The Ninth Circuit in Teleflex Medical Incorporated v. National Union Fire Insurance Company of Pittsburgh PA, No. 14-56366 (9th Cir. Mar. 21, 2017) affirmed a jury verdict finding that AIG must pay $3.75 million in damages plus attorneys’ fees to cover LMA North America, Inc.’s (“LMA’s”) settlement with its competitor over allegedly disparaging advertisements that characterized a competitor’s products as unsafe.

LMA had two general liability insurance policies covering claims that LMA disparaged other companies: (1) a primary policy issued by Transcontinental Insurance Company (called “CNA”) with a $1 million limit, and (2) an excess policy issued by AIG with a $14 million limit.

LMA conducted an analysis of its potential liability in the disparagement lawsuit, and concluded that its potential exposure was up to $10 million, excluding potential treble damages. After LMA negotiated a proposed settlement of $4.25 million, CNA, its primary insurer, agreed to fund up to its $1 million limit. AIG, however, declined to consent to the proposed settlement and did not offer to take up the defense if the settlement fell through. LMA then reiterated its request that AIG either consent to the settlement or agree to take up the defense. When AIG did not respond, LMA finalized the $4.25 million settlement and promptly notified AIG. Thereafter, AIG advised LMA that it would now assume the defense of the disparagement lawsuit if LMA could “undo” the settlement. LMA responded that the settlement could not be undone, and sued AIG for breach of conduct and bad faith in handling the matter.

After a trial, the jury unanimously found for LMA on both the breach of contract and bad faith claims, awarding $3.75 million in breach of contract damages and $1.22 million in attorneys’ fees and costs. The Ninth Circuit affirmed the judgment, holding that under California’s standard set forth in Diamond Heights Homeowners Ass’n v. Nat’l Am. Ins. Co., 227 Cal. App. 3d 563 (1991), an excess insurer has three options when presented with a proposed settlement of a covered claim that has met the approval of the insured and the primary insurer: The excess insurer must (1) approve the proposed settlement, (2) reject it and take over the defense, or (3) reject it, decline to take over the defense, and face a potential lawsuit by the insured seeking contribution toward the settlement. The Court rejected AIG’s argument that it had an absolute right to veto the settlement under the AIG policy’s “no action” and “no voluntary payments” clauses, concluding that such circumvention of Diamond Heights’ three-option framework would impose unnecessary burdens on settling parties and their primary insurers. The Court also affirmed the bad faith verdict, noting AIG’s “foot-dragging” and holding that a reasonable jury could conclude that AIG had not presented a “genuine dispute” as to its coverage liability.

The Ninth Circuit’s affirmance of the Diamond Heights standard will likely send a lifeline to policyholders who are negotiating with excess carriers over large settlements. The decision stands to encourage those excess insurers to participate in such settlements in order to avoid bad faith liability, so long as those settlements are reasonable and not the product of fraud and collusion.