Employers Liability Insurance: The Kotecki Coverage Exclusion And The Importance Of A Reservation Of Rights Letter

June 2014

In Illinois, an employer's contribution liability cannot exceed the amount of workers' compensation payments in accordance with the Illinois Supreme Court decision Kotecki v. Cyclops Welding Corp., 146 Ill.2d 155, 166 Ill.Dec. 1, 585 N.E.2d 1023 (1991). This well-known rule of law in Illinois is commonly referred to as the "Kotecki" capon damages. Subsequent to the Kotecki decision, Illinois courts held that an employer may waive its Kotecki protection by contract and thereby become potentially liable for its full pro rata See Liccardi v. Stolt Terminals, Inc.share of contribution liability., 178 Ill.2d 540, 227 Ill.Dec. 486, 687 N.E.2d 968 (1997); Braye v. Archer Daniels-Midland, Co., 175 Ill.2d 201, 222 Ill.Dec. 91, 676 N.E.2d 1295 (1997). A Kotecki waiver is typically found in a contractual indemnity provision, where a party agrees to indemnify and hold harmless another party.

The issue of coverage under an employers liability policy for liability above the Kotecki cap was addressed in Christy-Foltz, Inc., v. Safety Mutual Casualty Corporation, 309 Ill.App.3d 686, 722 N.E.2d 1206, 243 Ill.Dec. 137 (4th Dist. 2000). In Christy-Foltz, the plaintiff insured filed a declaratory judgment action seeking a determination that its employers liability policy covered all contribution liability, including any liability above the Kotecki cap. The defendant insurer, Safety National, conceded that it owed coverage for any judgment up to the Kotecki cap, but denied any duty to cover damages above the Kotecki cap. Safety National relied on a policy provision which excluded coverage for "any loss or claim expenses voluntarily assumed by the employer under any contract or agreement, express or implied." The Appellate Court held the plaintiff's contractual Kotecki waiver constituted a voluntary agreement to assume liability beyond the Kotecki limit on damages and, therefore, the policy did not provide coverage for any liability above the Kotecki cap.

Following the Christy-Foltz decision, the Illinois Supreme Court weighed in on this issue. In Virginia Surety v. Northern Ins. Co. of New York, 224 Ill.2d 550, 866 N.E.2d 149 (2007), the Illinois Supreme Court held that a commercial general liability policy did not provide coverage for liability above the Kotecki cap where the insured had a contractual Kotecki waiver. In seeking coverage, the insured argued that the "insured contract" exception to a standard employers liability exclusion provided coverage because the insured had agreed to assume the "tort liability" of the other party. The Illinois Supreme Court reasoned that the contractual Kotecki waiver (found in an indemnity agreement) did not constitute the assumption of another party's tort liability. Rather, the Illinois Supreme Court deemed the indemnity agreement as "a simple anticipatory waiver of an affirmative defense in a contribution action."

The impact of the Virginia Surety decision is relatively straightforward as concerning commercial general liability policies. However, the issue is not as clear-cut under employers liability policies. Virginia Surety discussed the Christy-Foltz decision, stating "to the extent that Christy-Foltz ... would hold otherwise, [it is] overruled." Thus, Virginia Surety arguably can be read as overruling Christy-Foltz, in support of an argument that exposure for liability above the Kotecki limit, resulting from a waiver, falls to the employers liability policy and not to the commercial general liability policy.

In response to Virginia Surety, many employers liability policies began to include specific exclusions in an effort to avoid coverage above the Kotecki limit. The National Council on Compensation Insurance drafted endorsement WC 12 03 06, which excludes coverage for "liability assumed under a contract, including any agreement to waive your right to limit your liability for contribution to the amount of benefits payable under the Workers' Compensation Act."

Insurers issuing employers liability policies in Illinois which exclude coverage above the Kotecki limit should analyze the potential application of the exclusion upon receipt of a request for coverage from the insured. In other words, has the insured entered into a contract with a Kotecki waiver? If the answer is yes, insurers may need to take additional steps in order to preserve the right to disclaim coverage for liability above the Kotecki limit.

In Illinois, in order to preserve a policy defense or coverage exclusion, an insurer generally must defend under a reservation of rights or file a declaratory judgment action. If the insurer fails to take either of these options, it may be estopped from later raising policy defenses to coverage. Standard Mutual Ins. Co. v. Lay, 2013 IL 114617, 989 N.E.2d 591, 371 Ill.Dec. 1. The reservation of rights must make specific reference to the policy defense which ultimately may be asserted and to any potential conflict of interest. Royal Insurance Company v. Process Design Associates, Inc. 221 Ill.App.3d 966, 582 N.E.2d 1234, 164 Ill.Dec. 290 (1st Dist. 1991). An insurer which notifies its insured that it is defending under a reservation of rights and identifies the policy provisions that may preclude coverage is not estopped from subsequently denying coverage. State Farm v. Martinez, 384 Ill.App.3d 494, 893 N.E.2d 975, 323 Ill.Dec. 501 (1st Dist. 2008).

It is not difficult to envision a large contribution verdict against a culpable third-party defendant employer which waived its Kotecki protection. When the time comes to pay the judgment, an insurer's attempt to disclaim coverage for liability above the Kotecki limit may be too late if a proper reservation of rights letter was never sent to the insured. Insurers in Illinois, whose policies exclude coverage above the Kotecki cap, should issue reservation of rights letters citing this policy exclusion or risk the consequences of paying a judgment for which they never bargained.