EXCESS LIABILITY: DUTY OF LIABILITY INSURER TO SETTLE WITHIN POLICY LIMITS

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1 EXCESS LIABILITY: DUTY OF LIABILITY INSURER TO SETTLE WITHIN POLICY LIMITS Lewis A. Schiller* The proliferation of large damage awards in automobile accident cases has become an acute problem. Typically, the driver-defendant is covered by public liability insurance the limits of which conform to the Motor Vehicle Responsibility Act of his particular state. These limits of liability are generally low. For example, in the District of Columbia the minimum requirements are $10,000 per person, $20,000 per accident and $5,000 property damage. Thus, frequently a verdict is returned against a defendant in an automobile accident case which exceeds the limits of liability of his insurance policy. Whenever this occurs, assuming the insurance company has previously had an opportunity to settle the claim against the insured for less than the policy amount, the problem of excess liability of the insurer arises. No attempt will be made to present here an exhaustive survey of all of the cases which have been decided on this problem in the last several years. Rather, an analysis of the problem will be made in all its facets and issues. The clause in the liability insurance policy which typically gives rise to the problem reads: "The Company will defend any law suit, even if groundless, false or fraudulent, against any insured for such damages which are payable under the terms of this policy, but may make such settlement of any claim or suit as it deems expedient." Thus, the insurer retains the exclusive right to settle claims against the insured. This exclusive right to make settlements under the policy is, of course, necessary for the protection of the insurer, since if the insured were permitted to make settlements, which the insurer would have to pay, there would be no incentive for the insured to settle below policy limits. The sole interest of the insured would be to obtain a release from liability from the claimant and he would almost always settle at the policy limits if this were necessary to obtain a release. Further, the insurer retains control over the settlement process so as to take advantage of its greater expertise in the area of evaluating claims-the insurer's adjusters and attorneys are much more likely to know * Assocaite Professor of Law, The National Law Center, George Washington University D.C. CODE ANN (1967).

2 1969] EXCESS LIABILITY whether a claim should be paid and, if so, in what amount, than is the insured. The following hypothetical might be used to help define the problem: X Insurance Company issues a liability insurance policy to insured covering the insured's liability to a third person for bodily injury up to the amount of $5,000. The insured negligently injures a third party, who claims damages in the amount of $15,000. At some point after negotiations have commenced with the claims adjuster, the injured party offers to settle the case for $5,000. The insurance company refuses to accept the offer, whereupon the injured party sues the insured and recovers a judgment for $12,000. If the insurance company had settled the claim for $5,000, insured would be free and clear of any further liability. However, the insurer's refusal to settle the case has in fact resulted in a $7,000 excess judgment against insured, which insured must pay out of his own resources. Nevertheless, the insurance company should not be considered the villain in this piece before more information is known. The insurance company has legitimate interests of its own to protect, and the lower the settlement figure, the better for the insurance company. It may well be that the claims adjuster in good faith believed that there was no liability on the part of the insured or that if there was liability, the damages were much less than $5,000. The insurance adjuster may also have believed in good faith that if the case went to trial, a verdict would be less than $5,000. These conflicting interests-the interest of the insured to have the claim against him settled within policy limits and the interest of the insurance company to settle a claim for as low a figure as possible-must be weighed to reach a just determination of the problem. GENERAL RULES AS TO INSURER'S EXCESS LIABILITY It has long been recognized that under certain circumstances an insurer may be liable over the policy limits for a failure to take advantage of an opportunity to settle a claim against the insured for an amount below the policy limits where a judgment is later recovered against the insured in an amount over the policy limits. 2 Therefore, the insurer is obligated to consider interests of the insured as well as its own in deciding whether to reject or accept an offer of settlement. The question then is what criteria have the courts developed to impose G. COUCH, INSURANCE 51.1 (2d ed. 1965).

3 THE AMERICAN UNIVERSITY LA W REVIEW [Vol. 18 liability on the insurer for an amount.over the policy limits. There are basically two rules that have been formulated in this situation: the "good faith" rule and the "negligence" rule. Under the "good faith" rule an insurer may become liable to the insured in excess of the policy limits if it fails to exercise good faith in accepting or rejecting offers of settlement within the policy limitso Under the "negligence" rule, the insurer may become liable to the insured for an amount in excess of the policy limits if it fails to use due care in accepting or rejecting an offer of settlement within the policy limits. 4 Recently, the two standards have been merged into one standard, either by allowing proof of negligence in determining whether or not the insurer exercised the requisite good faith, or by stating the two standards in the alternative and allowing proof of either as satisfying the insured's burden of proof against the insurer for wrongful failure to settle within the policy limits. 5 Thus, in a recent Maryland case, State Farm Mutual Automobile Insurance Co. v. White, 6 a case of first impression, the Court of Appeals of Maryland approved a lower court instruction to the jury which in part stated: "You cannot find a verdict in this case in favor of the plaintiff unless you find from the evidence that the defendant, its attorneys or agents, were guilty of negligence or bad faith...." It is entirely logical that the two standards of "good faith" and "negligence" be merged into one standard allowing proof of either as sufficient to make out the insured's case against the insurer. It has generally been held that under the good faith standard the insured does not have to prove dishonesty, misrepresentation, deceit, or fraud on the part of the insurer in order to show the requisite lack of good faith. 7 Since a specific fraudulent intent is not required to be proved by the insured under the "good faith" standard, the insured's case is almost always predicated on acts by the insurer's agents and attorneys from which the inference of bad faith can be drawn by the jury. Furthermore, these acts which the insured would attempt to prove 3. Id. at 51.3; Abernethy v. Utica Mut. Ins. Co., 373 F.2d 565 (4th Cir. 1967); Bowers v. Camden Fire Ins. Ass'n, 51 N.J. 62, 237 A. 2d 857 (1968). 4. G. COUCH, supra note 2, at 51.5; United States Fidelity & Guar. Co. v. Evans, 116 Ga. App. 93, 156 S.E.2d 809 (1967), ajffd, 223 Ga. 789, 158 S.E.2d 243 (1968); Crisci v. Security Ins. Co., 66 Cal.2d 425, 426 P.2d 173, 58 Cal. Rptr. 13 (1967). 5. G. CoucH, supra note 2, at Md. 324, 236 A.2d 269 (1967); see also Southern Farm Bureau Cas. Ins. v. Parker, 232 Ark. 841, 341 S.W.2d 36 (1961). 7. I R. LONG, THE LAW OF LIABILITY INSURANCE 5.16 (1966); State Farm Mut. Auto. Ins. v. White, 248 Md. 324, 236 A.2d 269 (1967).

4 1969] EXCESS LIABILITY would be exactly the same if he were basing his case on negligence. In other words, the very same factors are used by the insured in proving his case, whether the theory of his case is negligence or lack of good faith Therefore, it would seem that the courts which state the rule in the alternative are recognizing the reality of the situation: the good faith rule is, in fact, a disguised negligence rule and use of the good faith rule only tends to confuse juries. The good faith standard is almost impossible to define satisfactorily. The rule should either be stated in the alternative or the good faith standard should be discarded entirely by defining the insurer's duty solely in terms of a duty to use due care in settling claims against the insured within the policy limits. FACTORS INDICATING INSURER HAS BREACHED DUTY TO SETTLE 8 The presence of the following factors, either singly or in combination, will tend to prove the insured's case against the insurer: (1) the claimant's case against the insured on the issues of liability and damages was very strong, (2) admissions by the insurer's agents or attorneys that the claimant's case against the insured was strong and that a large verdict exceeding policy limits would probably result if the case were tried, (3) attempts by the insurer to induce the insured to contribute to a settlement within the policy limits by threatening the insured with the possibility of a verdict over the policy limits if the case were tried, (4) negligent investigation and ascertainment of facts by the insurer, (5) the insurer's rejection of the advice of its own attorney to settle the case, (6) rejection of an offer of compromise within the policy limits after a trial verdict over the policy limits, (7) 8. These factors are discussed below. 9. The problem as to multiple claimants where the total of the claims exceeds the policy limits, in most states, is the same as the problem of the single claimant whose claim exceeds policy limits, as far as the insurer is concerned. As each of the multiple claimants presents his claim and makes his offer of settlement, the insurer must decide whether to accept or reject the offer on an individual basis, regardless of whether a particular settlement will exhaust the policy limits. Rejection of an offer of settlement by the insurer solely on the ground that it would exhaust the insurance fund and leave nothing for other claimants could result in excess liability of the insurer for bad faith refusal to settle, if the claimant's demand was reasonable, was within policy limits and the claimant then sues the insured, obtains a judgment which cannot be satisfied fully because the total judgments obtained exceed policy limits. See Alford v. Textile Ins. Co., 248 N.C. 224, 103 S.E.2d 8 (1958); 70 A.L.R.2d 408. See also State Farm Mut. Ins. Co. v. Marcum, 420 S.W.2d 113 (Ky. 1967). Suggestions for reform have been made to the effect that there should be a duty on the insurer to allocate the insurance fund equitably among all claimants, at the request of any of the claimants. See Keeton, Preferential Settlement o] Liability-Insurance Claims, 70 HARV. L. REV. 27 (1956).

5 THE AMERICAN UNIVERSITY LAW REVIEW [Vol. 18 failure to inform the insured of a compromise offer, (8) failure to advise the insured to hire his own attorney where it appears a claim is being made over the policy limits, and (9) a comparison of the risk of a large judgment against the insured as opposed to the small amount of additional money the insurer would have to pay to effect a settlement within the policy limits. Of course, along with one or more of the foregoing factors, there must be a judgment against the insured above the policy limits and an offer of settlement before trial for an amount below or at policy limits. Whether the presence of any one of the above factors along with the excess judgment is sufficient to impose liability on the insurance company is hard to determine, and is probably an academic question in any event. Rarely in the cases does one find the occurrence of merely one of the factors in isolation from at least some of the others. Obviously, the more of these factors that occur in combination, the stronger will be the insured's case against the insurer. The case law indicates how the presence or absence of some of the above factors affect decisions. In Crisci v. Securityr Insurance Co.,"' an action by an insured landlord who suffered a judgment in a personal injury action brought by her tenant after her insurer refused to settle the claim, the insurer was held liable for that portion of the judgment in excess of policy limits which the insured had to pay, as well as other damages," on the grounds that the insurer should have settled the claim because liability against the insured was clear and because a judgment exceeding policy limits was probable. The facts giving rise to the claim against the insured were that the insured's tenant was descending the outside wooden staircase of the apartment building owned by the insured when a tread gave way and the tenant fell through the resulting opening up to her waist and was left hanging 15 feet above the ground. The fall resulted in severe physical injuries as well as psychosis. The tenant had psychiatrists who would testify that the psychosis was caused by the fall; the insurer had psychiatrists who would testify to the contrary. All the psychiatrists agreed, however, that a psychosis could be triggered by a sudden fear of falling to one's death. The insured's liability policy had a limit of $ 10,000; the tenant offered to settle for $10,000. The insurer did not settle the claim for $10,000 because, although its claims manager believed that there would be a verdict of not less than $100,000 if the case went to trial and the jury believed the tenant's medical testimony, it was willing to Cal.2d 425, 426 P.2d 173, 58 Cal. Rptr. 13 (1967).

6 19691 EXCESS LIABILITY gamble on the possibility that a jury would believe the testimony of the insurer's doctors. Incidentally, the insured had retained her own attorney to work with the insurer, but it was clear at all times that the insurer had complete control of the settlement process. Thus, it seems that the factors which resulted in the insurer's liability were the clear case against the insured by the tenant and the strong possibility of a verdict over the policy limits if the case went to trial; the insurer's belief that its medical testimony would be believed was too tenuous a ground to have justified the insurer in rejecting the offer of settlement. The insurer had nothing to lose by trying the case rather than settling it, barring, of course, the possibility of being held for excess liability. Since the insurer had to pay the policy limits, $10,000, to settle the case, it was worth the gamble of trying the case to see if a jury would believe the insurer's medical testimony to the effect that the fall by the tenant had nothing to do with the development of the psychosis. If the jury believed this testimony, the award might be well below the policy limits. It would seem that in this kind of case the insurer must be especially careful before rejecting an offer of settlement and must consider the insured's interest at least equally as much as its own. Another way of presenting this proposition is to ask if the offer of settlement would have been one the insurer would have accepted if the policy limits had been higher. That is, the issue is whether the insurer rejected the offer primarily because it was at or near the policy limits, meaning the insurer had nothing to lose by trying the case (thereby of course considering only its own interests) or whether in rejecting the offer the insurer considered the insured's interests as well as its own interests. If the offer of settlement is substantially below the policy limits, and the insurer decides to reject it, it is risking some of its own money by trying the case, as well as the insured's resources. As Crisci demonstrates, the courts do not look favorably upon the insurer risking just the insured's resources. One factor alone is rarely enough to impose excess liability on the insurer. Thus in Crisci, there were the twin factors of a strong case against the insured on the issue of liability and the fact that the insurer had nothing to lose by trying the case, indicating a disregard of the insured's interest.' 2 Although it has frequently been said that II. See discussion of damages, p. 416 infra. 12. See also Abernethy v. Utica Mut. Ins. Co., 373 F.2d 565 (4th Cir. 1967); State Farm Mut. Auto. Ins. Co. v. Marcum, 420 S.W.2d 113 (Ky. 1967); Potomac Ins. Co. v. Wilkins, 376 F.2d 425 (10th Cir. 1967) for other examples of cases where the claimant's case against the insured

7 THE AMERICAN UNIVERSITY LA W REVIEW [Vol. 18 strong evidence indicating insured's liability to claimant may be considered on the issue of whether the insurer was guilty of bad faith in failing to settle the case, 3 this factor usually exists along with other factors and standing alone it is doubtful whether it would be sufficient to impose excess liability on the insurer. Another factor which has been mentioned in the cases and by commentators as affecting the decision of whether or not an insurer will be held for excess liability, is admissions by the insurer's agents or attorneys of the strength of the claimant's case against the insured, and predictions that if the case should go to trial, in all probability a large verdict would result against the insured. Again, it must be pointed out that this factor rarely appears alone and would not seem to be enough standing alone to make out a case of excess liability against the insurer. However, as with all the other factors mentioned above, it may be the predominant factor which along with other circumstances creates a case of excess liability against the insurer. Thus, in Critz v. Farmers Insurance Group," the claimant was seriously injured by the insured in an automobile accident, the injuries including the loss of sight in one eye and fractures of the neck and jaw. The limits of liability under the insured's policy were $10,000 for injuries to one person. Liability of the insured to claimant was clear. The claimant made an initial offer of settlement of $10,000, which the insurer rejected. The insurer's adjuster admitted in a report to insurer that this was an obvious case of liability and that injuries to the claimant were very serious, appearing to exceed the policy limits. In spite of this, the insurer rejected the offer of settlement. Ultimately, the jury returned a verdict against the insured of $48,000. The court held the insurer in this case for excess liability. The admission by the insurer's adjuster that the case was strong against the insured and that the claim exceeded policy limits had a strong bearing on the outcome of this case. Probably it would not be enough standing alone, although it might be considered a predominant factor. A similar situation is one in which the insurer's agents or attorneys deny the insured's liability but admit that if the insured is liable the judgment against the insured will run over policy limits. This situation was strong and offers of settlement were made at or near the policy limits, which were rejected, resulting in judgments over policy limits against the insured for which the insurer was held liable. 13. See State Farm Mut. Auto. Ins. Co. v. Marcum, 420 S.W.2d 113 (Ky. 1967) Cal. App.2d 788, 41 Cal. Rptr. 401 (1964), rehearing denied, Cal. S. Ct. Jan. 13, 1965.

8 1960] EXCESS LIABILITY occurred in State Farm Mutual A utomobile Insurance Co. v. White, 5 and the court pointed this out as an evidentiary factor supporting the jury's verdict, which held the insurer for excess liability. If the adjuster's denial of liability on the part of the insured is against the clear import of the evidence, the admission by the adjuster that if there is liability the recovery would probably be over the policy limits would make an even stronger case against the insurer in a suit to impose excess liability. As far as communications between the insurer and its attorney, it might be arguable that the attorney-client privilege would apply to keep out any evidence as to admissions by the attorney in his correspondence with the insurer's agents. 7 However, it would probably not be wise tactically for the insurer to assert the privilege in court and attempt to prevent the introduction of statements made by its attorney, as this might have an unfavorable effect on the jury. Also, the attorney hired by the insurance company actually has a dual role, representing both the insurance company and the insured, thereby raising the additional question as to whether the insurer alone could assert the privilege and attempt to keep out communications between it and its attorney. Attempts by the insurer to induce the insured to contribute to an offer of settlement within the policy limits by the threat of an excess verdict in the event the case against the insured went to trial would almost always be strong evidence of bad faith failure to settle on the part of the insurer. 1 8 The threat of an excess verdict if the case went to trial would be an admission by the insurer that there was a strong case against the insured both on the issues of damages and liability. Given this tacit admission and given the fact that there is an offer of settlement within the policy limits, there is no justification for the insurer not settling the case and paying the entire settlement out of its own resources, without contribution from the insured. There could never be any justification for the insured contributing to a settlement within the policy limits. The threat of an excess verdict exists only if the case goes to trial, and, if the insurer settles the case, this will never occur. To be distinguished, however, is the situation where there is an Md. 324, 236 A.2d 269 (1967). 16. In Potomac Ins. Co. v. Wilkins, 376 F.2d 425 (10th Cir. 1967), this factor was also present. 17. See Keeton, Liability Insurance and Responsibility Jbr Setlezent, 67 HARV. L. REV. 1136, 1168 (1954). 18. Zumwalt v. Utilities Ins. Co., 360 Mo. 362, 228 S.W.2d 750 (1950).

9 THE AMERICAN UNIVERSITY LAW REVIEW [Vol. 18 offer of settlement by the claimant within the policy limits which the insurer has decided to reject, and the insured upon learning of the offer of settlement and contemplated rejection offers to pay part of the settlement. This, standing alone, would not indicate bad faith by the insurer, as it had decided to reject the offer of settlement, indicating its belief that the offer was too large and, thereafter, the insured feeling the offer of settlement was fair, offered to contribute to effectuate the settlement." 9 If the insurer negligently investigates the case against the insured so that it is unable to properly evaluate the case and make an intelligent decision on the offer of settlement, it may be charged with any excess liability. The court mentioned this factor in affirming a lower court judgment against the insurer imposing excess liability in White. 0 Additionally, a negligent investigation by the insurer may impose liability on the insurer on the theory of a breach of the duty to properly defend the insured. The duty to defend is an absolute and unqualified duty and negligent investigation leading to a poor presentation of the insured's case would be a breach of duty; any damages incurred as a result thereof would be recoverable by the insured.2 If the insurer rejected the advice of its own attorney to settle the case against the insured within the policy limits it would be strong evidence of bad faith or negligence. 22 This factor is very similar to an admission by the insurer's agents or attorney that the case against the insured is very strong. In both of these instances, the persons appointed by the insurer to aid in the handling of the case are in effect saying the insured is liable to the claimant for the amount being claimed and the insurer should pay the sum. Rejection of this kind of advice would come close to indicating arbitrariness or capriciousness on the part of the insurer. One of the most significant factors in determining whether the insurer exercised good faith in the rejection of an offer of settlement is the question of timing, that is, the point during the negotiations when the offer was rejected. Offers of settlement may be made at any time from the first contact between the claimant and the insurer's adjuster, to the affirmance of a final judgment against the insured in the 19. This situation occurred in the Crisci case Md. 324, 236 A.2d 269 (1967) A APPLEMAN, INSURANCE LAW AND PRACTICE 4687 (1962). 22. Olympia Fields Country Club v. Bankers Indem. Ins. Co., App. 649, 60 N.E.2d 896 (1945).

10 1969] EXCESS LIABILITY highest appellate court of the jurisdiction. The cases indicate that rejection of an offer of settlement within the policy limits after a verdict against the insured exceeding the policy limits is a much more crucial indicator of bad faith on the part of the insurer than the rejection of an offer of settlement within the policy limits at some time before trial. In Foundation Reserve Insurance Co. v. Kelly, the limit of liability under the insured's policy was $5,000 per person. Insured was involved in a serious accident in which one George D. Madden was killed; thereafter an administrator was appointed to pursue the action against insured. Offers of settlement within the policy limits were made by claimant, up to the time of trial, but all were rejected by the insurer. A judgment in the amount of $12, was rendered against the insured. Even with judgment, the claimant renewed his offer of settlement of $5,000, the policy limit, but the insurer again rejected the offer. In sustaining a judgment against the insurer imposing excess liability, the United States Court of Appeals for the Tenth Circuit found as a matter of law that there was a bad faith refusal to settle. The court said: "Of particular importance here is the fact that an offer to settle was available after a judgment of over $12,000 had been rendered against the insured." Likewise, in United States Fidelity & Guaranty Co. v. Evans 24 a verdict had been returned against the insured for $25,000 and the claimant thereafter made an offer of settlement of $10,000 which was the policy limit, and which the insurer rejected. The appellate court upheld a jury verdict imposing excess liability. The insurer had decided to prosecute an appeal after the verdict and after its motion for new trial had been denied. The majority felt that the taking of an appeal did not give sufficient consideration to the interests of the insured and therefore there was a lack of good faith. There was a strong dissent in this case by Judge Eberhardt, who decried the denial of the right of appeal to an insurer which felt that its position on an issue was sound and sought review of this issue by an appellate court. It is doubtful whether this view by Judge Eberhardt of the insurer's "right to appeal" would be accepted by any court, since the cases make it clear that an insurer must give up the right of appeal in circumstances where there is a verdict against the insured over the policy limits and an offer of settlement within the policy limits, assuming it is in the F.2d 528 (10th Cir. 1968) Ga. App. 93, 156 S.E.2d 809 (1967), affd, 223 Ga. 789, 158 S.E.2d 243 (1968).

11 THE AMERICAN UNIVERSITY LAW REVIEW [Vol. 18 best interests of the insured to settle, which of course it would be in almost every conceivable case "5 However, it should not be assumed that an offer of settlement within the policy limits can be rejected with impunity before a verdict over the policy limits with the thought that an acceptance can later be tendered, and thus negate the bad faith at the time of the first rejection. A rejection of an offer of settlement at any time during the negotiating process may constitute a bad faith failure to settle on the part of the insurer, even though the insurer later tenders an acceptance of the original offer of settlement, which of course the claimant then rejects. Claimant then sues the insured and obtains a judgment over policy limits. Thus, in Critz 8 the claimant made an offer of settlement of $10,000 the policy limit, at an early stage in the negotiating process. The insurer rejected this offer even though it had finished its investigation and the case against the insured was strong both as to damages and liability. Later, the insurer offered to accept the initial offer of settlement. However, the claimant had put a 10-day time limit on the initial offer and refused the settlement when the insurer was willing to enter into it. The court said that the initial rejection of the offer of settlement by the insurer could constitute a bad faith rejection at the time it was made, if the jury found that the insurer was considering only its own interests and not the interests of the insured. Such a decision puts great pressure on the insurer to decide, when an offer of settlement comes in, whether to accept it immediately or to delay tendering an acceptance in the hope that the claimant will reduce his demand. Certainly an insurer should be forced to decide when an offer of settlement is made whether to accept it or not. It should not be allowed to stall in the hope that the passage of time will force the claimant to accept a lower figure. Although the possibility of finding bad faith increases as the insurer continues to reject offers of settlement within the policy limit up to the time of trial and becomes very strong after a trial court verdict over the policy limits, nevertheless it should not be assumed by an insurer that it can reject all initial offers of settlement with the thought that it cannot be held for bad faith rejection if it later decides to accept one of these initial offers (assuming of course the claimant has changed his mind and does not want to settle at the initial figure offered). 25. See Bowers v. Camden Fire Ins. Ass'n, 51 N.J. 62, 237 A.2d 857 (1968) (offer to settle within policy limits rejected after verdict over policy limits; excess liability imposed) Cal. App.2d 788, 41 Cal. Rptr. 401 (1964), rehearing denied, Cal. S. Ct. Jan. 13, 1965.

12 1969] EXCESS LIABILITY Failure to inform the insured of compromise offers has been mentioned in the cases as a' factor in deciding whether the insurer exercised good faith in refusing to settle. 27 The implication of this requirement is that if the insured is kept informed of offers of compromise he will urge the insurer, presumably vehemently, to make a settlement below policy limits, but that if he is not informed of offers of compromise the insurer thereby exhibits bad faith because concealing the offers removes the pressure to settle. This factor would apply to offers below the policy limits as well as offers above policy limits. As to the latter, if the insured felt the offer should be accepted he would urge the insurer to pay the policy limits and himself offer to contribute the balance to effectuate the settlement. Furthermore, the insurer should advise the insured that there may be liability over the policy limits (if this is the case) and advise him to hire his own attorney. Such efforts theoretically indicate good faith on the part of the insurer, which then works with the insured's attorney if the insured retains one, takes the attorney's advice and keeps him informed at all times of what is transpiring. However, such cooperation rarely occurs, primarily because the insurer, under the insurance contract and because of the practicalities of the situation, handles the case exclusively. In Coppage v. Firemens Fund Insurance Co." 8 the insured, after being advised by the insurer that he was at liberty to hire his own attorney, hired his own attorney. The attorney was subsequently ignored by the insurer's adjuster, who failed to advise the attorney of the progress of the case, its seriousness or offers of settlement. The court, in affirming a judgment for the insured for an amount over the policy limits, pointed out the foregoing facts as evidence of bad faith. A strict requirement that the insurer cooperate with the insured or the insured's attorney in the negotiating process in order to avoid the charge of bad faith failure to settle would seem to drastically hinder the insurer's handling of the case. It is believed that the courts, in passing on the good faith issue, should not give great weight to the fact that the insurer did not keep the insured or his attorney completely informed at all stages of the negotiating process, otherwise there would be too great an interference with the insurer's handling of the case. However, it is clear from the cases that the insurer must give some information to the insured as to the progress 27. Coppage v. Fireman's Fund Ins. Co., 379 F.2d 621 (6th Cir. 1967); State Farm Mut. Auto. Ins. Co. v. Smoot, 381 F.2d 331 (5th Cir. 1967) F.2d 621 (6th Cir. 1967).

13 THE AMERICAN UNIVERSITY LA W REVIEW [Vol. 18 of negotiations. If the insured does not hire his own attorney, he nevertheless should be informed generally, if not as to each specific step. As to the insurer's ability to protect itself against a charge of bad faith by merely advising an ifisured that he should hire his own attorney, this will be discussed below. 2 Finally, some courts have mentioned, as a factor bearing on the good faith or bad faith of the insurer, a comparison of the differential between what the claimant was willing to settle for and what the insurer was willing to settle for as weighed against the probable outcome of the case if it were to go to trial 0 In other words, if the amount separating the claimant and the insurer is relatively small and a large excess verdict against the insured looms if the case goes to trial, it is an indication of bad faith on the part of the insurer not to put out the small amount of extra money in order to save the insured from the possibility of a large excess verdict; the insurer in this situation is considering only its own interests. The way this factor is applied in practice is to compare the final verdict against the insured with the difference between the amount the claimant was willing to settle for before trial and the amount the insurer was willing to pay in settlement. Thus, in State Farm Mutual Automobile Insurance Co. v. Marcum " the claimant was willing to settle for $18,500 all during the trial, while the insurer would only offer $15,000 as a settlement figure. Limits of liability were $20,000. Ultimately, the jury returned a verdict of $54, against the insured. There was strong evidence of liability on the part of the insured and injuries were extensive, indicating the probability of a large verdict. By payment of a relatively small additional sum of money in settlement, the insurer could have prevented the foreseeably large excess verdict against the insured 3 FACTORS TENDING TO NEGATE BAD FAITH REFUSAL TO SETTLE BY INSURER If the insured misleads the insurer by, for example, giving a false account of the accident so that the insurer believes that it is justified 29. Seep. 412infra. 30. See, e.g., Communale v. Traders & Gen. Ins. Co., 50 Cal.2d 654, 328 P.2d 198 (1958) S.W.2d 113 (Ky. 1967). 32. See also Critz v. Farmers Ins. Group, 230 Cal. App.2d 788, 41 Cal. Rptr. 401 (1964) (offer of settlement by claimant of $10,000.00, insurer willing to give $8,250.00, final verdict of $48, against ihisured); Coppage v. Fireman's Fund Ins. Co., 379 F.2d 621 (6th Cir. 1967) (offer to settle by claimant at policy limits [$5,000.00] insurer willing to pay $2,500.00, final verdict $31,250.00).

14 1969] EXCESS LIABILITY in rejecting an offer of settlement within the policy limits, a strong indication of good faith on the part of the insurer will have been made. In Hall v. Preftrred Accident Insurance Co. 33 the insured had misled the insurer as to the status of one Garmon, who was involved in the accident in question. The insured had led the insurer to believe that Garmon was an independent contractor. If this were the case, there could be no liability on the insured. Based on this information, the insurer rejected an offer of settlement within the policy limits. It was later discovered just prior to trial that Garmon was in fact an employee, but at this point it was too late to settle at the original figure. A verdict resulted against the insured in an amount in excess of policy limits and insured sued for the excess amount. The court held that the insurer did not exhibit bad faith in failing to settle as the insured had withheld material facts so that the insurer had no opportunity to make a proper decision as to settle the settlement figure. Another defense by the insurer to a charge that it refused to settle in good faith is that the insured concurred in the rejection of a settlement offer. It would be a rare occurrence for the insured to concur in the rejection of a settlement,whenever the settlement offer was within policy limits. However, it would not be uncommon for the insured to concur in the rejection of a settlement offer or in fact to insist upon such rejection if the settlement offer were above policy limits and the insured must himself contribute in order for the settlement to be made. In Jackson v. St. Paul-Mercury Indemnity Co. 3 4 there was an offer of settlement by the claimant of approximately $16,000, which the insured insisted be rejected by the insurer and the case be tried. The limit of liability of the policy was $10,000, so that the insured would have had to contribute in order to effectuate the settlement. The insurer's attorney urged the insured to accept the settlement and indicated a readiness to pay the policy limit. The attorneys also advised the insured to hire an attorney if he so desired to protect his interests, but the insured did not do so. The trial resulted in a judgment against the insured for approximately $30,000, and the court held that there was no excess liability of the insurer. It would seem that in order for the insured's refusal to concur in a settlement to be a defense for the insurer, the insured must have realized the consequences of the failure to settle, either by the insurer's F.2d 844 (5th Cir. 1953) F.2d 40 (6th Cir. 1964).

15 THE AMERICAN UNIVERSITY LAW REVIEW [Vol. 18 attorneys explaining this fully or by the insured hiring his own attorney. The insurer, to be safe, should always advise the insured in this situation that it would be desirable for him to retain his own counsel. Another defense frequently used by an insurer when it is sued for a bad faith failure to settle is that it employed competent counsel to handle the case and this counsel advised rejection of the offer of settlement. 35 This is a very weak defense, as the insurer's attorney, although theoretically representing both the insured and the insurer, nevertheless is paid by the insurer. He would thus be influenced to weigh the interests of the insurer more heavily than the interests of the insured. Often the insurer defends an excess liability suit on the grounds that it advised-the insured to hire his own attorney to protect his interests, as soon as it appeared that the policy limits might be inadequate. 36 In fact, this course of conduct has been specifically recommended by an insurance company general counsel as a precautionary measure to avoid excess liability. 3 7 It is doubtful whether this step will bar a claim for excess liability on the part of the insured, unless the insured does hire an attorney and the insurer cooperates and is guided by the advice of this attorney. Normally, however, the insurer wants complete control of the handling of settlement negotiations and it studiously ignores the insured's attorney. 8 Further, the courts have said that failure of an ihsured to hire an attorney even when advised to do so by the insurer does not bar a claim for excess liability? 8 This result is logical because the insured in buying his liability policy is buying not only insurance protection but also the right to have any lawsuit against him defended. To suggest that the insured must hire his own attorney to protect his interests, even if it appears the claim against the insured will exceed the policy limits, and to suggest that his failure to do so after being so advised by the insurer forecloses a claim for excess liability, would defeat one of the main purposes for which the insured purchased the policy: the right to be defended in any action and to have his interests protected whether the claim may or may not exceed policy limits. Even if the insured does hire an 35. Dumas v. Hartford Accident & Indem. Co., 94 N.H. 484, 56 A.2d 57 (1947). 36. See, e.g., State Farm Mut. Auto. Ins. Co. v. Smoot, 381 F.2d 331 (5th Cir. 1967), 37. See Cunningham, Liability Beyond Policy Linilts, 25 TENN. L. REV. 437, 440 (1958). 38. See Coppage v. Fireman's Fund Ins. Co., 379 F.2d 621 (6th Cir. 1967). 39. See State Farm Mut. Auto. Ins. Co. v. Smoot, 381 F.2d 331 (5th Cir. 1967); State Farm Mut. Auto. Ins. Co. v. Marcum, 420 S.W.2d 113 (Ky. 1967).

16 1969] EXCESS LIABILITY attorney, the insured's interests are not protected unless the insurer cooperates fully with the attorney and is guided by this attorney's advice, including advice to settle below policy limits. There should be no requirement, as suggested in the dissenting opinion in Marcum, that the insured must hire an attorney who should then proceed to request settlement within the policy limits, and that failure to do this may be raised against the insured in his suit to impose excess liability Frequently an insurer asserts as a defense to a suit for excess liability the fact that it believed in good faith that due to a breach of condition or for some other reason the policy did not afford coverage, justifying its rejection of settlement at any figure. 40 This is not a good defense if it is later found that there was coverage.! The insurer takes the risk of deciding whether there is coverage. If all the factors indicate settlement should be made at a figure within policy limits, and the insurer refuses to settle on the gound that there is no coverage, it takes the risk that if coverage is later found and there is a judgment against the insured over the policy limits it will be liable for the excess. Finally, in Bowers v. Camden Fire Insurance Ass'n, 42 the insurer refused to settle within the policy limits on the ground that the insured stated that he "felt" that he was not liable. A suit against the insured by the claimant resulted in a judgment against the insured over the policy limits for which excess he sued the insurer. The court said that the insurer's refusal to settle because the insured felt that he was not responsible for the accident in question constituted bad faith, where all the other factors pointed toward a settlement which could have been made within policy limits. Even the insured urged the insurer to accept the offer of settlement, in spite of his feeling of nonliability. THEORY OF RECOVERY-CONTRACT OR TORT-SIGNIFICANCE OF DISTINCTION Most of the authorities, until recently, seemed to accept the idea that the cause of action against the insurer for wrongful failure to settle was one arising in tort! 3 The reason for this conclusion -was that the duty to settle in good faith was not one which was expressed in the 40. Foundation Reserve Ins. Co. v. Kelly, 388 F.2d 528 (10th Cir. 1968); Communale v. Traders & Gen. Ins. Co., 50 Cal.2d 654, 328 P.2d 198 (1958). 41. Id N.J. 62, 237 A.2d 857 (1968) A APPLEMAN, INSURANCE LAW AND PRACTICE 4712 (1962).

17 THE AMERICAN UNIVERSITY LAW REVIEW [Vol. 18 contract, but was implied; therefore a failure to settle in good faith was a wrong to the insured and not a breach of contract. However, the modern cases are more flexible in terms of characterizing the cause of action as contract or tort. There are three problem areas in which the distinction between contract and tort may be important: the applicability of the proper statute of limitations, the amount of damages recoverable and the assignability of the cause of action against the insurer for wrongful failure to settle. The problem as to statutes of limitation is which statute is applicable, the one barring contract claims or the one barring tort claims. Generally, statutes of limitation concerning contract claims are longer than statutes limiting tort claims. Thus, in Communale v. Traders & General Insurance Co. 44 there was a four year statute of limitations applicable to contract claims and a two year statute which applied to tort claims. The plaintiff brought suit less than four yeais but more than two years after the cause of action arose and the question was which statute applied, the one barring contract claims or the one barring tort actions. The court, in holding that the four year statute applied, recognized that generally a wrongful refusal to settle is treated as a tort. However, the court justified its decision by stating that although the insurer's duty to settle was not expressed in the contract, it nevertheless arose out of the contract and was as much a part of the instrument as if it were written in the policy. Further, the court held, if a case sounds both in contract and tort the plaintiff ordinarily has an election between the two theories and here the plaintiff elected to sue in contract. If the statute of limitations barring tort actions has run, but the statute as to contract actions has not, then it is clear that plaintiff should emphasize the contractual aspects of the insurer's duty; however, this might prejudice the plaintiff's case in other areas. A question which arises whenever there is a possibility that a cause of action is barred by limitations is when did the cause of action arise. This will be discussed below in connection with damages. 45 The next area in which characterization may be significant is that of consequential damages. The contract measure of damages normally attempts, through monetary compensation, to put the plaintiff in the same situation he would have been in if the contract had been performed so far as money can do it. 4 The insured's suit against the Cal.2d 654, 328 P.2d 198 (1958). 45. Seep. 419 infra. 46. L. SIMPSON, CONTRACTS 148 (1954).

18 1969] EXCESS LIABILITY insurer for excess liability includes the amount by which the claimant's judgment against the insured exceeded the policy limits, as well as interest on this amount if the insured has in fact paid the claimant. Whether the insured could recover under a contract theory for consequential damages, such as mental suffering and loss of profits due to disruption of a business caused by claimant's execution of his judgment against insured, is questionable under the contract rule of damages. In order for consequential damages to be recoverable, where there has been a breach of contract, it would have to be proved that they were foreseeable as a result of the breach of contract. 47 It might be very difficult for the insured to prove that consequences such as mental distress were foreseeable as a result of rendition of an excess judgment against him, after wrongful failure of the insurer to settle. Certainly punitive damages would rarely if ever be allowed if plaintiff's cause of action sounded in contract! 8 So, if plaintiff has suffered consequential damages as a result of the rendition of an excess judgment against him, the likelihood of recovering these damages would be much greater if plaintiff's cause of action sounds in tort, rather than contract, and if the court accepts the tort theory. Thus in State Farm Mutual Insurance Co. v. Smoot,. 9 the plaintiff, after rendition of a judgment against him over policy limits based on a claim which the court found could and should have been settled by the insurer for an amount well below policy limits, was unable to sell his home because the excess judgment constituted a lien against it. Later plaintiff lost the house through foreclosure for inability to meet the payments and as a result of the foreclosure his credit was destoyed. The court upheld an award of $10,000 to plaintiff as consequential damages arising out of the insurers wrongful failure to settle. The court also upheld an award of $10,000 in punitive damages against the insurer. The plaintiff's action was founded in tort, so that there was ample legal justification for upholding an award of general damages and punitive damages. Likewise, in Crisci the court upheld an award of $25,000 to insured as compensation for mental suffering resulting from the insured's becoming indigent in settling an excess judgment which arose out of a claim that the insurer had an opportunity of settling below policy limits. As a result of the change in her financial condition, the 47. Id. at Id. at F.2d 331 (5th Cir. 1967).

19 THE AMERICAN UNIVERSITY LA W REVIEW [Vol. 18 plaintiff sustained a decline in physical health, became hysterical and attempted suicide. As in Smoot, the court emphasized the tort nature of plaintiffs cause of action in sustaining the award of consequential damages. Finally, the theory of plaintiff's action might affect the assignability of the cause of action for the insurer's wrongful refusal to settle. The reason the problem arises is that it is generally accepted that tort claims are not assignable, so if there is an attempted assignment of the cause of action by the insured to the claimant and if the cause of action is characterized as one arising in tort, application of the general rule will result in a finding that claimant has no standing to sue the insurer. There is a split of authority on this question 5 The courts which allow assignment emphasize the contract nature of insured's cause of action against the insurer. In Grundy v. Manchester Insurance & Indemnity Co.," the insurer challenged the judgment creditor's standing to sue for excess liability under an assignment from the insured, on the ground that the assignment was invalid as the cause of action arose in tort. The court, however, held that even though the action was nominally in tort, it nevertheless was based on a contract and therefore was assignable. In Communale the court held that an action for damages in excess of policy limits based on the insurer's wrongful failure to settle was assignable whether the action was considered as sounding in tort or in contract. 3 If policy reasons dictate that the insured be permitted to assign his cause of action against the insurer to the judgment creditor for wrongful refusal to settle, there would seem to be no lack of a theoretical basis for holding the assignment valid. Even if a jurisdiction were bound by precedent to hold that the insured's cause of action was in tort, the reasoning of Grundy to the effect that the underlying basis of the insured's claim is in contract, even though the suit is nominally in tort, would provide a rational basis for the court's decision to allow assignment. Damages Must the insured mitigate damages by settling with the claimant if the insurer has wrongfully refused to settle? If the insured does in fact Cal.2d 425, 426 P.2d 173, 58 Cal. Rptr. 13 (1967) A.L.R.3d 1158 (1965) S.W.2d 735 (Ky. 1968). 53. It is interesting to note that in this same case the court held that the statute or limitations barring contract claims applied to insured's cause or action.

20 1969] EXCESS LIABILITY settle would he be entitled to reimbursement for this amount from the insurer? Of course, the insured's ability to settle with claimant after the insurer has refused to do so depends upon the insured's knowledge as to the course of negotiations and of the fact that negotiations have broken down. Assuming the insurer does not keep the insured informed of the course of negotiations and if the claimant never personally contacts the insured there could be no duty on the insured to settle. It is not unlikely that an insured would be kept in the dark during the entire period of negotiation between the claimant and the insurer and even until final judgment never actually know what has transpired with respect to settlement negotiations. Frequently, the insured never knows what is going on with respect to claims against him due to the insurer's exclusive handling of these claims. This exclusive handling is, of course, provided for in the insurance policy, 54 and because of this provision, it would not seem that there is a duty of the insured to inform himself of what is going on between the claimant and the insurer. If the insured is kept informed of settlement negotiations by the insurer or otherwise knows or finds out about the progress of negotiations so that he is aware when a breakdown occurs, he is presented with a dilemma concerning whether to make a settlement himself of the claim. The dilemma in which the insured finds himself here is created by the policy provision found in the typical liability policy, which states that if the insured settles a claim he does so at his own expense. Therefore, if there is in fact a duty on the insured to mitigate damages, the insured must make a determination whether the insurer has wrongfully refused to settle a claim, and if he decides in the affirmative he must himself make settlement. However, if the insurer has not wrongfully refused to settle, the insured will get nothing back if he himself settles. In other words, if negotiations break down between the claimant and the insurer and the insured takes it upon himself to make settlement, he does so at his peril, for he may not recover back any amount that he has paid in settlement unless he proves that the insurer wrongfully refused to settle. In Rosenthal v. Security Insurance Group, 55 the insured settled a claim being made against him after, as he testified at the trial, he was advised by his insurance agent that the insurer was not going to pay the claim. His policy contained the standard clause concerning payment of a claim by the insured, which read as follows: 54. Seep. 398 supra So.2d 816 (La. 1968).

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