In Santa’s Best Craft, LLC v. St. Paul Fire & Marine Ins. Co., 611 F.3d 339, 344, 349-50 (7th Cir. 2010), the court held that St. Paul was not estopped by its failure to defend or file a declaratory judgment where its insured filed a declaratory judgment action before St. Paul had time to complete its investigation. St. Paul issued a CGL policy to Santa’s Best. The underlying amended complaint alleged Lanham Act trademark infringement, false designation of origin, false advertising, trademark dilution and deceptive trade practices. The insured originally received a cease and desist letter demanding that it change the packaging of its “Stay-On” lights, which the underlying plaintiff claimed were similar to the look and slogan of its own “Stay Lit” holiday lights.
Santa’s Best tendered the letter to St. Paul, which denied that the CGL policy it issued to Santa’s Best afforded any coverage. In November 2002, the underlying plaintiff sued Santa’s Best, and when Santa’s Best tendered the claim, St. Paul again denied coverage. In 2004, after the underlying plaintiff joined additional defendants, St. Paul responded that it was investigating its duties and reserving its right to determine that the policy afforded no coverage. Id. at 344. Not waiting for St. Paul to complete its investigation, in February 2004, Santa’s Best and others filed a declaratory judgment action to compel St. Paul to defend them, and St. Paul then counterclaimed in June 2004, seeking a declaration that it owed no such duty.
Under Illinois law, if an insurer contests that it owes any duty to defend and chooses to seek a declaration that it owes no coverage, it must do so in a timely manner. To timely seek such a declaration, the insurer must file: “(1) before the underlying action is resolved; (2) before settlement or trial is imminent; or (3) within a reasonable time of being notified of the underlying suit.” (citations omitted). The Santa’s Best court held that St. Paul satisfied each of these timeliness tests – the plaintiff filed the declaratory judgment action before St. Paul had an opportunity to complete its coverage investigation; and St. Paul counterclaimed and sought its own declaration that it did not owe a duty to defend in June 2004, months before the underlying litigants even began settlement negotiations.
This case is a good example of how easy it is to confuse the concepts of “duty to defend,” “breach,” and estoppel. The Seventh Circuit concluded that there was no breach of the duty to defend because St. Paul satisfied all the timeliness tests. (Id. at 349-503) Time filing of the declaratory judgment does not affect whether there is a breach, only if estoppel should be applied. The correct analysis should have been:
(1) Determine if the underlying complaint triggered a duty to defend;
(2) If there is potential coverage on the face of the underlying complaint and the insurer does not defend, there is a breach of the duty to defend;
(3) If there is a breach of the duty to defend, then determine if estoppel applies which would bar the insurer’s right to deny coverage for indemnity;
(4) If a timely declaratory judgment was filed by either the policyholder or insurer, then estoppel will not be applied.