Does an excess insurer have an absolute right to veto a settlement under a policy’s “no action” and “no voluntary payments” clauses? The Ninth Circuit has predicted that, under California law, the answer is no. In a March 21, 2017 decision, the Ninth Circuit affirmed a district court’s $6,080,568 judgment in favor of an insured in a breach of contract and bad faith lawsuit against its excess general liability insurer arising from an underlying patent infringement dispute. (Teleflex Med. Inc., v. National Union Fire Ins. Co. of Pittsburgh, PA., No 14-563666, 9th Cir., 2017 U.S. App. LEXIS 4996.)

In reaching its decision, the Ninth Circuit confirmed the California rule set forth in Diamond Heights Homeowners Ass’n v. Nat’l Am. Ins. Co. (1991) 227 Cal. App. 3d 563, which provides that 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: (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

In Teleflex, the insured, LMA North America, Inc., had filed suit against a competitor for patent infringement, when the competitor counterclaimed for trade disparagement and false advertising, demanding $28 million. LMA’s primary insurer, which provided up to $1 million in coverage, agreed to defend LMA on the counterclaims. LMA’s excess insurer, National Union Fire Insurance Company of Pittsburgh, PA, which provided up to $10 million in coverage, did not dispute that the counterclaims were covered by its insurance policy.

National Union declined to consent or contribute to a proposed $4.75 million settlement of the underlying counterclaims, despite the fact that defense counsel had previously reported to National Union that LMA’s possible liability ranged up to $10 million. LMA ultimately accepted the settlement and then filed suit for breach of contract and bad faith against National Union. LMA alleged that National Union acted in bad faith by waiting until after the settlement to state a willingness to take on the defense. The case went to trial and the jury found for LMA on both the breach of contract and bad faith claims. The district court entered judgment in LMA’s favor for over $6 million, including $3.75 million in contract damages, over $1 million in attorney’s fees and costs, and prejudgment interest of over $1 million.

On appeal, the Ninth Circuit rejected the argument that the Diamond Heights rule was unfair to excess insurers. The Ninth Circuit reasoned excess insurers are “not without a means of avoiding a proposed settlement or challenging a final settlement” because excess insurers may agree to undertake the defense or may challenge the settlement as unreasonable.

The Ninth Circuit also held that (1) the district court did not err in denying National Union’s proposed jury instruction on the genuine dispute doctrine because “the doctrine is subsumed within the standard Judicial Council of California Civil Jury Instructions (CACI) for breach of good faith and fair dealing, which the district court gave to the jury”; and (2) the district court did not commit prejudicial error in defining the standard of proof applicable to LMA’s breach of contract claim.

The impact of the decision is that excess insurers faced with a settlement of the underlying claim that is approved by the insured and primary insurer (and is reasonable and not the product of fraud and collusion) have three options to avoid potential liability for bad faith: (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.