Five critical insurance issues for the plaintiff’s lawyer

Understanding the obligations of defendant’s insurer will be the basis for your strategy from case intake through resolution

Wesley Lowe
E. Gerard Mannion
2012 June

Insurance is a fact of life for the plaintiff’s lawyer. Indeed, insurance affects almost every aspect of the case, from whether to accept the case in the first place to how the case is handled to whether the case should be resolved. Understanding how certain liability insurance issues play out is essential for the plaintiff’s lawyer and critical to maximizing the client’s recovery. Based on our combined experience of over 60 years in representing policyholders in insurance coverage and bad faith litigation and advising plaintiff’s lawyers on various insurance issues, we offer our “top five” insurance issues for the plaintiff’s lawyer.

(1) Recognizing bad faith

The fundamental question in determining whether a carrier acted in bad faith is whether it acted reasonably under the circumstances. (Austero v. National Casualty Co. (1978) 84 Cal.App.3d 1, 32.) The reasonableness of the carrier’s conduct is determined from the factual situation confronting the carrier at the time the carrier made its decision and thus must be evaluated based on the information and circumstances existing at that time. (Id. at 32.) No “hindsight test” can be applied. (Ibid.) (This no “hindsight test” is often a two-edged sword. Sometimes a carrier can hide behind it to argue it did not have enough information to justify making any other decision while the insured can argue that given the information that the carrier had at the time the decision was made, it acted unreasonably even if later discovered information would have justified the carrier’s position decision.)

Courts have found “bad faith” in a number of varied situations and in the process have established several rules which derive from this “reasonableness” standard. Although many of these rules did not arise out of the handling of liability claims, they can nonetheless be applied to hold a carrier responsible. For example, there’s no doubt under the landmark Egan decision that a carrier must fully investigate all possible bases for coverage before denying an insured’s tender of defense which is itself a claim for coverage.

Some of the more significant rules are:

• It is essential that an insurer fully inquire into all possible bases that might support the insured’s claim “... [A]n insurer cannot reasonably and in good faith deny payments to its insured without thoroughly investigating the foundation for its denial.” (Egan v. Mutual of Omaha (1979) 24 Cal.3d. 809, 819.)

• A carrier’s duty to investigate is independent from the insured’s obligations and the carrier cannot rely on a policyholder’s failure to comply with minor policy provisions as an excuse from non-payment. (McCormick v. Sentinel Life (1984) 153 Cal.App.3d. 1030.)

• Unreasonable delay in processing a claim can constitute denial. (McCormick v. Sentinel Life, supra.)

• Focusing the investigation on ways to deny the claim, rather than on ways to pay it constitutes bad faith. (Mariscal v. Old Republic (1996) 42 Cal.App.4th 1617; Tomaselli v. Transamerica (1994) 25 Cal.App.4th 1269.)

• An insurer’s assertion of an untested legal argument against its insured in an uninsured motorist case may constitute bad faith and even merit an award of punitive damages. (Gourley v. State Farm (1991) 53 Cal.3d 121 (contrary authority exists in some circumstances); Morris v. Paul Revere (2003) 109 Cal.App.4th 966.)

• Using an unduly restrictive interpretation of policy terms can be bad faith. (Moore v. American United Life (1984) 150 Cal.App.3d 610.)

• The covenant of good faith continues even after litigation is filed by the insured against the carrier. (White v. Western Title (1985) 40 Cal.3d. 870, 886.)

• Improper cancellation of a policy can support a claim for bad faith. (Spindle v. Travelers (1977) 66 Cal.App.3d 951; Johnson v. Mutual (9th Cir. 1988) 847 F.2d 600.)

• Abusive and coercive claims practices can constitute bad faith. (Mustachio v. Ohio Farmers (2004) 44 Cal.App.3d 358, 362; Gruenberg v. Aetna (1973) 9 Cal.3d 566, 575-576.)

• Unreasonable denial of a defense can be bad faith. (Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825.)

Ultimately, it comes down to this basic test. If the carrier’s conduct does not seem fair, if it has failed to provide the insured with an essential benefit of the insurance, or if it has refused to fulfill some promise or meet some reasonable expectation, then it probably has acted in bad faith.

(2) The duty to defend requires a potential of coverage

Under California law, a liability insurer owes a broad duty to defend its insured against claims that create a potential for coverage. (Buss v. Superior Court Buss v. Superior Court (1997) 16 Cal.4th 35, 46;

(Montrose Chem. Co. v. Sup. Court (1993) 6 Cal.4th 287, 295.) The insurer’s duty is excused only where “the third party complaint can by no conceivable theory raise a single issue which could bring it within the policy coverage.” (Montrose, 6 Cal.4th at 300.) The Montrose Court clarified the standard governing an insurer’s duty to defend:

To prevail, the insured must prove the existence of a potential for coverage, while the insurer must establish the absence of any such potential. In other words, the insured need only show that the underlying claim may fall within policy coverage; the insurer must prove it cannot. Facts merely tending to show that the claim is not covered, or may not be covered, but are insufficient to eliminate the possibility that resulting damages (or the nature of the action) will fall within the scope of coverage, therefore add no weight to the scales.

Whether there is a duty to defend must be determined from all information available to the insurer, including extrinsic facts. (B & E Convalescent Center v. State Compensation Ins., (1992) 8 Cal.App.4th 78, 92.) Potential coverage and the duty to defend are triggered by facts the insurer knew or could have learned through reasonable investigation. (Eigner v. Worthington (1997) 57 Cal.App.4th 188, 195.) The complaint does not even have to allege a covered cause of action. (Barnett v. Fireman’s Fund Ins. Co. (2001) 90 Cal.App.4th 500, 510.) The title or style of the causes of action or the form of the action do not control whether a defense is owed. It is the facts that determine coverage. (Vandenberg v. Superior Court (1999) 21 Cal.4th 815, 828.) There is a duty to defend if a complaint can be amended to state a covered claim, even if the existing complaint does not presently state a covered claim. (Gray v. Zurich, supra, at 275-276.) “Any doubt as to whether the facts give rise to a duty to defend is resolved in the insured’s favor.” (CNA Casualty of California v. Seaboard Surety Co. (1986) 176 Cal.App.3d 598,607.)

If you represent the injured party and the carrier has refused to defend the insured, it may be advisable to inform the insured that he or she should consult with an insurance lawyer to determine if the carrier owes a duty to defend.

(3) The covenant to limit execution

When a carrier refuses to defend and the defendant has little or no assets, it may make sense to work with the defendant to maximize your client’s chance to collect against the carrier. Here, both the plaintiff and the defendant/insured work out an arrangement to resolve the case to maximize plaintiff’s recovery and the chance that insurance will cover it. This is done by obtaining a covenant not to execute, or preferably, a covenant to limit execution.

Before determining if a covenant to limit execution is appropriate, the plaintiff’s lawyer should determine whether there is a duty to defend. The analysis starts by getting a copy of the carrier’s denial letters from defense counsel. Sometimes defense counsel are reluctant to provide this information, but when it is explained to them that it is necessary in order to determine if there is a way that the parties can reach an agreement to resolve the case through a covenant to limit execution, most (but unfortunately not all) defense counsel will provide the denial letters. In addition, plaintiff’s lawyer needs a full copy of the insurance policy with all endorsements, and, if there any questions as to whether the broker has made a mistake in providing a particular type of coverage which would have covered the claims at issue, then there has to be disclosure of any communications between the broker and the insured about that issue. The plaintiff’s lawyer can then either do the coverage analysis herself, or hire a coverage lawyer to do it.

Assuming that there is a potential of coverage that obligated the carrier to provide a defense, and that the carrier has unequivocally refused to provide a defense, then the plaintiff’s lawyer should demand the policy limits. While this may seem to be a futile gesture, it is important because it will protect plaintiff’s right to eventually collect the full amount of the judgment, even if it is in excess of the  policy limits. (See Comunale v. Traders and General Insurance (1958) 50 Cal.2d 654, 660; Johansen v. CSAA (1975) 15 Cal.3d 9, 15-16.)

The next step (after the carrier has rejected the policy limits demand) is to proceed to judgment. However, before proceeding to judgment, the defendant/ insured will want protection from collection. This is done through an agreement typically referred to as a “covenant not to execute.” The covenant states that once a judgment is entered, plaintiff can seek to recover the amount of the judgment only from the insurance carrier (or sometimes the insurance broker). (See Pruyn v. Agriculture Insurance Co. (1995) 36 Cal.App.4th 500; Samson v. Transamerica Ins. Co. (1981) 30 Cal.3d 220.)

Although courts have approved the “covenant not to execute,” we believe it is safer to create a “covenant to limit execution” which gets the parties to the same place but avoids a potential trap. The potential trap is that liability insurance policies are indemnity policies. That means that the carrier has to reimburse or pay the insured for any sums that the insured is “legally obligated” to pay, or for which it is obligated to pay because it failed to provide a defense. (Amato v. Mercury Casualty (1977) 53 Cal.App.4th 825.) If the insured is found to owe nothing, there is no obligation to indemnify. From a purely logical standpoint, if the insured reaches an agreement with the plaintiff to eliminate any obligation to pay the plaintiff, then there is no longer anything to indemnify. Thus, it could be argued that a covenant not to execute eliminates the carrier’s obligation to pay any judgment. In fact, some unpublished and de-certified cases have reached that very conclusion. In order to avoid this trap, we suggest that the plaintiff and insured agree to a covenant to limit execution, which limits the plaintiff’s right to collect against the defendant/insured’s assets to the insurance assets, and any claims against any insurance professionals, such as brokers, agents, etc. Thus, some of the insured/defendant’s assets are still “on the line,” but they are limited to the insurance.

The next step is an agreement that the insured will assign all rights under the insurance policy to collect on the judgment to plaintiff, except for those rights which are not assignable (such as claims of punitive damages and emotional distress). In addition, plaintiff will need the insured to waive the attorney client privilege so that the carrier’s entire claim file can be obtained.

The final step in the process is to decide how plaintiff will obtain judgment. One way is to simply try the case with the defendant either not appearing, or not participating in the case. This, of course, is more expensive and if there are any liability or damage issues, the result is more unpredictable. The upside to such an approach is that whatever judgment is obtained cannot be attacked as collusive. An intermediate alternative is to stipulate to have the case heard by a retired judge, or an arbitrator appointed to sit as a judge pro-tem. This is less expensive, and the outcome is somewhat more predictable. The parties can also stipulate to a judgment, and have a court make a finding that the amount of the judgment was in good faith. (See Pruyn, supra.) This, of course, raises the possibility of a claim of collusion. The least desirable scenario is to simply stipulate to a judgment with no judicial oversight. We recommend against that option except in the most extreme circumstances.

One final note. If the carrier has provided a defense, the parties cannot stipulate to a judgment without the insurer’s consent. (Hamilton v. Maryland Casualty (2002) 27 Cal.4th 718.)

(4) Making the policy limits demand – perfecting the excess judgment

The standard liability insurance policy gives the carrier control over the defense and the corollary right to “investigate, negotiate, and settle any claim or suit” as it “deems appropriate.” However, the carrier’s right to “negotiate and settle” is not unlimited; rather it is constrained by the implied covenant of good faith and fair dealing which obligates the carrier to accept reasonable settlement demands within the policy limits in order to avoid exposing its insured to personal liability in excess of those limits. (Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 659.)

The obligation to accept reasonable settlement demands is imposed on the carrier because of the unavoidable conflict that arises when the plaintiff offers to settle within the policy limits. The insured desires protection, and settlement within the policy limits eliminates the risk that the insured will be exposed to personal liability. (See Crisci v. Security Ins. Co., supra, 66 Cal.2d at 431 (“common knowledge that settlement is one of the usual methods by which an insured receives protection under a liability policy.”)) In contrast, settlement may not be in the carrier’s interest since any settlement costs the carrier money, and the carrier has an interest in settling for less than the policy limits. With little to lose, a carrier may simply reject the policy limits demand and gamble on the outcome of trial. The dilemma is plain to see. “[T]he carrier who receives an offer to settle an excess claim within policy limits is instructed to weigh its own interest on the scales along with those of its assured in order to make a good faith determination whether to accept or reject the offer. . . must attempt to evaluate the merits of an offer to settle within the policy limits both from its own point of view and from that of the assured.” (Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 874.)

A carrier that rejects a reasonable settlement offer within the policy limits will be held liable in tort for the entire judgment against the insured, even if that amount exceeds the policy limits. (Johansen v. CSAA, supra, 15 Cal.3d 9, 15.) The carrier is liable in tort to the insured because that is the person whose interests and peace of mind are protected by the liability insurance. “If the insurer breaches the implied covenant by unreasonably refusing to settle the third party suit, the insured may sue the insurer in tort to recover damages proximately caused by the insurer’s breach.” (PPG Industries v. Transamerica Ins. Co., supra, 20 Cal.4th at 312.)

The plaintiff who has obtained a judgment in excess of the policy limits against the insured gains rights against the carrier. The claimant can bring a direct action per Insurance Code section 11580, sue for failure to pay and bad faith under Hand v. Farmers Ins. Ex. (1994) 23 Cal.App.4th 1847, and as seen in the Crisci decision, is now in a position to acquire by assignment the insured’s rights against the carrier to recover the entire amount of the judgment. The net effect is that the policy limits have “opened up,” i.e., there is no longer any limit on the amount that the carrier is bound to pay, and the plaintiff has his/her own right of action against the carrier. The policy limits demand therefore forces the carrier to make a good faith determination to accept or reject the demand and exposes the carrier to bad faith liability for refusing to accept a reasonable offer to settle within the policy limits.

However, perfecting the excess judgment depends on making a reasonable policy limits demand that affords the carrier an opportunity to settle. CACI 2334 provides “a settlement demand is reasonable if the [carrier] knew or should have known at the time the settlement demand was rejected that the potential judgment was likely to exceed the amount of the settlement demand based on [the claimant’s] injuries or loss and [the insured’s] liability.” In Johansen, the Court held that the “only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim’s injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settle offer.” (Johansen v. CSAA, supra, 15 Cal.3d at 16.) Furthermore, no hindsight test is allowed. “Determination of the reasonableness of a settlement offer . . . is based on the information available [to the insurer] at the time of the proposed settlement.” (Isaacson v. CIGA (1988) 44 Cal.3d 775, 793.)

The reasonableness of the demand therefore depends on facts known or available to the carrier at the time of the proposed settlement. Practically speaking, in order to ensure that the policy limits demand has maximum impact on the carrier, it should be supported by a demand letter that recites the evidence supporting liability and damages and includes all key supporting documentary evidence. This means that if defense counsel has not taken key depositions, subpoenaed vital records, or conducted other essential discovery, the plaintiff’s lawyer should consider initiating discovery and voluntarily providing copies of records to make the facts “known” to the carrier.

An additional factor in the reasonableness of the settlement demand is whether the carrier was given a sufficient time to accept or reject the demand. There are no set rules although 30 days as per Code of Civil Procedure section 998 is generally regarded as standard. One treatise offers this common sense pointer: “The longer the carrier has to investigate and evaluate the claim, the less time it should need to respond to the settlement demand. Thus, as the case approaches trial, even relatively short deadlines (e.g., “until the case goes to the jury”) may give the carrier an adequate opportunity to accept, exposing it to bad faith liability for refusal to settle.” (Crosky, Heeseman, Popik & Imre, Cal. Prac. Guide: Insurance Litigation (TRG 2011) 12:346, 12B-31-32.)

(5) Recognizing and appreciating a “burning limits” insurance policy

A standard liability insurance policy obligates the carrier to defend the claim being asserted against the insured and to indemnify the insured from sums that the insured is legally obligated to pay on account of a covered claim. The standard policy limits the amount the carrier must provide to indemnify the insured (to fund a settlement or judgment up to the limits of liability), but places no such limit on the amount that the insurer must pay to defend the claim. Increasingly, however, liability policies, particularly for professionals such as lawyers, architects and engineers as well as for directors and officers (D&O), and employment practices liability (EPL) policies, contain a provision that limits the amount the carrier is bound to pay for the defense of the claim and also erodes the limits of liability. These types of policies are known as “burning limits” or “wasting assets” because the coverage limits for indemnity are burned up or wasted by the costs of defense. In other words, every dollar spent on defense reduces or “erodes” the amount available to pay or fund a settlement or judgment.

The ramifications of a burning limits policy for the plaintiff are obvious. If the claim is worth payment close to or at the policy limits, then attention must be paid to litigating the case as efficiently as possible so that you are not needlessly burning up the dollars available for indemnity, while at the same time, fulfilling your duty to diligently prepare the case for trial. At the very least, a letter should be sent to the client upon discovering the burning limits provision, explaining how the burning limits provision works and how this affects the amount available for settlement. Finally, a demand to settle for policy limits should be made at the earliest opportunity even if the amount of available limits cannot be definitively determined because they are being burned up by the costs of defense. The policy limits demand can be crafted to state “plaintiff demands ‘x’ amount to settle the case or the total amount of the remaining limits of liability, whichever is less, subject to written verification.”

Wesley Lowe Wesley Lowe

Wesley Lowe also represents policyholders in their claims against insurance companies. He and Gerry Mannion have practiced together for almost 30 years. His practice emphasizes suing insurance companies for coverage and bad faith, and he has litigated claims involving a wide variety of insurance, including homeowners and renters, automobile property and liability, commercial property and liability, life, health and accident, and disability. He has extensive experience in insurance coverage matters, including duty to defend issues, and has served as coverage counsel for the insured/defendant in several different types of litigation.

E. Gerard Mannion E. Gerard Mannion

Gerard Mannion has been successfully representing policyholders in insurance coverage and bad-faith matters for 35 years. He has handled many different types of insurance matters, including duty to defend claims, property claims, excess judgment actions, life and disability actions, director and officer liability claims, disputes between primary and excess carriers, environmental claims, and maritime actions. He is a past president of San Francisco Trial Lawyers Association, and is an emeritus member of the Board of the Consumer Attorneys of California. He is a frequent lecturer on insurance coverage and bad-faith issues. He consults with plaintiff’s attorneys on these issues.

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