Bad faith claims can have major consequences for insurers. Stopping the Setup gets into the minds of plaintiffs' lawyers and addresses the ways they try to create bad-faith claims against insurance companies. This overview gives you gives you 10 tips for avoiding bad faith failure to settle claims in matters where exposure potentially may exceed policy limits. Over the course of the next few weeks, our insurance team will delve deeper into each of these steps, providing insights into ways insurers can identify the bad-faith "set up", stop it or challenge it in court.

Whether you are a claims professional or in-house or outside counsel, whether your focus is on cybersecurity, construction, professional liability, or anything in between, Dentons will provide you with the tools you need to stop the bad faith setup.

Finally, there is a ruling in an important Pennsylvania case that has been making its way up to that state’s highest court in the past year: the Pennsylvania Supreme Court held that an insured does not breach its insurance policy, and therefore forfeit its insurance coverage, by settling a tort claim without the consent of its insurer, when the insurer is defending subject to a reservation of rights—as long as the settlement is fair, reasonable, and non-collusive. Babcock & Wilcox Co. v. American Nuclear Insurers, No. 2 WAP 2014, 2015 WL 4430352 (July 21, 2015).

The Court in Babcock concluded that “the Superior Court erred by requiring an insured to demonstrate bad faith [on the part of the insurer] when the insured accepts a settlement offer in a reservation of rights case.” Id. at *16. The Court adopted a variation of the Arizona “fair and reasonable” standard set forth inUnited Services Automobile Ass’n v. Morris, 154 Ariz. 113, 741 P.2d 246 (Ariz. 1987) to hold insurers responsible for settlements within their policy limits made by insureds without consent in cases that meet the following conditions:

  1. The insurer is defending insured under a reservations of rights;
  2. The insurer breaches its duty to settle by refusing a fair and reasonable settlement;
  3. After the insurer breaches its duty by refusing to settle, insured accepts offer;
  4. The policy is ultimately deemed to cover the relevant claims; and
  5. The settlement is determined to be fair and reasonable.

Babcock, at *16. With this decision, Pennsylvania has joined a growing minority of states that allow insureds to settle without consent on the basis that the insurer breached its duty to defend by reserving its rights.

There are four lessons insurers can learn from the Babcock decision.

  • First, if an insurer is faced with a situation where the insured agrees to a settlement without the insurer’s consent, the insurer can still contest whether the settlement was fair and reasonable. This determination will entail consideration of: (a) the terms of the settlement; (b) the strength of the insured’s defense against the asserted claims; and (c) whether there is any evidence of fraud or collusion on the part of the insured.
  • Second, the insurer can still contest whether the settled claims are covered by the policy. Additionally, under Pennsylvania law, even if the insurer loses a declaratory judgment on coverage issues, it is unlikely that the insurer will have to reimburse the insured’s declaratory judgment fees.
  • Third, the court noted that on account of the protection afforded by this rule, insureds will have a more difficult time arguing that, by being provided with a defense under a reservation of rights, they are entitled to retain independent counsel at the insurer’s expense.
  • Fourth, when presented with a high settlement offer while defending under a reservation of rights, if the insurer does not wish to pursue its coverage defenses, then it can withdraw the reservation of rights and continue to defend the litigation if it believes based on totality of the circumstances that settlement is not warranted. This will protect the insurer from the insured being able to agree to a high settlement that the insurer could potentially be stuck having to reimburse.