United States: Excess Insurer Has Duty To Consent To A Reasonable Settlement Or Assume Policyholders Defense

Ninth Circuit Court of Appeals Finds Excess Insurer Had Duty to Consent to a Reasonable Settlement or Assume Policyholder's Defense

In a diversity action, the Ninth Circuit Court of Appeals held that under California law, where an excess insurer is asked to consent and contribute to a reasonable settlement that invades the excess layer and has been approved by both the primary carrier and the insured, its options are to: (1) approve the proposed settlement; (2) reject it and assume the defense; or (3) reject the settlement, decline the defense, and face a potential lawsuit for breach of the policy. See Teleflex Med. Inc. v. Nat. Union Fire Ins. Co. of Pittsburg, PA (March 21, 2017 Slip Opinion ("Slip Op."), citing Diamond Heights Homeowners Ass'n v. Nat'l Am. Ins. Co., 227 Cal.App.3d 563 (1991) ("Diamond Heights").

In reaching this conclusion, the court rejected the excess insurer's contention that Diamond Heights was "effectively overruled" by the California Supreme Court's decision in Waller v. Truck Ins. Exch., 11 Cal.4th 1 (1995), which held that an insurer will not be found to have waived a coverage defense absent evidence of intentional relinquishment. The Teleflex court held that Diamond Heights remains the law in California and is not inconsistent with Waller.

The Ninth Circuit also held that the "genuine dispute doctrine" – to the effect that an insurer does not act in bad faith where there is a genuine dispute as to the insurer's coverage liability – is subsumed within Judicial Counsel of California Civil Jury Instruction (CACI) 2331. Where CACI 2331 is given, a court may properly refuse to also give a separate special instruction on the doctrine.

Finally, the Court of Appeals held that the district court was not required to deny all unsegregated attorney fees from an award made under the California Supreme Court's decision in Brandt v. Superior Court, 37 Cal.3d 813 (1985). So long as the chosen apportionment appears fair, such award will be affirmed on appeal.

Discussion of the Teleflex Decision

Background

LMA North America, Inc./Teleflex Medical Inc. ("Teleflex") distributes laryngeal mask airway products. In 2007, it sued its competitor for patent infringement in federal district court. The competitor filed counterclaims for trade disparagement and false advertising, premised on allegedly false and disparaging statements made in Teleflex's advertising. The competitor sought $28 million from Teleflex.

At the time of the action, Teleflex was insured by a $1 million general liability insurance policy (issued by a different carrier) and $14 million excess policy issued by National Union Fire Insurance Company ("National Union"). The primary insurer agreed to defend the counterclaims which were potentially covered under the policies.

In January 2011, a mediation was held between the parties. Teleflex's primary insurer attended the mediation; National Union did not attend but was provided daily updates from defense counsel. During the mediation, the parties reached a conditional settlement wherein the competitor would pay Teleflex $8.75 million for the patent claims and Teleflex would pay $4.75 million for the disparagement claims. The settlement was conditioned on approval and funding from Teleflex's insurers.

Teleflex's primary insurer approved of the settlement and committed its full $1 million limit. National Union requested an updated liability and damages analysis from defense counsel so that it could consider the proposed settlement. Defense counsel's previous analysis, provided a couple of weeks before, estimated that Teleflex's potential exposure could reach as high as $10 million.

Defense counsel provided an updated analysis, including his belief that $4.75 million was a fair and reasonable amount to settle the disparagement claims and advised that the primary insurer had already approved the settlement and committed its limits. Defense counsel asked National Union for a prompt reply, advising that "time is scarce."

Defense counsel sent further requests to National Union seeking approval of the settlement or a promise to assume the defense. National Union ultimately declined to consent to the settlement but did not advise whether or not it would assume the defense.

Having no assurance from National Union, Teleflex agreed to finalize the settlement and immediately advised National Union. In response, National Union agreed to take over Teleflex's defense if it could "undo" the settlement. Teleflex advised that the settlement could not be undone.

Following execution of the settlement, Teleflex sued National Union for breach of contract and bad faith arising from its refusal to either contribute toward the settlement or assume immediate defense of the action.

After the court denied National Union's summary judgment motion based on its "no voluntary payments" and "no action" clauses, the action was tried to a jury, which awarded Teleflex $3.75 million in contract damages; $1.2 million in attorney fees, expert fees, and costs; and $1.1 million in prejudgment interest.

Decision by the Ninth Circuit

The Ninth Circuit, considering the issues under California law, affirmed the judgment in all aspects and rejected the various challenges made by National Union.

First, the court found the district court did not err in applying the rule of law set forth in Diamond Heights, and rejected National Union's argument that Diamond Heights was "effectively overruled" by Waller.

In Diamond Heights, a California Court of Appeal held that, subject to certain conditions, a primary insurer may negotiate a good faith settlement of a claim in an amount that invades excess coverage and, notwithstanding the excess insurer's "no action" clause, bind the excess insurer to such settlement even where the excess insurer did not consent to such settlement. 227 Cal.App.3d at 580-581. In reaching this decision, the Diamond Heights court found that an excess insurer may waive its right to assert the "no action" clause if it rejects a reasonable settlement and at the same time fails to offer to assume the defense of the insured. Id. at 581; see also Fuller-Austin Insulation Co. v. Highlands Ins. Co., 135 Cal.App.4th 958, 987 (2006).

In affirming the judgment, the Ninth Circuit found that Diamond Heights applied, notwithstanding the California Supreme Court's decision in Waller, which expressly rejects an automatic waiver rule in California. See Slip Op., pp. 10-21.

In finding that Diamond Heights is not inconsistent with Waller, the Ninth Circuit found that: (1) Waller did not mention Diamond Heights; (2) California appellate courts have relied on Diamond Heights since Waller; and (3) whereas Waller stands for the proposition that an insurer does not waive its right to rely on policy provisions simply by failing to mention such provisions in a claim letter, Diamond Heights "is not so much about the waiver of an insurer's contractual right than it is about an insurer's breach of a contractual obligation." Slip Op., pp. 14-19. "Whereas Waller prevents a policy from being expanded beyond the contacting parties' intent, the covenant of good faith underlying Diamond Heights is grounded on 'honoring the reasonable expectations created by the autonomous expressions of the contracting parties.'" Slip Op. at 18, quoting Tymshare, Inc. v. Covell, 727 F.2d 1145, 1152 (D.C. Cir. 1984) (Scalia, J.).

In reaching its decision, the Ninth Circuit noted that, "[t]he wisdom of the Diamond Heights rule may not be beyond reasonable debate," and that the rule "arguably gives the insured and primary insurers more than was bargained for, at least if excess insurers have not raised their rates to accommodate for additional costs imposed by the rule." Slip Op. at 18. However, the court went on to advise that "the rule is fairly supported by other insurance principles and policy considerations" and that it is "long established" that the "no voluntary payment" and "no action" clauses "do not create absolute rights to veto settlements." Id.

The Ninth Circuit also rejected National Union's attempts to distinguish Diamond Heights on its facts. See Slip Op., pp.19-21. In this part of its analysis, the court found that the facts in the present case were either similar to or slightly more egregious than those involved in Diamond Heights, specifically noting National Union's "foot-dragging" for months in considering the proposed settlement. Id. at 20. The court also found that substantial evidence supported the jury's finding that the settlement was reasonable and not the product of collusion.

In upholding the application of Diamond Heights, the Ninth Circuit held that an excess insurer cannot rely upon its "no voluntary payment" and "no action" clauses in its policy to reject a reasonable settlement without agreeing to assume the defense of the action.

Second, the Ninth Circuit held that the district court did not err in instructing the jury that Teleflex had to prove its contract claim under the preponderance of the evidence standard rather than by the clear and convincing evidence standard normally applied to waiver. See Slip Op., pp. 21-22. The court held that in analogous cases, California courts require the insured to show that the insurer wrongfully failed or refused to provide coverage or a defense to the insured and that the insured thereafter entered into a reasonable settlement of the litigation. The Ninth Circuit held that after the insured makes a prima facie showing, the burden then shifts to the insurer to prove, by a preponderance of the evidence, that the insured's settlement was not reasonable or was the product of fraud or collusion. Slip Op., pp. 21-22.

The court further advised that, "[a]pplying this burden-shifting rule to claims under the Diamond Heights rule would mean that the insured's prima facie burden includes, in addition to the elements listed above, showing that the insurer was 'afforded a reasonable opportunity of undertaking the defense in order to avoid settlement.'" Id. at 22. Once the insured sustains its burden on this additional element, the insurer must show that it was not provided with a reasonable opportunity to evaluate the settlement and decide whether to undertake the defense. While the Ninth Circuit found that the district court did not apply this burden-shifting framework, it found that any error was harmless to National Union. Id.

Third, the court rejected National Union's argument that the bad faith judgment was error due to instructional error and lack of substantial evidence. With respect to the alleged instructional error, the court found that the district court correctly found the "genuine dispute doctrine" subsumed within CACI 2331. Slip Op., pp. 23-24. The court held that CACI 2331 instructs the jury that a finding of bad faith requires five elements: (1) the insured suffered a loss covered under the policy; (2) the insurer was notified of the loss; (3) the insurer unreasonably failed to make or delayed payment of the policy benefits; (4) the insured was harmed; and (5) the insurer's failure or delay is a substantial factor in causing the insured's harm. Slip Op., p. 23 fn.4. The Ninth Circuit, relying on McCoy v. Progressive W. Ins. Co., 171 Cal.App.4th 785, 792-794 (2009), held that a trial court may refuse to give a special instruction on the genuine dispute doctrine where CACI 2331 is given because if there is a genuine dispute as to coverage, then the insurer did not withhold its payment unreasonably. See Slip Op., p. 24. Having concluded there was no instructional error on the genuine dispute doctrine, the court found substantial evidence supported the jury's verdict.

Lastly, the Ninth Circuit affirmed over $1.2 million in attorney fees awarded under Brandt v. Superior Court, 37 Cal.3d 813 (1985). See Slip Op., pp. 25-26. In finding the district court's apportionment fair (10% allocated to the bad faith claims and 90% to the breach of contract claims), the Court of Appeals held that the district court was not required to deny all unsegregated fees. So long as the chosen appointment seemed fair, it would not find an abuse of discretion under the circumstances.

Click here to read the Ninth Circuit's opinion.

Excess Insurer Has Duty To Consent To A Reasonable Settlement Or Assume Policyholders Defense

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