Insurance Law

LexisNexis Author William T. Barker To Speak at 1st Annual Bad Faith Litigation Strategies ExecuSummit on "Recent Developments in Third-Party Bad Faith: The American Law Institute Principles of the Law of Liability Insurance."

On November 4, 2014, LexisNexis author William T. Barker will speak at the 1st Annual Bad Faith Litigation Strategies ExecuSummit on "Recent Developments in Third-Party Bad Faith: The American Law Institute Principles of the Law of Liability Insurance."  Mr. Barker is the co-author, (with Ronald D. Kent) of New Appleman Insurance Bad Faith Litigation, Second Edition and (with Prof. Charles Silver) of Professional Responsibilities of Insurance Defense Counsel. 

The American Law Institute ("ALI"), best known for its production of highly influential "Restatements" of various bodies of law, is now engaged in a project to produce a set of "Principles of the Law of Liability Insurance."  (Mr. Barker is a member of the ALI and an Adviser to that project.)  While the project is still ongoing, the ALI has recently endorsed rules that, if adopted by courts, will significantly expand insurer liability for third-party bad faith and, in most jurisdictions, significantly expand the ability of insureds to settle without insurer consent.  Insurers need to be prepared to argue against adoption of those rules.  Mr. Barker's presentation describes what the ALI has endorsed and offers counterarguments.

Two of the rules endorsed by the ALI are versions of rules now followed in a minority of jurisdictions.  One states that, in litigation over responsibility for an excess judgment, an insurer may be held liable for failure to make an offer (or a large enough offer), rather than merely for rejecting a reasonable demand by the claimant.  The other states that, subject to some conditions, an insurer's reservation of rights to deny indemnification for some or all of the liabilities asserted frees the insured to settle without the insurer's consent so long as the settlement is reasonable in the amount allocated to covered claims.  (The insurer, of course, retains its coverage defenses.)

On its face, the rule stated by the Principles is the widely accepted one that "[a] reasonable settlement decision is one that would be made by a reasonable person that bears sole responsibility for the full amount of the potential judgment."  But the more detailed methodology described in the comments that accompany the Principles significantly modifies that rule as it has hitherto been explained and applied.

The methodology endorsed by the Principles is explained in a comment:

The reasonableness standard set forth in this Section is a flexible one that permits the factfinder to take into account the whole range of reasonable settlement values.  In the real world of civil litigation too many contingencies can affect trial outcomes for there to be only one reasonable settlement value.  To the contrary, there generally is a range of reasonable settlement values.  Because of the many contingencies that can affect trial outcomes and the corresponding difficulty of arriving at objective valuations there is no formula that can provide a definitive guide to what constitutes a reasonable settlement value, or even a reasonable settlement range, in many cases.  The illustrations are provided here to suggest how a court might use the computation of expected values as a factor in evaluating the reasonableness of a settlement offer or demand, recognizing that any such computation will be imperfect.  The liability insurer will be liable for any excess judgment against the insured in the underlying litigation if the trier of fact finds that the insurer rejected a settlement demand, or failed to consent to a settlement, that was within the range of reasonableness.  The effect of this rule is that, once a claimant has made a settlement demand in the underlying litigation that is within the range of reasonableness, a liability insurer that rejects that demand thereafter bears the risk of any excess judgment against the claimant at trial.  In the majority of jurisdictions, a liability insurer’s decision to reject a settlement demand that is within the range of reasonableness makes the insurer liable for any excess judgment in the underlying litigation.  This is true even if the rejected settlement demand was at the high end of the reasonableness range.

As Mr. Barker's paper, much of which is adapted from New Appleman Insurance Bad Faith Litigation, Second Edition, explains,

By subjecting the insurer to liability for failure to accept a demand at the high end of the range of reasonableness, this [rule] requires the insurer to behave in a risk averse fashion.  A risk neutral insurer, with a diversified portfolio of risks, would recognize that, while there is a range of reasonableness for any claim, their average settlement value will be near the middle of that range, with low verdicts balancing out high ones.  To always settle at the high end of the range of reasonableness would inflate insurance costs and, therefore, premiums.  Thus, a risk neutral insurer would treat reasonableness as a point, in the middle of the reasonable range and would decline settlement demands in excess of that value.

The paper argues that the disregard-the-limits rule was intended and has been interpreted to permit the insurer to behave in a risk-neutral fashion, so long as its settlement decisionmaking treats the entire amount of any judgment as if it alone would be liable.  It also argues that:

As the comments note, the rule stated by the Principles has the practical effect of giving "claimants an incentive during the pretrial phase of the case to make settlement demands at the high end of the reasonableness range, since the insurer's rejection of such a demand creates the conditions for a subsequent settlement-duty lawsuit in the event of a … verdict that produces an excess judgment."   The incentive which the law ought to be providing is to make an offer at the projected verdict value, which would be in the center of the range of reasonableness, not at the high end.

The rule stated by the Principles also allows a jury to consider other, procedural factors:

The reasonableness standard … requires the trier of fact in the breach-of-settlement-duty suit to evaluate the expected value of underlying litigation at the time of the failed settlement negotiations.  That inquiry may be complex and difficult in some cases.  Because of the difficulty of determining, in hindsight, whether a settlement demand or offer was reasonable, it is appropriate for the trier of fact to consider procedural factors that affected the quality of the insurer’s decisionmaking or that deprived the insured of evidence that would have been available if the insurer had behaved reasonably.  Factors that may affect the quality of the insurer’s decisionmaking include a failure to conduct a reasonable investigation or to follow the recommendation of its chosen defense lawyer (including not seeking the defense lawyer’s recommendation).  Factors that may deprive the insured of evidence include a failure to conduct a reasonable investigation, a failure to keep the insured informed of within-limits offers or the risk of excess judgment, and the provision of misleading information to the insured.

Such factors are not enough to transform a plainly unreasonable settlement demand into a reasonable demand, but they can make the difference in a close case by allowing the jury to draw a negative inference from the lack of information that reasonably should have been available or from the low quality of the insurer’s decisionmaking and fact-gathering processes.  Just as reasonable investigation and settlement procedures cannot guarantee that an insurer will make a decision that is substantively reasonable, however, the failure to employ reasonable procedures does not necessarily mean that the insurer’s decision was substantively unreasonable.  In breach-of-settlement-duty cases in which the facts do not make clear that the insurer’s settlement decision was substantively reasonable, the factfinder may decide on the basis of these procedural factors that the settlement decision was unreasonable.  In an extreme case, the insurer may be subject to liability for bad-faith breach.  The reasonableness of settlement demands and offers may also take into account other facts, such as the amount of time that is given to evaluate an offer and the jurisdiction in which the case would be tried.

Mr. Barker's paper argues that the focus ought not to be on whether there were imperfections in the insurer's claim handling, but rather on whether any imperfections led to an improper claim decision:

Hindsight evaluations by juries of insurer settlement decisions that led to excess judgments are already likely to lean heavily in favor of insureds who have suffered such judgments.  Juries ought not to be distracted from the correct inquiry by being invited to focus on procedural deficiencies, in the absence of evidence that those deficiencies contributed to an unreasonable settlement decision. 

The paper also argues that holding insurers liable for failure to make offers creates improper incentives for claimants to jockey to attempt to induce an arguable breach of the duty to make settlement decisions.  Such attempts create a risk that insureds will be subjected to excess judgments that would never have occurred had the insured simply demanded the policy limit.  Accordingly, it argues, insurers ought not to be liable except for refusing reasonable, within-limits demands.

The paper argues that standard policy language restricting the insured's ability to settle (except at its own expense) is proper and, absent a breach by the insurer, ought to be enforced.  Mere existence of a coverage question ought not to permit the insured to avoid the settlement restrictions.  Freeing the insured in such cases is supposedly intended to allow the insured to manage potentially noncovered liability.  But, despite the settlement restrictions, the insured can manage such liability by negotiating a covenant not to execute on noninsurance assets in retrun for a payment by the insured:

The only benefit from th[e] increase [in costs resulting from allowing insureds to settle] would be to (at least partially) protect the policyholders who are permitted to settle against liability for the uninsured portions of the claims against them. Because a contrary rule would still permit policyholders to settle uninsured exposures at their own expense, the result is simply to transfer some or all of the cost of settling noncovered claims from the policyholders who incur such exposures to their insurers and, thereby, to the risk pool.

Once again, the rule stated by the Principles on this issue should be rejected.

Mr. Barker is a member of the Insurance Litigation & Coverage Practice Group of Dentons US LLP, practicing in its Chicago office, with a nationwide practice, primarily representing insurers, in the area of complex commercial insurance litigation, including coverage, claim practices, sales practices, risk classification and selection, agent relationships, and regulatory matters.  He  is a Vice Chair of the American Bar Association ("ABA") Tort Trial & Insurance Practice Section ("TIPS") Insurance Coverage Litigation Committee and a co-chair of the Subcommittee on Bad Faith Litigation of the ABA Litigation Section Insurance Coverage Litigation Committee.

Mr. Barker is a regular speaker on bad faith issues.  In 2014, he spoke at the Midwinter CLE Meeting of the TIPS Committee on "The Jury's Out: When Is First-Party Bad Faith a Jury Question and When Can It Be Resolved as a Matter of Law" and at the similar meeting of the Litigation Section Committee on "Insurer Consent To Settle: When Does the Insured Need It and When Can It Do Without?"  He is scheduled to speak at the similar 2015 meeting of the TIPS Committee on the ALI Principles and at the 2015 Litigation Section meeting on "Post-Claim Underwriting."

Click here to download a complimentary copy or read Mr. Barker’s paper, “Recent Developments in Third-Party Bad Faith: The American Law Institute Principles of the Law of Liability Insurance” (43 pages).

Learn more about New Appleman Insurance Bad Faith Litigation, Second Edition.

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