A liability insurer's duty to defend its insured against covered suits seeking damages is purely contractual. There is no common law duty to defend.1 Accordingly, courts will look to the language of the policy at issue to determine whether an insurer has a defense obligation and, if so, the extent of that obligation.
The present (and since 1986) Insurance Services Office (ISO) standard form Commercial General Liability policy (CGL) expressly provides that:
Our right and duty to defend ends when we have used up the applicable limit of insurance in the payment of judgments or settlements under Coverages A [Bodily Injury and Property Damage] or B [Personal Injury and Advertising Liability] or medical expenses under Coverage C.2
The prior ISO 1966 and 1973 CGL policies achieved the same result, but through the use of somewhat different wording — "the company shall not be obligated to pay any claim or judgment or to defend any suit after the applicable limit of the company's liability has been exhausted by the payment of judgments or settlements."3
While the ISO wording made the underwriting intent clear and unambiguous4 — there is no duty to defend after policy limits have been exhausted by payment of judgments or settlements — several important issues remained for the courts to weigh in one.
Is the insurer's duty to defend terminated by settlements that, while exhausting the applicable policy limits, do not settle all suits, or claims within a suit, against the insured? May the insurer terminate its duty to defend by paying its policy limits to get one insured out of the action, to the detriment of another insured who remains in the action? Must the insurer wait until all potential claims against its insured(s) have been filed before settling with any claimant? Does a non-settling claimant have a cause for complaint because the settlement will deplete or exhaust coverage otherwise available for his or her injuries? What constitutes an insurer's good faith in settling less than all suits or claims against the insured?
"First in time, first in right"
Where multiple claimants bring suits against one or more insured defendants seeking damages for bodily injuries or death arising out of a single occurrence and, on any reasonable evaluation, the policy limits are plainly insufficient to cover the insured's total potential exposure, the rule generally applied is "first in time, first in right."5 This principle "applies regardless of "whether the priority is by way of judgment or by way of settlement."6
A liability insurer "has discretion to settle whenever and with whomever it chooses, provided it does not act in bad faith."7 Absent an allegation of bad faith with respect to settlement negotiations, an insurer will not be precluded from entering into a settlement agreement releasing less than all of the insureds.8 The insurer "has no duty to pay out claims ratably and/or consolidate them,"9 and it can settle less than all claims, even if the settlement exhausts policy limits so that the insured and other claimants are left without coverage under the policy.10 When the insurer "has paid the full monetary limits set forth in the policy, its duties under the contract of insurance cease."11
Where a covered occurrence gives rise to multiple claims, it is not necessary for the insurer to wait until all potential claims against its insured(s) have been filed before settling with any particular claimant.12 "Whether multiple claims are to be treated one at a time or collected and evaluated together, is a choice solely within the discretion of the insurer."13 As long as the insurer does not act in bad faith, it is not required to notify non-settling third-parties of the proposed settlement.14 When "a presumptively valid and adequate award has been made to one of several claimants, the fact that the remaining claimants, or any one of them, have not been taken into the confidence of the settling parties falls far short of establishing an adequate ground for equitable relief."15 If an insurer cannot obtain a global settlement and settles less than all claims, it will be subject to a bad faith suit only if the settlement is found not to have been made in good faith.
The "first in time, first in right" rule is supported by the strong public policy of encouraging speedy settlements.16 If insurers were required to know of and evaluate all potential claims against their insureds before settling any individual claim, insurers could only settle if they were willing to assume the risk that their remaining coverage, if any, would be insufficient to cover any future claim arising out of the same occurrence. Such a rule would discourage insurers from accepting reasonable settlement offers at an early stage of the litigation. As the Texas Supreme Court said that
when faced with a settlement demand arising out of multiple claims and inadequate proceeds, an insurer may enter into a reasonable settlement with one of the several claimants even though such settlement exhausts or diminishes the proceeds available to satisfy other claims. Such an approach, we believe, promotes settlement of lawsuits and encourages claimants to make their claims promptly.17
As a general rule, non-settling third-party claimants have no ground for complaining that the settlement depleted or exhausted policy proceeds that otherwise would have been available to them, leaving them no recourse against the insurer.18 The insurer's duty "is to its insured. It owes no correlative contractual duty to third-party claimants."19 As the Supreme Court of Kansas explained:
The insurer certainly could not be enjoined by plaintiffs from settling with other persons injured in the same accident and thereby exhausting the fund to the exclusion of plaintiffs. . . . If we were to follow plaintiffs' theory it could lead us to a result where one injured person could enjoin the compromise and settlement by an insurer of the claim of another injured person in the same accident. This would be in direct conflict with what has just been stated. The better rule is that where, as here, an insurer settles two of five claims arising out of an automobile accident, such settlement is not contrary to public policy as against the remaining three claimants who reduced their claims to judgment.20
Similarly, a liability insurer may settle claims against one insured under a particular policy even if such settlement exhausts the policy proceeds to the detriment of another named insured or additional insured. An insurer is "free to settle suits against one of its insureds without being hindered by potential liability to co-insured parties who have not yet been sued."21
A Texas Court of Appeals was presented with a case in which a primary insurer, having settled up to its policy limits and obtained a release on behalf of its named insured, refused to defend an additional insured in a separate action arising out of the same accident. The additional insured's excess insurer assumed the defense and then sued the primary insurer to recover its costs. The Texas Court of Appeals found that the primary insurer had breached no duty in obtaining the settlement for its named insured, and its duties to the additional insured terminated when that settlement exhausted the policy limits.22
An insurer has a duty to act in good faith with respect to the disbursement of the proceeds of a liability insurance policy and the insurer's "termination of its duty to defend, like all transactions between insurer and insured, requires the insurer to have acted in good faith."23 When an insured has surrendered all control over the handling of a claim to the insurer, the insurer assumes "a duty to exercise such control and make such decisions in good faith and with due regard for the interests of the insured."24 The duty of good faith requires the insurer to give "the interest of the insured" consideration "equal to that consideration given its own interest",25 or "to treat the claim as if it were alone liable for the entire amount."26 Where the policy limits are less than the insured's potential exposure, "the insurer cannot put its own interests first, but must negotiate as it would if its liability limits were unbounded."27
In Peckham v. Continental Cas. Ins. Co.,28 the court summarized the insurer's obligation in a multi-claim, limited coverage situation as follows:
The insurer has both the right and the duty to exercise its professional judgment in settling, or refusing to settle, such claims - but it must do so mindful of the insured's best interests and in good faith. The insurer's goal should be to try to effect settlement of all or some of the multiple claims so as to relieve its insured of so much of his potential liability as is reasonably possible, considering the paucity of the policy limits.. . . So long as it acts in good faith, the insurer is not held to standards of omniscience or perfection; it has leeway to use, and should consistently employ, its honest business judgment. . . The carrier, in fine, "will not be held to prophesy."
The insurer may not "dump its limits" by settling a claim for more than it is reasonably worth simply to avoid or terminate its duty to defend.29 The exercise of good faith "prevents an insurer from entering into a dubious release in order to quickly exhaust the limit of its liability to the insured. ‘An insurer which hastily enters a questionable settlement simply to avoid further defense obligations under the policy clearly is not acting in good faith and may be held liable for damages caused to its insured.'"30
- In Farinas v. Florida Farm Bureau Gen. Ins. Co.,31 Farm Bureau's insured, Copertino, lost control of his car, crossed a median and hit an oncoming car, causing the deaths of five teenagers and severe injuries to seven others, including a 14-year old girl who was rendered a quadriplegic. The policy limits were $100,000 per claim and $300,000 per accident.
Within two weeks of the accident, Farm Bureau settled for the policy limits with the driver of the other car and two of the death actions. It then filed a declaratory judgment action against the insured to determine whether it had any further duty to defend after having paid the policy limits. The remaining claimants intervened and ultimately filed third-party bad faith actions alleging that Farm Bureau entered into settlements without due regard for the interests of the insured.
While the trial court granted summary judgment to Farm Bureau as to all the appellants, the Florida Court of Appeal reversed and remanded for a jury trial to decide whether the insurer had met its good faith duty and had undertaken a reasonable claims settlement strategy. The court stated:
Farm Bureau's good faith duty to the insured requires it to fully investigate all claims arising from a multiple claim accident, keep the insured informed of the claim resolution process, and minimize the magnitude of possible excess judgments against the insured by reasoned claim settlement. This does not mean that Farm Bureau has no discretion in how it elects to settle claims, and may even choose to settle certain claims to the exclusion of others, provided this decision is reasonable and in keeping with its good faith duty.32
Whether Farm Bureau met its good faith duty and undertook a reasonable claims settlement strategy were held to be questions for a jury to decide.
[T]here are many factual issues for the jury to resolve, including whether Farm Bureau's quick settlement with three of the possible claimants was reasonable, whether Farm Bureau's rejection of global and other settlement options contemplated the best interests of the insured, whether Farm Bureau adequately investigated the facts of all of the claims, and whether Farm Bureau properly rejected advice of legal counsel and suggested settlement strategies proposed by Farm Bureau employees.33
- In re: East 51st St. Crane Collapse Litigation,34 involved multiple, consolidated wrongful death, personal injury and property damage claims arising out of a construction crane collapse. Lincoln, primary insurer of the project's construction manager, Joy, sought to intervene in the action to settle the claim of Rite Aid (a store in the vicinity of the accident which was damaged when the crane collapsed) for $1,000,000, or to deposit $1,000,000 with the court. That sum represented the full amount of coverage provided by Lincoln to both Joy and to the owner and developer of the property and the general contractor as additional named insureds. Lincoln also moved for a declaration that upon its payment of its full policy limits, either in settlement of Rite Aid's claims or by depositing it with the court, Lincoln's obligation to pay the defense costs of its insured and additional named insureds is extinguished pursuant to the terms of the applicable insurance policy.
The insured defendants opposed Lincoln's motion, arguing that the proposed settlement with Rite Aid was not in good faith, but only to relieve Lincoln of its obligation to defend the actions against the insureds and additional insureds and that, in any case, neither the settlement, nor a deposit into court, relieves Lincoln of its continuing obligation to defend.
The court found nothing in the terms of the contract permitting Lincoln to deposit the full amount of its coverage with the court without the consent of the named insured. Rather, the insurance policy clearly predicated extinguishment of Lincoln's obligation to defend on payment by Lincoln of the full amount of the policy coverage solely in satisfaction of a judgment or a settlement. Finding no New York case directly on point, the court looked to cases in other jurisdictions where the courts had allowed insurers to do what Lincoln sought to do, while emphasizing that for the insurer to be relieved of its duty to defend, based upon full payment of the insurance proceeds in settlement, the insurer must have acted in "good faith" and "not attempted to ‘artificially exhaust' its obligations by tendering its policy during the litigation."35
The court found Lincoln's policy language terminating its duty to defend was unambiguous and that:
There is no provision that such payment must cover all judgments or settlements in a multi-party litigation, nor can the policy language be construed in that manner. Absent an allegation of bad faith, or a claim that a settlement is unreasonable, an insurer who pays the entire proceeds of its policy in settlement of a claim in multi-party litigation, can be released from the continuing obligation to defend where the policy's language clearly and unambiguously provides for such result.36
The court rejected Lincoln's proposed settlement with Rite-Aid, finding that "where a substantial portion of discovery involving questions of liability has yet to be completed, such a large settlement that would deplete the entire primary insurance at this stage of the litigation without the settlement of even one of the personal injury plaintiffs, is not in the best interests of the insureds, nor the litigation as a whole."37
Lincoln, thereupon, proposed another settlement whereby it would pay its $1,000,000 policy limit to the estate of a deceased construction worker, who was unmarried and had no children, solely based on his claim for pre-impact terror; there was no evidence at that point as to whether and, if so, for how long, he suffered pre-impact terror. After the court rejected that proposed settlement as far in excess of amounts awarded in similar cases, Lincoln proposed yet another settlement: Lincoln's policy limit was to be divided between Rite Aid ($450,000) and a severely injured construction worker, Perez ($550,000), who underwent three separate surgeries to repair multiple fractures and had incurred $160,000 in medical expenses and a $189,000 Worker's Compensation lien. This time the court found the settlement was fair and reasonable and had been entered into by Lincoln in good faith. It granted Lincoln's application to intervene and declared that upon payment of the full amount of the settlement, Lincoln is released of its obligation to provide any further defense to the defendants.38
- In Liberty Mut. Ins. Co. v. Davis,39 Liberty's insured driver, Bess, a penniless, itinerant fruit-picker, struck the rear end of a car occupied by Mr. and Mrs. Rawls. Bess' car then careened head-on into a car occupied by plaintiffs, Mr. & Mrs. Davis and their three children. The double collision resulted in serious injury to the five Davises and the two Rawlses. It was soon evident to all concerned that the injuries to two Davises alone would exceed Liberty's $20,000 per accident policy limit, and that the Rawls' claim also would exceed $20,000. The Davies' attorney offered to compromise for $20,000.
Although Liberty recognized that its policy limit would have to be paid, it refused the offer to compromise for fear that it would be liable to the Rawls, if it depleted the entire amount of the insurance proceeds by settling with the Davises. House counsel for Liberty offered
the practical suggestion that all potential claimants involved in the 10 P.M. episode, or their attorneys, be notified that the value of claims will doubtless exceed limits, and that these people be invited to participate jointly in efforts to reach agreement as to disposition of available funds. If agreement cannot be reached after expenditure of reasonable effort, then I can see no present reason why individual claims could not thereafter be disposed of individually on the basis of fair value, first come, first served.40
Liberty ignored this advice and filed an interpleader action. Meanwhile, state court proceedings resulted in an affirmed default judgment in favor of Mr. & Mrs. Davis for $48,500 against Bess, which Liberty could have settled for the policy limits, but did not because of its concern about the Rawlses' claims. Eventually, Liberty paid a garnishment judgment of $27,526.85, its policy limits, plus interest and expenses. The Davises then obtained an assignment from Bess, who was in prison, of any claim Bess might have against Liberty for damage to Bess resulting from the company's refusal to settle the Davises' claim. In consideration of this assignment, the Davises released their claim to the unpaid portion of Bess' judgment debt.
When the assignees sued upon the refusal-to-settle claim, Liberty removed the case to the District Court for the Middle District of Florida. At the close of evidence, the district court denied the insurer's motion for a directed verdict on the issue of bad faith in the refusal to settle. The jury returned a verdict in favor of the Davises for $27,593, plus interest and the court added $10,000 for attorneys' fees.
The United States Court of Appeals for the Fifth Circuit affirmed the judgment finding that while, undoubtedly, Liberty's concerns about having to pay more than its policy limit were relevant to the ultimate jury question of bad faith, they did not, as a matter of law, justify the trial court's directing a verdict for the insurer. It was for the jury to decide whether Liberty's refusal to settle was primarily in its own interests and with too little regard for its insured's interests.
When several claimants are involved, and liability is evident, rejection of a single offer to compromise within policy limits does not necessarily conflict with the interest of the insured. He hopes to see the insurance fund used to compromise as much of his potential liability as possible. Of course, if the fund is needlessly exhausted on one claim, when it might cancel out others as well, the insured suffers from the company's readiness to settle. To put the point another way, even if liability be conceded, plaintiffs will usually settle for less than they would ultimately recover after trial, if only to save time and attorney's fees. Each settlement dollar will thus cancel out more than a dollar's worth of potential liability. Insured defendants will want their policy funds to blot out as large a share of the potential claim against them as possible. It follows that, insofar as the insureds' interest governs, the fund should not be exhausted without an attempt to settle as many claims as possible. But where the insurance proceeds are so slight compared with the totality of claims as to preclude any chance of comprehensive settlement, the insurer's insistence upon such a settlement profits the insured nothing. He would do better to have the leverage of his insurance money applied to at least some of the claims, to the end of reducing his ultimate judgment debt.41
The Fifth Circuit concluded that
efforts to achieve a prorated, comprehensive settlement may excuse an insurer's reluctance to settle with less than all of the claimants, but need not do so. The question is for the jury to decide. As this Court put it in Springer v. Citizens Casualty Company, 5 Cir. 1957, 246 F.2d 123, 128-129, it is "a question for jury decision whether the insurer had not acted too much for its own protection and with too little regard for the rights of the insured in refusing to settle within the policy limits". Here, bearing in mind the existence of multiple claims and the insured's exposure to heavy damages, did the insurer act in good faith in managing the proceeds in a manner reasonably calculated to protect the insured by minimizing his total liability? In many cases, efforts to achieve an overall agreement, even though entailing a refusal to settle immediately with one or more parties, will accord with the insurer's duty. In other cases, use of the whole fund to cancel out a single claim will best serve to minimize the defendant's liability. Considerable leeway, of course, must be made for the insurer's honest business judgment, short of mismanagement tantamount to bad faith.42
We have shown above that when a liability insurer with a duty to defend is faced with multiple claims arising out of a single covered occurrence, and its reasonable assessment of the injuries suffered by one or more of the claimants shows them to be in excess of the aggregate policy limits, the insurer must to treat the claim as if its policy was unlimited. In practice, this means the following:
- The insurer must not skimp on the defense it provides to its insured(s). Even though the insurer knows that its policy limits will be expended, it must still conduct a thorough investigation, retaining whatever experts may be necessary.
- It must provide the insured with experienced defense counsel, qualified to handle the particular type of case, and it must pay the prevailing rate in the community for such counsel's services. It may not minimize its defense costs by seeking out an inexperienced, newly-minted lawyer eager for clients who is willing to work for considerably less.
- The insurer should not make any settlement offer until there has been sufficient discovery as to liability and damages to enable it to thoroughly understand, evaluate and quantify the insured's exposure and the likelihood of an adverse result at trial.
- If possible, the insurer should defer making any settlement decisions until after all potential claims have been made or suits filed against its insured(s). This may not always be possible if the insurer receives a less than global policy limits demand that must be responded to or else the insurer risks a potential bad faith suit in the event of an excess judgment. In such cases, the insurer's dilemma is that it "has a duty to settle claims where it receives reasonable offers to do so, although settling may exhaust the policy limit and expose the non-settling insureds to personal liability; yet, by not settling, the insurer may subject itself to greater liability beyond the policy limit — an ‘excess verdict'— if it loses and is found to have unreasonably refused settlement."43 This is where the "first in time, first in right" rule protects the insurer if, in good faith, it seriously considers and accepts a reasonable settlement offer.
- Where claims are made for an amount greater than the limits of the policy and the insured is exposed to personal liability in case of an excess judgment, the insurer must inform the insured in writing of its conflicting interests, advise the insured of its rights, and keep it fully abreast of all settlement demands and offers and meaningful developments in the negotiations.44 Keeping the insured fully informed of all settlement demands and offers is especially important in multi-claimant, insufficient limits cases, "for payment to one claimant, exhausting or unreasonably depleting the available fund, may leave the insured unprotected - or nearly so - in respect to other claimants."45
- The insured and its counsel should be consulted as to the priority of claims for settlement purposes. Which claims present the greatest excess exposure? To which claims should the available policy limits be allocated? While the insurer is not bound by the insured's wishes, if it does not follow them, it should have a well-documented, sound reason for its decision.
- If a less than global policy limits settlement is achieved, the insurer must take steps to transfer control of the defense to the insured. ISO has a standard form endorsement to the CGL coverage part, "New York Changes - Transfer of Duties When a Limit of Insurance is Used Up" [CG 26 21 10 91]46, that sets out what is expected of each of the parties to facilitate the transfer of the defense to the insured. The steps to be taken, as outlined in this endorsement, are good practices that should be followed throughout the country, not merely in New York.
- First, the insurer must notify the first named insured in writing as soon as practicable that the applicable policy limit has actually been used up in payment of a settlement and that its duty to defend suits seeking damages subject to that limit has ended.
- Next, the insurer should initiate and cooperate in the transfer of control to any appropriate insured of all claims and suits seeking damages which are subject to that limit and which were reported to the insurer before that limit was used up.
- The insured must cooperate in the transfer of control of those claims and suits.
- The insurer must take such steps as it deems appropriate to avoid a default in or continue the defense of suits until an orderly transfer is completed, provided the appropriate insured is cooperating in completing the transfer.
- The first named insured and any other insured involved in a suit seeking damages subject to the exhausted limit must arrange for the defense of such suit within a time period agreed to between the appropriate insured and the insurer. Absent any such agreement, arrangements for the continued defense of such suit should be made as soon as practicable.
NEW YORK CHANGES — TRANSFER OF DUTIES WHEN A LIMIT OF INSURANCE IS USED UP
The following Condition is added to COMMERCIAL GENERAL LIABILITY CONDITIONS (Section IV):
Transfer of Duties When a Limit of Insurance is Used Up:
If we conclude that based on occurrences offense, claims or "suits" which have been reported to us and to which this insurance may apply, the:
- General Aggregate Limit other than the Products/Completed Operations Aggregate;
- Products Completed Operations Aggregate Limit;
- Personal and Advertising Injury Limit;
- Each Occurrence Limit; or
- Fire Damage Limit
is likely to be used up in the payment of judgments or settlement, we will notify the first Named Insured, in writing to that effect.
When a limit of insurance described in paragraph a. above has actually been used up in the payment of judgment or settlements
We will notify the first Named Insured in writing as soon as practicable that
- Such a limit has actually been used up and
- Our duty to defend suits seeking damages subject to that limit has also ended.
- We will initiate and cooperate in the transfer of control to any appropriate insured of all claims and suits seeking damages which are subject to that limit and which are reported to us before that limit is used up. That insured must cooperate in the transfer of control of said claims and "suits."
- We will notify the first Named Insured in writing as soon as practicable that
We agree to take such steps as we deem appropriate to avoid a default in or continue the defense of such "suits" until such transfer is completed provided the appropriate insured is cooperating in completing such transfer.
- The first Named Insured and any other insured involved in a suit seeking damages subject to that limit must arrange for the defense of such "suit" within such time period as agreed to between the appropriate insured and us. Absent any such agreement arrangements for the defense of such "suit" must be made as soon as practicable.