Originally Published in Law360 - December 20, 2013.
A good deal has already been written about the recent Reid case in California, but there is more to be said. On Oct. 7, 2013, Division 8 of the Second District Court of Appeals held in Reid v. Mercury Insurance Company, No. B241154, that although "the insured's liability was clear almost immediately after the collision" and the insurer quickly decided that it "must tender the policy limits to the third-party claimant ‘as soon as we have enough [information] available to do so,'" and although the case went to trial and resulted in a judgment in excess of $5.9 million, there was no duty on the insurer's part to initiate settlement discussions and try to settle the case within the $100,000/$300,000 policy limits.
This decision comes on the heels of a recent Ninth Circuit case where the court initially ruled that "the insurer's duty to settle ‘requires an insurer to effectuate settlement when liability is reasonably clear, even in the absence of a settlement demand.'" (Du v. Allstate Insurance Company, 681 F.3d 1118, 1123.) That opinion was withdrawn after considerable public discussion. In its final opinion, Du v. Allstate Insurance Company, 697 F.3d 753, the court decided that it need not resolve this issue because there was no factual foundation for that argument.
This recent history warrants some study of how the Reid ruling came about. It turns out that Reid's view of the law is unnecessarily narrow and not based on careful study of California precedent.
Two leading cases which liberalized California insurance law half a century ago unwittingly set the scene for the Reid formulation. Everyone who deals with insurance coverage knows Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654 and Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425.
In both cases the injured plaintiff let it be known that he or she would settle a case with great exposure for less than the policy limits, but the insurer declined. It was then found liable for breaching its covenant of good faith and fair dealing toward its insured because it had failed to make an effort to protect the insured against an excess verdict by seeking a settlement within the policy limits.
In Comunale, the insurer declined to defend the case on grounds which were not sustained on appeal. The underlying plaintiff recovered more than the policy limits and obtained an assignment of the insured's rights against the insurance company. In Crisci, the insurer did provide a defense. Plaintiff claimed damages well in excess of policy limits and eventually reduced her settlement demand to the policy limits; but the insurance company thought the larger claims were defensible, declined the plaintiff's offer and offered only an amount well below policy limits, which the plaintiff rejected. Here, too, the verdict was in excess of policy limits. The insured assigned her rights against the insurance company to the underlying plaintiff.
These cases cut new ground in California on the subjects of insurers' duties to their insureds and the insurers' liability for an excess verdict (and, in Crisci, for emotional distress damages), where the insurer refused to settle and there was a recovery beyond policy limits.
The Comunale opinion stated that "[u]nder such circumstances the implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty." The court confirmed that "[w]hen there is great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith that the insured's interest requires the insurer to settle the claim."
Nothing in that language depends on an initial offer by the injured party. But since the insurance company had rejected a settlement proposal from the plaintiff; the court also stated that "[t]he decisive factor in fixing the extent of Traders' liability is not the refusal to defend; it is the refusal to accept an offer of settlement within the policy limits." A little further on, the court twice referred to the fact that the insurer had been "refusing a settlement" or "rejected a reasonable offer of settlement." (Ibid.)
Crisci is similar. The court began its substantive discussion by noting that "it is common knowledge that one of the usual methods by which an insured receives protection under a liability policy is by settlement of claims without litigation; that the implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose the duty [etc.]."
Crisci then stated that "[i]n determining whether an insurer has given consideration to the interests of the insured, the test is whether a prudent insurer without policy limits would have accepted the settlement offer." (p. 429; emphasis supplied.) For this, it cites five cases, in all of which the plaintiff made a settlement offer which the insurer rejected or ignored. It was this last language which has animated California law ever since and was the key for the Reid court's conclusion:
Reid stated, "[a]s Crisci tells us, liability is imposed ‘not for a bad faith breach of the contract but for failure to meet the duty to accept reasonable settlements, a duty included within the implied covenant of good faith and fair dealing." Crisci indeed so states, but the full context shows that this was simply the court's treatment of the facts of the case, not the pronouncement of a general rule or limitation. Here are two consecutive sentences from Crisci, p. 430: "Comunale ... makes it clear the liability based on an implied covenant exists whenever the insurer refuses to settle in an appropriate case and that liability may exist when the insurer unwarrantedly refuses an offered settlement where the most reasonable manner of disposing of the claim is by accepting the settlement. Liability is [then] imposed not for a bad faith breach of the contract but for failure to meet the duty to accept reasonable settlements ..." That language clearly states that the insurer breaches its duty "whenever the insurer refuses to settle in an appropriate case," and that refusing to accept the plaintiff's settlement offer is one way — but not the only way — in which that liability may be created.
Comunale cited two cases from other states as authority for the implied covenant of good faith and fair dealing which "requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty." (Page 659.) These cases date to the early days of the automobile, and both clearly hold that an insurer has a duty to settle, not just a duty to accept appropriate settlement offers.
The older case is Douglas v. United States Fidelity and Guaranty Co. (1924) 81 N.H. 371; 127 A. 708. The court there stated that:
[t]he fundamental question is, does or does not the insurer owe to the insured a duty in the matter of a settlement?
That subject was in question in the early days of automobile insurance.
Concluding that the insurer indeed had such a duty, the New Hampshire court stated that:
[i]t is a matter of common knowledge that the great majority of claims arising out of these policies are settled ... [T]he parties ... must have contemplated that the undertaking of the insurer ... included the making of settlements ... The parties must have understood that settlements would be undertaken by the insurer, and that in carrying out this undertaking the insurer would act in a reasonable way.
The other case is from the same decade: Hilker v. Western Auto Ins Co. (1930) 204 Wis. 1; 231 N.W. 257. There, a jury found that in failing to settle within policy limits a claim arising from an automobile accident, the insurance company had acted in bad faith. The court rejected insurer's argument that it had no duty to settle, holding that since the insurer "must have known that the injury was one for which a verdict might be rendered for a sum much in excess of the coverage of the policy, ... the failure to make some more effective effort to adjust the cases does present evidence which sustains the finding that the defendant acted in bad faith toward [the insured]." (P. 260.)
Thus, though Comunale and Crisci both spoke of the insurer's duty to accept reasonable settlement offers from the injured party, they did so because in both cases the insurer had rejected such offers, and in reliance on these cases. Their reasoning is clearly based on the prior cases' holding that the insurer has a broader duty to undertake reasonable efforts to settle within policy limits.
ln 1975 the California Supreme Court answered some questions left open by Comunale and Crisci. Specifically, the court rejected an argument that these cases applied only to tort claims, not in contract. (The statute of limitations is longer in contract cases and the law on liability differs between tort and contract claims.) It left no doubt that the duty to settle is founded in both tort and contract: "The scope of the duty imposed upon the insurer by the covenant of good faith and fair dealing does not turn on whether we characterize its breach as contractual or tortious, since, in either case, the duty itself springs from the contractual relationship between the parties. Johansen v. California State Automobile Ass'n Inter-Insurance Bureau, 15 Cal. 3d 9, 18.
Many other states — including parts of the country not known for their liberalism — have long been quite explicit in holding that insurers have a duty to try to settle cases with a potential of exposure beyond policy limits, whether or not the underlying plaintiffs initiated the settlement negotiations. I cite just a few examples.
In Bostrom v. Seguros Tepeyac SA. (N.D. Tex. 1963) 225 F.Supp 222, the court upheld a jury verdict that "the defendant insurance company was guilty of negligence in not initiating and attempting to bring about a settlement of the claim of the [underlying] plaintiff" within the policy limits. (P. 227) It held that "the relationship created by a policy giving the insurer the exclusive control over settlements imposes the duty to initiate negotiations for settlement, to negotiate and to settle, and to exercise ordinary prudence in the performance of such duties." (P. 234)
In Estate of Louis Penn v. Amalgamated General Agencies (1977) 148 N.J. Super. 419, 372 A.2d 1124, 1127, the court held that:
"the primary carrier owes to the excess carrier the same positive duty to take the initiative an[d] attempt to negotiate a settlement within its policy limit that it owes to its assured."
And in Powell v. Prudential Property & Cas. Ins. Co. (Fla. 1991) 584 So.2d 12, 14, the court held:
"The lack of a formal offer to settle does not preclude a finding of bad faith. Although an offer of settlement was once considered a necessary element of a duty to settle [citation], this court held in [a 1980 case] . . . that an offer to settle is not a prerequisite to the imposition of liability for an insurer's bad faith refusal to settle, but is merely one factor to be considered . . . Where liability is clear, and injuries so serious that a judgment in excess of the policy limits is likely, an insurer has an affirmative duty to initiate settlement negotiations."
(Citing Kansas, New Jersey, New York, Oregon, Tennessee, Texas and Wisconsin cases.)
Between Johansen and the current Reid case, a few California cases came close to the question of an insurer's bad faith in not actively pursuing settlement rather than merely responding to a claimant's offers. The closest case is Boicourt v. AMEX Assurance Company (2000) 78 Cal.App.4th 1390, 1399, where the court "conclude[d] that a formal settlement offer is not an absolute prerequisite to a bad faith action in the wake of an excess verdict when the claimant makes a request for policy limits and the insurer refuses to contact the policyholder about the request." (Emphasis in text.) Compare Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 877, which held [to quote Boicourt's discussion of it]:
"Bad faith can occur ‘only' when a formal offer to settle an excess claim within policy limits is made."
Boicourt called this language "dicta," noting that "there was there was no reason for the Merritt court to gratuitously stick in the word ‘only' when, at the end of its discussion, it said that a ‘conflict of interest' could ‘only' develop when an offer to settle is actually made." (Boicourt at 1396-7.)
In conclusion, the Reid court misread the factual contexts of Comunale and Crisci to expand their holdings into an absolute rule of law that no settlement duties are triggered on the part of the insurer with potential liability beyond policy limits unless the claimant actually makes an offer within those limits. That is clearly an unnecessarily narrow construction of the law, and not supported by the history of how the law on insurer's duty to settle was developed.
There is no reason why insurers should be allowed to take such a hard line. Many cases, going back to the 1920s, have held that an insurer must be proactive in protecting its insured in such a situation. One can only hope that future courts will see the error in Reid and will bring California law into line with that of so many other states.