized that an

insured is “obliged to cooperate” with the insurer defending the action. Id. Further, our

precedent allows the insurer to defend subject to a reservation of rights, which permits

the insurer to control the defense from the beginning of the litigation while still alerting

the insured to the potential lack of coverage. Id. We observed, however, that where the

insurer believes that coverage does not exist, the insurer should deny coverage to

“allow the insured to control its own defense without breaching its contractual obligation

to be defended by the insurer.” Id. at 542. We further encourage insurers to seek

declaratory relief to eliminate the uncertainty regarding its responsibility for continued

defense and ultimately for indemnity coverage. With this understanding of the burdens

and benefits to both parties resulting from the broad duty to defend and the reservation

of rights procedure, we next review how Pennsylvania courts have addressed related

disputes between insurers and insureds pertaining to pre-trial settlement offers.




                                     [J-86-2014] - 19
       Pennsylvania’s Approach in Related Scenarios of Cowden and Alfiero

       As discussed by the parties, this Court, in Cowden, considered a case involving

an insurer’s refusal to settle. The issue presented was whether an insurer acted in bad

faith in refusing to settle, when the ultimate verdict far exceeded policy limits, thus

subjecting the insured to substantial costs that could have been avoided had insurer

agreed to settle pretrial. We recognized that the weight of authority supported the

conclusion that an insurer may be liable for the entire judgment against an insured

“regardless of any limitation in the policy, if the insurer's handling of the claim, including

a failure to accept a proffered settlement, was done in such a manner as to evidence

bad faith on the part of the insurer in the discharge of its contractual duty.” Cowden,

134 A.2d at 227.

       In regard to the decision to settle, we observed, that the interests of the parties

are “substantially hostile” where there is little or no likelihood of a verdict or settlement

within policy limits.   Id. at 228.   “In such circumstances, it becomes all the more

apparent that the insurer must act with the utmost good faith toward the insured in

disposing of claims against the latter.” Id. We acknowledged, however, that there is “no

absolute duty on the insurer to settle a claim when a possible judgment against the

insured may exceed the amount of the insurance coverage.” Id. After considering how

other courts had weighed the competing interests, we set forth the insurer’s proper

consideration of the insured’s interests:

              It means that when there is little possibility of a verdict or
              settlement within the limits of the policy, the decision to
              expose the insured to personal pecuniary loss must be
              based on a bona fide belief by the insurer, predicated upon
              all of the circumstances of the case, that it has a good
              possibility of winning the suit. While it is the insurer's right
              under the policy to make the decision as to whether a claim
              against the insured should be litigated or settled, it is not a



                                      [J-86-2014] - 20
              right of the insurer to hazard the insured's financial well-
              being. Good faith requires that the chance of a finding of
              nonliability be real and substantial and that the decision to
              litigate be made honestly.
Id. Although no bad faith was found in Cowden, the Court suggested that in the event

of a bad faith determination, the insurer would be subject to the entire judgment, even

the amount in excess of the policy limits. Id. at 227. While instructive, Cowden does

not control in the case at bar because, in Cowden, the insured did not settle but rather

allowed the insurer to continue its defense, whereas Insureds in the case at bar

accepted the settlement without Insurer’s consent.

       In contrast, in Alfiero, our Superior Court addressed a case where the insured

entered into a settlement without the consent of its excess insurer, where, unlike the

case at bar, the excess insurer breached the insurance policy by refusing to defend or

indemnify the insured, even after a declaratory judgment that the insurer had a duty to

defend. Notably, the settlement had been presented to the excess insurer and was less

than the excess insurance policy limits. The court held that, given that the excess

insurer had breached the duty to defend, the insured was free to “negotiate a settlement

according to terms intended to preserve its assets from execution.” Alfiero, 500 A.2d at

172. The court noted that there was no evidence of collusion on the part of the insured.

Accordingly, it held that the settlement could be imposed upon the breaching excess

insurer “so long as it was done in good faith and the settlement was fair and

reasonable.” Id. As noted, Alfiero is distinguishable from the case at bar because here

Insurer did not breach the policy by refusing to defend but instead offered a defense

subject to a reservation of rights.

       Other Jurisdictions’ Approaches to Settlement Absent Insurer’s Consent in

Reservation of Rights Cases




                                      [J-86-2014] - 21
      Absent Pennsylvania caselaw addressing an insured's decision to settle without

an insurer's consent where an insurer is defending subject to a reservation of rights, we

consider the decisions of our sister courts faced with similar dilemmas.14 We observe

that Insurer claims that a majority of courts have rejected Morris while the Insureds

claim that most courts have adopted tests consistent with Morris.            Rather than

attempting to tally the votes, we recognize that well-intentioned, thoughtful jurists have

found themselves on both sides of the Morris divide. Moreover, our review of other

court's decisions on this question reveals that courts are often swayed by the facts of

the case to either adopt a test protective of the insurer or the insured based on which

party acted in an arguably improper manner in that peculiar case. After consideration,

like many of our sister courts, we adopt a variant of the Morris fair and reasonable

standard limited to those cases where an insurer defends subject to a reservation of

rights and breaches its duty to settle, as described herein, in a case where the policy is

ultimately found to cover the relevant claims. As fully developed infra, in such cases an

insured may accept a settlement over the insurer’s refusal where the settlement is fair,

reasonable, and non-collusive.




14
       The issues presented in this case only arise in a subset of reservation of rights
cases where the interests are not aligned in considering settlement. Indeed, the parties
in the case at bar recognize that insureds' and insurers' interests are generally aligned
even in many reservation of rights cases where settlement is in the best interest of both
insurer and insured. Where the interests are not aligned, both parties are often acting
with substantial uncertainty as they consider settlement. There is uncertainty whether
the insurance policy covers the claim, whether the insured will be determined to be liable
to the plaintiff for the damages, and, if the insured is liable, whether the damages will
exceed the policy's coverage limits. While an insurer must act as a fiduciary toward its
insured, it is obligated only to provide coverage for which the insured paid premiums.




                                     [J-86-2014] - 22
       We first address the seminal case of Morris. The Arizona Supreme Court aptly

summarized the conflicting interests of an insurer and an insured where questions are

raised regarding whether the policy covers the claims. While acknowledging the

propriety of a reservation of rights defense, the court observed that an insured is

"placed in a precarious situation" because the insured faces the potential of paying a

verdict in excess of policy limits or the entire verdict if it is ultimately determined that the

policy does not cover the claim. The court rejected the insurer's argument that the

policy's "cooperation clause gave it a right to force the insureds to reject any settlement,

no matter how reasonable, risk trial, and place themselves at danger of a judgment

larger than the policy limits or one that might not be covered." Morris, 741 P.2d at 251.

It concluded that "such an interpretation of the cooperation clause hamstrings insureds

while granting the insurer a double bite at escaping liability" by being able to contest the

insured's liability and the coverage defense. Id.

       In contrast, the court also recognized the danger in not allowing an insurer to

defend under a reservation of rights and instead forcing it to choose whether to defend

without reservation or refuse its defense. In an oft-cited passage, the court explained

the insurer’s dilemma:

                 This solution puts an insurer honestly attempting to perform
                 its duties between Scylla and Charybdis. The insurer must
                 either give up its right to raise tenable coverage defenses or
                 its right to insist on full application of the cooperation clause.
Id. at 251-52.

       The Arizona court opined that, rather than forcing this choice, the better solution

“would permit the insurer to raise the coverage defense, and also permit an insured to

protect himself from the risk of noncoverage or excess judgment, while at the same time

protecting the insurer from unreasonable agreements between the claimant and the




                                         [J-86-2014] - 23
insured.” Id. at 252. The court concluded that the insurer who “reserves the right to

deny the duty to pay should not be allowed to control the conditions of payment." Id.

Instead, it opined that the reservation of rights "narrows the reach of the cooperation

clause" to allow the insured to settle in certain cases absent the insurer’s consent. Id.

       In a somewhat problematic statement, the court held that that "the cooperation

clause prohibition against settling without the insurer's consent forbids an insured from

settling only claims for which the insurer unconditionally assumes liability under the

policy.”15 Id. The court, however, required the “agreements must be made fairly, with

notice to the insurer, and without fraud or collusion on the insurer.” Id. Again arguably

overstating its holding, the court further opined, “The insurer's reservation of the

privilege to deny the duty to pay relinquishes to the insured control of the litigation,

almost as if the insured had objected to being defended under a reservation.” 16 Id.

       In speaking to the question of the reasonableness of the insured’s settlement, the

court relied heavily on the decision of the Minnesota Supreme Court’s in Miller, 316

N.W. 729, and observed that an “insured being defended under a reservation might

settle for an inflated amount or capitulate to a frivolous case merely to escape exposure

or further annoyance.” Morris, 741 P.2d at 253. To protect the insurer, the court held

15
       This sentence broadly suggests that the insured can settle any claim for which
the insurer defends subject to a reservation of rights. We agree with Amici, however,
that not all reservations of rights are equal, see supra at 17 n.13. The mere fact that an
insurer restates that it will not cover what the insurance policy does not cover, where it
arguably might be part of the damages sought, does not automatically result in allowing
the insured to settle the entire suit. Parties and courts may need to consider whether a
particular reservation of rights justifies diverging from the contract’s cooperation clause,
a question which is not squarely before this Court.

16
        Notably, Insureds in this case argue that the reservation of rights does not
entirely relinquish the insurer’s control over the defense to the insured, but rather only
allows the insured the limited discretion to accept a fair and reasonable settlement,
while maintaining the insurer’s control over all other aspects of the defense.



                                     [J-86-2014] - 24
that the insurer would only be responsible for paying the settlement if coverage is

eventually determined to apply and the insured demonstrates that the settlement was

“not fraudulent or collusive and was fair and reasonable under the circumstances,” as

viewed by “what a reasonably prudent person in the insureds' position would have

settled for on the merits of the claimant's case.” Id. at 254 (emphasis omitted).17

       A number of courts and commenters have criticized the Morris decision as an

improper attempt to rewrite an insurance policy for the insured’s benefit. Several courts

have cited Windt’s treatise, Insurance Claims and Disputes, critiquing the Morris


17
         An analysis similar to the Morris decision has been adopted in the following
cases: Cay Divers, Inc. v. Raven, 812 F.2d 866 (3d Cir. 1987) (holding, similar to
Morris, that a reasonable settlement effectuated by the insured does not bar the
insured’s action for indemnification against the insurer where a complaint is arguably
within the scope of insurance coverage and the insurer discharged its duty to defend by
providing independent counsel, but reserved its right to contest coverage); Midwestern
Indemnity Company v. Laikin, 119 F.Supp. 2d 831, 842 (S.D. Ind. 2000) (following
Morris and holding that a “consent judgment with a covenant not to execute would bind
the insurer on issues of the insured’s liability and the extent of injured parties’ damages”
if: coverage is shown; the consent judgment did not result from bad faith; and the
consent judgment was a reasonable settlement of the dispute); Spangler, 881 F.Supp.
at 544 (following Morris and holding that “where the insurer was defending under a
reservation of rights and had filed a declaratory judgment action contesting coverage,
the insured’s assignee is not barred from recovery from the insurer for a stipulated
liability to which the insurer did not consent and the insured is not personally liable”);
Great Divide Insurance v. Carpenter, 79 P.3d 599, 609 (Alaska 2003) (citing Morris for
the proposition that a covenant settlement agreement is enforceable against an
insurance company who defends an insured under a reservation of rights if the
settlement agreement is reasonable); Patrons Oxford Ins., 905 A.2d 819, 827 (Me.
2006) (following Morris and holding that where an insurer defends an action against the
insured under a reservation of rights, the insurer is bound by the settlement entered into
by its insured to the extent that the settlement is reasonable and that coverage is
deemed to exist); and Gainsco Ins. Company v. Amoco Production Co., 53 P.3d 1051,
1071 (Wy. 2002) (following Morris and holding that “when the insured and the claimant
settle a case that is being defended by the insurer, even under a reservation of rights,
the insured and the claimant should bear the burden of proving that the settlement was
reasonable”).



                                     [J-86-2014] - 25
decision's failure to apply the plain language of the insurance contracts which

"unambiguously state that the insurer will not pay a settlement that is entered into

without the insurer's authorization.    Courts cannot rewrite the contract to reach the

opposite conclusion simply because they believe that it would have been 'fairer' if the

contract had so provided." Am. Family Mut. Ins. Co. v. C.M.A. Mortgage, Inc., 682 F.

Supp. 2d 879, 892 (S.D. Ind. 2010) (quoting Allen D. Windt, 1 Insurance Claims and

Disputes 5th § 3.9 at 3-56)). The analysis further provided:


             An insured should not be allowed to enter into an
             unauthorized settlement simply because it is being defended
             pursuant to a reservation of rights. If it does so, and the
             settlement is not one that the insurer would have been duty-
             bound to accept, the insured should not be able to recover
             anything . . . . As long as the insurer complies with its
             contractual obligations, it should have the benefit of its
             contract, and should not be subjected to such disputes with
             its insured.
Id.

      Other courts, recognizing some of Morris's shortcomings, have instead adopted a

modified version, limiting the cases to which the fair and reasonable standard applies.

Specifically, we look to the Supreme Court of Iowa, which addressed issues of law and

fact similar to those before this Court. In Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637,

639 (Iowa 2000), the insurer, faced with a wrongful death claim brought against its

insured, defended its insured subject to a reservation of rights, asserting that the

employee exclusion provision of the policy resulted in a lack of coverage because the

victim was alleged to be an employee of the insured. The insurer properly provided

independent counsel to the insured, while contesting its coverage obligations. The

insurer, however, refused to engage in settlement negotiations because it contended that

the tort defense would be successful. Nonetheless, the insured ultimately settled with



                                       [J-86-2014] - 26
the victim's estate for $507,500, where the insured agreed to pay $7,500 and the estate

agreed not to make further claims against insured but to seek the additional $500,000

from insurer, which constituted the policy limits. When victim sought to recover the

$500,000 from insurer, insurer defended claiming that the insured had breached the

policy by settling. In response, insured claimed that insurer breached the policy by

reserving its rights and by refusing to approve the settlement.
       The Iowa Supreme Court recognized its prior case law, similar to our Superior

Court’s decision in Alfiero, holding that when an insurer refuses to provide a defense

outright, it breaches the insurance policy (assuming the policy is later determined to

apply), releasing the insured from its contractual obligations and setting it free to settle

as it sees fit. However, the court observed that in the case before it, as in the case at

bar, the insurer had provided a defense, even though it also reserved its rights to

contest coverage. The Iowa Supreme Court emphasized that Morris and other decisions

have held that an insured may settle without obtaining the insurer's consent in a

reservation of rights case as if the insurer had breached the policy by reserving its rights.

Kelly, 620 N.W.2d at 642 (citing Cay Divers, Inc. v. Raven, 812 F.2d 866, 870 (3d Cir.

1987); Spangler, 881 F.Supp. at 545; Morris, 741 P.2d at 252)). The court rejected this

aspect of the Morris line of cases, observing that "the reasoning of these cases is flawed

because they permit an insured to breach his duties under the policy without losing

coverage, even though there has not been a breach of the contract by the insurance

company.” Id. at 642.

       Instead, the Iowa Supreme Court applied a more nuanced analysis based upon

its observation that an insurer breaches its duty to its insured when it refuses to settle in

the appropriate case. It recognized its prior caselaw, similar to our analysis in Cowden,

finding that the insurer can commit bad faith by refusing to settle in an appropriate case.

It extended this analysis to cases where an insurer defends its insured subject to a


                                      [J-86-2014] - 27
reservation of rights and denies consent to a reasonable settlement offer. The court

recognized that the insurer does not breach its duty by denying consent because the

policy provides that the insurer has control over the defense and any settlement.

Instead, the court, similar to Insureds’ argument in the case at bar, held that the denial of

consent to a reasonable settlement offer releases the insured from its duty not to settle

absent the insurer's consent.

       The court explained its holding:

              Certainly under these circumstances, where the insured may
              ultimately be responsible for a judgment if coverage is found
              not to exist, it is extremely important that the insurance
              company, who is controlling the defense, fulfill its contractual
              obligation to settle where appropriate. One commentator
              has observed that an insurer may breach the contract by
              failing to settle an appropriate case, even though its failure to
              settle is attributable solely to the company's negligence. See
              1 Windt § 5.14, at 329. This commentator suggests that,
              [‘]recognizing that the company has, despite the absence of
              bad faith, breached the insurance contract, the company
              should be precluded from enforcing the provisions in the
              policy inuring to its benefit, such as the one prohibiting
              unauthorized settlements by the insured.[’] Id.
Kelly, 620 N.W.2d at 644.

       Given that the duty of good faith includes a duty to settle in appropriate cases,

the court held that when faced with a reasonable settlement demand in a reservation of

rights case, an insurer “must either abandon its coverage defense and pay the demand

or lose its right to control the conditions of settlement.” Id.   The court held “that when

an insurer provides a defense under a reservation of rights and rejects a fair and

reasonable settlement demand that a reasonable and prudent insurer would pay, the

insured is free to consummate the settlement on terms that protect the insured from any




                                      [J-86-2014] - 28
personal exposure.” Id. at 645. If coverage is later found to apply, the insurer will be

liable for the insured's settlement up to policy limits. Id. at 644-45 n.6.

       Other courts have likewise considered reasonableness of a settlement to

encompass consideration of "facts bearing on the liability and damage aspects of

plaintiffs’ claim, as well as the risks of going to trial." Miller, 316 N.W.2d at 735; see also

Guillen ex rel. Guillen v. Potomac Ins. Co. of Illinois, 785 N.E.2d 1, 14 (Ill. 2003) (same).

Moreover, courts place the burden of demonstrating the reasonableness of settlement on

the insured or its plaintiff. Miller, 316 N.W.2d at 735 ("The burden of proof is on the

claimant, the plaintiff judgment creditor, to show that the settlement is reasonable and

prudent.").

       Considering our prior decisions in Cowden and the Superior Court’s decision in

Alfiero, along with the line of cases following Morris, we adopt a variation on the Morris

fair and reasonable standard limited to those cases where an insured accepts a

settlement offer after an insurer breaches its duty by refusing the fair and reasonable

settlement while maintaining its reservation of rights and, thus, subjects an insured to

potential responsibility for the judgment in a case where the policy is ultimately deemed

to cover the relevant claims. Like our sister states, we observe that a determination of

whether the settlement is fair and reasonable necessarily entails consideration of the

terms of the settlement, the strength of the insured’s defense against the asserted

claims, and whether there is any evidence of fraud or collusion on the part of the

insured. See e.g., Miller, 316 N.W.2d at 735 (requiring consideration of the risks of

going to trial)).

       We recognize that the test in the case at bar has attributes of the Cowden bad

faith test, where an insurer’s decision not to settle had to be supported by the

conclusion “that the chance of a finding of nonliability be real and substantial and that

the decision to litigate be made honestly.” Cowden, 134 A.2d at 228.               Under the


                                      [J-86-2014] - 29
Cowden bad faith test, however, if the insured establishes that the insurer breached its

duty of good faith by failing to settle, the insurer is held responsible for the entire

verdict, which resulted from the bad faith decision not to settle, even if it far exceeds

policy limits.   In contrast, if an insurer breaches its duty to settle while defending

subject to a reservation of rights and the insured accepts a reasonable settlement

offer, the insured need only demonstrate that the insurer breached its duty by failing to

consent to a settlement that is fair, reasonable, and non-collusive, as described above,

rather than demonstrating bad faith by the insurer, as the damages sought are subject

to the policy limits to which the insurer originally contracted.18 See Kelly, 620 N.W.2d

at 645 (“The bad faith standard is simply not appropriate here, where the issue is one

of contractual liability as opposed to extra-contractual liability”) (emphasis in original).

      In this case, after an extensive trial where the jury was presented with voluminous

evidence relating to the strength of the underlying action and the settlement offer, the

jury determined that the settlement was “fair and reasonable from the perspective of a

reasonably prudent person in the same position of [Insureds] and in light of the totality of

the circumstances,” a standard which we adopt herein as the proper standard to apply in

a reservation of rights case where an insured settles following the insurers’ refusal to

consent to settlement. Notes of Testimony, Sept. 19, 2011, at 2009. We conclude that

18
       The dissent opines that we distinguish the case at bar from Cowden based on
the fact that Cowden did not involve an unauthorized settlement, which the dissent
contends is a “distinction without a difference.” Dissenting Op. at 4. Respectfully, we
disagree with this simplification which focuses solely on the immediate facts without
acknowledging the consequences resulting from the factual differences. As explained
more fully above, we conclude that it is reasonable to require an insured to demonstrate
the higher burden of bad faith in order to recover from the insurer an excess verdict, an
amount which exceeds the coverage limits for which the insured paid premiums.
Conversely, the lower standard of proof of a reasonable settlement is proper where the
insurer’s liability is confined to the previously contracted policy limits. Accordingly, we
find Cowden, substantively distinguishable.



                                      [J-86-2014] - 30
the Superior Court erred by requiring an insured to demonstrate bad faith when the

insured accepts a settlement offer in a reservation of rights case.19 Accordingly, we

reverse the decision of the Superior Court and reinstate the judgment of the trial court.

       Former Chief Justice Castille and former Justice McCaffery did not participate in

the decision of this case.

       Madame Justice Todd and Mr. Justice Stevens join the opinion.

       Mr. Justice Eakin files a concurring and dissenting opinion in which Mr. Chief

Justice Saylor joins.




19
       As noted supra at 10, we reject the Superior Court’s adoption of the
Taylor/Insured’s Choice test.



                                    [J-86-2014] - 31
