Excess insurers can sue if primary insurer fails to settle within limits

ZALMA ON INSURANCE LAW

A primary insurer owes the same good faith and fair dealing to an excess insurer to settle within policy limits that it owes to the insured. The California Court of Appeal was recently asked to apply the covenant of good faith and fair dealing to a primary insurer who failed to accept a settlement within its policy limit, without a judgment, and reimburse the excess insurer who contributed to a settlement it claimed would have not been necessary but for the failure of the primary insurer to settle.

In ACE American Insurance Company v. Fireman's Fund Insurance Company, 2 Cal. App. 5th (2016), the excess insurer sought damages for amounts it was require to spend because of the failure of the primary insurer to settle for less than its limits when it had the opportunity.

Ace American then sued Fireman's Fund for equitable subrogation, alleging that the injured worker initially offered to settle his case within the limits of the Fireman's Fund policies, and that Fireman's Fund unreasonably rejected those settlement offers. Ace American alleged that as a result, it was required to contribute to the eventual settlement, which exceeded the limits of the Fireman's Fund policies.

The facts of Ace American are simple. John Franco was working on a film set when a special effects accident caused him to suffer serious injuries. Franco's injuries included pelvic crush injuries, a broken hip, fractures to both femurs, crush injuries to both knees, broken tibias and fibulas, broken ribs, a punctured lung, and soft tissue injuries to his face. Franco alleged that the incident left him with permanent nerve pain, an eye injury, urinary and sexual dysfunction, and fear and depression.

Fireman's Fund provided a defense to Warner Brothers pursuant to a primary insurance policy with a $2 million limit, and an umbrella insurance policy with a $3 million limit. Ace American provided the Warner Brothers entities an excess insurance policy with a $50 million limit. The Francos made settlement demands within the limits of the Fireman's Fund policies. According to Ace American's complaints, the demands were reasonable and supported by substantial evidence, but Fireman's Fund "failed and/or refused to pay those demands within [the insurance policies'] limits." The Francos settled their lawsuit "for an amount substantially in excess" of the limits of the Fireman's Fund policies. According to Ace American, Fireman's Fund "consented to the settlement and contributed to it", and Ace American contributed the amounts in excess of the Fireman's Fund policies' limits.

Ace lost its equitable subrogation claim when the trial court sustained Fireman Fund's demurrer without leave to amend. The court held that until the judgment is actually entered, the mere possibility or probability of an excess judgment does not render the refusal to settle actionable.

California recognizes an implied duty on the part of the insurer to accept reasonable settlement demands on covered claims within the policy limits. An insurer's liability for failing to accept a reasonable settlement offer is imposed not for a bad faith breach of the contract but for failure to meet the duty to accept reasonable settlements, a duty included within the implied covenant of good faith and fair dealing. An insurer that breaches its duty of reasonable settlement is liable for all the insured's damages proximately caused by the breach, regardless of policy limits.

Equitable subrogation allows an insurer that paid coverage or defense costs to be placed in the insured's position to pursue a full recovery from another insurer who was primarily responsible for the loss. Since the insured would have been able to recover from the primary carrier for a judgment in excess of policy limits caused by the carrier's wrongful refusal to settle, the excess carrier, who discharged the insured's liability as a result of this tort, stands in the shoes of the insured and should be permitted to assert all claims against the primary carrier which the insured himself could have asserted.

Ace American alleged that Fireman's Fund unreasonably refused to settle within policy limits, and as a result, Ace American (as Warner Brothers' subrogee) actually contributed to the eventual settlement, in which Fireman's Fund, as the primary insurer, also participated. There is no explicit requirement for bad faith liability that an excess judgment is actually suffered by the insured, since the reasonableness analysis of settlement decisions is performed in terms of the probability or risk that such a judgment may be forthcoming in the future.

Ace American alleged that it was damaged in an ascertainable amount as a direct result of Fireman's Fund's failure to accept the Francos' reasonable, within-limits settlement offers. The was no persuasive reason for a court to hold that either Warner Brothers or its assignee, Ace American, must suffer that loss with no remedy simply because the case reached an eventual settlement instead of being litigated through trial. Ace American's alleged damages are clear, liquidated, and certain, and Fireman's Fund participated in reaching the settlement.

California's public policy is to encourage settlement. An excess judgment is not a required element of a cause of action for equitable subrogation or breach of the duty of good faith and fair dealing. Where the insured or excess insurer has actually contributed to an excess settlement, the plaintiff may allege that the primary insurer's breach of the duty to accept reasonable settlement offers resulted in damages in the form of the excess settlement.

The existence of excess insurance that prevents the insured from being personally damaged, does not protect the primary insurer from a bad faith suit when an eventual settlement exceeds the primary limit. Ace was allowed to prove Fireman's Fund caused it damage by not paying a reasonable settlement offer within its policy limits.