Insurers don’t, as a rule, like bad faith suits.  But life can play funny tricks—as when a judgment against an insured breaches a layer of excess coverage, because the primary carrier failed to settle within its policy limits.  In those circumstances, a number of jurisdictions hold that the excess carrier is subrogated to the insured’s right to sue the primary insurer for bad faith failure to settle.  Northwestern Mut. Ins. Co. v. Farmers Ins. Co., 76 Cal App. 3d 1031 (Cal. App. 1978); Rangers Ins. Co. v. Travelers Indem. Co., 389 So. 2d 272 (Fla. 1st DCA 1980); Penn’s Estate v. Amalgamated General Agencies, 372 A. 2d 1124 (N.J. Super. Ct. 1977); Hartford Acc. & Indem. Co. v. Aetna Cas. & Sur. Co., 792 P. 2d 749 (Ariz. 1980).

But what if there was no excess judgment?  What if the excess insurer voluntarily settled the underlying suit?  And what if the underlying plaintiff never offered to settle within the limits of the primary policy?  Recently, in RSUI Indem. Co. v. American States Ins. Co., 768 F. 3d 374 (5th Cir. 2014), the U.S. Court of Appeals for the Fifth Circuit ruled that, even under those circumstances, an insurer-vs.-insurer bad faith claim could still be viable, based on the primary carrier’s failure to provide an adequate defense to the insured.

Get Me My Lawyer!

Ameraseal, L.L.C., a gasketing company in Port Allen, Louisiana, maintained (1) a primary liability policy with a $1 million limit from American States Insurance Company (ASIC) and (2) an excess policy, with a $4 million limit, from RSUI Indemnity Company (RSUI).  In June 2010, an Ameraseal employee made a left turn in front of Stacia Barrow, who allegedly was speeding and made no effort to avoid a collision.  Ms. Barrow claimed to have suffered serious injuries from the ensuing accident, including brain and spinal injuries.  Taking advantage of Louisiana’s direct action statute, Ms. Barrow filed suit in state court against Ameraseal, its employee and ASIC—but not against RSUI.

ASIC assumed the defense of the case, without notifying the excess carrier.  The defense did not go well:  ASIC’s attorneys conducted virtually no meaningful discovery and failed to oppose Barrow’s motion for summary judgment as to liability.  (The motion was granted.)  Shortly after the discovery deadline in Ms. Barrow’s suit had passed, ASIC retained new counsel, who opined “that much more defensive action should have been taken,” and who revised ASIC’s valuation of the case, from $500,000 to upwards of $5 million.

One month before the scheduled start of the trial to determine the amount of damages, Barrow offered to settle the case for the combined limits of the primary and excess policies.  ASIC agreed to pay its $1 million primary limit; in return, Barrow agreed to release ASIC from all liability, and to release Ameraseal from liability in excess of the combined policy limits.  ASIC then tendered the defense to the excess carrier, RSUI.  At that point, RSUI negotiated its own settlement with Barrow:  $2 million for a full release of Ameraseal.

RSUI then sued ASIC in the Eastern District of Louisiana, as a subrogee of its insured.  The suit charged ASIC with “bad faith failure to defend to defend the insured properly in the underlying suit.”  Crucially, RSUI alleged that ASIC’s dereliction “drove up the settlement value of the case … and left RSUI with no choice but to reach a settlement … excess to the primary policy limit.”  Specifically, it accused ASIC of

failure to evaluate and investigate the claim adequately so as to develop a comparative default defense, which was lost when the defense failed to oppose the summary judgment motion as to liability; … failure to investigate the plaintiff’s medical history and background and obtain prior medical records in order to contest damages; … failure to depose Barrow prior to the summary judgment; … failure to depose the passenger in [Ameraseal’s] car, even though he told [ASIC] that he believed [the employee] was not at fault; … failure to retain appropriate neurological experts or to arrange for an independent medical examination; and … failure to consult with liability experts.

The district court, applying Louisiana law, awarded summary judgment to ASIC, on the ground that a claim for bad faith failure to settle does not lie “in the absence of an adjudicated excess judgment.”  RSUI appealed.

It’s Not That Simple

With no Louisiana case directly on point, the Fifth Circuit analyzed the reasoning behind the Louisiana Supreme Court’s decision in Great Southwest Fire Ins. Co. v. CNA Ins. Cos., 557 So. 2d 966 (La. 1990).  Although that case arose out of an excess judgment, the Fifth Circuit found that “[the] causation element was central … to allowing recovery by the excess insurer.”  For this reason, the court concluded, an excess judgment is not a prerequisite to a bad faith claim, and a voluntary settlement is not a bar.

RSUI has alleged that [ASIC’s] bad faith caused excess liability exposure … because [ASIC’S] conduct allegedly drove up the value of the case above the primary policy limit.  The fact that RSUI stepped in and satisfied the increased amount to settle … does not change the fact that the insured was allegedly exposed to liability above the primary limit that may not otherwise have faced.

The court distinguished cases in which the bad faith claim was asserted by an underlying plaintiff, who had settled her claim for an amount in excess of policy limits.  In those cases, the courts recognize the danger of collusion between the plaintiff and the insured.  But the Fifth Circuit found it unlikely that an excess carrier would engage in similar collusion, given its own incentive to keep the settlement within the limits of the primary policy, as well as the risk that it will be unable to recover the cost of an unreasonable settlement in a bad faith suit against the primary carrier.

The court was also unmoved by the fact that Barrow never offered ASIC an opportunity to settle within the limits of its primary policy.  As a general matter, the court explained, the question of whether an insured may maintain a claim for bad faith in the absence of a firm settlement offer is unresolved in Louisiana, and it was recently certified to the Louisiana Supreme Court.  Kelly v. State Farm Fire & Cas. Co., Case No. 12-31064 (5th Cir. Sept. 10, 2014).  But in this case, the court continued, the issue was not ASIC’s failure to settle per se, but, rather, its alleged failure to conduct the defense in a way that could have kept the settlement value of Barrow’s case within the limits of the primary policy.  RSUI accused ASIC of “exposing the insured to increased liability and making the excess insurer’s liability more burdensome,” and that claim, the court held, could not be resolved as a matter of law.

The court reversed the award of summary judgment and remanded the case for a trial of the issue of whether ASIC’s conduct had unreasonably increased the value of the underlying claim.

The Best Defense is a Good Defense

The facts of RSUI were extreme: in most bad faith cases, the insurer’s own lawyer has not opined that “much more defensive action should have been taken.”  But RSUI is not the only case in which a court has allowed an excess carrier to pursue a bad faith claim in the absence of an adjudicated excess judgment.  See, e.g.Phoenix Ins. Co. v. Florida Farm Bureau Mut. Ins. Co., 558 So. 2d 1048 (Fla. 2d DCA 1990); General Acc. Fire & Life Assur. Corp., Ltd. v. American Cas. Co. of Reading, Pa., 390 So. 2d 761 (Fla. 3d DCA 1980);Continental Cas. Co. v. Reserve Ins. Co., 238 N.W. 2d 862 (Minn. 1976).  The rights of excess carriers to sue for bad faith are expanding in lock-step with those of policyholders.  It’s one more reason to keep a close eye on insured’s counsel.