This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 14, #8, p. 23 (August 22, 2000). © Copyright Butler 2000.
It is beyond dispute that the duty to defend, under liability insurance, is contractual, and is broader than the duty to indemnify. National Grange Mut. Ins. Co. v. Continental Cas. Ins. Co., 650 F. Supp. 1404 (S.D.N.Y. 1986). Even if some allegations of the complaint clearly are outside the scope of coverage, the insurance company is obligated to defend the entire suit. Id. See also, Aerojet-General Corp. v. Transport Indemnity Co., 948 P.2d 909 (Cal. 1997).
Consider this: A suit against an insured contains counts which may be covered, and others which are not. The liability insurance company instructs the defense attorney to settle the former, thereby leaving the latter open. The defense attorney does as he or she is told, obtains a release of all counts which may be covered, and the insurance company stops defending.
Can the insurance company do that? At first blush it looks “unfair” and like “bad faith.” However, a closer examination leads to the conclusion that such action by the insurance company is consonant with all rights and obligations under the policy and the law.
One case that gives a good overview of this issue is Meadowbrook, Inc. v. Tower Insurance Co., Inc., 559 N.W.2d 411 (Minn. 1997). In that case, the insured contended that “[t]he insurer . . . operated against the insured’s best interests by negotiating a settlement of the arguably covered claims ‘behind the back’ of the insured.” Id. at 417 (emphasis added). The Supreme Court of Minnesota held: “Even though the insurer agreed to defend the entire claim against the insured, its duty extended only to those claims arguably covered by the policy. . . . Once the insurer settled and paid those claims, it had completely performed its contractual duty.”
The Meadowbrook case involved a suit by employees against their employer, the insured. There were numerous uncovered counts such as sex discrimination, sexual harassment, battery, etc. There also were covered counts for defamation. The trial court dismissed the defamation counts and the insurance company withdrew its defense of the entire action.
The insured filed a declaratory action to determine coverage as well as the insurance company’s duty to continue a defense. The insurance company moved for summary judgment, claiming no duty to defend, on the grounds that all covered counts had been dismissed. The trial court denied the motion however because, among other things, the dismissal was not a final adjudication. The trial court awarded the insured its fees incurred during the time the defense had been withdrawn.
The insurance company then settled the defamation counts with the employees and moved for summary judgment again. The trial court again denied the motion because there was yet no adjudication that the other counts were not covered. Again the trial court awarded fees to the employer to pay for the ongoing defense.
Finally, after some of the plaintiffs had gotten judgments on some of the counts, the trial court entered a partial summary judgment for the insurance company that there was no duty to indemnify the employer for those judgments and no coverage for the remaining counts. The trial court, however, held to its view that the duty to defend was ongoing. It awarded more fees to the insured/employer. The state appellate court affirmed essentially this ruling.
In the Supreme Court of Minnesota, the insurance company argued that its duty to defend ended with the dismissal of the defamation counts and the partial summary judgment. The insured/employer argued that “the duty to defend continued because the insurer assumed the defense of the entire claim and could not, as a matter of law, abandon the defense without court approval.” 559 N.W.2d at 415.
The Supreme Court held the duty to defend continued because the summary judgment was not final until all appeals had been exhausted. However, the Court delineated the circumstances in which the insurance company unilaterally may withdraw the defense.
Although the insured argues that public policy requires courts to block insurers from ‘casting adrift’ an insured in the midst of litigation, we conclude that public policy requires the opposite rule. To require an insurer who undertakes a defense on the basis of arguably covered claims to remain in the litigation even after those claims have been resolved, is to force the insurer to defend claims not arguably covered by the policy. [note omitted]. Such a rule would encourage insurers to avoid defending lawsuits that actually include arguably covered claims. The result would be an increase in declaratory judgment actions brought by insureds to force insurers to perform their contractually mandated duties. Consequently, we hold that an insurer who undertakes an insured’s defense under a reservation of rights can withdraw its defense once all arguably covered claims have been dismissed with finality.
559 N.W.2d at 416.
Fine, said the plaintiffs. But what about when the covered claims are extinguished by settlement rather than final adjudication? A “court should not allow insurers to shirk their duties of defense by unilaterally settling only the arguably covered claims.” Id. at 417. The Supreme Court of Minnesota did not agree.
The insured assumes he had a right to force the insurer to defend claims not arguably covered by the policy, but he did not. Regardless of the insurer’s motivation in settling the defamation claims, the fact remains that the insurer’s actions relieved the insured of any liability resulting from those arguably covered claims.
Id. Indeed, that is what the insurance company contracted to do.
Most policies have pertinent language as well. The ISO Commercial General Liability Coverage Form provides, as a part of the “Insuring Agreement,” “We may at our discretion investigate any ‘occurrence’ and settle any claim or ‘suit’ that may result . . .” The ISO Homeowners 3 Special Form provides under “Liability Coverages,” “We may investigate and settle any claim or suit that we decide is appropriate.” The ISO Personal Auto Policy provides under “Liability Coverage,” “We will settle or defend, as we consider appropriate, any claim or suit asking for [covered damages].” The ISO Personal Umbrella Policy provides, in the “Insuring Agreements,” “We may investigate and settle the claim or suit as we see fit.” And so on.
Although the few pertinent cases have not focused on it, such language too supports the conclusion in Meadowbrook. By analogy, one might look at settlement over the insured’s objection. In Shuster v. South Broward Hosp. District Physicians’ Prof’l Liability Ins. Trust, 591 So. 2d 174 (Fla. 1992), the insured medical doctor objected to settlement of a malpractice suit against him. The Florida Supreme Court, in upholding the settlement, focused on policy language giving the insurance company the right to settle any claim “as it deems expedient.” The Court noted that the policy provision placed the insured on notice that the insurer retained exclusive authority to control settlement and be guided by its own self interest. Id. at 176—77.
In North American Van Lines, Inc. v. Lexington Ins. Co., 678 So. 2d 1325 (Fla. 4th DCA 1996), the Florida Fourth District Court of Appeals recently explained Shuster.
[T]he insurer [in Shuster] had broad discretion as to when and how to settle a case. . . . Furthermore, in Shuster, the company actually paid under the policy, thus preventing its insured from being exposed to a judgment, the very risk for which insurance is obtained. Thus, there was no breach of contract.
Id. at 1333 (emphasis added).
As with most legal principles, there is a point beyond which this one will not extend. In Matison v. Transamerica Title Ins. Co., 845 F.2d 867 (9th Cir. 1988), a title insurance company had issued title binders on three transfers of the same property. The initial transferors, the insureds, were the Matisons. Down the line, Schwarz brought an action to quiet title against Transamerica and also sued the Matisons for, among other things, fraud. Transamerica settled with Schwarz “without participation by the Matisons.” 845 F.2d 867.
The settlement between Transamerica and Schwarz did not resolve all claims against the Matisons. Indeed, the settlement provided specifically that Schwarz would continue to prosecute the fraud and other remaining claims against the Matisons “vigorously, in good faith and with due diligence.” Id. Schwarz further agreed not to settle those claims for less than the full amount paid in settlement by Transamerica and, essentially, to reimburse Transamerica up to the settlement amount from monies collected on any judgment against the Matisons.
The Matisons sued Transamerica for breach of contract and “tortious breach of good faith.” The United States District Court for the District of Arizona decided the case on stipulated facts and documents. The District Court ruled in favor of Transamerica on the grounds that its settlement actions “did not impair any duty under its contract with the insured.” Id.
The Ninth Circuit Court of Appeals reversed. Although Transamerica did not have a duty to prevent all harm against the Matisons, it did “have a duty of ‘a fiduciary nature’ not to benefit at the expense of its insured.” Id. [citation omitted]. That duty, said the Circuit Court, “may be breached even though Transamerica performed its express contractual undertakings.” Id. Moreover, the fact that the attorney for the Matisons had been excluded from the settlement negotiations emphasized “the unfaithful character of Transamerica’s effort to gain at it’s insured’s expense. Infidelity of this kind made Transamerica ‘a second source of injury to the insured.'” Id. (Although not stated in the Matison opinion, this result may be justified on the grounds that it violates the settled principle that a liability carrier may not subrogate against its own insured. See, e.g., Dix Mutual Ins. Co. v. LaFramboise, 597 N.E.2d 622 (Ill. 1992)).
It seems, then, that a liability insurance company may withdraw its defense of uncovered claims after all covered ones have been finally resolved, including appeal where applicable. It should not matter whether those covered claims are adjudicated or settled. Nor should the “motivation” of the company matter. The insurance company has discretion to settle as it sees fit. However, that discretion ends where the company begins to benefit unfairly, and directly, to the detriment of its insured.