A Zurich Insurance Group Ltd. unit is absolved of its duty to defend a product liability lawsuit because of its policyholder's insistence on controlling the defense, says an appellate court.

According to Wednesday's ruling by the 8th U.S. Circuit Court of Appeals in St. Louis in Heubel Materials Handling Co. Inc. v. Universal Underwriters Insurance Co., Kansas City, Mo.-based Heubel is an authorized dealer of Greene, N.Y.-based Raymond Corp. products, which include forklifts.

Heubel's coverage included a general liability insurance policy from Kansas City, Mo.-based Universal, a Zurich unit. That policy gave Universal the right and duty to defend any suit from covered damages, but required the insured to “cooperate and assist (Universal) in the investigation, settlement, defense, enforcement of contribution or indemnification.” In addition, Raymond pays for an insurance policy from a unit of Liberty Mutual Group to cover its obligations under its indemnification program, which requires dealers to cooperate in the defense of claims.

In August 2007, William Harris was severely injured while operating a Raymond forklift that had been serviced by Heubel, and filed a personal injury lawsuit against Heubel, charging that it had failed to properly service the forklift, according to the ruling. Raymond was not named as a defendant, although it paid for and controlled the underlying suit's defense from the outset.

Heubel did not give notice to Universal about the underlying lawsuit until more than six months after it was filed. Universal initially agreed to defend Heubel, subject to a full reservation of rights based on Heubel's late notice. In response, Heubel sued in Missouri state court for a declaratory judgment that, under state law, the reservation of rights entitled Heubel to choose its own counsel and control the underlying lawsuit's defense.

In response, Universal moved the case to federal court, withdrew its reservation of rights, and offered to retain counsel to defend Heubel going forward, but told Heubel it would require the company to cooperate in pursuing indemnification from Raymond. Heubel responded by amending its complaint to seek a declaratory judgment that Universal's requirement to pursue indemnification against

Raymond created a “potential or actual conflict of interest between Universal and Heubel” which entitled Heubel to select its own counsel and control the underlying lawsuit's defense.

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The federal district court in Kansas City, Mo., held that Heubel had breached the Universal policy's cooperation clause; that it was not excused by a conflict of interest or reservation of rights, and that its lack of cooperation ”substantially prejudiced Universal, absolving it of the duty to defend or provide coverage for the underlying suit.”

A three-judge panel agreed with the lower court. “Heubel and Raymond take the position that the Universal policy provides primary coverage for the Harris suit, and yet, at the same time, the Raymond indemnification program provides primary control of the defense to Raymond,” says the ruling.

The appellate court said, however, “Because no reservation of rights or conflict of interest entitled to Heubel to select its own counsel while continuing to enjoy the coverage benefits of the Universal policy, Heubel breached the policy by refusing to allow Universal to control the defense.”

“Because nothing in the Universal policy for the Raymond indemnification program precluded a third-party indemnification claim against Raymond in the Harris suit, Universal suffered substantial prejudice from Heubel's refusal to allow Universal to control the defense. As a result, Universal was justified in denying coverage based on Heubel's breach of the cooperation clause” said the tie ruling, in affirming the grant of summary judgment to Universal.