Bad Faith “Set Up” Fails

No Duty to Defend Breach of Contract

Insurance covers many risks of loss but not all. Essentially, a liability insurance policy, insures the insured against risks of loss due to the negligence of the insured that causes property damage or bodily injury to a third person. It does not guarantee the work of the insured or that it will fulfill the terms of contracts it entered into.

In Altom Transport, Inc. v. Westchester Fire Ins. Co., United States Court of Appeals, Seventh Circuit — F.3d —- , 2016 WL 2956834 (May 20, 2016.) the Eighth Circuit was faced with a suit seeking defense and indemnity to a claim and lawsuit that alleged the insured, Altom Transport, Inc. (Altom) breached its contract with a truck driver to pay for his services as an independent contractor.


Altom is an interstate motor carrier that focuses on the hauling of liquid products throughout North America. It typically hires independent-contractor drivers to handle its business. Stampley was one of those drivers. He owned and operated his own truck and leased his services to Altom.

Insured interstate motor carrier brought action in state court against its insurer and truck driver, seeking declaration that insurer had duty to defend it under management liability policy in underlying action by driver, that insurer had wrongfully failed to do so, and that insurer’s handling of the matter had been unreasonable and vexatious. Following removal, the United States District Court for the Northern District of Illinois dismissed for failure to state a claim, and insured appealed.

Michael Stampley, a truck driver, sued Altom alleging that Altom had failed to pay him enough for driving his truck for it. Altom turned to its insurer, Westchester Fire Insurance Co., for coverage in the suit. Westchester denied coverage; Altom handled its own defense; and the parties tried to settle the case. At that point, counsel for both Stampley and Altom tried to pull Westchester back into the case, by making settlement offers within the limits of the Westchester policy trying to set up Westchester for a bad faith claim, and seeking Westchester’s approval. Westchester refused to be set up so Altom sued in state court for a declaratory judgment establishing that Westchester had a duty to defend, that it wrongfully had failed to do so, and that its handling of the matter had been unreasonable and vexatious.

Stampley sued Altom, alleging that Altom had wrongfully withheld payment from him and other similarly situated owner-operator drivers who leased their services to Altom. Stampley offered three theories in support of this claim: (1) that the contract violated the Department of Transportation’s regulations, 49 C.F.R. § 376.12, because it failed to include aspects of how Stampley’s compensation would be calculated; (2) that Altom breached the contract by failing to pay the required compensation; and (3) that Altom unjustly enriched itself by failing to pay Stampley and other drivers 70% of the gross revenue per shipment, as contractually required.

Altom had purchased an ACE Express Private Company Management Insurance Policy from Westchester, effective August 3, 2013 through August 3, 2014.  Westchester denied coverage.

Altom sued Westchester in state court for a declaratory judgment. Altom alleged that Westchester had wrongfully refused to defend it, in violation of § 155 of the Illinois Insurance Code, 215 ILCS 5/155, and that Westchester was estopped from asserting noncoverage.

Westchester removed the suit to federal court and moved to dismiss Altom’s complaint for failure to state a claim. Westchester argued that the policy’s plain language excluded coverage for Stampley’s suit because the suit was covered by two policy exceptions: one for claims about unpaid wages, and the other for claims based on a contract.


The contract claim exception states: “Insurer shall not be liable for Loss on account of any Claim: ¶ (a) alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving the actual or alleged breach of any contract or agreement; except and to the extent the Company would have been liable in the absence of such contract or agreement….”


Both at the time Altom filed its coverage suit in state court and at the time Westchester removed it to federal court, Altom was an Illinois corporation with its principal place of business in Illinois. Westchester is a Pennsylvania corporation with its principal place of business in Pennsylvania. Stampley, however, who was a party to the action on Westchester’s side at the time of removal, is also an Illinois citizen. That poses a problem under the old “complete diversity” rule.

The Supreme Court, however, has endorsed a more flexible rule, under which even a court of appeals may dismiss dispensable, nondiverse parties to preserve subject-matter jurisdiction. Stampley is just such a party. Under Illinois law, an injured third party is indispensable when an insurer sues an insured for a declaratory judgment defining coverage. Stampley has no legal interest in this suit: he has no claims against Altom or Westchester; nor do they have any claims against him. Stampley may therefore stay or go, as far as the joinder rules are concerned.

An insurer’s duty to defend arises when facts alleged in the underlying complaint fall even potentially within the policy’s coverage. The duty to defend is broader than the duty to indemnify. Nevertheless, the language of the policy controls and the policy here unambiguously excludes coverage for lawsuits stemming from the insured’s contracts with third parties.

Stampley’s claim against Altom, no matter what the legal theory may be, rests fundamentally on the lease agreement under which he was performing his carriage services. Since it is a contract Westchester has no duty to defend or indemnify Altom from claims arising out of it.

Stampley’s breach of contract and unjust enrichment claims are likewise excluded under the policy. Altom’s enrichment is “unjust” only if it failed to pay Stampley everything to which the contract entitled him (and hence retained too much of the profit from Stampley’s hauls). But that is just another way of describing a possible breach of contract. Stampley’s requested damages underscore this point: he seeks the difference between the amount he says he was owed under the contract and the amount Altom actually paid him. This describes expectation damages, the classic measure of contract damages, to a “T”. All three of Stampley’s claims in his underlying suit arise directly from his lease agreement with Altom, and therefore fall within the policy’s contract claim exception.

Altom’s last argument is that Westchester is estopped from claiming noncoverage. Under Illinois law, if an insurer neither defends nor seeks a declaratory judgment defining its coverage obligation, it will be estopped from raising the defense of noncoverage in a subsequent action. But estoppel applies only when the insurer breaches its duty to defend in the later action. Westchester did not breach its duty, and so Altom cannot assert estoppel.

Because all of Stampley’s claims fall within the policy’s contract claim exception, we do not reach the question whether his claims are within the unpaid wages exception. Michael Stampley is dismissed as a party in this case, and the judgment of the district court is otherwise affirmed.


Liability insurance does not cover every dispute between its insured and a third party. The only claim against Altom was for breach of a lease agreement – a contract – and nothing else.  There were no torts alleged. The plaintiff only wanted the benefits of his contract with Altom and the insurer unambiguously excluded the claims. If an insurer wrongfully denies a claim it can be held for extra-contractual damages. However, if a bad faith set up fails because there is no coverage, the plaintiff has wasted the fees paid to its counsel.

ZALMA-INS-CONSULT                      © 2016 – Barry Zalma

Barry Zalma, Esq., CFE, practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 49 years in the insurance business.  He now limits his practice to service as an insurance consultant and expert witness specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes.

He founded Zalma Insurance Consultants in 2001 and serves as its only consultant.

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About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
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