The United States Court of Appeals for the Seventh Circuit, applying Illinois law, has held that extrinsic evidence that does not decide an “ultimate issue” in the underlying claim may be admitted in a declaratory judgment action for purposes of establishing that an insurer has no duty to defend.  Landmark Am. Ins. Co. v. Hilger, 2016 WL 5239833 (7th Cir. Sept. 22, 2016).

An insurance broker contracted with several credit unions to sell life insurance-related products.  The credit unions sued several executives associated with the broker, asserting that the individuals overstated the value of collateral for certain loans.  The suits asserted counts for fraud, negligence, negligent misrepresentation, conspiracy, and related legal theories.

One of the executives sued was not an officer or director of the broker, but an executive at another company that was involved in the creation of the products.  That third-party executive sought coverage under the broker’s E&O policy, which provided specified coverage to principals, partners, officers, directors, employees, or independent contractors of the broker.  The E&O insurer denied coverage, asserting that the third-party executive was not an “independent contractor” of the broker.

In the ensuing coverage litigation in the district court, the insurer offered extrinsic evidence that purported to show that the third-party executive was an agent of the broker, and not an independent contractor.  In ruling on the insurer’s motion for judgment on the pleadings seeking a determination that the insurer had no duty to defend the executive, the district court held that the underlying complaints were “ambiguous” as to whether the third-party executive was an agent or an independent contractor of the insured.  The district court refused to consider extrinsic evidence offered by the insurer to show that the executive was in fact an agent of the insured, concluding that doing so was impermissible under Illinois law.

The court of appeals reversed.  The court agreed that Illinois law does not permit consideration of extrinsic evidence if an insurer chooses to deny coverage without seeking a declaratory judgment or defending under a reservation of rights.  However, the court went on to hold that, under Illinois law, consideration of extrinsic evidence is permissible to determine whether an insurer has a duty to defend, where the insurer has sought a declaratory judgment as to its coverage obligations, and where the extrinsic evidence does not tend to determine an ultimate issue in the underlying case.  Because none of the counts in the underlying cases turned on whether the executive was an agent or independent contractor of the insured, the court of appeals held that consideration of extrinsic evidence was permissible, and it remanded the case to the district court for consideration of that evidence.