Must the insurer’s conduct be “unreasonable” to trigger bad faith? What if the adjuster is hit by a bus on his way to mail you an offer?
Most of us have heard someone say at one time or another that “there is no such thing as third-party bad faith in California anymore.” Yet, we’ve also heard about “the duty to settle,” “bad faith failure to settle,” and insurers who pay settlements and verdicts above policy limits. What’s going on here?
The “death” of third-party bad faith
In 1988, the California Supreme Court made a drastic pronouncement. For the previous nine years, California law had seemingly allowed people who had suffered bodily injury or other harm through the fault of others to sue those tortfeasors’ insurers for treating them unfairly in violation of California’s Unfair Claims Practices Act. (See Royal Globe Ins. Co. v. Superior Court (1979) 23 Cal.3d 880.) That statute prohibits insurers from, among other things, “Not attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” (Ins. Code, § 790.03(h)(5).) Royal Globe gave third parties a right of action when insurers made “lowball” settlement offers or rejected reasonable attempts to settle; the insurers could be held responsible for treating third-party claimants unfairly. (Royal Globe, supra, 23 Cal.3d at 884.)
In 1988, our Supreme Court reversed course and decided Moradi-Shalal v. Fireman’s Fund Ins. Cos. (1988) 46 Cal.3d 287. With that decision, the Court effectively eliminated the doctrine of “third-party bad faith,” and returned to its previous holding that the insurers had no independent duty or civil liability to third parties. (Id. at 304.) The Court laid out six separate factors that drove its decision, but as other courts have explained, the primary rationale for relieving insurers of the duty to treat third-party claimants fairly or in good faith is that the two are not in privity. (Murphy v. Allstate (1976) 17 Cal.3d 937, 944.)
The fear after Moradi-Shalal was that insurers were free to act on their worst impulses. Unreasonable settlement offers, refusals to participate in settlement talks, needlessly forcing cases to trial on the courthouse steps . . . everything was permitted. Or was it?
The duty to settle
It is a misconception that the Moradi-Shalal decision opened the door to insurer impunity in third-party litigation. Regardless of what insurers’ duties (or lack thereof) might be when it comes to third-party claimants, they still have a duty to their own insureds to settle cases within limits. That rule was well-settled at the time of the Moradi-Shalal decision. In fact, the very first time that the California Supreme Court recognized the concept of insurance bad faith of any kind was when it held an insurer responsible for wrongfully failing to settle. (Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654.)
The root of the duty to settle is in liability insurers’ right to control the defense and resolution of claims against their insureds. (E.g., Western Polymer Tech., Inc. v. Reliance Ins. Co. (1995) 32 Cal.App.4th 14 [insured cannot prevent insurer from settling “any claim or suit it deems expedient”].)1 Insurers hold their insureds’ fates in their hands, and in the decades since Comunale, our courts have repeatedly told insurers not to abuse that power. “[A] liability insurance policy’s express promise to defend and indemnify the insured against injury claims implies a duty to settle third party claims . . . .” (Kransco v. Am. Empire Surplus Lines Ins. Co. (2000) 23 Cal.4th 390, 401.) An insurer’s duty of good faith and fair dealing requires that when it receives a reasonable offer within policy limits and has a reasonable opportunity to accept, it must do so. (Johansen v. Cal. State Auto. Ass’n Inter-Ins. Bureau (1975) 15 Cal.3d 9, 16.) As our Supreme Court explained back in 1976, “[t]he duty to settle is implied in law to protect the insured from exposure to liability in excess of coverage as a result of the insurer’s gamble – on which only the insured might lose.” (Murphy, supra, 17 Cal.3d at 941.) The consequence to an insurer for failing to accept a reasonable settlement offer is that it becomes liable for the entire excess judgment against its insured. (Samson v. Transamerica Ins. Co. (1981) 30 Cal.3d 220, 237; Comunale, supra, 50 Cal.2d at 660.)
Time for a jury instruction
Insurers did not really get the message. Wrongful failures to settle became frequent enough that the Judicial Council of California (an arm of our Supreme Court) decided that it was worth the time and effort to write a standard jury instruction on the subject: CACI 2334. The elements of a wrongful failure-to-settle suit are straightforward. An insurer is liable for a bad faith failure to settle when:
- There is a covered claim against the insured;
- There is a reasonable offer to settle within policy limits;
- The insurer fails to accept that offer; and,
- There is a subsequent judgment against the insured for a sum greater than the policy limits.
A reasonable offer from claimant
Despite the simple nature of the jury instruction, there is a significant amount of caselaw underlying CACI 2334 (and still some ongoing debate over the elements, discussed below). Most of the cases focus on what constitutes a reasonable offer. An offer within policy limits is reasonable when, after taking into account the facts on liability and damages, there is a reasonable likelihood that covered damages will exceed policy limits. (Kransco v. American Empire Surplus Lines Co. (2000) 23 Cal.4th 390, 400-01; Crisci v. Security Ins. Co. of New Haven, Conn. (1967) 6 Cal.2d 425.)
It is important to note that in order to trigger the duty to settle, there must be an offer, or some indication of a desire to negotiate or settle that comes from the claimant. As the Court of Appeal explained: “In the absence of a settlement demand or any other manifestation the injured party is interested in settlement, when the insurer has done nothing to foreclose the possibility of settlement, we find there is no liability for bad faith failure to settle.” (Reid v. Mercury Ins. Co. (2013) 220 Cal.App.4th 262, 266.) Despite decades of law on the duty to settle, there is no California case holding that an insurer must initiate settlement negotiations.
The term “exceed policy limits” also deserves highlighting. If covered damages are not likely to exceed policy limits (or cannot exceed them), then the insured is not likely exposed. There is no “gamble” by the insurer. Factors such as comparative fault and apportionment of fault come into play, of course. They must, because they affect the amount of the judgment. However, the existence of those factors does not absolve an insurer of liability for wrongful failure to settle. Indeed, even when an insured is only responsible for a fraction of the plaintiff’s damages, an insurer will still be liable for bad faith failure to settle if the verdict against the insured exceeds policy limits. (E.g., Jackson v. State Farm Mut. Auto. Ins. Co. (1983) 148 Cal.App.3d 1179 [insured only 20% responsible].)
Are damages “likely” to exceed limits?
So, how do we know if the damages are “likely” to exceed limits? Sometimes the answer is obvious. Cases with strong liability facts and damages that dwarf policy limits should trigger a very quick duty to settle. Alternatively, cases with relatively low damages compared to policy limits would not. So what about cases in between? Unfortunately, there is no bright line rule. One option with such cases is to take the risk and try them. An excess judgment “. . . furnishes an inference that the value of the claim is the equivalent of the amount of the judgment and that the acceptance of an offer within those limits was the most reasonable method of dealing with the claim.” (Crisci, supra, 66 Cal.2d at 431 (emphasis added).) An insurer that wants to avoid paying an excess judgment faces an uphill battle.
Some courts have suggested a more practical option for evaluating whether an offer is reasonable: math. In order to evaluate the reasonableness of settlement offers, what some courts have done is multiply insureds’ maximum exposure by the possibility of achieving that result. (E.g., Isaacson v. CIGA (1988) 44 Cal.3d 775, 794; Miller v. Elite Ins. Co. (1980) 100 Cal.App.3d 739, 757.) In Isaacson, the insured’s maximum exposure was $750,000, but (based on the evidence at trial, not the Court’s own opinion) the likelihood of a verdict of that amount was only 50%. Therefore, the Supreme Court concluded that a reasonable settlement offer would have been $375,000. The plaintiff’s demand of $500,000 was, therefore, unreasonable and CIGA did not act in bad faith by failing to accept it. In Miller, the offer was $5,000 against a potential exposure of $11,000, again with a 50/50 chance of winning. Because $5,000 was less than 50% of $11,000 the offer was reasonable.
Reasonable opportunity to accept
Another factor in determining whether an offer is reasonable is the amount of time the insurer had to accept it. There is no fixed amount of time that an insurer needs in order to consider an offer in order for it to be reasonable. Courts have generally looked at this as a balancing of the amount of time the insurer has to decide and the amount of information it has available. The more complex the case and the more documents and records involved, the more time an insurer should get to evaluate a demand. On the other hand, the simpler cases, or cases that have gone through more discovery before there is a demand, need less time. In appropriate cases, all the time that might be needed is a single day. (Kelly v. British Commercial Ins. Co. (1963) 221 Cal.App.2d 554.)
Factors that are not really factors
There are also factors that do not count in determining whether an offer is reasonable. Non-covered or excluded types of damages do not count. An insurer does not have to pay for uncovered damages (or overpay for covered damages), even if that ultimately exposes the insured to personal liability. (PPG Industries, Inc. v. Transamerica Ins. Co. (1999) 20 Cal.4th 310 (punitive damages); Camelot by the Bay Condominium Owners’ Assn. v. Scottsdale Ins. Co. (1994) 27 Cal.App.4th 33 (damages outside policy period).) As the Camelot court put it, “The insurer does not insure the entire range of the insured’s well-being, outside the scope of and unrelated to the insurance policy . . . It is an insurer, not a guardian angel.” (Camelot, supra, 27 Cal.App.4th at 52.)
Another non-factor is damages which have no coverage limit at all. For example, many liability policies cover interest, costs (including those awarded under Code Civ. Proc., § 998), and attorneys’ fees as “supplementary payments.” That coverage is almost always in addition to the limit of liability, and without any upper limit. An insurer cannot “gamble” with the insured’s money if the insured would never be exposed to having to pay those parts of a judgment.
Another factor that is not part of the determination of whether an offer is reasonable is the existence of a coverage dispute. Our Supreme Court held that even “an insurer’s ‘good faith, though erroneous belief in noncoverage affords no defense to liability flowing from the insurer’s refusal to accept a reasonable settlement offer.’” (Johansen, supra, 15 Cal.3d at 16; Comunale, supra, 50 Cal.2d at 660.) This is not to be confused with non-covered damages, which an insurer would not have to pay. Insurers are simply barred from arguing that an offer was unreasonable because the claim itself was not covered. (This sometimes arises in cases where insurers refuse to defend entirely).
Duty to engage
Insurers have a duty to engage when confronted with settlement demands. “An insurer’s duty of good faith would be trifling if it did not require an insurer to explore the details of a settlement offer that could prove extremely beneficial to its insured.” (Allen v. Allstate Ins. Co. (9th Cir. 1981) 656 F.2d 487, 490.) An insurer cannot “in good conscience use its own failure to explore the settlement offer as defense of its own breach of duty to tender the policy limits.” (Betts v. Allstate Ins. Co. (1984) 154 Cal.App.3d 688, 708; see also Barickman v. Mercury Cas. Co. (2016) 2 Cal.App.5th 508, 522 [insurer liable for excess judgment when it unreasonably sought release of rights that plaintiff could not release]; Reid v. Mercury Ins. Co. (2013) 220 Cal.App.4th 262, 278 [insurer cannot “ignore the opportunity to explore settlement possibilities to the insured’s detriment . . . .”]; Heredia v. Farmers Ins. Exchange (1991) 228 Cal.App.3d 1345, 1360 [insurer’s duty of good faith requires it to explore details of a settlement offer with a view toward resolving issues that may take the offer outside policy limits].)
A claimant, on the other hand, does not have to continue negotiating when an insurer rebuffs attempts to engage. “In all realism, rejection of an initial settlement offer is frequently regarded as a preliminary bargaining tactic, not as a break off of negotiations . . . The injured party, however, . . . may take an initial rejection at face value and choose thereafter to submit [her] claim to the uncertainties of litigation . . . . (Critz v. Farmers Ins. Group (1964) 230 Cal.App.2d 788, 797 [partially disapproved on other grounds by Crisci v. Security Ins. Co. of New Haven, Conn. (1967) 66 Cal.2d 425, 433].) Indeed, the risk that a claimant will take a case to trial and obtain an excess judgment is exactly the risk that gives rise to the duty to settle in the first place. (See Rest.2d Torts, § 449 (“The happening of the very event the likelihood of which makes the actor’s conduct negligent and subjects the actor to liability cannot relieve him from liability.”).) Arguably, provided that the insurer had one reasonable chance to accept one reasonable demand, the insurer cannot escape liability for a subsequent excess judgment.
Must insurer’s conduct be “unreasonable?”
One issue that is currently under debate is whether CACI 2334’s third element is missing a word: “unreasonable.” As the instruction currently reads, insurers’ reasons for failing to accept a reasonable offer are essentially irrelevant. This reflects the language that our Supreme Court used in 1975, when it explained the “only permissible consideration” is whether the ultimate judgment will exceed the amount of the offer. (Johansen, supra, at 16.) That rule has eroded over time, and in a somewhat unusual step, in 2019 the Judicial Council added a comment to the CACI 2334 use notes that seems to question the accuracy of the instruction: “A number of cases suggest that some degree of insurer ‘culpability’ is required before an insurer’s refusal to settle a third party claim can be found to constitute ‘bad faith.’” (CACI 2334, use notes (internal citation omitted).) The notes go on to cite those cases and include some commentary from the Rutter Guide on Insurance Litigation. (For decades, the lead author of that treatise was Justice H. Walter Croskey, who also happened to be Chair of the Judicial Council Advisory Committee on Civil Jury Instructions).
The Judicial Council has raised the question of whether insurers should really be held liable for failing to settle without any examination of why they did not do so. Bad faith is not a strict liability tort. What if there is a legitimate excuse for not accepting a demand? As one treatise points out, if the insurer’s conduct is not considered, then “an insurer would be liable for failure to accept a reasonable settlement demand in a timely fashion if its adjuster is hit by a bus while in the process of mailing a letter accepting a settlement demand.” (DiMugno & Glad, California Insurance Law Handbook: A Reference and Guide § 11:185 (Thomson Reuters, 2019).) In essence, the question being debated is whether the third element of CACI 2334 should really say: “The insurer unreasonably fails to accept that offer.”
From the perspective of policyholders, expanding the inquiry on failure to settle is worrying because it puts the law on a slippery slope. What starts with an extreme hypothetical of the well-meaning adjuster hit by a bus, quickly devolves over time into the new “genuine dispute doctrine.” (But see Wilson v. 21st Century Ins. Co. (2007) 42 Cal.4th 714 [exposing doctrine as nothing more than ordinary good faith].) On the other hand, expanding the inquiry also potentially poses problems for insurers. If we assign more relevance to insurers’ conduct in settlement negotiations, that could move our courts closer to imposing an affirmative duty to offer policy limits.
One takeaway from this discussion is that the duty to settle can be straightforward. A single clear demand within limits, for a reasonable amount, made with a reasonable amount of time to decide, and accompanied by enough information for an insurer to consider, can be enough to hold an insurer responsible for an excess verdict. However, each element of the duty to settle has its own nuances. Determining whether an offer is reasonable, or whether an excess verdict is likely, can be challenging and more art than science. It can be difficult to predict whether an excess verdict will be collectible.
Perhaps the more metaphysical conclusion here is that, to a large degree, the insured and the third-party claimant are two sides of the same coin. An insurer has an obligation to protect its insured from third-party claims. It does so by defending, but also by paying to settle. Every time an insurer misses an opportunity to settle, that puts the insured that much more at risk of personal exposure for an excess judgment. So, despite the absence of a duty to the third-party claimant, the insurer must keep coming back. It must keep exploring the possibilities of settlement when offered because resolving a claim is good for the insured. If and when the insurer finally pays, that can be good for everyone.
Demián Oksenendler is a shareholder at Mannion, Lowe & Oksenendler, P.C. in San Francisco. His represents policyholders against insurance companies of all kinds in both litigation and consulting matters. He is AV Rated, has been named to the Northern California Super Lawyers Rising Stars list every year since 2011, and is a member of the Board of Directors of the San Francisco Trial Lawyers Association. When he is not in the office or at a consumer attorney event, you will usually find him riding his bicycle through the hills of Marin, at a Giants game, or watching his beloved Cal Bears. If you meet him, be sure to ask about his karaoke trophy.
2023 by the author.
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