Reprinted with permission from the September 1, 2016 edition of the The Legal Intelligencer.
A client was angry because his company’s insurer would not agree to pay the plaintiff’s settlement demand in an ongoing trial against his company, even though the demand fell within policy limits.
“It’s like they’re playing Russian roulette, but with the gun pointed at my head,” he grumbled. “They get all the benefit, while I bear all the risk.”
As a result, my client was at risk of an excess verdict that could have included punitive damages. Under the law at the time, we couldn’t settle the case on our own, but we could (and did) exhort the insurer to settle using the threat of a bad-faith lawsuit in the event of an excess verdict.
Since then, however, two more recent decisions under Pennsylvania law may have fundamentally changed the nature of such refusal-to-settle negotiations during underlying lawsuits.
In the first case, Wolfe v. Allstate, 790 F.3d 487 (3d Cir. 2015), the U.S. Court of Appeals for the Third Circuit (applying Pennsylvania law) ruled that a jury considering a bad-faith failure-to-settle claim against an insurer could not consider punitive damages awarded against the insured in the underlying suit. The Third Circuit found this result to be consistent with Pennsylvania law prohibiting the insurability of punitive damages. But the court went a step further still, finding that “[i]t follows from our reasoning that an insurer has no duty to consider the potential for the jury to return a verdict for punitive damages when it is negotiating a settlement of the case. To impose that duty would be tantamount to making the insurer responsible for those damages, which, as we have discussed, is against public policy.”
If the threatened excess verdict consists solely of punitive damages, in other words, then the insurer is now free to ignore that punitive-damage risk entirely — and without fear of any downstream bad-faith repercussions. The insurer can try the case to verdict and still avoid liability for an excess verdict that is attributable to punitive damages. Obviously, that ruling takes away a lever that insureds could use, previously, in pushing their insurers to settle before verdict.
But another recent case has given insureds a different lever that may prove even more powerful. In Babcock & Wilcox v. American Nuclear, 131 A.3d 445 (Pa. 2015), the insureds paid $80 million in settlement to a class of plaintiffs alleging damages arising from living near a nuclear facility.
The insureds then brought suit against their insurer, which had defended the underlying action under a reservation of rights, to recover their settlement payment. In opposition, the insurer pointed to standard contractual language that gave the insurer control over settlement by providing that the insureds “shall not, except at [their] own cost, make any payment”; that any settlement must be “by written agreement of the insurer” as a prerequisite for bringing a coverage action; and that “liability assumed by the insured under contract” was expressly excluded from coverage.
The Pennsylvania Supreme Court, however, upheld the trial court’s judgment in favor of the insureds, finding that “if an insurer breaches its duty to settle while defending subject to a reservation of rights and the insured accepts a reasonable settlement offer, the insured need only demonstrate that the insurer breached its duty by failing to consent to a settlement that is fair, reasonable, and non-collusive.” The Court ruled that this determination does not require any finding of insurer bad faith – only that the claim was covered, and the settlement reasonable. As the Court explained, “[an] insurer who ‘reserves the right to deny the duty to pay should not be allowed to control the conditions of payment.’”
As a result of the Babcock holding, an insured can now feel much more confident seizing the reins and settling an underlying lawsuit directly on terms it believes to be fair and reasonable. To be sure, the insured will still have to establish coverage, and the reasonableness of the settlement payment, but these are elements that have always had to be shown. They do not present insureds with nearly the obstacle that the insurer-consent clauses did previously.
The combined effect of these two cases can make for very different coverage negotiations between insurers and insureds during the trial of underlying lawsuits. The insured will no longer be able to invoke the specter of an excess verdict encompassing punitive damages in seeking to persuade its insurer to settle by threatening a bad-faith lawsuit. On the other hand, the insured can now simply ignore its contract’s standard insurer-consent clauses and strike a settlement by itself.
If the insured decides to strike a settlement on its own, however, then in the downstream coverage litigation it had better be prepared to establish the reasonableness of the payment relative to the compensatory damages risk alone, and without reference to the risk of punitive damages. If a coverage jury instead finds that fear of punitive damages is what really drove the insured to settle – and perhaps even to overpay – then the jury may require the insured itself to pay for some, or even all, of the underlying settlement.
As a result, of course, the insurer in such a downstream coverage action may well argue that its insured’s unilateral settlement of the underlying lawsuit was motivated largely by the threat of uninsurable punitive damages. What may make this dynamic particularly interesting is that insurer-appointed counsel will likely have strenuously argued, in the underlying litigation, that punitive damages were not even warranted against the insured.
The good news for insureds is that they no longer need to stand by feeling helpless as their insurers appear to gamble with their fates (and for reasons that may seem tight-fisted). And insurers, at least, will surely sleep better having received judicial confirmation of what they have long maintained – that they are not responsible for their insured’s punitive damages, and may safely ignore them for settlement purposes.
Reprinted with permission from the September 1, 2016 edition of the The Legal Intelligencer. Copyright 2016 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For further information, contact 877-257-3382 – [email protected] or visit www.almreprints.com.