This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Bad Faith, Vol. 12, #10, p. 22 (Sept. 15, 1998) (Part I), and Vol. 12, #11, p. 21 (Oct. 20, 1998) (Part II). Copyright Butler 1998.
Liability insurance policies typically provide the insurer with complete control over thedefense and settlement of third-party claims against the insured. This control imposesupon the insurer a duty to exercise good faith in settling claims. When the claimant makesa reasonably prudent offer to settle within the policy limits, courts generally agree the good-faith duty owed an insurer will require the insurer to settle the case. However, when theclaimant does not make an offer to settle within the policy limits, courts are split as towhether the insurer’s good-faith duty requires it to initiate settlement negotiations.(1)
Part I of this article reviews the numerous rationales and policy concerns offered by thecourts with regard to a liability insurer’s duty to initiate settlement negotiations. Part II ofthis article then presents general views regarding a liability insurer’s duty to initiatesettlement negotiations. It also focuses on a handful of decisions which epitomize theviews espoused by a majority of the jurisdictions.
No Duty to Initiate Settlement Negotiations
Courts have offered a number of rationales and policy concerns for not imposing the dutyto initiate settlement negotiations. First, courts have found placing the burden on theinsurer to initiate settlement within the policy limits creates an incentive to delay settlementnegotiations until the eve of trial. In American Physicians Insurance Exchange v. Garcia,the Supreme Court of Texas expounded on this public policy concern:
Requiring the claimant to make settlement demands tends toencourage earlier settlements. Unlike the insurer, the claimant owes theinsured no Stowers duty(2) and cannot face any additional risk or become adefendant in a second lawsuit for refusal to settle, no matter howunreasonable. However, the claimant stands to benefit substantially andincrease the assets available to satisfy any judgment by committing to settlefor a reasonable amount within policy limits if the insurer rejects the demand.If the claimant makes such a settlement demand early in the negotiations,the insurer must either accept the demand or assume the risk that it will notbe able to do so later. In cases presenting a real potential for an excessjudgment, insurers have a strong incentive to accept. Early acceptance notonly settles the liability case but obviates the possibility of subsequentStowers litigation altogether.
Conversely, if the burden of proposing settlement within policy limitsis on the insurer, then the incentives shift in favor of delayed settlement.First, if the insurer offers less than the policy limits, the claimant canreasonably anticipate that the offer will increase as trial approaches, so longas the case presents a genuine risk of an excess judgment. For the insurerto stand on a below-limits offer under such circumstances is to risk excessliability for its recalcitrance. Therefore, a claimant will have an incentive to”play chicken” with the insurer in anticipation that the final offer on the eveof trial will equal either the policy limits or the insurer’s reservation price — themost the insurer thinks the case could reasonably be worth for settlementpurposes.
Second, if the insurer tenders the policy limits earlier than the trialdate, the claimant will not necessarily accept the offer. One reason isbecause the insurer has now established a “floor” for negotiations and muststand by its offer or later risk excess liability for unreasonably withdrawing itsoffer. Because the claimant bears little risk of losing the opportunity to settlefor the policy limits, the claimant has no incentive to settle until he or shedetermines whether the defendant’s assets other than liability insurancewould make an excess judgment worth collecting. This is further complicatedby the fact that evidence of the assets available to satisfy the judgment is notrelevant before liability is established, and except for liability insurance,remains undiscoverable until after the liability case is finally resolved.(3)
Second, absent some indication from the claimant that the claim can be settled within thepolicy limits, requiring insurers to initiate settlement negotiations is tantamount to requiringthem to bid against themselves. In Garcia, the court briefly touched upon this policyconcern: “From the standpoint of judicial economy, we question the wisdom of a rule thatwould require the insurer to bid against itself in the absence of a commitment by theclaimant that the case can be settled within the policy limits.”(4)
Third, requiring insurers to initiate settlement negotiations imposes a burden on insurersthat is not imposed on any other litigant.(5)
Lastly, some critics contend that requiring insurers in all cases to bear the financial consequences of its failure to offer its policy limits in settlement will make it easier for plaintiffs’ counsel to extract money from insurers by means of nuisance suits, will increase claims costs, and will thereby raise premium rates substantially.(6)
Duty to Initiate Settlement Negotiations
Courts have strenuously argued that insurers should have an affirmative duty to initiate settlement negotiations on a number of grounds. In Rova Farms Resort, the court announced several policy reasons to support its holding. Among them, the court emphasized that such a duty should be imposed because of the insured’s relatively powerless position to guide the litigation:
The assured is not in a position to exercise effective control over thelawsuit or further his own interests by independent action, even when thoseinterests appear in serious jeopardy. The assured may face the possibilityof substantial loss which can be forestalled only by action of the carrier. Thus the assured may find himself and his goods in the position of apassenger on a voyage to an unknown destination on a vessel under theexclusive management of the crew.(7)
Second, courts have imposed the duty to initiate settlement negotiations because separate representation for the insured does not adequately insulate the insured from the inherent conflict of interest created by the risk of an excess verdict. One court has stated:
The normal legal remedy for conflicts of interest is separaterepresentation for the conflicting interests. This remedy, however,possesses only a limited usefulness in the present situation, for while theassured can be advised, as he usually is, that he may employ separatecounsel to look after his interests, separate representation usually amountsto nothing more than independent legal advice to the assured, since controlof the litigation remains in the hands of the carrier. Control of the defenseof the lawsuit cannot be split, and independent legal advice to the assuredcannot force the carrier to accept a settlement offer it does not wish toaccept. In this instance the normal legal remedy of separate representationis an inadequate solution to the conflict in interest.(8)
Third, courts believe that when a duty to initiate settlement negotiations does not exist,insureds are faced with an anomalous situation:
Where a settlement opportunity exists, the more faultless the client seemsto have been the more feasibly he may be subjected by the company to atrial of the case and all the dangers it entails. In the case of an obviouslyblameworthy client, the carrier would normally take advantage of asettlement opportunity within policy limits since any other disposition wouldbe unduly optimistic. The least blameworthy insured, however, may morereadily be delivered to face the risk of excess judgment, since a refusal tocompromise a case thought to be a “no liability” case would not be regardedas unreasonable. Thus, in those cases where a compromise may beeffected within policy limits the more innocent an insured appears to be, theworse position he is in and the more he is exposed to loss.(9)
Fourth, courts have attempted to undercut the argument that cost to insurers and insuredsshould militate against imposing a duty to negotiate by contending that costs will be offset by other factors and should not alone defeat the rule’s adoption. With regard to this issue, the Rova Farms Resort court stated:
[A]ny conceivable effect on costs such a rule [insurer’s duty to initiatesettlement negotiations] could exert might be more than offset by otherfactors. For example, savings might be realized from the company’s nothaving to maneuver for position on the issue of bad faith during the originaltrial, or from not having to litigate excess liability suits brought by its clients.. . .
[T]he possibility that a broadened standard may increase insurancerates should not alone defeat its adoption. An insurer’s decision not to settleis justified on the basis of that decision’s contribution, in keeping costs down,to the benefit of all insureds. Since policyholders as a class, rather than theparticular individual involved in a case, thus profit from the company’s refusalto settle within the coverage afforded, then surely insureds as a whole shouldshare the expense when the refusal results in an excess judgment.(10)
Lastly, courts have pointed to the “elementary justice” in the duty to initiate settlementnegotiations. That is, where the insurer’s and insured’s interests conflict, the insurer, which may reap the benefits of its determination not to settle, should also suffer the detriments of its decision.(11)
Courts across the county have not adopted consistent positions regarding an insurer’s duty to initiate settlement negotiations.(12) In fact courts within the same jurisdiction sometimes adopt conflicting positions. Accordingly, it is very difficult to solidify the morass of decisions on this issue into a simple discussion. The discussion that follows classifies the cases on this issue based on common threads running throughout them.
Conflict of Interest
Some jurisdictions couch the issue of whether the insurer had a duty to initiate settlement negotiations in terms of whether a conflict of interest developed between the insured andthe insurer.(13) If no conflict of interest ever arose then the insurer could not be liable for bad faith in not initiating settlement negotiations. For example, in Merritt v. Reserve Insurance Company, Plaintiff Dewey Merritt sued J.A. Stafford Company (Stafford) after his truck collided with a Stafford truck. Defendant Reserve Insurance Company had issued aliability insurance policy to Stafford that provided limits of $100,000 for each person and$300,000 for each accident. Merritt sought $400,000 in damages and raised his prayer forrelief to $650,000. Reserve accepted the tender of Stafford’s defense, and the counsel hired to defend Stafford consistently maintained the defendant would prevail. The jury, however, returned a verdict in favor of the plaintiff for $434,000. Reserve paid Merritt its policy limits of $100,000, and Stafford paid an additional $20,000 and assigned to the plaintiff its cause of action against Reserve. Merritt sued Reserve as Stafford’s assignee,claiming in part that Reserve had acted in bad faith towards Stafford by failing to initiate settlement discussions with Merritt during the underlying litigation.
The Merritt court concluded Merritt owed Stafford no duty to initiate settlement discussionswith Merritt. After surveying prior decisions, the court noted:
While much remains obscure in this field of the law it is apparent . .. that (1) the legal rules relating to bad faith come into effect only when aconflict of interest develops between the carrier and its insured; (2) a conflictof interest only develops when an offer to settle an excess claim is madewithin policy limits or when a settlement offer is made in excess of the policylimits and the assured is willing and able to pay the excess.(14)
After restating the essential facts, the court concluded:
[T]he interests of carrier and assured at all times were parallel and notdivergent [and] nothing occurred to create any conflict of interest betweenthem or to suggest the existence of any factors, which, if acted upon, mighthave created some conflict of interest. Since no offer to settle was evermade, either within policy limits (the normal prerequisite for conflict ofinterest) or above policy limits but within feasibility limits of the assured’sresources, we conclude that no conflict of interest ever developed betweenassured and carrier, and therefore the issue of the carrier’s bad faith inrelation to its assured never arose.(15)
On the other hand some courts believe a conflict of interest develops between an insurer and insured as soon as “an excess verdict far beyond the policy limit” becomes possible regardless of whether there has been an offer within the policy limits.(16) In Rova Farms Resort, the court asserted:
There was always, in fact and in law, a conflict of interest between[the insurer] and its insured from the time it realized the gravity of [theplaintiff’s] awful injury and recognized that its insured must one day confronta jury, unspared from such ordeal by legal control by the trial court andvulnerable, under the most simplistic view of the probabilities, to an excessverdict far beyond the policy limit. These factors projected immediately themost urgent duty to act in good faith and with diligence in attempting toarrange a possible settlement, including the policy limit, even if somethinghad to be added by [the insured]. Only thus could the larger interest of [theinsured] be protected.(17)
Some courts have looked to the presence or absence of certain policy provisions todetermine whether a duty to initiate settlement negotiations existed.(18) In some cases thisis a somewhat inconsistent approach because the duty to deal in good faith with the insured “is a duty imposed by law, not one arising by the terms of the contract itself.”(19)
In Morrell Construction the insured brought an action against its liability insurer claiming it exercised bad faith in refusing to investigate and pursue settlement negotiations before suit was filed against the insured. The trial court granted summary judgment in favor of the insurer, and the insured appealed to the Ninth Circuit Court of Appeals. After the SupremeCourt of Idaho declined to address questions certified by the Ninth Circuit, the Ninth Circuit addressed whether Idaho’s bad faith tort imposes a noncontractual duty on insurers to initiate settlement negotiations before a third party files a suit.(20)
In answering this question in the negative, the court looked to whether there was any evidence in the policy which required the imposition of such a duty:
[I]f Morrell wanted its insurer to investigate third party claims beforea complaint was filed, it could have bargained for a different insurance policy,most likely with a higher premium. Instead, it purchased a policy whichexplicitly left investigations to the discretion of its insurer. We decline torewrite the parties’ insurance policy via tort law to impose an obligation on aninsurer to investigate a claim before a third party files suit.
. . . .
[W]e see little reason to impose a judicially-created contract term herewhich would require insurers to investigate third party claims before suit isfiled. We are in no position to guess what terms the parties would haveagreed to if they had equal bargaining power. Nor do we think insurersshould have to waste their time investigating third party losses which maynever give rise to legal action. A contrary holding would increase the cost ofinsurance premiums and would force all Idaho insurance purchasers to payfor coverage which they may not need or want. We choose not to extendIdaho’s bad faith cause of action.(21)
On the other hand many courts find that a duty to initiate settlement negotiations exists based, in part, on policy language vesting the insurer with total control over the litigationof any action or claim brought against the insured.(22)
Some courts have imposed the duty to initiate settlement negotiations when liability is clear, certain, or probable and when the damages will likely exceed the policy limits, whenthe probability of an excess judgment is high, or when the injuries are severe or serious.(23) In one case the court admitted that the application of such a rule could be problematic:
Application of this relatively simple principle to a case in which the plaintiffhas made no demand for settlement and has eschewed the process ofnegotiation by refusing to submit counter-offers is, however, fraught withgreat difficulty. Unfortunately too, any settlement offer, viewed from thehindsight perspective of a high verdict, inevitably tends to be colored therebyand look disproportionately low.(24)
In Florida the opinion in Powell v. Prudential Property & Casualty Ins. Co.(25) is frequently cited for the proposition that if an insured’s liability is clear and the injuries are so seriousa judgment in excess of the policy limits is likely, an insurer has an affirmative duty toinitiate settlement negotiations. In Powell the insured’s daughter struck two pedestrianswalking along side the road. The insurer evaluated liability as 80-100% “within days”following the accident and placed the entire policy limits of $10,000.00 in reserve acknowledging the severity of the injuries. Within nine days of the accident, an attorney representing one of the injured pedestrians wrote the insured and related the seriousness of the injuries, the need for immediate funds to satisfy medical bills which alreadyexceeded $20,000.00, and asked that Prudential disclose its policy limits. A second letter to the same effect was sent approximately two weeks later. Prudential failed to respond to either of these letters and the attorney sent a third letter describing his client’s direfinancial situation and demanded Prudential to disclose its policy limits within three days. This letter went on to indicate the attorney was interested in promptly settling the casewithin policy limits. Once again Prudential did not respond, nor did they inform the insuredof his potential liability.
Sixty-two days after the accident a Prudential claims adjuster informed the claimant’s attorney’s secretary Prudential was tendering its policy limits. The attorney responded indicating a lawsuit had already been filed and rejected the tender of policy limits. At trialthe injured pedestrian presented expert testimony that in cases where liability is clear,injuries are severe, and policy limits are minimal, settlements are standard practice withinthe insurance industry. The trial court directed a verdict in favor of the insurer holding thatin the absence of a time demand, an insurer is entitled to a judgment as a matter of lawon the issue of bad faith.
The appellate court reversed the trial court’s decision. In determining that sufficient evidence existed to send this case to a jury, the appellate court found that the lack of a formal offer did not preclude a finding of bad faith, but was only one factor to be considered along with a failure to disclose policy limits, a failure to affirmatively initiate settlement negotiations in view of the severity of the claim, and the failure to properly advise the insured as to his potential exposure.(26)
The Powell court held that because there was sufficient evidence of bad faith to take the case to the jury, it should not have been decided as a matter of law. In short Powell standsfor the following when assessing whether an insurer acted in bad faith: the court mayconsider whether liability is “clear,” and whether the injuries are so serious that a judgmentin excess of the policy limits is “likely.”
Similarly, some states have imposed a duty to initiate settlement negotiations throughstatute when liability is “reasonably clear.”(27)
Some courts hold that if there is no demand or offer to settle within the policy limits the insurer cannot be liable for bad faith for failing to initiate settlement negotiations.(28) Other courts hold that an offer from the claimant is not a prerequisite to instituting a bad faithaction against an insurer.(29)
In American Physicians Insurance Exchange v. Garcia,(30) the Texas Supreme Courtconcluded an insurer did not breach its Stowers duty(31) to settle because it never received a settlement demand within its policy limits. From 1980 until the beginning of 1983, Dr.Ramon Garcia treated Gustavo Cardenas. He prescribed two drugs which allegedly caused Cardenas to develop a debilitating brain disease. In 1980 Garcia was covered bya $100,000 claims-made malpractice insurance policy issued by Insurance Corporation ofAmerica (ICA). In 1981 and 1982 Garcia was covered under two consecutive one-year ICA “occurrence” policies, each providing him with $500,000 in coverage. In 1983 Garciapurchased a $500,000 occurrence-based policy from American Physicians InsuranceExchange (APIE).
On March 23, 1984, APIE received the Cardenases’ original petition which alleged Garciahad treated Cardenas from October 3, 1980 until April 12, 1982. On the day of the trial,the Cardenases filed a sixth amended petition alleging for the first time that Garcia’s malpractice had continued into 1983, and thus into APIE’s coverage period. After a trialthe court found Garcia’s treatment of Cardenas constituted continuing negligence fromSeptember 1980 until February 1983. The court rendered judgment for $2,235,483.30.
The Cardenases, as Garcia’s assignees, sued ICA and APIE for breach of their duty to accept a reasonable settlement demand within policy limits. The claimants settled with ICAfor $2,000,000 and entered into a partial settlement with APIE for $500,000. After a trialon the bad faith claims, the jury found that APIE had failed to settle the malpractice caseand had failed to defend Garcia. The court rendered judgment against APIE in the amount of $1,331,574.
On appeal, the Supreme Court of Texas addressed whether APIE had breached any duty to settle the malpractice case. The court reasoned an insurer has no duty to settle a claim that is not covered under its policy and APIE, therefore, had no duty to settle before the Cardenases filed their sixth amended petition on the morning of trial. The court then setout the circumstances in which a settlement offer may trigger a duty to settle.(32) The court acknowledged that in Ranger County Mutual Insurance Co. v. Guin(33) it had extended the Stowers’ doctrine to include a duty not only to accept reasonable settlement offers or demands, but to explore settlement possibilities and to enter into reasonable settlement negotiations.(34) The court, however, rejected the contention that Ranger requires an insurer to initiate settlement negotiations.(35) The court then distinguished out-of-state cases which impose such a duty because those cases involve “affirmative misconduct by the insurer to subvert or terminate settlement negotiations.”(36) The court reasoned that to require the insurer to initiate settlement negotiations would undermine the public policy to encourage settlement of claims.(37)
On the heels of this reasoning, the court addressed whether APIE had ever received apolicy limits settlement offer. Because APIE was never faced with the opportunity to settlethe Cardenases’ claim within the policy limits, the court held that APIE was not subject to liability for not settling.
Taking the opposite approach to Garcia is Rova Farms Resort, Inc. v. Investors Insurance Co.,(38) which imposes an affirmative duty upon insurers to initiate settlement negotiations even when the claimant does not make an offer to settle within the policy limits. In Rova,an accident entailing severe personal injuries occurred on Rova’s premises(39) where it operated a recreational resort. Rova’s insurer, Investors Insurance Company of America(Investors), issued to Rova a comprehensive general liability policy with a limit of $50,000. The policy entitled Investors to make such investigations, negotiations, and settlement of any claim or suit as it might deem expedient.
The injured party, Lawrence McLaughlin, sued Rova and its general manager. Investors assumed the defense and once plaintiff added an allegation of willful and want negligence, Rova retained independent counsel because of Investor’s admonition thatsuch wrongful conduct may not be covered. On the first day of trial, Investors offered $12,500 in settlement of the case, which approximated the plaintiff’s “special” damages. The jury returned a verdict of $225,000 and the magnitude of the verdict did not causeInvestors to increase its offer nor cause it to explore the possibility of settlement. After an appeal, a reversal, and a reinstatement of the verdict, Investors paid its $50,000 and Rova paid the excess judgment of $175,000.
Rova then sued Investors for bad faith in not settling or attempting to settle in good faith. After a full hearing on the merits, the trial judge entered judgment for Rova for the amountof the excess judgment plus interest. The intermediary appellate court in Texas affirmed. The Texas Supreme Court granted certification.
The supreme court first noted that “substantial evidence before the court revealed amultitude of circumstances which should have impelled Investors to energize a clearly attainable settlement of the McLaughlin claim.”(40) The court then rejected Investors’argument that it had no obligation, as a matter of law, to offer its policy limit in settlement without a firm demand from the plaintiff’s attorney:
This seems to us an unduly restricted view of the law. Although thecases cited involved claimant offers either during trial or pending appeal,their delineation of the carrier’s obligation of good faith would clearlyembrace the situation vis-a-vis settlement disclosed in the instant case. When Investors suggests that no conflict of interest can exist, in law, underany circumstances until there has been a formalized offer within policy limitsby plaintiffs, it may be thinking of older concepts, before the emergence anddevelopment of those principles of equity, fair dealing and good faith (suchas in the very cases Investors cites) which breathed new lifegiving honestyinto the bare contractual relationship sometimes mentioned as existingbetween insured and insurer.
. . . .
[I]t would be unrealistic to believe that such an offer is a prerequisitefor finding the insurer to have acted other than in good faith. The better viewis that the insurer has an affirmative duty to explore settlement opportunities. At most, the absence of a formal request to settle within the policy is merelyone factor to be considered in light of the surrounding circumstances, on theissue of good faith.(41)
In conclusion, the court found that insurers have an affirmative duty to initiate settlementnegotiations:
We, too, hold that an insurer, having contractually restricted theindependent negotiating power of its insured, has a positive fiduciary duty totake the initiative and attempt to negotiate a settlement within the policycoverage. Any doubt as to the existence of an opportunity to settle within theface amount of the coverage or as to the ability and willingness of theinsured to pay any excess required for settlement must be resolved in favorof the insured unless the insurer, by some affirmative evidence,demonstrates there was not only no realistic possibility of settlement withinpolicy limits, but also that the insured would not have contributed to whateversettlement figure above that sum might have been available.(42)
Accordingly, the court affirmed the verdict against Investors finding them liable for the excess verdict.
The extreme views espoused by the courts on this issue-an absolute and affirmative duty to initiate settlement negotiations versus no duty at all-do not appear toprovide insurers, insureds or courts with a reasonable approach to this issue. On the one hand, courts have remarked that an absolute duty to initiate settlement negotiations imposes a more onerous obligation upon the insurer to seek settlement than is imposed where an actual offer of settlement within the policy limits is made.(43) On the other hand, courts have objected to an insurer being totally insulated from bad faith simply because the claimant has not offered to settle within the policy limits. In sum courts should develop astandard that reasonably balances the conflicting interests of the insurer and insured.