Your company is sued in a lawsuit for which you believe it has valid defenses, but which nevertheless has the potential to embarrass the company and result in a significant award of damages. You tender the defense of the lawsuit to the company’s liability insurer, which agrees to defend. Early in the case, the plaintiff in the lawsuit makes a settlement demand. You tell the insurer that the company wishes to minimize the negative publicity and wants to accept the settlement. The insurer, however, believes that the lawsuit can be successfully defended and claims the settlement demand is too high. It therefore refuses to agree to the settlement.
A Defending Insurer Drives Settlement Decisions
Has the insurer acted properly? And, if not, what remedies are available to you as the policyholder? The answers depend on a number of factors.
An insurer that is defending its policyholder has the right to control the defense and ultimately to settle the case. Liability insurance policies typically contain a provision that the insurer "may in [its] discretion . . . settle any claim or suit." See, e.g., Emcasco Ins. Co. v. American Intern. Specialty Lines Ins. Co., 438 F.3d 519, 521 (5th Cir. 2006). They also contain a provision that prohibits the policyholder from making "voluntary payments" toward the defense or settlement of any claim or suit. Belz v. Clarendon America Ins. Co., 69 Cal. Rptr. 3d 864, 871 (Ct. App. 2007) ("courts have applied a no-voluntary-payment provision to . . . the making of unapproved expenditures in response to a claim or suit, including the payment of a settlement"). Thus, the policyholder cannot settle a case without the consent of the insurer, and the insurer may choose not to settle, even when the policyholder believes that it is in its best interests to do so.
The converse is also true. In a case where the insurer wants to settle, but the policyholder would prefer to litigate with the expectation that a verdict will be rendered in its favor, the insurer can agree to a settlement even over the policyholder's objection. Vintilla v. Safeco Ins. Co., 417 F. Supp. 2d 922, 925 (N.D. Ohio 2006) ("the insurer's duty to defend its insured is generally held to include the right to settle rather than litigate claims"); Harris v. Standard Acc. & Ins. Co., 191 F. Supp. 538, 540 (S.D.N.Y.), rev'd on other grounds, 297 F.2d 627 (1961), cert denied, 369 U.S. 843, 82 S.Ct. 875, 7 L.Ed.2d 847 (1962) ("duty [to defend] confers upon the [insurer] the exclusive control over all decisions concerning settlement").
But the insurer must act in good faith when settling a case without the policyholder's consent. It cannot agree to a settlement that would harm the policyholder, for example, by exposing the policyholder to additional liability because the insurer did not obtain a complete release, or prejudicing the policyholder from pursuing claims that it might have against the third party. For example, in Barney v. Aetna Cas. & Sur. Co., the California Court of Appeal held that an insurer had settled an automobile accident claim in bad faith when the settlement terms foreclosed the policyholder's own claims against another party for injuries arising from the accident. 230 Cal. Rptr. 215, 221 (Ct. App. 1986). While certain insurance policies, generally those providing coverage for professional liability, contain a provision requiring the policyholder's written consent to a settlement, this provision is generally absent from liability policies. Thus, even where a policyholder would rather fight the allegations in a lawsuit, the insurer can settle the case, thereby terminating its defense obligation.
Nevertheless, the policyholder in this situation is not without options. Rather than settle, the policyholder may assume its own defense, although whether it could force the insurer to pay for any subsequent judgment that might be rendered against the policyholder is unclear. The policyholder might also ask that the insurer continue the defense, but waive any claim against the insurer for bad faith resulting from its refusal to settle the claim. The policyholder could reasonably expect the insurer to pay any judgment within policy limits, but could not pursue the insurer for any judgment in excess of policy limits (as discussed below).
An Insurer Has a Duty to Settle
The insurer's refusal to settle a case is not unlimited. The insurer cannot arbitrarily withhold its consent to a settlement of a claim that is covered under the policy. Instead, the insurer owes its policyholder a duty to act in good faith, which requires the insurer to agree to a settlement where (i) the policyholder receives a reasonable settlement demand or is able to negotiate a reasonable settlement subject to its insurer's approval; and (ii) the settlement amount is within the limits of the insurer's policy.
- The Settlement Demand Must Be Reasonable
"[T]he 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." Johansen v. California State Auto. Ass'n Inter-Ins. Bureau, 538 P.2d 744, 748 (Cal. 1975). In evaluating the reasonableness of the settlement offer, the insurer must consider such factors as the extent of the injuries or damage, the evidence related to the insured's liability, defense counsel's evaluation of the claim, and jury verdicts rendered in similar cases. E.g.,id. at 749; Howard v. American Nat'l Fire Ins. Co., 115 Cal. Rptr. 3d 42, 45 (Ct. App. 2010). The insurer must place itself in the position of the policyholder and evaluate the underlying case on its merits, as though the insurer alone would be liable for the entire amount of any judgment. Id. at 44; see also Boston Old Colony Ins. Co. v. Gutierrez, 386 So. 2d 783, 785 (Fla. 1980) ("The insurer must investigate the facts, give fair consideration to a settlement offer that is not unreasonable under the facts, and settle, if possible, where a reasonably prudent person, faced with the prospect of paying the total recovery, would do so."); Johnson v. Tennessee Farmers Mut. Ins. Co., 205 S.W.3d 365, 370-371 (Tenn. 2006) (insurer must investigate and evaluate the facts in the underlying action "to such an extent that it can exercise an honest judgment regarding whether the claim should be settled").
Even where the insurer may be disputing coverage—for example, by contending that a policy exclusion bars coverage—the insurer still has a duty to settle. See Rappaport-Scott v. Interinsurance Exch. of Auto. Club, 53 Cal. Rptr. 3d 245, 249 (Ct. App. 2007) ("The insurer must evaluate the reasonableness of an offer to settle a lawsuit against the insurer . . . without regard to any coverage defenses."). And at least in some states, when the insurer is faced with a reasonable settlement within policy limits, but believes the claim is not covered, it may be obligated to settle the case, though it may reserve its rights to seek reimbursement of the settlement amount from the policyholder in a subsequent coverage action. See, e.g., Mowry v. Badger State Mut. Cas. Co., 385 N.W.2d 171, 183 (Wis. 1986).
Similarly, where only some of the claims against the policyholder are covered, some courts have found that the insurer must nevertheless attempt to negotiate a settlement that resolves both the covered and uncovered claims. Magnum Foods, Inc. v. Continental Ins. Co., 36 F.3d 1491, 1506 (10th Cir. 1994). In this case, the insurer can request that the policyholder contribute to the settlement, but the amount of the policyholder's contribution must be reasonably related to the liability imposed by the uncovered claims. See J.B. Aguerre, Inc. v. American Guar. & Liability Ins. Co., 68 Cal. Rptr. 2d 837, 843 (Ct. App. 1997). Other courts, however, have permitted the insurer to settle only the covered claims, leaving the policyholder to defend against the uncovered claims remaining in the suit. See, e.g., Meadowbrook, Inc. v. Tower Ins. Co., Inc., 559 N.W.2d 411, 417 (Minn. 1997). These courts reason that by settling the covered claims, the insurer has fulfilled its contractual obligation. If faced with this possibility, the policyholder may want to contact an insurance coverage attorney to determine what other options may be available.
- The Demand Must Be Within Policy Limits
To trigger the insurer's duty to settle, the settlement demand must be within policy limits. "[T]he duty of good faith compels acceptance of a settlement offer only if the offer is within the insurer's policy limits[.]" Walbrook Ins. Co. Ltd. v. Liberty Mut. Ins. Co., 7 Cal. Rptr. 2d 513, 519 (Ct. App. 1992). As one court phrased it: "An insurer cannot unreasonably refuse to settle within policy limits and thus gamble with its insured's money to further its own interests." W. Polymer Tech., Inc. v. Reliance Ins. Co., 38 Cal. Rptr. 2d 78, 84 (Ct. App. 1995). Thus, the insurer is obligated to settle a claim within policy limits when the settlement value of the claim against the policyholder reasonably can be expected to exceed policy limits.
A dilemma often arises when multiple insurers provide coverage for a claim, and a reasonable settlement demand is received for an amount greater than the limits of any one policy, but less than the available limits under all policies combined. In that case, each insurer has an obligation to accept and fund the settlement up to its policy limits. Howard, supra, 115 Cal. Rptr. 3d at 49-50. In Harris v. Standard Acc. & Ins. Co., supra, for example, two insurers—Standard and Travelers—covered the same accident. Travelers offered to settle for its policy limits; Standard refused to contribute more than Travelers, regardless that its policy limits were greater. The case proceeded to trial and a judgment exceeding the limits of both policies was entered. In subsequent litigation against Standard, the court found that it had acted in bad faith by refusing to offer more than Travelers to settle the case:
[Standard's] arbitrary equation, throughout the case, of the amount it was willing to pay with that offered by [Travelers], despite factual distinctions and differences in policy coverage, cannot conceivably be reconciled with a good-faith consideration of the interests of the insured. Certainly, there can be no rational correlation between the insured's interests and potential liabilities, and the amount offered by another insurance company . . . Furthermore, it seems clear throughout, that the defendant knew that its chances of success on the issue of liability were minimal. In addition, Standard's attorney admitted that [plaintiff's] injuries were very substantial, and, therefore, that any verdict for the plaintiff would be far in excess of the combined policy coverage. . . In this situation, it is difficult to attribute the refusal to consider a settlement within the policy limits to anything other than bad faith.
191 F. Supp. at 542-543. See also Berglund v. State Farm Mut. Auto. Ins. Co., 121 F.3d 1225, 1228 (8th Cir. 1997).
But an insurer cannot simply walk away when presented with an above-limits settlement demand. Even though the insurer has no duty to accept a settlement demand that exceeds policy limits, in this situation, the duty to settle still imposes an obligation on the insurer to attempt to negotiate a settlement within policy limits. The insurer must fully inform the policyholder of the demand and the risk of a judgment in excess of policy limits for which the policyholder might be liable, and may request a contribution from the policyholder in order to avoid the uninsured liability.
In Continental Casualty v. U.S. Fiduciary & Guaranty Co., 516 F. Supp. 384 (N.D. Cal. 1981), for example, an insurer was found to have acted in bad faith when it refused either to negotiate with the third party or ask its policyholder to contribute to a settlement when the policyholder's liability was clear and a verdict was likely to exceed policy limits. "[N]o reasonable trier of fact could find other than that USF&G's refusal to negotiate either with [plaintiff] or with its insured to attempt to arrive at an acceptable settlement was a breach of its duty of good faith and fair dealing, i. e., that no prudent carrier without policy limits would have conducted itself in that manner." Id. at 390.
The Policyholder Has Remedies When the Insurer Breaches Its Duty to Settle
The consequences of an insurer's failure to settle can be far-reaching. Under California and other states' laws, a breach of the covenant of good faith and fair dealing is both a breach of contract and a tort. This is important because it subjects the insurer to liability for all damages proximately caused by the insurer's breach of duty—even outside the limits of the insurance policy—including such items as economic loss. Thus, where the insurer has refused to settle and a judgment is subsequently rendered against the policyholder in an amount in excess of policy limits, the policyholder may recover the full amount of the judgment from the insurer, notwithstanding the policy limits. See generally Luke v. Am. Family Mut. Ins. Co., 476 F.2d 1015, 1021 (8th Cir. 1973) ("the vast number of jurisdictions which have considered the question hold that when an offer of settlement within the policy limits has been made and ignored, a good faith refusal to defend is not a valid defense to a claim in excess of the policy limits").
In some states, the policyholder may also be able to recover the attorneys' fees it incurred to pursue coverage and obtain the benefits due under the insurance policy. "When an insurer's tortious conduct reasonably compels the insured to retain an attorney to obtain the benefits due under a policy, it follows that the insurer should be liable in a tort action for that expense. The attorney's fees are an economic loss—damages—proximately caused by the tort." Brandt v. Superior Court, 37 Cal. 3d 813 (1985); see, e.g., DeChant v. Monarch Life Ins. Co., 547 N.W.2d 592, 597 (Wisc. 1996); Berhard v. Farmers Ins. Exch., 885 P.2d 265, 272 (Colo. Ct. App. 1994). In addition, as with any tort action, the insurer may be subject to punitive damages provided the policyholder can establish the requisite standard of conduct.
The fact that an insurer may be liable for a judgment in excess of policy limits and, in some states, face tort damages for refusing a reasonable settlement can be a powerful hammer that the policyholder can use in convincing the insurer to settle a case. Nevertheless, an insurer may refuse to settle and continue to defend the policyholder against the third-party action, taking the risk that any subsequent judgment rendered against the policyholder will not exceed policy limits. In this situation, the policyholder that wants to settle has limited options:
- First, the policyholder may offer to contribute a portion of the settlement in order to resolve the lawsuit, although any attempt by the insurer to force the policyholder to contribute to a settlement may subject the insurer to bad faith. See Hamilton v. Maryland Cas. Co., 41 P.3d 128, 130 (Cal. 2002).
- Second, the policyholder could settle the action with its own funds. But the policyholder should notify the insurer of that fact, reserve its rights against the insurer, and seek a waiver of the voluntary payments clause. Even so, the policyholder may forfeit the right to recover the amount of the settlement from the insurer if it is later found that the insurer acted properly in refusing to settle.
- Third, the policyholder could proceed with the litigation, but protect itself against an excess judgment. It can do so by assigning its bad-faith claim to the third party with a covenant not to execute against the policyholder's assets, and the third party can proceed against the insurer in any subsequent bad-faith action. See Executive Risk Indem., Inc. v. Jones, 89 Cal. Rptr. 3d 747, 752 n.6 (2006).
Before agreeing to any of these options, the policyholder will want to consult with an experienced insurance coverage attorney to determine which option best suits its needs.
Where an Insurer Has Breached the Insurance Policy, the Policyholder Can Settle a Case Without the Insurer's Consent
The principles discussed above apply only where the insurer has fulfilled its obligations under the policy and is defending the policyholder. Where the insurer has denied coverage for the claim and failed to defend the policyholder, the policyholder is free to act on its own and to settle cases as it sees fit. Indeed, in this situation, the policyholder will likely want to settle in order to minimize its exposure. In agreeing to such a settlement, the policyholder is not forfeiting its right to coverage. As described above, a settlement with the third party can include an assignment of any bad-faith claims that the policyholder may have against the insurer for wrongfully denying coverage.
Again, before taking this step, the policyholder will want to consult with an insurance coverage attorney. It will be important to obtain a careful assessment of whether the insurer has committed a breach that frees the policyholder to act independently and in its own best interests. Because the policyholder will ultimately be pursuing its rights to coverage from the insurer, it will be essential to ensure that the settlement is, in fact, reasonable and thus does not unfairly increase the exposure of the insurer, which the insurer could later attempt to leverage into an independent defense to coverage.