Practical problems with Pennsylvania’s new approach to control of settlement decisions

September 3, 2013

Insurance LawMy last post discussed the option afforded insureds under Babcock & Wilcox Company v. American Nuclear Insurers, __ A.3d __, 2013 WL 3456969 (Pa.Super. July 10, 2013), of rejecting an insurer-provided defense subject to reservation of rights and settling over insurer’s objections.

Size Matters

The practical significance of the  Babcock & Wilcox Company decision depends on the financial resources of the policyholder. Policyholders under personal lines policies, such as homeowners insurance, and small businesses without resources to finance their own defense will have little choice but to cede control of their defense to their liability insurer. And liability insurers will feel little extra pressure to refrain from sending a reservation of rights letter. However, the court’s decision dramatically alters the balance of power in Pennsylvania between liability insurers and large corporate policyholders with the resources to finance their own defense. The court’s decision places great pressure on insurers to provide large corporate policyholders an unqualified defense in order to avoid losing control—a bold and unusual move for an intermediate appellate court.

This is why Judge Judith Olsen dissented from the majority’s decision to remand the case for a new trial. She found nothing in the Pennsylvania Supreme Court’s 56-year-old Cowden decision that justifies giving insureds the option to reject a defense whenever their insurers reserve the right to contest coverage. She observed, “as an intermediate appellate court, I do not believe that it is within our prerogative to sidestep binding Supreme Court authority in favor of rules that we may deem preferable or even broadly accepted.”

Triable Issues

What Judge Olsen does not explain is why no triable issues of fact existed under the Cowden standard, which she would apply automatically and the majority would apply if B&W is found to have accepted ANI’s defense.  Although Cowden involved an attempt to hold an insurer liable for an excess judgment following a verdict, both the majority and the dissent in Babcock & Wilcox expressly state that a verdict is not essential to recovering under the Cowden standard. As Judge Olsen expressly acknowledged, under Cowden, B&W still would be free to settle over ANI’s objections despite the  consent-to-settlement clause if it can establish: “1) there was no real chance of a defense verdict; 2) there was little possibility of a verdict or settlement within policy limits; 3) the insurer’s decision to reject settlement and go to trial was not based on a bona fide belief that there was a good chance of winning; and, 4) the insurer’s decision to litigate rather than settle was made dishonestly.” J. Olsen dissenting, 2013 WL 3456969, *19.

The majority’s opinion points to evidence suggesting that a verdict may well have exceeded not just the $80 million settlement but B&W’s $320 million policy limits. The court notes that  settlement occurred following a trial of eight “test cases” in which a jury found B&W liable for more than $36 million in damages. Extrapolating these test case awards averaging approximately $4.5 million per plaintiff across 250 to 300 claimants, the court conjectured that ANI’s refusal to agree  to the settlement exposed B&W to the strong possibility of “a massive excess verdict” well in excess of policy limits, “and perhaps as high as $1billion, exclusive of pre- or post-judgment interest and what would have been voluminous defense costs associated with the defense of litigation involving hundreds of plaintiffs.” 2013 WL 3456969, *17, fn. 12. Of course, the chance of a defense verdict and ANI’s motivation for rejecting the $80 million settlement are questions of fact that would need to be resolved in B&W’s favor in order to support recovery of the $80 million, but, contrary to Judge Olsen’s position, those factual questions should preclude judgment as a matter of law in ANI’s favor.

Tactical Choices

The choice the majority has afforded policyholders poses difficult tactical considerations for large policyholders faced with the dilemma of whether to accept or reject a defense subject to a reservation of rights. If at the outset of the litigation, the insured faces a recalcitrant claimant unwilling to settle for anything less than policy limits and the possibility of a judgment well in excess of policy limits, the policyholder’s interests may be better served by an insurer-controlled defense. Although the court does not address the question of insurer responsibility for an excess judgment after the insured opts to take control of its own defense, the theoretical basis for imposing liability on the insurer for judgments in excess of policy limits—the conflict of interest that exists when the insurer controls the insured’s defense while the insurer’s liability is capped—no longer exists once the insurer loses control of the defense. Policyholders therefore arguably have greater protection against an excess judgment if they leave control of their defense in their insurers’ hands.

This is particularly true in light of dicta in the court’s opinion regarding the scope of an insurer’s duty to settle under Cowden. The court suggests, for example, that the insurer has an affirmative duty to initiate settlement negotiations. 2013 WL 3456969, *18. Moreover, language in the court’s opinion allows policyholders to argue that insurers, in assessing the reasonableness of a settlement demand or in determining how much to offer the claimant, must consider not just the likely outcome if the case goes to trial but the cost of litigating the claim to judgment as well. In footnote 12, the court assessed the reasonableness of an $80 million settlement opportunity in light likelihood of an excess verdict and “what would have been voluminous defense costs associated with the defense of litigation involving hundreds of plaintiffs.” 2013 WL 3456969, *17, fn. 12.  This implies that an insurer must include both the likely result if the case goes to a jury and the cost of litigating the case to judgment in assessing the reasonable settlement value of a claim. In other words, if an insurer determines that the claimant has a 50 percent chance of recovering $1 million and the projected cost of defending the claim is $500,000, the settlement value of the case is not $500,000 (50 percent x $1 million) but $1 million (the predicted jury verdict plus the $500,000 cost of defending the insured). If the insurer’s policy limits are $ 1 million or higher, the insurer must accept any settlement demand up to $1 million.