August 26, 2013
Liability insurance has been described as the fuel that drives the American tort system. The aptness of this metaphor is nowhere more evident than in the willingness of plaintiffs to enter into settlements or uncontested judgments that insulate defendants from all personal liability in exchange for defendants’ rights, both contractual and extra-contractual, against their liability insurers. The sometimes irresistible appeal of such no-personal-liability settlements is understandable in light of the dynamics of many civil lawsuits. In many cases, the defendant’s only significant executable asset is an insurance policy. Thus, neither side has anything to lose. By settling early in the litigation for the defendants’ insurance rights, both plaintiff and defendant avoid the burden, delay, expense and risk of a trial, and the defendant’s liability insurer typically presents a far more inviting, less sympathetic target in plaintiff’s subsequent bad faith suit as the defendant’s assignee.
Despite the pervasiveness of attempts to resolve civil lawsuits on a no-personal liability basis, the law regarding the enforceability of such settlements is uncertain and evolving. Most of the case law has focused on two fundamental problems, one theoretical and one practical.
Theory and Practice
The theoretical problem arises from insurance policy language limiting the insured’s right to settle without the consent of the insurer. The rebuttal arguments available to policyholders and claimants when an insurer invokes such policy language depend on whether the insurer was in breach of the insurance contract at the time of the settlement. Under fundamental principles of contract law, a party in breach of a contract may not insist that the other party perform its obligations under the same contract. Thus, an insurer’s breach of the policy frees the insured from his or her duty not to settle without the insurer’s consent.
Determining when an insurer is in breach for purposes of releasing the insured from his or her policy obligations has, however, proved to be a difficult conundrum for courts. Is breach of the insurer’s implied duty to accept reasonable policy limits settlement offer sufficient? Or must the insurer breach an express contractual obligation to defend the insured? If the latter, what constitutes a breach of the duty to defend? Must the insurer deny coverage and refuse to defend? Or does an inadequate defense or a conflicted defense free the insured to protect his or her interests through a no-personal-liability settlement? Is a qualified defense subject to reservation of rights to contest coverage later enough?
The practical problem stems from the parties’ natural incentive to inflate the amount of the judgment. In an adversarial setting, the claimant’s desire to maximize recovery is tempered by the desire of the defendant, and more particularly the defendant’s insurer, not to part with their money. But once the claimant offers the insured a no-personal-liability settlement, the insured, assured that his personal assets are immune from judgment, has no reason to bargain with the claimant over the value of the claim. The claimant can demand a stipulated judgment or settlement for an amount well in excess of the claim’s true worth and the defendant’s insurance policy limits without any resistance from the defendant.
Courts have struggled with these theoretical and practical issues for more than 80 years. Despite these efforts, the body of law that has emerged is confusing, and leaves insurers, insureds and third party claimants with difficult choices. Until recently, no source provided a current and comprehensive analysis of the circumstances in which each jurisdiction around the country enforces policy provisions prohibiting settlements without the insurer’s consent. Fortunately, that void has now been filled by a special issue of Insurance Litigation Reporter dedicated to analysis of the ongoing battle between insurers and insureds over control of settlement decisions. The authors, Don R. Sampen and Alec M. Barinholtz of Clausen Miller P.C., critique the approaches courts are taking to the evaluation of settlements and identify factors that influence, sometimes implicitly, the approach courts chose to take.
My next two posts will analyze Babcock & Wilcox Company v. American Nuclear Insurers, in which a Pennsylvania intermediate appellate court charts a new approach to the theoretical dilemma discussed above.