In Ace American Ins. Co. v. Fireman's Fund Ins. Co. (No. B264861, filed 8/5/16), a California appeals court held that an excess insurer that contributes to the settlement of an underlying case due to the primary insurer’s failure to reasonably settle the case within policy limits can bring an action for equitable subrogation and breach of the duty of good faith and fair dealing against the primary insurer, notwithstanding the lack of an excess judgment against the insured.

In Ace American, a production worker was severely injured on a Warner Brothers film set. Warner Brothers had $1 million in primary coverage and another $3 million in umbrella coverage from Fireman’s Fund. Ace American provided a further $50 million in excess coverage. In suing Fireman’s Fund after the underlying case was resolved, Ace American alleged that the injured worker had offered to settle the case within the Fireman’s Fund limits, and that Fireman’s Fund had unreasonably rejected the settlement offers with the result that Ace American was required to contribute to the settlement that exceeded the Fireman’s Fund limits. Ace American alleged causes of action for equitable contribution and breach of the duty of good faith and fair dealing.

Fireman’s Fund demurred, arguing that the rights of an excess insurer such as Ace American derive from the rights of the insured, Warner Brothers, and an excess insurer may only sue for equitable subrogation if there has been a judgment against the insured that exceeds the limits of the primary policy. But because the lawsuit settled with no judgment against Warner Brothers, Fireman’s Fund argued, Ace American could not sue for equitable subrogation. Fireman’s Fund relied on RLI Insurance Company v. CNA Casualty of California (2006) 141 Cal.App.4th 75, 82 (RLI), which stated that an “insured’s right to recover from the primary insurer hinges upon ‘a judgment in excess of policy limits.’” (RLI, quoting Hamilton v. Maryland Casualty Co. (2002) 27 Cal.4th 718, 725 (Hamilton).) RLI had also stated that: “Without an excess judgment, the primary insurer’s refusal to settle is not actionable.” (RLI, 141 Cal.App.4th at p. 82.)

For its part, Ace American argued that it was irrelevant whether the underlying action was resolved by a settlement or a judgment, as long as the insured—and by extension, the excess insurer—was liable for any amount beyond the limits of the primary policy as a result of the primary insurer’s bad faith refusal to settle within policy limits. Ace American relied on Fortman v. Safeco Insurance Co. (1990) 221 Cal.App.3d 1394 (Fortman), which held that an excess judgment was not a prerequisite to an equitable subrogation claim, as long as the excess insurer demonstrated that it actually paid an amount in excess of the primary insurer’s policy limits. But the trial court found the RLI case dispositive, and sustained the demurrer without leave to amend.

Faced with RLI and Fortman as conflicting decisions within the same appellate district, the Ace American court chose to follow Fortman and reversed the trial court. The Ace American court noted that the RLI decision relied on the Supreme Court’s decision in Hamilton, but that Hamilton had involved a stipulation to judgment by the insured. Among other things, the Hamilton court had questioned the evidentiary value of a stipulated judgment as reliable evidence of damages where coupled with a covenant not to execute. Also, Fireman’s Fund had agreed to the underlying settlement, unlike Hamilton where the stipulated judgment had been entered without the defending insurer’s consent. Further, the Hamilton court had also recognized that generally, a bad faith action may be brought by the insured or the insured’s assignee despite the absence of a litigated excess judgment. Thus, the Ace American court concluded that Hamilton does not mandate an excess judgment in all cases.

The Ace American court went on to distinguish a number of cases argued by Fireman’s Fund as requiring a judgment, finding that for the most part, “[t]he focus of these cases was whether the insured had incurred measurable damages—not whether those damages had been reduced to a judgment.” The court stated that “[a] closer examination of the cases cited by Fireman’s Fund makes clear that the purpose behind the statements requiring a judgment in an underlying lawsuit is simply to ensure that a plaintiff has a reliable basis for alleging that damages have resulted from the insurer’s alleged breach of the duty to settle within policy limits—the same concern reflected in Hamilton.” And the Ace American court noted that the sufficiency of any evidence proving actual damages was not an issue that could be decided on demurrer.

The Ace American court stated: “As noted above, two required elements for equitable subrogation are that the insurer has suffered damages caused by the defendant’s act or omission, and ‘the insurer’s damages are in a liquidated sum, generally the amount paid to the insured.’ [] A judgment may constitute reliable evidence of damages. [] But it does not follow that a judgment is the only manner by which an insured or subrogee may prove damages resulting from an unreasonable failure to settle within policy limits.” The Ace American court cited Camelot by the Bay Condominium Owners’ Assn. v. Scottsdale Ins. Co. (1994) 27 Cal.App.4th 33, 48-49, for the proposition that there is no explicit requirement for bad faith liability that an excess judgment is actually suffered by the insured “[h]owever, the actual excess judgment, if any, is highly relevant in any bad faith damages determination.”

Further supporting its decision, the Ace American court pointed to California’s stated public policy of encouraging settlement, citing statistics from the Los Angeles County Superior Court that 78% of all cases resolved in 2015 were settled without trial. And the Ace American court found further support outside of California:

“The Seventh Circuit, in an opinion by Judge Posner, also relied on Fortman in rejecting an argument that a judgment is required in an equitable subrogation action by an excess insurer: ‘Country Mutual [the primary insurer] argues that a breach of the insurer’s duty to act in good faith in settlement negotiations is not actionable unless, by refusing to settle, the insurer precipitates a trial that results in the entry of a judgment against the insured. This is not a ridiculous argument. If the temptation at which the duty is aimed is the temptation to gamble with the insured’s money, it is not obviously a violation merely to dawdle in settling until the golden moment of opportunity passes. But though the case law is sparse, we are pretty confident that the line should not be drawn here. [] The basic temptation of the insurer comes from the fact that its liability is capped at the policy limits, so that it can shift many of the losses of a risky strategy to the insured (or any excess insurer). It may dawdle in settling, hoping to drive a harder bargain and knowing that if it fails and the case goes to trial and it loses big, still most of the loss will fall on the insured or on an excess insurer rather than on itself. The fact that on the eve of trial it may throw in the towel because it sees no hope of winning should not excuse it from having failed to settle earlier on better terms if it would have settled earlier on those terms had all the risks of loss lain on itself.’” (Citing Twin City Fire Ins. Co. v. Country Mut. Ins. Co. (7th Cir. 1994) 23 F.3d 1175, 1181.)

The Ace American court summed up: “we conclude that in an equitable subrogation action, ‘an excess insurer which has settled and discharged the insured’s liability may recover from the primary insurer an amount in excess of the primary insurer’s policy limits if the excess insurer can prove the primary insurer’s unreasonable refusal to settle within its policy limits resulted in loss to the excess insurer in an amount in excess of the policy limits of the primary insurer it would not otherwise have had.’ [] An excess judgment is not a required element of a cause of action for equitable subrogation or breach of the duty of good faith and fair dealing; where the insured or excess insurer has actually contributed to an excess settlement, the plaintiff may allege that the primary insurer’s breach of the duty to accept reasonable settlement offers resulted in damages in the form of the excess settlement.”