Settlement And Assignment Agreements And The Threat Of ‘Underlitigation’

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A recent Supreme Judicial Court (SJC) decision offers guidance for situations in which a defendant settles a case and assigns its insurance rights to the plaintiff. Settlement agreements are encouraged as a matter of general policy. However, must an insurer be bound by the terms of such an agreement, even if not a party? What happens when the parties are engaged in “underlitigation,” a collusive arrangement where the parties refrain from introducing evidence that would destroy insurance coverage? What recourse does the insurer have to challenge the settlement amount?

The case of Commerce Insurance Company vs. Justina S. Szafarowiczet al. (131 N.E.3d 782 (Oct. 1, 2019)) analyzes these issues. In a long, but clear opinion, Chief Justice Ralph D. Gants reaffirmed the SJC policy of encouraging settlement agreements, while also providing clear protections for insurers and methods of challenging agreements that might prejudice liability carriers.

The Underlying Wrongful Death Action

The case arises from a wrongful death action. David Szafarowicz was struck and killed by a car driven by Matthew Padovano. The decedent’s estate sued Padovano, who tendered the claim to his family’s auto liability insurer, Commerce Insurance Company.

Commerce agreed to defend the claim, and paid its compulsory policy limits of $20,000, but reserved its rights to deny an additional $480,000 in indemnification obligations if it was determined that the accident was caused by an intentional act, and thus not an “accident,” as defined by the policy.

Commerce also filed a separate declaratory judgment action to determine whether the policy provided coverage for the estate’s claim. Meanwhile, Commerce attempted to intervene in the wrongful death case. It cited to a criminal proceeding against Padovano arising out of the same accident, and evidence from that proceeding that Padovano’s actions were intentional, as opposed to accidental. Commerce claimed that neither party had incentive to introduce that evidence because they both “would prefer that insurance coverage exist for this loss.”

Underlitigation

The judge denied Commerce’s request to intervene, but also recognized the unfairness of “underlitigation,” which in this case meant that the plaintiff refrained from introducing evidence of the defendant’s intentional conduct, offering instead evidence of mere negligence. As a result, the defendant’s insurer would not be able to disclaim coverage on grounds that the policy did not cover intentional conduct.

The judge identified competing interests. On one hand, underlitigation is inherently unfair to the insurer, which is forced to cover claims based on cherry-picked facts. On the other, the Padovanos would be unable to defend themselves without insurance proceeds. In the end, the Superior Court reached a solution: Commerce could overcome the unfairness of underlitigation by bringing a subsequent declaratory judgment action. In that setting, it could examine whether the issue of negligent versus intentional conduct was fairly litigated and, if not, could re-litigate the issue.

The Declaratory Judgment Action

That is exactly what Commerce did. The judge in the declaratory judgment action reviewed all the evidence related to the underlying case — not just the evidence produced in that case — and concluded that Padovano’s actions were intentional. As a result, the Commerce policy did not cover the claims in the underlying case.

Settlement Agreement and Assignment of Rights

While the court was making its coverage determination, the estate and the Padovanos entered into a settlement agreement, which included an assignment of rights. They did not obtain Commerce’s assent. As part of the agreement, Padovano stipulated to “gross negligence” and the parties agreed that damages would be determined at a jury-waived proceeding. Further, the estate agreed to not seek damages or enforce any judgment against the Padovanos beyond the Commerce insurance proceeds, and the Padovanos assigned all their insurance rights to the estate.

Commerce objected to the settlement, but a judge overruled the objection. After the jury-waived assessment of damages hearing, the judge determined damages in the amount of $7,669,254.41. Included in this was $2,201,744.41 in prejudgment interest.

Even though the court decided that the Commerce policy did not provide coverage for the wrongful death claim, Commerce would still be required to pay postjudgment interest on the $20,000 in compulsory limits. The interest alone would exceed the policy limits. Commerce filed a petition for interlocutory review, and the SJC transferred the appeal on its own motion.

Challenging the Judgment

On appeal, the SJC addressed whether Commerce could challenge the judgment when (1) its objection to the settlement agreement was overruled, and (2) there was a substantial risk of underlitigation.

The SJC first addressed the Commerce policy’s “consent to settle” clause, which provided that “[i]f any person covered under this policy settles a claim without our consent, we will not be bound by that settlement.” The court acknowledged that, while “consent to settle” clauses are usually enforced if the insurer can show that it was prejudiced by the settlement, this is not the case where the insurer is defending under a reservation of rights. It is a well-settled principle that, in such cases, an insurer relinquishes the right to control its insured’s defense.

When an insurer reserves the right to deny indemnification, the insured has the right to protect itself by entering into a settlement agreement. Such an agreement is enforceable against the parties to the settlement but, as the SJC pointed out, is not necessarily enforceable against the insurer.

The mere existence of a settlement agreement does not create indemnification obligations where none were present in the first place. In this case, Commerce had obtained a declaration that its policy did not cover the claims in the wrongful death case because Padovano’s actions were deemed to be intentional. Therefore, there was no coverage for the claim and Commerce was not bound to pay the $7.7 million judgment. This left the court to decide whether Commerce was still responsible for postjudgment interest on the $20,000 compulsory insurance payment.

The SJC undertook a similar analysis with regard to underlitigation as the Superior Court had done, balancing the risk of collusion against the policy considerations that encourage settlement agreements. The court concluded that an insurer who defends a claim under a reservation of rights is bound by the amount of a judgment arising from a prejudgment settlement/assignment agreement where (1) the insurer is given notice of the settlement/assignment agreement and an opportunity to be heard by the court before judgment enters; (2) the insurer contests the judgment; and (3) the insured, after hearing, meets his or her burden of showing that the settlement is reasonable in amount.

Further, the court held that a “reasonable” settlement amount cannot exceed the limits of insurance coverage, since any recovery under the assignment agreement will come from the insurer. In this case, because no reasonableness review had been conducted, the SJC remanded the case for a review on the reasonableness of the settlement/assignment agreement.

Conclusion

This case illustrates how an insurer can challenge underlitigation in certain situations. It also shows that, while settlement and assignment agreements are useful, they cannot unfairly expose an insurer to liability that exceeds its policy limits.

This case should act as a warning to counsel to carefully assess the recoverability of judgments. In the absence of a defendant who can personally pay a large judgment, or other extraneous circumstances, such as Chapter 176D liability against the insurer, settlement and assignment agreements should be kept within the limits of any applicable insurance policy.

This item appeared initially in the Feb. 2020 issue of ComCom Insights, the Massachusetts Bar Association’s Complex Commercial Litigation Section newsletter.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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