Insurance Bad Faith: Assignments, Consent
Judgments
and Covenants Not To Execute
Amy C. Kovarik
I.
Disputes between liability insurers and their insureds over the settlement of claims often result in assignments. The insured settles with the claimant and assigns to the claimant any rights the insured has against its insurer. In this manner, the insured removes the insurer from participation and involvement in the settlement of the claim. In the typical scenario, the insured receives a release or a covenant not to execute in exchange for the assignment. The issue is to what extent are these assignments enforceable, and taxable, against the insurer.
While there is no
consensus of opinion regarding an insurer’s liability for “covenant judgments,”
some states find these judgments to be unenforceable, as they do not create a
legal duty to pay on behalf of the insured.
Other states subject these assignments to strict scrutiny while still
others have no clear approach.[1] This article addresses the issues that
typically relate to consent judgments.
II.
In the instance of an insurance coverage dispute, the
assignment given by the insured to the claimant typically contains three
components. The first is a judgment
establishing the insured’s liability.[2] This judgment can be obtained through various
procedures, that may be important in determining the weight a subsequent court
will give to the judgment.[3] The second element is a covenant not to
execute given by the claimant to the insured, guaranteeing that the claimant
will not attempt to enforce the judgment on any of the insured’s assets, with
the exception of the insurance policy.[4] Finally, the insured assigns to the claimant,
any rights it may have under the insurance policy or against the insurer.[5] Armed with this assignment of rights, the
claimant then brings suit against the insurer as assignee of the insured for
payment on the policy and additional bad faith damages.
The exchange of
the assignment and covenant not to execute holds obvious advantages for both
the claimant and the insured. The
insured has no further exposure to damages stemming from the claim that give
rise to the suit. Particularly when the
insured may feel abandoned by its insurer, the potential of escaping the suit
with no financial liability and no further defense costs is attractive. By concluding a deal with the insured, the
claimant also stands to profit. First,
the insured’s liability for injuries may be conclusively liquidated without a
contested proceeding.[6] Second, the claimant will have greater
latitude to introduce facts establishing high damages and will not face a
vigorous defense.[7] Thus, when the claimant’s case is weak, there
will be a strong incentive to strike a deal with the insured.[8] Finally, if the insured is judgment-proof,
the claimant has nothing to lose by concluding a deal and shifting the focus of
its efforts to a suit against the insurer.
If the insurer has refused to defend its insured, the claimant will bring
suit against the insurer and establish coverage before recovering any amount
allegedly owed under the policy resulting from the judgment against the
insured. The deal with the insured
provides an additional means for the claimant to recover by bringing the
insurer’s conduct into question and establishing a bad faith breach of
contract.[9] In the instance of a verdict in excess of
liability limits, the claimant will often file garnishment proceedings in the
same action.[10]
The consequences
of an assignment-covenant not to execute are potentially severe for the
insurer. After the insured’s liability
is established, the insurer may no longer argue that the insured was not at
fault, because doing so may represent a collateral attack on the judgment.[11] The issue of whether damages fixed in the
“judgment” may be attacked is more complicated, and usually is a function of
state law.[12] In general, coverage cannot be established by
agreement of the parties in the tort action, although the parties may stipulate
to facts that would establish coverage.[13] Most importantly, the consent judgment covers
the action against the insured to be supplanted by one testing the actions of
the insurer in its handling of the claim.
This means that the insurer also faces liability for extracontractual
damages that are normally not a part of the tort case.[14]
III.
A. Deterrence
and Protection
The use of
assignments and covenants not to execute did not evolve in a vacuum. Courts have advanced two primary policy
rationales for allowing the use and enforcement of these arrangements: the
assignment-covenant gives the insured leverage to protect its interests, and
the insurer is given an incentive to act in good faith when dealing with the
insured.[15]
An insured that
has been wrongfully abandoned by its insurer faces a pair of unappealing
choices. It can pay to conduct its own
defense of the action, risking an adverse judgment and litigation costs that it
may recover only at the end of more protracted litigation with its own
insurance company.[16] As many insureds are not repeat players in
the legal system and are litigation averse, this is an unattractive
option. If the insured is unwilling or
unable to conduct a defense of the suit on its own, it may feel compelled to
enter into an unfavorable settlement with the claimant to avoid the risk of
catastrophic loss, even if it believes the real value of the suit is minimal.[17]
The
assignment-covenant mechanism effectively ends the insured’s problems. Although the deal with the claimant concedes
liability, there is no financial risk.
Litigation costs are capped, since the remaining battle is left to the
insurer and the claimant. A wrongfully
abandoned insured will see this as a fair resolution -- the insured has paid
for insurance with the expectation of avoiding the burdens and expenses of
litigation and should be allowed to strike the best deal possible once the
insurer breaches its duties.
A second argument
involves the incentive it gives to insurers to treat their insureds
fairly. As one observer pointed out,
liability insurance is not purchased solely for its indemnification function;
it also serves as “litigation insurance.”[18] Allowing insureds to assign their rights
against the insurer to the claimant in exchange for a covenant not to execute
gives the insurer a strong incentive to fulfill the litigation insurance aspect
of the contract. If the insurer defends
a suit from the outset, it will be insulated against the use of a “sweetheart
deal” because the no-action and cooperation clauses of the insurance contract
will prevent the insured from striking an enforceable deal with the claimant.[19] The pressure exerted by the
assignment-covenant not to execute is the threat of extracontractual liability
from a breach of the duty to defend.[20] Contractual damages alone arguably do not
provide sufficient incentives to perform under the contract.[21]
The
assignment-covenant is also argued to play a valuable role in encouraging
settlements. With the ability to assign
its rights against the insurer in return for capping its own liability, the
insured has greater leverage in controlling the settlement process. This resolution is more efficient than
litigation between the claimant and insured that only serves to preserve the insured’s
cause of action against the insurer.[22] By allowing litigation between the claimant
and the insurer to proceed, the arrangement avoids wasting the limited
resources of litigants and courts, and may result in a quicker resolution of
the issues in a case.
B. Potential
Problems Arising from Covenant Judgments
The deterrence and
protective functions of the assignment-covenant mechanism are often outweighed
by abuses. While the foregoing
discussion focused on the abandoned insured, this section addresses the
problems posed by an opportunistic claimant.
The
assignment-covenant not to execute may be used aggressively in conjunction with
strategic pleading or unreasonable settlement offers to induce the insurer to
commit a tort and thereby access insurance funds that would otherwise be
unavailable. The close cooperation
between the claimant and the insured in these situations is responsible for the
“sweetheart deal.”
1.
Fraud and Collusion Potential
The most obvious
prejudice arising from the sweetheart deal is the potential for fraud or collusion
on the part of the claimant and the insured acting in tandem against the
insurer. If the assignment and covenant
are exchanged before the judgment, there is no incentive for either party to
engage in the kind of adversarial process that normally ensures that a
settlement or judgment accurately reflects the value of the case.[23] The claimant will always strive for a
judgment admitting liability and substantial damages. The usual check is a vigorous defense that
minimizes the loss. But since the covenant
relieves the insured of personal liability, its only incentive is to agree to
whatever terms will persuade the claimant to abandon its suit.[24] The incentive for the claimant is the
potential for an increased recovery by pursuing the insured’s bad faith claim
against the insurer.[25] The final result is that neither party is
motivated to seriously mitigate damages and liability because the end goal is
to structure the deal so that the insurer, a nonparty to the agreement, pays.
The forms of fraud
or collusion that may arise are limited only by “the ingenious assistance of
counsel.”[26] Obvious examples are cases in which the
claimant and insured agree to a highly inflated damage figure that is then
entered by the court. Increasingly,
default judgments or uncontested trials are preferred to straight settlement
agreements, but in either case, there is no real opposition to the damage
figure advanced by the claimant.[27] In a similar vein, certain facts or
admissions may be stipulated to show liability and coverage. This is most dangerous when the claimant has
a weak case, because the insurer may have no right to later contest an
admission of liability.[28]
Insurers
frequently complain of “set-up” settlement offers, which the claimant makes
after coverage is denied, in an attempt to manipulate the insurer into acts
that can later be cited as evidence of bad faith.[29] A settlement offer may be made early in the
discovery process, when the insurer has inadequate time to ascertain the value
of the claim or to fully establish facts concerning the insured’s liability.[30] Settlement offers may remain open for an
unreasonably limited time.[31] A claimant has the power to control the
terms and conditions of a settlement offer. However, when these tactics are
combined with a subsequent refusal to accept the same settlement later in
negotiations and with an assignment of the insured’s rights to the plaintiff,
the situation looks less like a bargaining tactic than an attempt to lay the
groundwork for a future bad faith suit.[32]
Many appellate
courts take a jaundiced view of these practices.[33] Almost every case involving a sweetheart deal
contains at least some mention of the potential for fraud and collusion,
regardless of whether the final decision favors the claimant or insurer.[34] Insurers typically challenge the judgment
that forms the base of the sweetheart deal on grounds of fraud or collusion.[35] However, this may be difficult to prove. The insurer was not a party to the
negotiations, and typically does not have detailed information regarding how a
deal was realized.[36] Further, the burden of proving fraud or
collusion is high.[37]
All settlements
require some measure of cooperation between opposing parties, and drawing a
line between the permissible and the fraudulent is not always precise. Insurers are unlikely to be satisfied with
this as the sole option.
2.
Abuse of the Judicial Process
A related concern
is that sweetheart deals have the potential to abuse the judicial process. The assigned judgment is arguably a “sham” judgment
because there is no independent adjudication of facts and because the insured,
while admitting liability, will never be expected to pay the assessed or agreed
damages.[38] To the extent this practice is allowed, it
has the potential to undermine trust and confidence in the courts.[39] The objection takes on greater force to the
extent that the argument is hidden from the finder of fact in the subsequent
trial against the insurer.[40]
Sweetheart deals
also raise concerns about the potential for perjury on the part of the claimant
and insured. After receiving an
assignment of the insured’s bad faith cause of action, the claimant must
establish that the insured was damaged by the insurer’s actions in failing to
defend or settle the case. Only arguing
that the insured’s damages would have been less if the insurer had provided the
defense can this be done. In effect, the
claimant must disparage the strength of its own case to prove the insured’s
damages. Some commentators have
suggested this inconsistency can be alleviated by careful use of expert
witnesses.[41] But in some instances, the contradiction
simply cannot be overcome.
In State Farm Fire & Casualty Co. v. Gandy,[42]
as part of a sweetheart deal, the insured admitted liability, confessing that he
had molested his stepdaughter, the plaintiff.[43] Damages were assessed at more than $6
million. The stepdaughter, as the
insured’s assignee, then sued the insurer for extracontractual damages and was
put in the position of arguing that if the insurer had provided a proper
defense in the first case, the insured would have been liable for approximately
$4 million less.[44] The insured testified in the second case that
he had not ever molested the plaintiff but had admitted liability simply to end
the suit. The insured must have
committed perjury at some point -- as it is impossible that he could have both
molested and not molested the plaintiff.
The troublesome aspect of this realization is that the motivation for
perjury stems directly from the use of the sweetheart deal.
3.
Economics
A final problem
arising from sweetheart deals is a distortion of the damages. This risk arises because neither party to the
sweetheart deal has any incentive to make sure that damages are a true
reflection of real injuries.[45] If this tendency were not checked, activities
would appear to entail greater risks than would be indicated by normal
actuarial calculations. The effect would
be reflected in higher premiums charged over the pool of all insureds. In this event, all policyholders would pay
higher rates and would thus pay for the windfall received by the claimant.[46]
A related problem
is that successful sweetheart deals extend the limits of the insurance contract
beyond what the parties intended.
Assuming that parties purchase insurance based on a rational assessment
of risks they control (and therefore do not require insurance against other
risks) and risks they cannot control (and therefore need insurance against),
the additional coverage resulting from a successful deal between the plaintiff
and the insured is inefficient.[47]
Again, the likely result is that insurance rates would adjust to reflect these
payouts. These problems suggest the need
for a careful balancing of any deterrent placed on insurers, as overly frequent
use of consent judgments would merely shift the cost of extracontractual
damages to policyholders as insurers readjust their calculations and rates.
III.
When insureds and
insurers dispute coverage, particularly when the insurer is not defending,
insureds may settle claims by entering into agreements with one or more of the
following features:
(1) The insured pays
little or nothing to the claimant out of pocket. Some insureds actually reserve a share of any
money collected from their insurers.
(2) The claimant and the
insured stipulate to the entry of judgment against the insured, either fixing
the amount of damages or establishing liability while reserving the issue of
damages.[48] The amount of damages may be within or in
excess of the policy limits.
(3) The claimant agrees to release the insured from paying any part of the damages set out in the agreed judgment or settlement and to rely only on the insurer for payment of the judgment. Usually this involves a covenant not to execute on the assets of the insured. However, it may be phrased as a covenant to execute on or collect the judgment only from one asset of the insured (the rights under the insurance policy) or it may be structured as a provision in the judgment making it collectible only to the extent that insurance may apply.
(4) The insured assigns
to the claimant all rights against the insurer, whether under the policy or for
bad faith in connection with the insurer’s handling of the plaintiff’s claim.
In this article,
the term “covenant judgment” refers to an arrangement with this combination of
features. Such a settlement, if effective, eliminates all defenses to the
claimant’s tort suit and, without any evidentiary foundation or trial,
transforms the tort claim against the insured into a claim against the insurer
that may lie both in contract and in tort. Unlike a judgment rendered after
trial, a consent judgment does not require the parties to present evidence to a
factfinder, and the court usually acts in a ministerial capacity in entering
the judgment. There is no protection for the insurer’s interests if it is not a
party to the case.
The effectiveness
of a covenant judgment depends on the following factors, which are often interrelated:
(1) whether the law of
the jurisdiction regards a judgment or settlement with a covenant not to
execute as an obligation of the insured covered by insurance or, a release of
the insured and the insurer from liability;
(2) whether the insured
has the right, under the policy or the law of the jurisdiction, to settle the
case under the circumstances;
(3) whether the
settlement is reasonable under all the facts (if the law of the particular
jurisdiction permits the insurer to challenge the reasonableness under the
circumstances); and
(4) whether the settlement was the product of bad faith, fraud, or collusion (if the law of the jurisdiction permits the insurer to challenge the settlement on that sort of basis under the circumstances).
To enforce a covenant judgment, the claimant (now a judgment
creditor and assignee) must prove that its claim falls within the coverage of
the policy.[49]
Covenant judgments
are vulnerable when: (1) the insured does not have the right to settle the case
without the consent of the insurer; (2) the amount of the settlement is
unreasonable in relation to the claimant’s chances for success against the
particular insured or to the likely amount of damages if a judgment is
recovered;[50]
(3) the claimant and insured have acted secretively and unfairly toward the
insurer or have attempted to create or affect insurance coverage in the
settlement; (4) the particular jurisdiction does not recognize a consent
judgment accompanied by a covenant not to execute as a legal obligation of the
insured; or (5) the particular jurisdiction does not recognize a consent
judgment as satisfying the necessary element of a judgment in excess of policy
limits for common law or statutory bad faith claims.
When the insured
and claimant, both of whom have interests directly adverse to the insurer, seek
to stipulate in their covenant judgment those facts that establish coverage,
but the insurer disputes those facts; courts generally give no weight to such
stipulations.[51]
V.
Courts in several
jurisdictions have held that a covenant judgment does not create a “legal
obligation” of the insured or “damages which the plaintiff is legally entitled
to recover from the insured” within the terms of insurance policies. In other words,
the covenant judgment is unenforceable because it does not create a legal duty
of the insured to pay anything.[52]
Other courts have
held that a covenant not to execute given in connection with a consent judgment
does not affect the insurer’s responsibility under the policy or release it
from liability.[53] Still other courts have held such covenant
judgments to be presumptively enforceable and have placed on the insurer the
burden to show fraud, collusion, bad faith, or unreasonableness.[54]
Two related lines
of cases hold that covenant judgments can constitute legal obligations, but
modify the burden of proof. One line, following Griggs v. Bertram,[55]
places the initial burden on the insured or the claimant-assignee of showing
reasonableness and lack of bad faith in reaching the settlement -- because the
claimant and the insured, and not the insurer, have first-hand knowledge of how
the settlement was reached. Once that
initial burden is met, the burden of pleading and persuasion regarding unreasonableness,
bad faith, or collusion shifts to the insurer. The second line, following Miller v. Shugart,[56]
places the burden on the claimant to show that the stipulated judgment is
reasonable and prudent, while apparently retaining the insurer’s burden of
proof regarding fraud and collusion.
The difference is
whether the refusal to defend was a breach of the insurer’s duty. However, as
discussed below, some states have allowed this arrangement even when the
insurer has defended or offered to defend under a reservation of rights to deny
coverage.
VI.
In instances when
the claim is for a bad faith refusal to settle, there must be a judgment in
excess of limits.
With respect to
common law bad faith claims, the opinions in Chaussee v. Maryland Casualty Co.[57]
and Florida Farm Bureau Mutual Insurance
Co. v. Rice[58]
assume, and the opinions in Lozier v.
Auto Owners Insurance Co.[59]
and Glenn v. Fleming[60]
expressly state that such a settlement may support a claim to extra-contractual
damages in certain circumstances.
However, in Miller v. Shugart,[61]
the Minnesota Supreme Court indicated that stipulated judgments could not be
the basis for common law bad faith suits to collect stipulated amounts in
excess of policy limits.
The logic is that
consent judgments are settlement agreements, and therefore cannot form the
basis for an excess judgment for failure to settle claim. This is because an
essential element -- a judgment in excess of policy limits that is binding as
collateral estoppel on the liability of the insured and the amount of damages
-- is missing.[62]
In California, a
stipulated judgment with a covenant not to execute cannot support a claim for
violation of the Unfair Claims Settlement Practices Act unless the insurer
participates in negotiating the settlement and signs the stipulation so that
the stipulated judgment is binding on the insurer as res judicata.[63]
This conclusion flows from the requirement of Moradi-Shalal v. Fireman’s Fund Insurance Cos.[64]
that there be a conclusive judicial adjudication of liability and damages as a
condition precedent to an excess judgment claim under the California Unfair
Claims Settlement Practices Act.
The opinions of
the California Court of Appeal in Doser
v. Middlesex Mutual Insurance Co.[65]
and Smith v. State Farm Mutual Automobile
Insurance Co.[66]
indicate that stipulated judgments and other settlements in which the insured
pays little or nothing of the agreed “damages” also will not support common law
bad faith or excess judgment claims. In Smith
the court emphasized:
We wish to
make clear that the $500,000 settlement here is entitled to no consideration in
determining the amount of damages. Moreover, appellants have not stated a cause
of action for recovering damages above policy limits of State Farm’s insurance
policy; the stipulated judgment with covenant not to execute does not
constitute an excess judgment within the meaning of Communale v. Traders & General Insurance Co.[67]
These California decisions will not necessarily be followed in
other states that have recognized private causes of action for violation of
their respective unfair claims settlement practices acts. The Montana Supreme
Court, for example, has allowed a third-party cause of action under the Montana
Unfair Claims Settlement Practices Act. [68] In so doing it has rejected the argument of
insurers that a statutory bad faith claim must rest upon an establishment of
liability in the underlying settlement, judgment, or an admission by the insured
or insurer in the settlement process. West Virginia’s Supreme Court, in
recognizing a private cause of action under that state’s bad faith statute,
appears to have followed the California Royal
Globe decision in requiring that the underlying suit be “resolved.” [69] However, it did not indicate whether
resolution requires a “conclusive judicial determination” of liability as later
specified by Moradi-Shalal.
In the excess
judgment situation, the refusal of the insurer to settle within policy limits creates
only the potential that the insured will be subject to an excess judgment.
Neither injury nor damage flows automatically from the refusal to settle or
from a delay in settling. The refusal to
settle does not create the risk that the insured will be subject to an amount
in excess of policy limits. As such, the
“potential” prejudice to the insured should not be used to tax a collusive
settlement agreement against the insurer.
VII.
Just as the
insurer must abide by its duty to defend, the insured must obey the policy’s
cooperation clause. An insured will be deemed to have breached a cooperation
clause of a liability insurance policy when he or she appears to be assisting
in the maintenance of the claimant’s action.[70]
On the other hand,
a lack of good faith is not to be inferred merely from the relationship between
the insured and the claimant.[71] However, this nexus should be taken into
account. Similarly, the fact that the
insured has an inherent sympathy with the claimant is not controlling on the
issue of whether the insured failed to cooperate with the insurer.[72]
An insured has
been found to have breached the duty to cooperate under circumstances where:
·
The insured
was unavailable to the insurer and actively assisted the claimants.[73]
·
The
passenger and insured concealed the identity of the driver.[74]
·
The insured
and the minor claimant, who had been a passenger in the vehicle, concealed the
fact that the insured had been playing “chicken” at the time of the accident in
order to obtain recovery for the victim, and a consent judgment had been
entered in favor of the victim.[75]
On the other
hand, it has been held that an insured did not breach a cooperation clause by:
·
Sending a
letter to the insurer suggesting settlement.[76]
·
Giving
testimony that did not support the insurer’s affirmative defense.[77]
·
Giving
testimony similar to that given by the driver and passenger.[78]
·
The insured
signing a non-recourse agreement with the insured’s alleged victims, which was
not hidden from insurer, but was made a matter of public record.[79]
·
The
insured’s successful bargaining with claimant to seek recovery only from
insurer, in circumstances where damages were justified.[80]
Nor has
breach of the duty to cooperate been found when the insurer’s ignorance of relevant
circumstances resulted from its own lack of diligence.[81]
To constitute a breach of the
cooperation provision, there must be a lack of cooperation by the insured in
some material and substantial respect. In Barbian
v. Cooper, [82]
the evidence failed to establish that the insured’s misrepresentation to his
insurance adjuster that he had consumed “only a half quart of beer” prior to
the automobile accident was of such a nature to violate the cooperation clause
of an automobile policy. This was despite the fact that consumption of “five
quarts of beer and a few shots of whiskey” were related in subsequent statement
to counsel for the plaintiff suing the insured in wrongful death action. His statement did not constitute collusion
and noncooperation so as to render the automobile policy void.[83]
The
general rule remains that a failure of the insured to cooperate with the
defense of an action may constitute a breach of contract. That conduct may relieve the insurer of
liability on the policy. But this general
rule is not absolute. Accordingly,
whether an insured by its actions or omissions breached the cooperation clause
is a question that must be determined by examining the totality of the
circumstances surrounding each case.[84] Moreover, in order to prevail on the breach
of the cooperation clause, there must be evidence of collusion.
Several states, including Minnesota,
Arizona and California, permit insureds to settle with claimants when the
insurer refuses to settle the claim itself.
In Hospital Underwriting Group,
Inc. v. Summit Health Ltd., [85]
the Sixth Circuit Court of Appeals, interpreting Arizona law, addressed the issue of bad faith and
settlement agreements in this context. Hospital Underwriting dealt with an
excess insurer seeking to establish that it had no coverage under the excess
policy for payment of an Arizona state court judgment. Alternatively, it sought indemnification from
the primary insurer for the amounts that the excess insurer might be found liable
to pay.[86] The court interpreted the Arizona law in
question as allowing insureds who find themselves facing exposure in excess of
available insurance coverage or denial of coverage by insurer to enter into
settlement agreements with claimants.[87] Thus, the court could not invalidate the Arizona
settlement agreement between an insurer and a claimant merely because the court
found that the jury’s verdict in the state court was excessive and that the
Arizona trial judge would have reduced verdict.
The trial judge did not reduce verdict, the Arizona judgment became
final, and trial court had subject matter jurisdiction over the case.
In summary, the insured has the duty
to cooperate with its defense. And
colluding with the claimant may violate the cooperation clause.
A.
Requirement of Final Judgment
As a general rule, once a final
judgment has been entered on behalf of the party suing the insured, the insurer
may not, absent collusion, reopen the factual or legal basis of the judgment
when the insured makes a coverage or lack of notice claim.[88] In
Howell v. Richardson, [89]
the court recognized that the general rule binding insurers to judgments
against their insureds is inappropriate when the interests of the insurer and
the insured are not identical. This is consistent with the view expressed in
the Restatement,[90]
which holds that an insurer in this situation would be precluded from
relitigating only those issues as to which there was no conflict of interest
between itself and the insured.[91]
A consent judgment requires a final judgment, or
if the judgment is not final, it may be opened.
B.
Interpretation of Collusive Settlements
The various states have different
rules as to the interpretation of collusive settlement agreements. For example, under Missouri law, the Eighth Circuit
Court of Appeals held that while the insurer was liable only for covered
claims, its liability was not limited to the insured’s out-of-pocket payment to
settle the lawsuit in exchange for an assignment of rights against the insurer. Further, the insurer was not liable for
punitive damages or the assignee’s attorney fees.[92]
In Kobbeman v. Oleson,[93] the South Dakota Supreme Court
evaluated the case of an automobile accident victim, as the assignee of the
tortfeasor’s cause of action against insurance agents. He sued the agents for failure to procure
additional insurance. The court held that the settlement between the victim and
the tortfeasor, which included a covenant not to execute in exchange for an
assignment of the cause of action against the agents, was neither intrinsically
collusive nor ineffective for lack of damages.[94] The court explained that with assignments of
causes of action for failure to procure insurance, a judgment establishing a
loss is critical, though its timing is not.
The California
courts have been thorough in their examination of the rights of insurers to
avoid liability for collusive settlements.
In Isaacson v. California
Insurance Guarantee Ass’n.,[95]
the California Supreme Court acknowledged the rule that came to be known as the
“Isaacson presumption”:
[I]f an insurer wrongfully
fails to provide coverage or a defense, and the insured then settles the claim,
the insured is given the benefit of an evidentiary presumption. In a later action against the insurer for reimbursement
based on a breach of its contractual duty to defend the action, a reasonable
settlement made by the insured to terminate the underlying claim against him
may be used as presumptive evidence of the insured’s liability on the
underlying claim, and the amount of such liability. According to the court, the presumption
operates “where the insurer has wrongfully refused to cover or defend a claim,
leaving the insured to mount his own defense or suffer a default. In order to recover reimbursement from the
insurer, the insured must demonstrate that the claim was covered under the
policy in question, or that the insurer breached its duty to defend. Once a breach of contract is proved, the
insured’s act of settling the claim is said to raise the presumption that the third party’s claim against him was
legitimate, and that he was liable in the amount which he agreed to pay in
settlement.[96]
The Isaacson
presumption was further refined in Xebec
Development Partners, Ltd. v. National Union Fire Insurance Co.[97]
and Pruyn v. Agricultural Insurance Co.[98] In Xebec,
the court held that the presumption is one affecting the burden of proof (as
opposed to the burden of producing evidence) and that the insured bears the
burden of proving three foundational facts before the presumption comes into
play:
(1) [that the settlement] was
occasioned by a breach of the insurance contract by [the insurer], (2) [that
the settlement] was valid with respect to [the insurer], and (3) [that it] was
reasonable in the sense that it reflected an informed and good faith effort by
the settling parties to reconcile their presumably differing views as to the
relative strengths of their respective claims and defenses.[99]
The court in Pruyn described the foundational facts
somewhat differently. It stated that to
establish a prima facie case for the
presumption, the insured should be required to prove: “(1) the insurer wrongfully failed or refused
to provide coverage or a defense, (2) the insured thereafter entered into a
settlement of the litigation which was (3) reasonable in the sense that it
reflected an informed and good faith effort by the insured to resolve the
claim.”[100]
In Andrade v. Jennings, the insured’s
collusion in procuring a judgment for the injured person was found to be a
breach of the cooperation clause, absolving insurer of liability to the injured
person.[101] There was a stipulated judgment for $1.5
million following a settlement found to be the product of collusion between
attorneys for the injured and the insured against excess liability insurer
whose policy had a threshold of $1 million. The excess insurer’s knowledge of
and decision not to participate in the damages hearing was simply one factor in
adjudicating the insurer’s defense of collusion between the insured and the
claimant. No bright line rule existed
barring the insurer from asserting the defense of collusion simply because the
insurer, despite notice, failed to attend the prove-up hearing involving some
independent adjudicatory action
In the most recent
case examining this issue in California, the assignee of the insured’s claim
against the liability insurer for bad faith brought suit against the insurer
seeking to recover the amount of the stipulated judgment in the underlying
action.[102] The
insurer admitted that it breached the duty to defend, but claimed that the
underlying settlement was fraudulent, and moved for an in camera review of privileged attorney-client communications under
the crime-fraud exception in order to support its defense. Under California law, the insurer could avoid
paying all or part of a stipulated judgment against the insured if it could
show that the settlement was a product of fraud, collusion, bad faith, or was
unreasonable.[103] The court held that the insurer did not make
the requisite factual showing of fraud in the settlement and the court would
not presume fraud based merely on the settlement’s inclusion of a stipulated
judgment and a covenant not to execute against the insured.[104]
VIII.
Assignment-covenants
not to execute are a powerful means for insureds to prejudice insurers in
instances of coverage disputes. By
allowing the use of this procedure only in those situations in which the
provider has breached its duty to defend, the courts can balance the interests
of insureds and insurers. They can also restrain the risk of fraudulent and
collusive agreements to those situations in which such a risk is tolerable due
to the relative positions of the parties.
[1] See Freeman v. Schmidt Real Estate
& Ins., 755 F.2d 135, 138 (8th Cir.1985); Jones v. Southern Marine &
Aviation Underwriters, 739 F. Supp. 315 (S.D. Miss. 1988) (insurer could rely
on policy language placing such limitations on the duty to indemnify), aff’d, 888 F.2d 358 (5th Cir.1989);
Putman v. Insurance Co. of N. Am., 673 F. Supp. 171 (N.D. Miss. 1987) (ruling
limited to cases involving no failure to defend), aff’d, 845 F.2d 1020 (5th Cir.1988); Bendall v. White, 511 F. Supp. 793, 795 (N.D. Ala. 1981) (not bad
faith action); American Casualty Co. v. Griffith, 129 S.E.2d 549, 552 (Ga. Ct.
App. 1963); Huffman v. Peerless Ins. Co., 193 S.E.2d 773, 774 (N.C. Ct. App.)
(not bad faith action, but involves refusal to defend); Stubblefield v. St.
Paul Fire & Marine Ins. Co., 517 P.2d 262 (Or. 1973).
[2] See Chris Wood, Note, Assignments of Rights and Covenants Not to
Execute in Insurance Litigation, 75 Tex.
L. Rev. 1373 (1997).
[3] The judgment
against the insured may arise via a stipulation of liability, or by entry of a
judgment after an uncontested/default trial.
Although the amount of judicial participation in either case is minimal,
the difference is of considerable importance in California with regard to the
collateral estoppel effect on the insurer in a subsequent action. See
Pruyn v. Agricultural Ins. Co., 42 Cal. Rptr. 2d 295, 308 (Ct. App. 1995) (“[A]
default judgment hearing in which the injured party was required to present
some evidence . . . would bind the insurer . . . . However, we do not believe that the same can
be said where the nature of the judicial participation is limited to the
settlement process and simply consists of a good-faith determination . . . .”).
[4] See, e.g., Stephen L. Paine & Wynn
Heather Sourial, Recent Developments in
California Insurance Law: Enforceability of Stipulated Judgments Against
Insurance Carriers, 22 Pepp. L. Rev.
1017, 1044-45 (1995) (Discussing means by which practitioners can increase the
likelihood of enforcing stipulated judgments, including retaining some measure
of liability for the insured through greatly extended payout terms or qualified
covenants not to execute).
[5] Id.
[6] See, e.g., National
Union Fire Ins. Co. v. Lynette C., 33 Cal. Rptr. 2d 496, 505-06 (Ct. App. 1994)
(uncontested trial could bind the insurer to the liability of the insured and
damages when the judgment has the hallmark of an independent adjudication).
[7] Michael Sean Quinn,
Sweet and Sour Deals, 12 Bad Faith L. Rep. 163, 165 (1996).
[8] Stephen R. Schmidt,
The Bad Faith Setup, 29 Tort & Ins. L.J. 705 (1994).
[9] See Ellen S. Pryor, The Stories We Tell: Intentional Harm and
the Quest for Insurance Funding, 75 Tex.
L. Rev. 1721 (1997). Professor Pryor described the bad faith suit as one
among a number of “underlitigating” strategies that a plaintiff might employ to
access insurance funding in cases in which the plaintiff has a weak case for
recovery under the policy and the defendant-insured likely will be unable to
satisfy any judgment from his own (noninsurance) assets.
[10] The motivation is
typically to preclude removal, which usually favors the insurer.
[11] See Restatement (Second) of Judgments § 58(1)(a) (1982) (Stating
that a judgment has the effect of estopping an indemnitor who has a duty and an
opportunity to defend the indemnitee “from disputing the existence and extent
of the indemnitee’s liability to the injured person”); Gus M. Hodges, Collateral Attacks on Judgments, 41 Tex. L. Rev. 163, 198 (1962) (Observing
that a “judgment is an operative fact which may affect the rights of a stranger
although he is not bound by it in any res
judicata sense”).
[12] The reasonableness
of damages determined by an uncontested judgment can now be attacked in every
jurisdiction. Until recently, Texas had
been the sole exception. See Employers Cas. Co. v. Block, 744
S.W.2d 940, 943 (Tex. 1988) (Commenting in dictum
that the insurer was barred from collaterally attacking the reasonableness of
damages recited in an agreed judgment), overruled
in part by State Farm Fire & Cas. Co. v. Gandy, 925 S.W.2d 696, 714
(Tex. 1996) (Disapproving the dictum
in Block and stating that a judgment on the damage amount, without an adversary
proceeding, would not necessarily bind the insurer). Most jurisdictions allow a challenge to the
reasonableness of the settlement, with the initial burden of proof on the
plaintiff. See, e.g., Glenn v. Fleming, 799 P.2d 79, 92-93 (Kan. 1990); Miller
v. Shugart, 316 N.W.2d 729, 735 (Minn. 1982); Griggs v. Bertram, 443 A.2d 163,
172-74 (N.J. 1982); Chaussee v. Maryland Cas. Co., 803 P.2d 1339, 1342-44
(Wash. Ct. App.), modified on other
grounds, 812 P.2d 487 (Wash. Ct. App. 1991). Jurisdictions may place the ultimate burden
of proof on the insurer to establish the damage award as unreasonable. See
Samson v. Transamerica Ins. Co., 636 P.2d 32, 46 (Cal. 1981); Steil v. Florida
Physicians’ Ins. Reciprocal, 448 So. 2d 589, 592 (Fla. Dist. Ct. App. 1984).
[13] This tactic is
generally unsuccessful. See, e.g., United Servs. Auto. Ass’n v.
Morris, 741 P.2d 246, 253 (Ariz. 1987); Buysse v. Baumann-Furrie & Co., 448
N.W.2d 865, 871-72 (Minn. 1989); Block,
744 S.W.2d at 943 (when a stipulation of facts purporting to establish coverage
is contained in a settlement agreement to which the insurer was not privy, such
stipulated facts are not binding on the insurer).
[14] See 1 Allan D. Windt, Insurance Claims and Disputes § 6.05, at
345-48 (3d ed. 1995).
[15] The most frequently
cited explication of these principles is from a 1964 California case, Critz v.
Farmers Ins. Group, 41 Cal. Rptr. 401, 408 (Ct. App. 1964) (“Public policy
permitting or proscribing tactical weapons developed by claimants and insurers
should be shaped by two influences: (1) the public interest in encouraging
settlements, and (2) fairness, that is, equalization of the contenders’
strategic advantages.”).
[16] See Lawrence D. Rose, Note, Attorney’s Fee Recovery in Bad Faith Cases:
New Directions for Change, 57 S.
Cal. L. Rev. 503, 521 (1984) (arguing that allowing insureds to recover
attorney’s fees will forestall insurers from “snowballing” litigation costs).
[17] See Kenneth S. Abraham, Distributing Risk 11-13
(1986)(Hypothesizing that in the absence of insurance, the unpredictability of
tort damages for small businesses involved in lawsuits would make it impossible
to accurately internalize the costs their activities imposed on consumers).
[18] See Pryor, supra note 9, at 1724.
[19] See, e.g., Wright v.
Fireman’s Fund Ins. Cos., 14 Cal. Rptr. 2d 588, 595-96 (Ct. App. 1992).
[20] See Critz v. Farmers Ins. Group,
41 Cal. Rptr. 401, 408 (Ct. App. 1964); see
also American Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 869 (Tex.
1994) (Hightower, J., dissenting) (“If there were no recovery for the excess
judgment, there would be more of an incentive for breach of the contract than
its performance”).
[21] See Rawlings v. Apodaca, 726 P.2d 565, 575 (Ariz. 1986).
[22] See Lawrence D. Rose, Note, Attorney’s Fee Recovery in Bad Faith Cases:
New Directions for Change, 57 S.
Cal. L. Rev. 503, 521 (1984); 7C Appleman
on Insurance Law and Practice § 4691 (1997).
[23] See Schmidt, supra note
8, at 727.
[24] Courts commenting on
the sweetheart deal have not ignored this point. See,
e.g., Romstadt v. Allstate Ins. Co., 844 F. Supp. 361, 367 (N.D. Ohio 1994)
(Noting that “it did not matter to [the insured] whether the agreed judgment
entry stated that she agreed to judgment in the amount of $125,000 or
$1,125,000”), aff’d, 59 F.3d 608 (6th
Cir. 1995); National Union Fire Ins. Co. v. Continental Ill. Corp., 673 F.
Supp. 267, 274-75 (N.D. Ill. 1987) (Observing there was “no rational limit
imposed on the [amount of the] putative settlement”); Wright, 14 Cal. Rptr. 2d at 603 (“[T]he insured has no incentive to
contest liability or damages.”); Miller v. Shugart, 316 N.W.2d 729, 735 (Minn.
1982) (Asserting that it was “evident that . . . the defendants would have been
quite willing to agree to anything”).
[25] See 1 Windt, supra note
14, § 5.24, at 347 (Noting that the plaintiff has nothing to lose in most cases
by taking an assignment of a bad faith claim against the insurer).
[26] Doser v. Middlesex
Mut. Ins. Co., 162 Cal. Rptr. 115, 120 (Ct. App. 1980).
[27] See Raphael Cotkin, Extracontractual
Liability of Insurers in 1994: A Tale of Four States, in 112th Annual Insurance, Excess and Reinsurance
Coverage Disputes 177, 223-24 (Barry R. Ostrager & Thomas R. Newman
eds., 1995).
[28] Coverage, however,
may be contested later.
[29] See Glenn v. Fleming, 799 P.2d 79, 82 (Kan. 1990) (Describing a
plaintiff’s settlement letter which claimed that the insurance company was
liable for the entire verdict because it had rejected a chance to settle within
the policy limits).
[30] See Schmidt, supra note 8, at 712-13.
[31] See id. at 709-15 (Describing cases in which settlement offers with
unreasonably short deadlines for acceptance were presented to the insurer).
[32] See id. at 709.
[33] See, e.g., Wright v. Fireman’s Fund Ins. Cos., 14 Cal. Rptr. 2d
588, 604 (Ct. App. 1992) (“The potential for fraud and collusion is evident.”);
Span, Inc. v. Associated Int’l Ins. Co., 277 Cal. Rptr. 828, 839-40 (Ct. App.
1991) (Finding that the circumstances surrounding a sweetheart deal raised
issues of fact regarding collusion that precluded summary judgment); Steil v. Florida Physicians’ Ins.
Reciprocal, 448 So. 2d 589, 592 (Fla. Dist. Ct. App. 1984) (Noting that the
real problem with consent judgments is that it is difficult to tell if fraud or
collusion was involved in the agreement); Carlson v. Zellaha, 482 N.W.2d 281,
284 (Neb. 1992) (“the evidence supports the finding that the consent judgment
was obtained by collusion”); Wolff v. Royal Ins. Co. of Am., 472 N.W.2d 233,
235-36 (S.D. 1991) (allowing a collateral attack on a consent judgment arrived
at in collusion and bad faith).
[34] See, e.g., White v. Western Title Ins. Co., 710 P.2d 309, 328 n.2
(Cal. 1985) (Kaub, J., dissenting) (“It seems to me that attorneys who handle
policy claims against insurance companies are no longer interested in
collecting on those claims, but spend their wits and energies trying to
maneuver the insurers into committing acts ... of bad faith.”); Doser v.
Middlesex Mut. Ins. Co., 162 Cal. Rptr. 115, 121 (Ct. App. 1980) (describing
the sweetheart deal as a “worthless paper transaction”).
[35] See e.g., Employers Cas. Co. v. Block, 744 S.W.2d 940, 943 (Tex.
1988) (refusing to allow a insurer to collaterally attack the agreed-upon
judgment between the plaintiff and the insured, but allowing it to litigate the
issue of coverage).
[36] See Zander v. Texaco Inc., 66 Cal. Rptr. 561, 570 (Ct. App. 1968)
(holding that to demonstrate fraud or collusion, the insurer must plead with
specificity that the insured had “no substantial claim or chance of recovery
and that the parties had permitted a judgment in [the victim’s] favor which was
disproportionate to his injuries”).
[37] See id. at 569 (stating fraud must be “pleaded and shown with
specificity”).
[38] See State Farm Fire & Cas. Co.
v. Gandy, 925 S.W.2d 696, 705 (Tex. 1996)
(commenting that the agreement between the plaintiff and the insured
“perpetuates a fraud on the court, because it bases the recovery on an untruth,
i.e., that the judgment debtor may
have to pay the judgment”).
[39] This argument is
most frequently leveled against Mary Carter agreements on similar grounds of
false adversarial posture and the potential to skew the trial process. See,
e.g., Kelly P. Cambre, Casenote, Elbaor
v. Smith--Shattering the “Sham of Adversity” of Mary Carter Agreements, 39 Loy. L. Rev. 359, 376-77 (1993)
(Arguing that Mary Carter agreements are likely to confuse the jury despite any
precautions taken at trial); J. Michael Philips, Note, Looking Out for Mary Carter: Collusive Settlement Agreements in
Washington Tort Litigation, 69 Wash.
L. Rev. 255, 278 (1994) (concluding that “Mary Carter agreements distort
the traditional aspects of litigation to such an extent that they are simply
incompatible with the adversarial process”).
[40] This point was made
in a Texas case allowing parties to a sweetheart deal to recover damages within
policy limits. See Maryland Ins. Co. v. Head Indus. Coatings & Servs., Inc.,
906 S.W.2d 218 (Tex. Ct. App. 1995), rev’d
on other grounds, 938 S.W.2d 27 (Tex. 1996). On the abuse of the judicial process, a dissenting
judge wrote: “If the lawyer representing the party against whom the judgment
was taken-- like Head in these proceedings--held up the judgment before the
jury and said, ‘Look how we have been damaged,’ he would surely look away from
the jury and wink at the other lawyers aligned with him or perhaps whisper,
‘Ha! Ha!’ to them. . . . But the jury is
not given the facts.” Id. at 242 n.22
(Bleil, J., dissenting).
[41] See, e.g., Michael Sean Quinn, Common
Law Insurance Bad Faith in Texas and the Duty to Defend, 11 Bad Faith L. Rep. 105, 112 (1995).
[42] Gandy, 925 S.W.2d 696.
[43] Id. at 702-03.
[44] Id. at 704.
[45] See Michael J. Brady et al., Demise
of the Stipulated Judgment as Basis for Bad Faith Actions, 60 Def. Couns. J. 59, 60-61, 63-64 (1993).
[46] See Egan v. Mutual of Omaha Ins. Co., 620 P.2d 141, 149 (Cal. 1979)
(Clark, J., concurring in part and dissenting in part) (commenting that
“punishing insurance companies for their settlement practices will necessarily
result in the industry passing its punishment costs on to the public in the
form of increased premiums”).
[47] See Pryor, supra note
9.
[48] These settlements
may simply fix the amount of the plaintiff’s damages in a settlement agreement
without entry of any judgment. This practice is uncommon due to the rejection
of such settlements by many courts. See, e.g., Doser v. Middlesex Mut. Ins.
Co., 162 Cal. Rptr. 115 (Ct. App. 1980).
[49] In some states the
tort plaintiff may be relieved of this burden if he or she can establish a
wrongful failure to defend. Illinois, for instance, precludes an insurer that
wrongfully refused to defend from contesting many coverage defenses. See
Maneikis v. St. Paul Ins., 655 F.2d 818, 821 (7th Cir.1981) (Illinois law); see also Rhodes v. Chicago Ins. Co., 719
F.2d 116, 120-21 (5th Cir.1983) (Texas law). But see Cincinnati Ins. Co. v. Vance, 730 S.W.2d 521 (Ky. 1987)
(declining to adopt the Illinois rule estopping the insurer from litigating
coverage after refusing to defend).
[50] The reasonableness
of a settlement or consent judgment may be affected by the particular
jurisdiction’s adoption of comparative fault, jury apportionment of fault, or
the abolition of joint and several liability. The insured’s liability may be
only a small portion of the plaintiff’s potentially large verdict. See Cooper v. Automobile Ins. Club Co.,
638 S.W.2d 280, 282 (Ky. Ct. App. 1981) (In deciding a bad faith claim, the
likely apportionment of only a small percentage of the plaintiff’s potential
recovery on the underlying claim bears on whether a possible judgment was
likely to exceed policy limits.).
[51] See, e.g., United Services Auto Ass’n v. Morris, 741 P.2d 246, 253
(Ariz. 1987); Buysse v. Baumann-Furrie & Co., 448 N.W.2d 864, 873, 874
(Minn. 1989); Employers Casualty Co.
v. Block, 744 S.W.2d 940 (Tex. 1988).
[52] See Freeman v. Schmidt Real Estate
& Ins., 755 F.2d 135, 138 (8th Cir.1985); Jones v. Southern Marine &
Aviation Underwriters, 739 F. Supp. 315 (S.D. Miss.) (no duty to defend, so
insurer could rely on policy language placing such limitations on duty to
indemnify), aff’d, 888 F.2d 358 (5th
Cir.1988); Putman v. Insurance Co. of N. Am., 673 F. Supp. 171 (N.D. Miss.
1987) (ruling limited to cases involving no failure to defend), aff’d, 845 F.2d 1020 (5th Cir.1988);
Bendall v. White, 511 F. Supp. 793, 795 (N.D. Ala. 1981) (not a bad faith
action); American Casualty Co. v. Griffith, 129 S.E.2d 549, 552 (Ga. Ct. App.
1963); Huffman v. Peerless Ins. Co., 193 S.E.2d 773, 774 (N.C. Ct. App. 1973)
(not a bad faith action, but involved a refusal to defend); Stubblefield v. St.
Paul Fire & Marine Ins. Co., 517 P.2d 262 (Or. 1973).
[53] See Shook v. Allstate Ins. Co., 498 So. 2d 498, 500 (Fla. Dist. Ct.
App. 1986); Kagele v. Aetna Life & Casualty Co., 698 P.2d 90, 92 (Wash. Ct.
App. 1985).
[54] See authorities
cited in note 1 supra.
[55] 443 A.2d 163 (N.J.
1982). Griggs was followed in Steil
v. Florida Physicians’ Ins. Reciprocal, 448 So. 2d 589, 591 (Fla. Dist. Ct.
App. 1984), and Glenn v. Fleming, 799 P.2d 79, 92-93 (Kan. 1990).
[56] 316 N.W.2d 729,
734-36 (Minn. 1982); United States Auto. Ass’n v. Morris, 741 P.2d 246, 253-54
(Ariz. 1987); Black v. Goodwin, No. 519101, 1992 WL 353635 (Conn. Super. Ct.,
New London Dist. January. 13, 1992) (burden of proof is on insured); Chaussee
v. Maryland Casualty Co., 803 P.2d 1339 (Wash. Ct. App. 1991) (Burden is on
insured to prove settlement was reasonable when insurer has not denied
coverage).
[57] 803 P.2d 1339 (Wash.
Ct. App. 1991).
[58] 393 So. 2d 552 (Fla.
Dist. Ct. App. 1980).
[59] 951 F.2d 251, 256
(9th Cir. 1992).
[60] 799 P.2d at 91-93.
[61] 316 N.W.2d 729, 734
n.5 (Minn. 1982).
[62] If the settlement is
within the policy limits, there is no excess liability. If the settlement is for an amount in excess
of the policy limits, the insurer is protected by the language in its policy
capping its exposure at its limit.
[63] See California State Auto. Ass’n Inter-Ins. Bureau v. Superior Ct.,
788 P.2d 1156 (Cal. 1990); Smith v. State Farm Mut. Auto. Ins. Co., 7 Cal.
Rptr. 2d 131 (Ct. App. 1992).
[64] 758 P.2d 58 (Cal.
1988).
[65] 162 Cal. Rptr. 115 (Ct.
App. 1980).
[66] 7 Cal. Rptr. 2d 131
(Ct. App. 1992).
[67] Id. at 139 n.5.
[68] Lough v. Insurance
Co. of N. Am., 789 P.2d 576 (Mont. 1990); Klaudt v. Fink, 658 P.2d 1065,
1067-68 (Mont. 1983). However, Montana does require that discovery on the
statutory bad faith claim be suspended until the underlying claim is resolved
by judgment or settlement. Fode v. Farmers Ins. Exch., 719 P.2d 414, 417 (Mont.
1986).
[69] Jenkins v. J.C.
Penney Casualty Ins. Co., 280 S.E.2d 252, 259
(W. Va. 1981).
[70] Elliott v.
Metropolitan Cas. Ins. Co., 250 F.2d 680 (10th Cir. 1957); Span, Inc. v.
Associated Internat. Ins. Co., 277
Cal. Rptr. 828 (Ct. App. 1991) (not only breach of cooperation clause in excess
policy but also breach of covenant of good faith and fair dealing); Quisenberry
v. Kartsonis, 297 S.W.2d 450 (Mo. 1956); Strickland v. Hughes, 160 S.E.2d 313
(N.C. 1968) (insurer’s liability under compulsory automobile liability policy
issued under assigned risk plan cannot be predicated on a judgment obtained
against insured by collusion); Wolff v. Royal Ins. Co. of Am., 472 N.W.2d 233
(S.D. 1991) (evidence supported trial court’s determination that a stipulated
judgment between the insured entertainment agency and injured workers was
unreasonable and arrived at in collusion and bad faith where the agency’s
acceptance of injured the workers’ covenant not to execute on judgment against
it, in exchange for agency’s assignment of any and all rights it might have
under liability policy, breached cooperation clause in that policy); Warren v.
American Nat. Fire Ins. Co., 826
S.W.2d 185 (Tex. Ct. App. 1992) (insured violated the duty to take reasonable
steps to avoid or minimize excess insurer’s liability by his or her lack of
cooperation and improper collusive conduct on part of insured and his or her
counsel). Since the cooperation clause
is violated if the insured, by collusive conduct, appears to be assisting the
claimant in the maintenance of the suit rather than assisting the insurer, the
existence of conspiracy to defraud the insurer, between the insured and a
passenger injured in an accident involving the insured’s automobile, was the
only issue to be decided in declaratory judgment action to determine whether
the insured had breached the contract with the insurer, and it was not necessary
to decide whether the insured had injured the insurer by deposition testimony
revealing a conspiracy. Hurston v. Georgia Farm Bureau Mut. Ins.
Co., 250 S.E.2d 886 (Ga. Ct. App. 1978).
[71] U.S. Fidelity &
Guaranty Co. v. Pierson, 89 F.2d 602 (8th Cir. 1937); Ohio Cas. Co. v. Swan, 89
F.2d 719 (8th Cir. 1937); State Auto. Mut. Ins. Co. v. York, 104 F.2d 730 (4th Cir. 1939); Howe v. Howe, 179
A. 362 (N.H. 1935); Conroy v. Commercial Casualty Ins. Co., 140 A. 905 (Pa. 1928). The fact that plaintiff, the named insured
and the additional insured (who was a driver of the car) were all brothers and
that the named insured was appointed by the court as the curator of injured
party, and therefore owed him not only natural but legal duties arising from
trust relationship, and that both brothers employed an attorney to bring an
action on behalf of the injured party, did not constitute a violation of the
cooperation clause of insurance policy so as to avoid the insurer’s liability
in an action brought against it for injuries sustained. Levy v. Indemnity Ins. Co.,
8 So. 2d 774 (La. Ct. App. 1942).
[72] Employers Ins. Co.
v. Brooks, 33 So. 2d 3 (Ala. 1947);
State Farm Mut. Auto. Ins. Co. v. Sharpton, 66 So. 2d 915 (Ala. 1953).
[73] Insured’s
disappearance and lack of cooperation with aircraft liability insurer and his
active assistance to the injured parties in prosecuting the actions against him
relieved the insurer of any obligation to appear and defend or to indemnify the
insured. Airway Underwriters v. Perry, 284 N.E.2d 604 (Mass. 1972).
[74] Schaefer v. Northern
Assur. Co. of Am., 513 N.W.2d 615 (Wis. Ct. App. 1994).
[75] Travelers Ins. Co.
v. Godsey, 273 A.2d 431 (Md. 1971).
Injured boat captain’s stipulated judgment for $1.5 million in federal
court against insured owner following a collusive settlement could be found to
be the product of collusion between attorneys for the captain and the insured
against the excess liability insurer whose policy had threshold of $1
million. At the prove-up hearing, the
insurer did not contest damages or present liability defenses. The judge was
not informed of captain’s covenant not to execute in return for insured’s
assignment of claims rendering insured and vessel mortgagees immune from
damages, and the insurer’s attorney was entitled to believe that insured’s
attorneys were truthful and were providing complete and accurate information.
Andrade v. Jennings, 62 Cal. Rptr.2d 787 (Ct. App. 1997).
[76] The insured writing
a letter to the insurer suggesting that the pending case be settled within
policy limits did not amount to collusion and did not constitute lack of
cooperation, even though letter had been suggested by the injured third party
or his or her attorney. General Mut. Ins. Co. v. Dennis, 194 So. 2d 838 (Ala.
1967). The fact that copies of a letter
from the insured’s personal attorney to insurer, disclosing policy limits and
conceding liability, were sent to respective counsel for injured parties was
not a violation of cooperation clause when automobile liability insurer
unjustifiably refused to defend action in which claims amounted to more than
$340,000. Milbank Mut. Ins. Co. v. Wentz, 352 F.2d 592 (8th Cir. 1965).
[77] The cooperation
clause of liability policy was not breached merely because testimony by the
insured did not support insurer’s affirmative defense the driver did not have
permission to use the automobile.
Bourgeois v. Great Am. Ins. Co., 222 So. 2d 70 (La. Ct. App. 1969).
[78] In the absence of
more substantial evidence as to collusion between the driver and the passenger,
other than the inference drawn from the similarity in their testimony, the
insurer is not absolved under the cooperation clause from liability on grounds
of conspiracy and collusion. King v. King,
210 So. 2d 917 (La. Ct. App. 1967), aff’d,
217 So. 2d 395 (La. 1968).
[79] National Union Fire
Ins. Co. v. Cagle, 68 F.3d 905 (5th Cir. 1995) (nonrecourse agreement was legal
and was approved by state court in succession proceeding).
[80] Neither the fact that
the psychotherapist bargained for and received a personal benefit, in that
patient agreed to seek collection of a $650,000 settlement from insurer, nor
the therapist’s subjective belief that patient was not actually damaged was
evidence of fraud and collusion.
Uncontradicted evidence showed that patient suffered severe
psychological injuries as result of therapist’s mishandling of his or her case,
and that the amount of settlement was reasonable and prudent. McNicholes v. Subotnik, 12 F.3d 105 (8th Cir.
1993).
[81] Carter v. Aetna Cas.
& Sur. Co., 473 F.2d 1071 (8th Cir. 1973).
[82] Barbian v. Cooper,
285 N.E.2d 96 (Ohio 1972).
[83] Id., see also Moore v.
State Farm Fire & Cas., 1985 WL 62876, 1985 Ohio App. LEXIS 9595 (Ohio Ct.
App. 1985)(Ohio courts follow the weight of authority in requiring that an
insured’s lack of cooperation must result in material and substantial prejudice
to the insurer to constitute a defense to liability.); State Farm Mut. Auto
Ins. Co. v. Holcomb, 458 N.E.2d 441
(Ohio 1983)(failure of cooperation must therefore prejudice the material rights
of the insurer before such conduct can warrant cancellation of the entire
policy).
[84] See Gabor v. State Farm Mut. Auto Ins. Co., 583 N.E.2d 1041, 1043
(Ohio Ct. App. 1990) (Whether the insured by its actions or omissions breached
the cooperation clause of its policy is a question that must be determined by
examining the totality of the circumstances in each case.).
[85] 63 F.3d 486 (6th
Cir. 1995).
[86] Arizona uses the “Morris”
standard to determine whether an insurer could assert the policy’s cooperation
clause to prevent the insured being defended under the reservation of rights
from seeking protection by settling with claimant. However, this cannot be applied to
post-verdict settlement in favor of claimant on a wrongful death claim against
an insured doctor and hospital. See United Services Automobile Ass’n v. Morris,
741 P.2d 246, 254 (Ariz. 1987). Further,
Morris does not apply to cases
wherein merits have been decided by jury after fully-contested trial of all
issues and verdict has been rendered for plaintiff against insured.
[87] A “Damron Agreement”
permits an insured to assign to the injured party, before or after judgment,
the insured’s rights against the insurer for bad faith or breach on the part of
the insurer. Damron v. Sledge, 460 P.2d 997, 999
(Ariz. 1969).
[88] See, also, Alan D. Windt,
Insurance Claims and Disputes 330-34, § 6.20 (2d Ed.1988).
This is true whether or not the insurer defended the insured and,
if it did not defend, whether or not such refusal was justified. . . .
. . . The proper rule, . . .
recognizing well-settled principles of indemnity law, is that the insurer is
collaterally estopped if it was duly notified of the pendency of the suit and
given full opportunity to control the insured’s defense.
. . .
There is, however, a
significant exception to the foregoing rule.
. . . [I]n the event the interests of the company and the insured in
defending the original action conflict, the insurer does not have the right to
control the insured’s defense. Under
those circumstances, therefore, if the insurer does not in fact so assume the
insured’s defense, it should not be bound by any resulting adverse judgment.
The rationale for that
exception to the general rule is obvious.
The underlying purpose of the collateral estoppel doctrine, as applied
in indemnity situations, is to obviate the delay and expense of two trials on
the same issues--one by the injured party against the indemnitee and the other
by either the indemnitee or the injured party against the indemnitor. That result is accomplished by giving the
indemnitor an opportunity to appear in the first suit on behalf of the
indemnitee so that everything that can be offered in exculpation of the
indemnitee by either party to the indemnity contract may be presented. This necessarily assumes, however, that the
interests of the parties to the contract of indemnity are identical with regard
to the injured person’s claim. As a
result, in the absence of such an identity of interest, the collateral estoppel
doctrine should not apply.
[89] 544 N.E.2d 878 (Ohio 1989).
[90] Restatement (Second) of Judgments §58
(1982) provides:
(1) When an indemnitor has an obligation to indemnify an indemnitee
(such as an insured) against liability to third persons and also to provide the
indemnitee with a defense of actions involving claims that might be within the
scope of the indemnity obligation, and an action is brought against the
indemnitee involving such a claim and the indemnitor is given reasonable notice
of the action and an opportunity to assume its defense, a judgment for the
injured person has the following effects on the indemnitor in a subsequent
action by the indemnitee for indemnification:
(a) The indemnitor is estopped
from disputing the existence and extent of the indemnitee’s liability to the
injured person; and
(b) The indemnitor is precluded
from relitigating those issues determined in the action against the indemnitee
as to which there was no conflict of interest between the indemnitor and the
indemnitee.
(2) A “conflict of interest” for purposes of this Section exists
when the injured person’s claim against the indemnitee is such that it could be
sustained on different grounds, one of which is within the indemnitor’s
obligation to indemnify and another of which is not.
[91] State Farm Insurance
Co. v. Metcalfe, 1989 WL 47884, 1989
Ohio App. LEXIS 1620 (Ohio Ct. App.1989) (There is no language in Ohio R.C. §
3901.21(M)) (Unfair and deceptive acts or practices in the business of
insurance) prohibiting insurance companies from seeking to minimize possible
collusive suits by excluding coverage to named insureds. See also State Farm Fire
& Cas. Co. v. Cummings, 535 N.E.2d 318 (Ohio Ct. App. 1987).
[92] Esicorp, Inc. v.
Liberty Mutual Ins. Co., 193 F.3d 966 (8th Cir. 1999).
[93] Kobbeman v. Oleson,
574 N.W.2d 633 (S.D.1998).
[94] Id.
[95] Isaacson v.
California Ins. Guarantee Ass’n., 750 P.2d 297 (Cal. 1988).
[96] Id. at 308. Isaacson was not a failure to defend
case. The court discussed the rule in
the context of an insurer’s alleged breach of duty to accept a reasonable
settlement offer. The issue was whether the insurer should bear the burden of
proving that a settlement offer within policy limits was unreasonable or
whether the burden should be on the insured to prove that it was
reasonable. Despite the fact that the
court’s discussion of the presumption was not essential to its holding and was
a restatement of a long-established rule, we will continue the terminology of
the parties, and refer to it as the “Isaacson
presumption.”
[97] Xebec Development
Partners, Ltd. v. National Union Fire Ins. Co. 15 Cal. Rptr.2d 726 (Ct. App.
1993).
[98] Pruyn v.
Agricultural Ins. Co., 42 Cal. Rptr.2d 295 (Ct. App. 1995).
[99] See Xebec, 15 Cal.
Rptr.2d at 750.
[100] See Pruyn, 42 Cal. Rptr.2d at 312.
[101] Andrade v. Jennings,
62 Cal. Rptr.2d 787 (Ct. App.1997).
[102] Ekeh v. Hartford Fire
Ins. Co., 39 F. Supp.2d 1216 (N.D.
Cal. 1999).
[103] Id.
[104] Id.
(Authors’ Bios)
Robert J. Franco
concentrates his practice in insurance coverage, appeals and commercial
litigation as a partner in the Chicago firm of Bollinger, Ruberry &
Garvey. He is the author of numerous
articles and has been a frequent speaker in the areas of insurance law and
civil litigation. He is a member of the
Defense Research Institute, Appellate Lawyers Association, Chicago, Illinois
State and American Bar Associations. Mr.
Franco received his B.A. from Southern Illinois University, his M.A. from
Rutgers University, and his J.D. from IIT/Chicago-Kent College of Law.
Amy C. Kovarik
concentrates her practice in insurance coverage and commercial litigation as an
associate in the Chicago law firm of Bollinger, Ruberry & Garvey. She is a member of the Chicago, Illinois
State and American Bar Associations. She
received both her B.A. and J.D. from the University of Illinois,
Urbana-Champaign.