The Restatement of the Law of Liability Insurance (“RLLI”) passed in May 2018 after a one-year delay in voting, following strong negative reactions from practitioners, insurers, and states. Indeed, following the release of the 2017 draft, several governors sent letters of protest – Iowa, Maine, Nebraska, South Carolina, Texas and Utah – stating that the ALI was usurping the state legislatures and the RLLI was at odds with their states’ common law.
Although changes were made to that draft, the version that was eventually passed remains extremely policyholder-oriented and not a “restatement” of existing legal principles in any real sense of the word. This is not surprising, as it began as a Principles of Law project – aspirational rather than reflecting settled legal holdings. Following its passage, the State of Ohio passed a law specifically to prevent its adoption, providing that the RLLI “does not constitute the public policy of Ohio.” Ohio Revised Code of Insurance, Title XXXIX, Chapter 3901.82.
In this series of blog posts regarding provisions of the RLLI, we will examine how it is not a “restatement” of settled common law, but instead adopts minority or even entirely novel principles. The RLLI reflects a profound lack of insight into practical claims handling practices, and in many respects is internally inconsistent or unworkable. We will periodically update these posts as a type of “scorecard,” tracking how various jurisdictions have responded to the RLLI.
Our sixth post considers RLLI’s thoughts on an insurer’s bad faith failure or refusal to settle. Bad faith is very much a creation of state law, and the RLLI’s proposals here are not a “restatement” so much as an entirely novel approach to bad faith law.
THE RLLI LANGUAGE
§ 24. The Insurer’s Duty to Make Reasonable Settlement Decisions
(1) When an insurer has the authority to settle a legal action brought against the insured, or the insurer’s prior consent is required for any settlement by the insured to be payable by the insurer, and there is a potential for a judgment in excess of the applicable policy limit, the insurer has a duty to the insured to make reasonable settlement decisions.
(2) A reasonable settlement decision is one that would be made by a reasonable insurer that bears the sole financial responsibility for the full amount of the potential judgment.
(3) An insurer’s duty to make reasonable settlement decisions includes the duty to make its policy limits available to the insured for the settlement of a covered legal action that exceeds those policy limits if a reasonable insurer would do so in the circumstances.
§ 27. Damages for Breach of the Duty to Make Reasonable Settlement Decisions
An insurer that breaches the duty to make reasonable settlement decisions is subject to liability for any foreseeable harm caused by the breach, including the full amount of damages assessed against the insured in the underlying legal action, without regard to the policy limits.
§ 36. Assignment of Rights Under a Liability Insurance Policy
(1) Except as otherwise stated in this Section, rights under a liability insurance policy are subject to the ordinary rules regarding the assignment of contract rights.
(2) Rights of an insured under an insurance policy relating to a specific claim that has been made against the insured may be assigned without regard to an anti-assignment condition or other term in the policy restricting such assignments.
(3) Rights of an insured under an insurance policy relating to a class of claims or potential claims may be assigned without regard to an anti-assignment condition or other term in the policy restricting such assignments, if the following requirements are met:
(a) The assignment accompanies the transfer of financial responsibility for the underlying liabilities insured under the policy as part of a sale of corporate assets or similar transaction;
(b) The assignment takes place after the end of the policy period; and
(c) The assignment of the rights does not materially increase the risk borne by the insurer.
§ 49. Liability for Insurance Bad Faith
An insurer is subject to liability to the insured for insurance bad faith when it fails to perform under a liability insurance policy:
(a) Without a reasonable basis for its conduct; and
(b) With knowledge of its obligation to perform or in reckless disregard of whether it had an obligation to perform.
§ 50. Remedies for Liability Insurance Bad Faith
The remedies for liability insurance bad faith include:
(1) Compensatory damages, including the reasonable attorneys’ fees and other costs incurred by the insured in the legal action establishing the insurer’s breach of the liability insurance policy and any other loss to the insured proximately caused by the insurer’s bad-faith conduct;
(2) Other remedies as justice requires; and
(3) Punitive damages when the insurer’s conduct meets the applicable state-law standard.
WHY IT IS PROBLEMATIC
Bad faith is a highly state-specific cause of action
Bad faith, as a cause of action, is one of the most distinct and individualized expressions of each jurisdiction’s public policy. There is no uniform agreement as to whether “bad faith” is a contractual or tort cause of action, and state-specific expressions of what conduct rises to the level of “bad faith.” It is, therefore, a difficult subject for a “restatement” of the law.
Failure to settle
Initially, RLLI reformulates an existing cause of action commonly known as “bad faith failure to settle” or “bad faith refusal to settle” as simply a “breach of the duty to make reasonable settlement decisions.” Comment a to § 24 makes it clear that liability is imposed for less than a bad faith state of mind on the part of the insurer, but for simple negligence. RLLI construes the standard of care in terms of “commercial reasonableness.” As is clear from Comment c, it is a “disregard the limits” remedy, which blows up the limits even in the absence of wrongful intent by the insurer. Amazingly, the RLLI argues that this is a more lenient approach than “strict liability,” with Comment b being the only nod in the entire RLLI to any interest in preventing the bad faith setup, while citing no authority for the proposition that any jurisdictions presently impose a strict liability standard for failure to settle.
This is not a “restatement.” The Reporter’s Note to § 24 cites treatises rather than case law in support of the contention that this is a “majority rule,” and admits, without clearly addressing the issue, that liability for failure to settle is determined by different standards of “bad faith” or negligence by the various jurisdictions. Remarkably, the Reporter’s Note to § 27, in claiming that the majority of jurisdictions have adopted the principle, cite to cases establishing the measure of damages for “bad faith failure to settle,” without noting that this section is the measure of damages for a breach of duty to settle that is not predicated in “bad faith.”
The RLLI approach would eliminate the minimal protections afforded to insurers in some notorious “set up” states like Missouri. Every reported Missouri case involving insurer bad faith, beginning with Zumwalt v. Utilities Ins. Co., 228 S.W.2d 750 (Mo. 1950), limits liability to a bad faith refusal of an offer to settle within or for the liability policy’s limits. See Id. at 754 (bad faith for insurer to refuse reasonable settlement offer within liability limits and instead gamble on escaping liability by favorable verdict); Landie v. Century Indem. Co., 390 S.W.2d 558, 564-66 (Mo. App. K.C. 1965) (the insurer’s duty is to give good faith consideration to settlement offers within the liability limits; insurer’s refusal to accept such offer, if in bad faith, entitles insured to recover); Levin v. State Farm Mut. Ins., 510 S.W.2d 455, 458 (Mo. banc 1974) (offer to settle within liability limits is a “necessary predicate” to bad faith claim); Bonner v. Auto. Club Inter-Ins. Exch., 899 S.W.2d 925, 928 (Mo. App. E.D. 1995) (not only must there be an offer to settle within the liability limits, but also the offer must be definite in amount); Ganaway v. Shelter Mut. Inc. Co., 795 S.W.2d 554, 556 (Mo. App. S.D. 1990) (insurer liability results from failure to exercise good faith in considering offers to compromise within liability limits). An offer to “settle” within policy limits is a “necessary prerequisite” for a claim for bad faith in Missouri. Levin, 510 S.W.2d at 458. The “good faith” contemplated by the law is a duty to give consideration to settlement offers within the liability limits. Landie, 390 S.W.2d at 564-66. The RLLI would eliminate the need for the policy-limits demand to trigger potential bad faith liability in Missouri, and other similar jurisdictions.
Moreover, the RLLI would propose to blow up the policy limits without addressing circumstances in which the insurer’s position on settlement was based upon its coverage analysis. Again, even in insurer-hostile jurisdictions, this kind of liability generally requires more than an erroneous denial of coverage. See, e.g., Shobe v. Kelly, 279 S.W.3d 203, 211-12 (Mo. App. W.D. 2009).
Punitive damages are the only additional remedy brought to the table by the bad faith cause of action, with RLLI’s proposed standard for failure to settle already accomplishing the elimination of the policy’s liability limits and recovery of the insured’s attorneys’ fees and consequential damages. Again, the RLLI is lacking in case law support for this approach.
Many courts will define “bad faith” as a “state of mind” consisting of the insurer’s “‘intentional disregard of the financial interest of [the] insured in the hope of escaping the responsibility imposed upon [the insurer] by its policy.’” Scottsdale Ins. Co. v. Addison Ins. Co., 448 S.W.3d 818, 828 (Mo. banc 2014). Often, evidence must establish that the insurer “intentionally disregarded” the insured’s financial interests in the hope of escaping its responsibility under the policy. Rinehart v. Shelter Gen. Ins. Co., 261 S.W.3d 583, 595 (Mo. App. W.D. 2008). The principle is that the insure
The measure of damages
The RLLI fails to address a critical topic – how to measure the insured’s damages for bad faith failure to settle. There is a significant question as to whether courts should presume that the amount of the underlying judgment equals the amount of the judgment or settlement entered into by the insured.
This includes circumstances in which the insured has protected itself from the impact of a judgment in excess of its policy limits by virtue of a covenant not to execute against the insured’s assets, a/k/a a “Mary Carter” agreement, an agreement pursuant to Mo. Rev. Stat. § 537.065, etc. The essence of a bad faith cause of action is that the insured suffered tangible economic loss as a result of its insurer’s tortious refusal to settle claims against it. However, where the insured has not suffered these tangible economic losses, including by virtue of a covenant not to execute, there is case law in many jurisdictions holding that the insured has sustained no actual damages. Allowing a party in such circumstances to collect all or part of the judgment amount:
perpetrates a fraud on the court, because it bases the recovery on an untruth, i.e., that the judgment debtor may have to pay the judgment. Such a result should be against public policy, because it allows, as here, parties to take a sham judgment by agreement, without any trial or evidence concerning the merits, and then collect all or a part of that judgment from a third party. Allowing recovery in such a case encourages fraud and collusion and corrupts the judicial process by basing the recovery on a fiction.... [T]he courts are being used to perpetrate and fund an untruth.
H.S.M. Acquisitions, Inc. v. West, 917 S.W.2d 872, 882 (Tex. App. Corpus Christi 1996) (citations omitted). The Texas court found that the consent judgment entered by the parties pursuant to the covenant not to execute could not be enforced against the insurer in a bad faith action. Id.
Moreover, Courts have found that a judgment entered into by the insured with the injured party need not even have been collusive for a court to refuse to give it any weight in determining the amount of insured’s damages in a bad faith action against his insurer. See Hamilton v. Maryland Casualty Co., 117 Cal. Rptr. 2d 318, 327 (Cal. 2002). “A defending insurer cannot be bound by a settlement made without its participation and without any actual commitment on its insured’s part to pay the judgment.” Id. RLLI is astonishingly silent on these issues.
HOW THE COURTS HAVE REACTED
As of the date of this writing, we have not seen reported decisions addressing these RLLI provisions.