Where an insurance carrier is defending its insured in a third-party suit under a reservation of rights, there may be any number of conflicts between the insurer and its insured.
One such conflict may arise where the plaintiff in the liability suit seeks damages in excess of policy limits, but makes a settlement offer to the insured for an amount equal to or less than policy limits. Believing that the settlement offer is too high, or that facts will be established at trial that will undermine coverage, the carrier may have an incentive to decline the settlement and proceed to trial. By contrast, the insured may prefer to settle within policy limits and avoid a trial.
In this circumstance, the insurance carrier may face a difficult choice: if it accepts the settlement offer, and it is later determined that there was no coverage for the claim, it faces the credit risk of having to seek reimbursement of settlement payment from its insured--who may or may not have the financial means to repay it.On the other hand, if it rejects the settlement offer, and the claimant "hits" against its insured, it could be liable not only for a judgment in excess of policy limits but additional damages that its insured has sustained.
What is a "reasonable" settlement offer that an insurer is required to accept"?
While the exact formulation of an insurer's settlement offer may vary from state to state, the California Supreme Court formulated the test in these terms: "The only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim's injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer."
In making this determination, such factors as (1)
the limits imposed by the policy, (2) a desire to reduce the amount of future settlements and (3) a belief that the policy does not provide coverage are not to enter into the insurer's decision-making process.
In those cases where a carrier has spurned an offer within policy limits, and a verdict in excess of that offer is thereafter rendered, the liability carrier will face a claim for the breach of implied covenant of good faith and fair dealing. In some states, including California, such a claim will give rise to both contract and tort measures of damages.
What are the risks to a carrier that has declined to provide coverage to its insured?
This is the classic "coverage refusal" case in which the carrier is deemed to be acting "at its own risk." Having failed to accept a reasonable settlement offer from the claimant on the ground that the claim against its insured was not covered, the insurer will be at risk for any excess judgment (and possibly additional damages) in the event that it is later determined that the insurer's coverage determination was incorrect.
This scenario is potentially dangerous from the perspective of the carrier. First, the threshold for liability is extremely low. In order to be liable for the excess judgment, the carrier need only to have been "incorrect" in connection with its evaluation of coverage. No finding of "bad faith," "unreasonableness" or other culpable conduct is necessary. Even the carrier's good faith belief that no coverage existed for the underlying claim is not a defense to liability.
Second, even where the carrier's coverage determination did not cross the line into "bad faith," the insured will be able to recover the amount of the excess judgment and "the full amount which will compensate the insured for all the detriment" caused by the insurer's conduct.
Third, a carrier that has improperly failed to provide coverage for its insured is not entitled to notice of trial or other developments in the pending liability suit. Thus, if an insurer denies coverage to the insured, the insured's contractual obligation to notify the insurer ceases. In these circumstances, the insured is free to strike the best deal it can with the claimant--and that deal will ordinarily be binding on the carrier in any subsequent bad faith suit.
Can a carrier that has assumed its insured's defense settle with the claimant over the insured's objections and then seek reimbursement of the settlement payment from the insured on the ground that there was no coverage for the claim?
An insurer might wish to accept a policy limits demand from the claimant and then, after the underlying suit is resolved, seek recoupment of the settlement amount from its insured. Thus, in Blue Ridge Ins. Co. v. Jacobsen, the California Supreme Court held that an insurer who is defending its insured under a reservation of rights may settle with the claimant over its insured's objections. The insurer may thereafter seek recoupment of the settlement payment from its insured following a determination that there was no coverage.
Can an insurer condition its contribution to a settlement with the claimant on its insured's "splitting" the amount of the settlement payment?
In a so-called "mixed" case involving both covered and noncovered claims, a carrier's duty to settle does not extend to the noncovered portions of the injured party's claim. Thus, the "reasonableness" of the carrier's settlement offer is measured by the insured's potential exposure in respect to the covered, as opposed to the noncovered claims.
A carrier may therefore request that its insured contribute to a settlement where there is a dispute about the extent of the carrier's obligations. According to one commentator, "in such cases, the insurer's suggesting the insured contribute the balance (of payments in order to complete a settlement with the claimant) should not be regarded as a breach of its implied covenant of good faith and faith dealing." The same commentator also notes that the "insurance carrier must be careful not to coerce or improperly induce the insured to contribute to the settlement. Demands upon the insured to contribute are indicia of 'bad faith' by the insurer."
Can an insured who is dissatisfied with the amount that its carrier is willing to contribute to a settlement settle directly
with injured party and then pursue its carrier for bad faith?
Difficult questions arise where an insurer defending under a reservation of rights offers an amount of money in settlement which its insured deems to be inadequate. This conflict may be particularly acute where defense costs reduce the amount of coverage available to pay a settlement or judgment. In such an instance, the insured has a strong incentive to have the carrier settle with the claimant early in the litigation.
By contrast, the carrier's incentive may be to continue to defend through trial, especially where facts may be established undermining coverage.
An insured in this circumstance may therefore be motivated to settle without its carrier's participation. But this course can be risky for the insured if it wishes to later seekreimbursement from its carrier. Since the insured's breach of the policy's "no voluntary payments" provisionwill ordinarily lead to a loss of coverage, the insured must establish in any subsequent bad faith suit that the carrier's committed an antecedant breach by failing to satisfy its duty to settle.
Not all courts allow this approach. Thus, in Hamilton v. Maryland Cas., the court held that an insured's settlement with a claimant would not be binding on the insurer in the subsequent bad faith action. In Hamilton, the carrier had been defending its insured under a reservation of rights. After the carrier rejected the claimant's settlement offer, the insured and the claimant reached a settlement on a "no personal liability" basis without the carrier's participation or consent. The Supreme Court held that in these circumstances, the settlement would not be binding on the carrier and no bad faith suit against the carrier would lie.
PETER SELVIN is a partner with Loeb & Loeb LLP in Los Angeles.
October 15, 2007
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