When May An Excess Liability Insurer Sue A Primary Insurer For Failing To Settle A Claim?

When May An Excess Liability Insurer Sue A Primary Insurer For Failing To Settle A Claim?

11.18.2015

Excess liability insurers commonly have a right to pursue recovery from primary insurers in the situation in which the primary insurer should have settled the claim, but instead allowed it to go to trial and a verdict for an amount within the excess layer of coverage results.  Equitable subrogation is the typical theory of recovery in that scenario; i.e., the excess insurer “stands in the shoes” of the insured and is allowed to pursue the claim that the insured would have against the primary insurer if there were no excess coverage.  In that case, the excess insurer bears the burden of proving that the primary insurer had an opportunity to settle the claim within the primary policy limit, when there was a substantial probability or likelihood that the claim would result in a judgment in excess of the primary limit, but failed to do so.  The existence of the excess judgment demonstrates there was actual harm to the excess insurer. 

Courts across the country continue to wrestle with the question of whether an excess insurer may settle a claim before trial and then sue the primary insurer for failing to settle earlier or whether the excess insurer must wait until after a judgment is entered against the insured in order to pursue the primary insurer for failing to settle.  Courts in a majority of jurisdictions have held that the excess insurer may state a “failure to settle” claim against a primary insurer even if a judgment in excess of the primary limit has not been entered.  A minority of courts have held that the excess insurer’s rights against the primary insurer do not accrue unless and until the insured is saddled with an excess judgment.

Excess insurers argue that they should not be compelled to wait for a trial and judgment in a case in which the insured faces a substantial likelihood of an excess judgment.  Such a rule is contrary to the public policy that favors the settlement of claims.  It promotes litigation and may force trials for cases that otherwise could and should be settled.  Why be forced to wait for the train wreck to happen when you can see it shaping up?

Yet, the situation is more complicated when the excess insurer settles a claim before trial.  In that situation, there is some chance that the case would not have actually resulted in an “excess” judgment.  Without the clarity of a judgment, there is a risk the excess insurer overpaid the claim.  Perhaps, primary insurers argue, an actual trial would have resulted in a judgment within the primary limit.  Why should the excess insurer be allowed to pursue a subrogation action against the primary insurer without definitive proof that the primary insurer’s conduct actually caused any harm to the excess insurer?

A settlement by the excess insurer also arguably deprives the primary insurer of the right to control the defense and settlement of claims.  The core issue here is over which insurer has the right to control settlement negotiations.  Should the primary insurer have the right to “gamble” with the excess insurer’s limits by allowing the case to go to trial and judgment?  The primary insurer’s argument is that the excess insurer should not be allowed to jump the gun and usurp the primary insurer’s right to control settlement negotiations.  The excess insurer’s response is that it should not be compelled to stand by idly and wait for a judgment even after the primary insurer has breached its duty to settle.

The California Court of Appeal has a split of authority on this issue.  In Fortman v. Safeco, 221 Cal.App.3d 1394 (1990), the excess insurer contributed $1.25 million to settle and was deemed to have a right to pursue equitable subrogation against the primary insurer even in the absence of a judgment against the insured.  By contrast, in RLI Ins. Co. v. CNA Cas. of California, 141 Cal.App.4th 75 (2006), the court ruled that an excess insurer can recover under equitable subrogation principles from a primary insurer in breach of the duty to settle only if an excess judgment has been rendered against the insured.

The California Supreme Court eventually may decide this issue.  In so doing, it will face the consideration of whether a primary insurer should have an absolute right to insist on an actual trial and judgment.  A competing consideration will be to determine if the excess insurer should ever have the right to control settlement negotiations and still have a remedy against the primary insurer.  This is a variation of the difficulty plaintiffs have in bringing “settle and sue” legal malpractice actions.  Who can say what would have happened if there had been no settlement?  Who has the burden of responsibility for that uncertainty?

One approach might be to distinguish the situation in which the excess insurer negotiates a settlement with an assignment of the excess insurer’s rights against the primary insurer to the claimant, as compared to the situation in which the excess insurer actually pays a significant settlement and then seeks to recover some or all of the payment from the primary insurer.  The latter situation would appear to present less opportunity for collusion to set up a claim against the primary insurer; that concern has motivated many courts to impose the requirement of an excess judgment before an insured may sue a primary insurer for bad faith failure to settle.  Where the excess insurer has paid a significant amount to settle above primary limits, the Supreme Court might be more willing to conclude that a primary insurer should face extra-contractual exposure if it truly did breach its duty to settle.  If the excess insurer actually does make a settlement payment, the Court may deem it equitable to give the excess insurer an opportunity to prove the primary insurer breached its duty to settle and thereby harmed the excess insurer.  The contrary rule forces cases to trial or creates immunity for primary insurers who breach the duty to settle and could be deemed contrary to public policy.

David A. Tartaglio is a partner at Musick, Peeler & Garrett at its Los Angeles office.  His full bio and contact information can be found at: http://musickpeeler.com/professionals/bio.cfm?id=84

On December 3, 2015, Mr. Tartaglio will be a panelist on the topic “Don’t Do Me Like That:  Bad Faith Against An Excess Carrier”  at the 2015 New York Conference of the Claims and Management Litigation Alliance.

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