By Joseph G. Finnerty III and Aidan M. McCormack, Partners, DLA Piper
Confounding most observers, the United States Court of Appeals for the Ninth Circuit has issued a decision contradicting established insurance law jurisprudence in nearly every state. In Du v. Allstate Insurance Company, the court held that liability insurers have an affirmative obligation to attempt to effectuate the settlement of a liability claim when an insured's liability is "reasonably clear" - even before the underlying plaintiff has made any settlement demand upon the insured. Du v. Allstate Insurance Company, et al., No 10-56422 (9th Cir. June 11, 2012).
The Ninth Circuit's holding in Du, handed down on June 11, adopts a minority view of a liability insurer's settlement obligations. Under the established view, an insurer's obligations are triggered upon receipt of a demand for a reasonable settlement of a covered claim within the limits of liability of its insurance policy. The Ninth Circuit's decision in Du, however, seeks to impose an obligation upon insurers to consider potential settlement before the underlying plaintiff (or claimant) has even made any settlement proposal to its insured. Under this case, an insurer's failure to engage in settlement efforts when its insured's liability has become "reasonably clear" could expose insurers to bad faith liability under California law.
The case involved a car accident that resulted in personal injuries. Despite the fact that the insured, Joon Hak Kim, and the injured passengers did not cooperate with the insurer's requests for information, the insurer accepted coverage for the claims and acknowledged that serious injuries had been incurred by the underlying plaintiffs. Several months later, the underlying plaintiffs' attorney made a global demand on behalf of all four plaintiffs, seeking the policy's US$300,000 limit of liability. When the insurer responded that it lacked sufficient information to settle three of the injured plaintiffs' claims, but offered US$100,000 to settle Du's claims, plaintiffs' counsel rejected the offer and proceeded to trial. Du received a US$4.1 million jury verdict on her personal injury claims, and Kim assigned his bad faith claim to Du in exchange for a covenant not to execute.
The US District Court rejected a jury instruction proposed by Du that would have instructed the jury in the bad faith case that the insurer's duty of good faith imposed a duty to initiate settlement discussions. The District Court rejected the instruction for two reasons. First, the district court held that the duty of good faith did not impose a positive settlement obligation on insurers, and, second, the district court held that Du had not established a factual foundation for the instruction because the issue of settlement arose at a sufficiently early time in the underlying litigation.
On appeal, the Ninth Circuit focused on the legal question "[d]oes an insurer have a duty, after liability of the insured has become reasonably clear, to attempt to effectuate a settlement in the absence of a demand from the claimant?" The court answered that question in the affirmative, holding that the implied covenant of good faith and fair dealing creates a "duty to effectuate a settlement where liability is reasonably clear - even in the absence of any settlement demand." In support of its decision, the court first noted that the duty of good faith serves to protect insureds from the conflict of interest that arises when the insured faces liability in excess of policy limits. In those cases, an insurer confronted with the decision between a settlement for its policy limits or a defense of the action may be more inclined to defend the action than settle, believing that the possibility of securing a less costly defense victory justifies the risk of a judgment that will exceed its policy limits. An insured, on the other hand, likely will prefer to settle for policy limits. In the Ninth Circuit's analysis, this conflict arises regardless of whether the insured makes a settlement demand, thus the insurer's attendant duty of good faith applies even in the absence of such a demand. The court next noted that, while the California state courts have not held that insurers have a positive duty to effectuate settlement in the absence of a demand, the state courts also have not issued decisions denying the existence of such a duty, and, further, prior Ninth Circuit precedent supports the existence of such a duty. Finally, the Ninth Circuit believed that provisions of the California Insurance Code governing the duties of insurers support its holding here.
The Ninth Circuit's reasoning has several significant implications for insurers. Most notably, the Ninth Circuit did not explain whether its reasoning applied outside the personal injury context. Thus, insureds are very likely to seek to raise Du in connection with other types of insurance claims, including D&O and professional liability claims.
How the expanded settlement obligation imposed by Du might apply in other contexts remains an open question. For example, the decision provides no guidance on whether and to what extent an insurer may have a positive obligation to affirmatively pursue settlement in cases in which the insurer is not obligated to defend its insured and does not control the defense of the underlying claim - or, for example, where there are several insurers on the risk.
The decision also introduces considerable uncertainty into an insurer's settlement obligations in California. Du rejects the bright line rule that an insurer's settlement obligations are triggered by a settlement demand and instead suggests that an insurer must at all times exercise vigilance in evaluating the potential for settlement at all stages of a claim once liability has become "reasonably clear." Accordingly, policyholders will argue that the absence of a settlement demand from the plaintiffs does not provide a dispositive defense to bad faith under Du, and that Du expands the possible factual scenarios that insureds and claimants may present to assert a claim for bad faith. In this regard, insurers in California are advised to exercise greater vigilance and care - including consultation with appropriate experts and counsel where necessary - in order to evaluate and document the response to claims and the ongoing analysis of the insured's exposure and potential settlement opportunities.
For more information about the effect of this decision on your business, please contact Joseph G. Finnerty III and Aidan M. McCormack.
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This decision shouldn't be surprising. It is simply good claims handling to try to settle a case as soon as liability becomes clear and the damages are known enough to negotiate. When an offer is made before a demand the chances of a favorable settlement is increased.
On rehearing, the Ninth Circuit has retracted the conclusion that an insurer is obliged to make offers in the absence of a demand. Of course, those comments were always dicta, unnecessary to the actual disposition of the case.