RISKVUE ARCHIVE | FEATURE STORIES

Are Policyholders Left in the Lurch When Insurance Companies Refuse to Settle?

By John B. Berringer and Natasha Z. Millman

Policyholders facing substantial liability from products liability or "mass tort" claims are often presented with an additional dilemma: what to do when their insurance company either refuses to get involved in settlement negotiations or, even worse, affirmatively refuses to authorize the policyholder to settle the claims. In the first scenario, an insurance company may, in effect, leave the policyholder to its own devices, while continuing to reserve its purported right to deny coverage. In the second scenario, an insurance company may decide to "roll the dice" on the first of a host of similar claims, even though a loss may expose the policyholder to judgments in subsequent cases far in excess of the insurer's policy limits. The good news for policyholders is that such conduct by an insurance company may free the policyholder to settle the case on its own and then recover the cost of the settlement as damages from its insurers. Moreover, the policyholder may even be entitled to punitive damages and attorneys' fees, at least in some states.

Background

There is a fundamental principle of insurance law that has been validated by courts around the country: once a liability claim has been settled by a policyholder, the relevant inquiry is whether the claim was covered under the policyholder's liability insurance, and not whether the claim, if brought to trial, would have resulted in a judgment triggering the insurance policy's coverage.

Courts around the country have uniformly held that once an underlying action is settled, an insurance company must provide coverage to the extent the settlement compromised claims that are covered by its policy. Thus, the only relevant inquiry in a post-settlement coverage dispute, aside from whether the amount paid was reasonable, is whether the claim as settled is covered by the policy at issue.

Because only claims as settled are relevant, numerous other courts have similarly held that no party is ever entitled to retry an underlying claim in a coverage action. The actual merit of the underlying claim is simply irrelevant in a post-settlement coverage dispute. As one court explained, a party "need only prove the underlying claims were covered by the policies ... [T]o require claims to be actually proved in an action to enforce a settlement would defeat the purpose of settlement agreements."

When Insurance Companies Refuse to Settle

Courts around the country also have held that a liability insurance company's unreasonable refusal to settle a claim will free a policyholder of any obligation to seek the insurance company's consent before settling an action. In fact, an insurance company may be liable to its policyholder for damages sustained by the policyholder due to the insurance company's bad faith or negligent refusal to settle a claim within policy limits. Under Georgia law, for example, an insurer "is negligent in failing to settle if the ordinarily prudent insurer would consider choosing to try the case as creating an unreasonable risk." Moreover, although the law is uncertain on this point, there is case law indicating that an insurance company may be held liable for tortious refusal to settle for failing to initiate settlement negotiations.

Alabama law similarly holds that if an insurance company fails to settle a case against its policyholder--either negligently or in bad faith--the insurance company may be liable for the full amount of any judgment, including any excess over the policy limits. The insurance company will be liable in negligence for any excess judgment if it fails to exercise "ordinary care" to "ascertain the facts" necessary to make a settlement decision, and if it fails to make a settlement "when such knowledge would have caused a reasonably prudent person" to settle the action. However, if it is shown that the insurance company made an investigation and ascertained the necessary facts, and refuses to settle based upon an "honest judgment" that settlement is "not warranted," then the insurance company will not be liable for negligence.

Although most of the reported decisions on this issue have dealt with the far more common scenario of contentions that an insurer should have settled a case that ultimately was tried and resulted in a greater-than-limits verdict, the principles developed in these "failure to settle" cases should apply equally to cases where a policyholder has settled the action without the insurance company's consent, rather than risking an excess verdict by going to trial. In fact, a number of courts have applied identical reasoning in cases where a settlement was achieved by the policyholder after an insurance company's wrongful refusal to settle.

As far back as 1942, a court held that the duty of good faith "applies with equal force to a prudent settlement made by the assured in the face of a potential judgment far in excess of the limits of the policy." Traders & General Insurance Co. v. Rudco Oil & Gas Co., 129 F. 2d 621 (10th Cir. 1942). That court concluded that before an insurer may interpose the policyholder's settlement of the underlying action without consent as a defense, the insurer must show that it acted in good faith in rejecting the settlement offer. In Rudco, because Traders had acted in bad faith in rejecting a settlement offer, Rudco was relieved of its contractual duty to refrain from settling the underlying action, and Traders was held liable for the settlement.

The Rudco court noted that a policyholder should not "be required to wait until after the storm before seeking refuge" when faced with "a potential judgment far in excess of the limits of the policy." Significantly, absent evidence of collusion between the policyholder and the underlying plaintiff, courts around the country have cited Rudco with approval.

In yet another case, the Fifth Circuit commented that:

It is well established that the law imposes upon the insurer the duty to exercise diligence, intelligence, good faith, and honest and conscientious fidelity to the common interest of the insured as well as itself in determining whether to accept or reject an offer of settlement. While the insurer may properly give consideration to its own interest, it must in good faith give at least equal consideration to the interest of the insured, and if it fails to do so, it acts in bad faith.

State Farm Mutual Auto Insurance Co. v. Smoot, 381 F 2d 331 (5th Cir. 1967).

Significantly, the Smoot court also held that punitive damages were available under Georgia law to the extent that the insurance company's refusal was willful and in reckless disregard of the policyholder's rights, and that an award of attorneys' fees was available under Georgia law if the insurer acted in bad faith. Id. at 338-39. While punitive damages generally are not available under Georgia law for breach of contract, where an insurer acts with "such entire want of care amounting to a conscious indifference to the consequences," this may constitute tortious conduct making punitive damages authorized in any action for negligence or the intentional tort of bad faith.

Conclusion

A policyholder facing "bet the company" liability from product liability, "mass tort," or other forms of liability need not "roll the dice" when its insurance company unreasonably refuses to participate in settlement negotiations or even when its insurer affirmatively presses to try the underlying claims. Under well-recognized law in many states, a policyholder in such circumstances should be entitled to settle the underlying claims and then look to its insurance company for reimbursement of the settlement costs, along with punitive damages and attorneys' fees in some states.

ABOUT THE AUTHORS

John B. Berringer is the co-managing shareholder and Natasha Z. Millman is an associate in the New Jersey office of Anderson Kill & Olick, P.C. The authors regularly represents policyholders in insurance coverage disputes.

Reprinted with permission from the May/June 2007 issue of Policyholder Advisor, published by Anderson Kill & Olick, P.C.

riskVue | The webzine for risk management professionals
July 2007