Court's holding imposes duty on insurers to pursue settlements within policy limits once liability has become reasonably clear.
The U.S. Court of Appeals for the Ninth Circuit, applying California law, has clarified a liability insurer's affirmative duty to initiate and pursue settlements on behalf of policyholders, even in the absence of a settlement demand. The decision in Yan Fang Du v. Allstate Insurance Co., No. 10-56422 (9th Cir. June 11, 2012), affirms that liability insurance companies have an affirmative duty to effectuate a settlement where a policyholder's liability is "reasonably clear." The Ninth Circuit held that, instead of an insurer waiting for a claimant to come forward with a settlement offer, the duty of good faith and fair dealing implied in all insurance contracts requires an insurer to effectuate a settlement within policy limits, regardless of whether a settlement demand has been made. This decision continues a trend under California law that expansively construes a liability insurer's duties.
Background
The Du decision arises from an automobile accident in June 2005 in which Yan Fang Du and three others were injured. The responsible party, Joon Hak Kim, was insured by Deerbrook Insurance, a subsidiary of Allstate, with a per-person limit of $100,000 and an aggregate limit of $300,000 per incident. Upon investigation of the accident, Deerbrook learned that Du's claim involved serious injury. In June, Du's counsel made a settlement offer equal to the liability limit of $300,000. Deerbrook's adjuster countered with an offer of $100,000, contending that there was insufficient evidence of the other three passengers' injuries, and offering to settle with only Du. Du's counsel rejected the settlement, filed a personal injury lawsuit against Kim, and received a judgment in favor of Du for approximately $4,100,000.
In exchange for a covenant not to execute, Kim assigned his insurance claim against Deerbrook, including a bad-faith claim for extracontractual damages, to Du. Du filed suit against Allstate and Deerbrook, alleging that Deerbrook breached the covenant of good faith and fair dealing owed to its policyholder by not settling the claim within the $300,000 aggregate limit.
At trial, Du proposed a jury instruction to the effect that an insurer breaches its duties when it fails to make a good-faith attempt to reach a settlement after liability has become reasonably clear. The district court rejected the instruction, holding that there was no affirmative duty for a liability carrier to initiate settlement discussions. Further, the district court produced a modified version of the jury instruction that told jurors that Deerbrook would only be liable if it failed to accept, not effectuate, a reasonable settlement demand. Accordingly, the district court entered judgment for Deerbrook.
The Ninth Circuit Decision
Although the Ninth Circuit ultimately affirmed the district court's decision on evidentiary grounds, in addressing the issue, the court held that under California law an insurer has an affirmative duty to effectuate a settlement where liability is reasonably clear, even in the absence of a settlement demand. Recognizing that this issue had not been directly addressed in California, the court proffered three fundamental principles in support of its first-impression holding.
First, the court discussed the conflict of interest that exists between the insurer and the insured when an opportunity to settle within policy limits arises. From the insurer's perspective, if the injured party makes a settlement offer that approaches or is equal to the policy limit, the insurer has no incentive to settle. If the insurer is successful at trial, it pays less than the amount of the policy. However, even if it is unsuccessful, it still only pays a maximum amount equal to the policy limit or the settlement offer. This places the policyholder at risk for any excess judgment. Because the implied covenant of good faith and fair dealing requires the insurer to treat its insured's interests as equal to its own, the duty to effectuate a settlement arises regardless of whether a settlement demand has been proffered. According to the court, if there is a substantial chance of a judgment in excess of policy limits, a rational party would attempt to settle, regardless of which party makes the settlement demand. There is no difference whether the insurer or the injured party makes the settlement demand.
Second, the court recognized that California case law has traditionally imposed duties on liability insurers in connection with settlement obligations. See, e.g., Gibbs v. State Farm Mut. Ins. Co., 544 F.2d 423, 426–27 (9th Cir. 1976) (oral settlement offers sufficient to trigger insurer settlement obligation). Further, the court determined that no California appellate courts had specifically addressed the issue of an affirmative duty to settle in the absence of a settlement demand.
Third, the court found that California Insurance Code section 790.03(h)(5) specifically supports the existence of the duty to settle. The Ninth Circuit interpreted the statute as imposing a duty to actively "investigate and attempt to settle a claim by making, and by accepting, reasonable settlement offers once liability has become reasonably clear." Violations of this section can support the finding that the insurer breached the implied covenant of good faith and fair dealing.
Accordingly, the Ninth Circuit determined that an insurer's settlement obligations are triggered when the policyholder's liability has become reasonably clear, regardless of whether a policy limit demand has been made. However, after establishing this standard, the Ninth Circuit found that because Deerbrook had been denied access to medical records early in its investigation, its duty to settle never arose. Thus, the district court's decision in favor of Deerbrook was affirmed.
Implications
This holding provides a powerful tool for policyholders with liability claims to require insurers to not only provide a vigorous defense but also to pursue policy limit settlements once liability has become reasonably clear. The failure of an insurer to meet this standard may give rise to recoveries in excess of policy limits.
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