An insured has an opportunity to settle a $150 million class action suit for $4.9 million and asks its liability insurance carrier to pay the settlement under a policy that prohibits the carrier from “unreasonably withholding consent to settle.”  The carrier refuses to contribute more than $1 million toward the settlement.  Can the policyholder settle and then sue the carrier for the full $4.9 million?  The United States Court of Appeals for the 11th Circuit has asked that very question of the Georgia Supreme.

Most commercial liability insurance policies give the insurance company the absolute right to control the defense of the insured in a covered lawsuit and to settle the lawsuit in the discretion of the carrier.  It is, after all, the carrier’s money that pays for the defense and the settlement.  A corollary to the provision that settlement is in the carrier’s discretion is that the insured can’t go ahead and settle a claim or lawsuit without the insurance company’s consent.

Some liability policies, though, add a twist to the prohibition on the insured’s right to settle without consent.  The twist is that the carrier’s consent to settle “will not be unreasonably withheld.”  That provision appears quite frequently in Directors’ & Officers’ liability insurance policies, under which it is common for the insured to control its own defense and for the carrier to reimburse defense costs.  The question arises whether the provision requires anything meaningful of the carrier, such as — here’s a novel approach to the question — not unreasonably withholding consent to settle.

Last week, the United States Court of Appeals for the 11th Circuit, which hears appeals from the United States District Courts located in Georgia, Florida and Alabama, certified three questions to the Georgia Supreme Court in a case involving coverage for a policyholder’s settlement of an underlying lawsuit without the insurer’s consent.  (Federal courts, which are supposed to apply state law except where a dispute requires application of U.S. statutory or Constitutional law, will sometimes seek the guidance of a State’s Supreme Court — called “certifying” a question — when a case involves unsettled issues of state law.)  The case is Piedmont Office Realty Trust, Inc. v. XL Surplus Ins. Co., Docket No. 1:13-cv-02128-WSD (get a copy here).

Piedmont was sued in a class action that sought $150 million in damages.  Years of litigation ensued, in which Piedmont’s primary insurance company had paid $10 million in defense costs and the excess carrier, XL Surplus Insurance Company, paid another $4 million in defense.  Eventually, the dispute went to mediation (a formal settlement negotiation facilitated by a trained mediator) and the parties agreed to settle the case for a payment by Piedmont of $4.9 million.  Piedmont asked XL to fund the settlement.  XL refused and offered to contribute only $1 million to the settlement.

Without consulting XL further, and without obtaining the carrier’s consent, Piedmont settled the case for the $4.9 million settlement amount and sued XL for coverage in federal court in Georgia.  The United States District Court granted a motion to dismiss filed by XL, finding that Piedmont was under an “unconditional” obligation to obtain XL’s consent for the settlement.  Its failure to do so was a breach of contract, according to the District Court.

It is never appropriate — or at least it never should be — to read policy language out of a policy so that it favors a carrier’s denial of coverage.

On Piedmont’s appeal to the 11th Circuit, the Court of Appeals determined that there was no controlling Georgia case law to resolve the questions of coverage, of which the 11th Circuit found three.  The second certified question, however, is the truly interesting one:

In a case like this one, when an insurance contract contains a “consent-to-settle” clause that provides expressly that the insurer’s consent “shall not be unreasonably withheld,” can a court determine, as a matter of law, that an insured who seeks (but fails) to obtain the insurer’s consent before settling is flatly barred — whether consent was withheld reasonably or not — from bringing suit for breach of contract or for bad-faith failure to settle? Or must the issue of whether the insurer withheld unreasonably its consent be resolved first?

Here is what the XL policy said about Piedmont’s right to settle:

No Claims Expenses shall be incurred or settlements made, contractual obligations assumed or liability admitted with respect to any Claim without the Insurer’s written consent, which shall not be unreasonably withheld. The Insurer shall not be liable for any Claims Expenses, settlement, assumed obligation or admission to which it has not consented.

Except in unusual circumstances, insurance policies are written by an insurance industry trade group called the Insurance Services Office without any input from the insured.  They are sold on a take-it-or-leave-it basis and the standard form language of the policy cannot be changed by negotiation.  For this reason, courts interpret policy language strictly against the insurer and in favor of coverage whenever it is possible to interpret it in that way reasonably.  It is never appropriate — or at least it never should be — to read policy language out of a policy so that it favors a carrier’s denial of coverage.

The U.S. District Court had, according to the 11th Circuit, concluded that the “Consent-to-Settle” provision would “forbid unconditionally Piedmont from settling a claim without XL’s consent.”

But, there was a condition, wasn’t there?  It’s right there in the first sentence of the clause, which says that the carrier’s consent to settle, when requested by the insured, “shall not be unreasonably withheld.”  A great many standard liability policies do not contain that condition.  But this one does.  It is clearly there for a reason and it plainly limits an insurer’s ability to reject coverage for a settlement that the policyholder seeks to enter into.

The District Court’s view of the policy language put Piedmont right between a rock and a hard place.  It observed that Piedmont had two choices if it believed that XL’s consent to settle a $150 million case for $4.9 million was withheld unreasonably: (1) forego the settlement, or (2) wait until after a judgment had been entered against Piedmont following a trial and then sue XL for breach of contract.  Let’s count the number of things that are wrong with that approach.

First, there is a strong public policy in every jurisdiction in the country that favors settlement of lawsuits.  The District Court’s interpretation of the Consent-to-Settle clause not only discourages settlement, it affirmatively encourages scuttling settlements.

Second, the District Court’s approach goes even further than adopting a rule that scuttles settlements.  After thwarting the parties’ desire to settle a dispute, the District Court would actually require the insured to go to trial.  There is no language in the Consent-to-Settle provision that requires a policyholder to try a case when it desires to settle instead.

Third, the Consent-to-Settle provision is in the nature of an exclusion in coverage.  Courts are supposed to be especially vigilant in protecting policyholders against the denial of coverage on the basis of an exclusion.  The District Court, however, actually removed a clause from the exclusion that limits the carrier’s ability to deny coverage and then interpreted the remaining language in a manner favorable to the carrier.

Fourth, the District Court’s approach to the question permits the carrier to gamble with the policyholder’s money.  What happens, for example, if the policyholder does as the District Court instructs, foregoes the settlement, takes the case to trial, and gets hit with a judgment that exceeds the remaining limits of liability in the policy?  Whose responsibility will it be to pay the amount above the limits?  In most states, a carrier has a duty of good faith and fair dealing to settle an underlying lawsuit against the insured within the limits of the policy if possible.  If it fails to do so, and forces the insured into an ill-conceived trial of the underlying suit, the carrier can be held liable for any amount of the judgment that exceeds the remaining limits of liability.  Would the same rule apply here, if the District Court’s directive holds sway?  Who knows?

In the Piedmont case, there was only $6 million dollars left in the liability limits of the XL policy and the settlement was well within those limits.  By offering to pay only $1 million, XL knew that its gamble would cost it an additional $5 million, and no more.  With the District Court’s decision in favor of dismissal of Piedmont’s claims, that gamble turned out to be a very profitable one.

The insurance relationship is one of unequal bargaining power, in which the insurer holds the upper hand.  For this reason, and others, courts will sometimes interpret exclusions in coverage in a way that seems to do violence to the policy language — or even to read an exclusion entirely out of a policy — if it is necessary to do so in order to conform the policy to the policyholder’s reasonable expectations of coverage.  They should never, ever do so, however, to benefit the carrier’s interest in denying coverage.

The 11th Circuit was quite plainly troubled by the District Court’s ruling against Piedmont.  As we have observed before, you can often tell how a decision is going to come out by the way a court frames the issue.  Here, for example, the 11th Circuit’s question to the Georgia Supreme Court points out that the Consent-to-Settle clause “provides expressly” that consent may not be unreasonably withheld.  When lawyers and judges want to emphasize a contractual or statutory obligation that must be enforced, they will often observe that the language of the provision in question “expressly provides” for compliance.

The 11th Circuit also uses imperatives to describe what the District Court did: “as a matter of law,” “flatly barred” “whether consent was withheld or not.”  Perhaps it’s reading too much into the language, but the use of these imperatives suggests that the Circuit court would not have ruled in the same way.

Especially telling, however, is the part of the certification opinion that points out to the Georgia Supreme Court that “it appears that at least some courts across the nation have approached the issue differently than the district court did here.”  The 11th Circuit then cites to decisions by federal District Courts in Oregon, Delaware and Colorado, all of which held that the reasonableness of an insurer’s refusal to consent to a settlement had to be resolved, and that an insured may act reasonably in breaching a Consent-to-Settle provision if the insurer unreasonably withheld its consent.

Here’s hoping that the Georgia Supreme Court finds these cases persuasive.