Expert Commentary

Excess Insurer May Not Refuse Reasonable Settlement

The state of California gives an excess insurer three options if it disagrees with the proposed insurance settlement by the primary insurer and an insured that would require payment by the excess insurer. In a recent case, the insurer refused to take any of the three options and claimed a settlement breached a term of the excess policy.


Claims Practices
April 2017

In Teleflex Med., Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa., No. 14-56366 (9th Cir. Cal. Mar. 21, 2017), National Union attempted to do away with the California standard, Diamond Heights Homeowners Ass'n v. National Am. Ins. Co., 227 Cal. App. 3d 563 (1991), that requires an excess liability insurer to exercise one of the following three options when presented with a proposed settlement of a covered claim that has met the approval of the insured and the primary insurer.

  • Approve the proposed settlement;
  • Reject it and take over the defense; or
  • Reject it, decline to take over the defense, and face a potential lawsuit by the insured seeking contribution toward the insured settlement.

Under Diamond Heights, the insured is entitled to reimbursement if the excess insurer was given a reasonable opportunity to evaluate the proposed settlement and the settlement was reasonable and not the product of collusion. The insured, LMA North America, Inc., sued its excess insurer, National Union Fire Insurance Company of Pittsburgh, Pennsylvania, in connection with National Union's refusal to either contribute $3.75 million toward the settlement of claims brought by a third party or take over the defense.

The Underlying Ambu Litigation

LMA and its competitor Ambu distribute competing laryngeal mask airway products. In 2007, LMA brought a patent infringement suit in federal district court against Ambu related to certain laryngeal masks. Ambu filed trade disparagement and false advertising counterclaims, demanding $28 million.

The parties held a mediation on January 10–11, 2011. National Union did not attend the mediation, but Transcontinental Insurance Company (called CNA) did. LMA's counsel, Stephen Marzen, updated National Union each day. On the second day, LMA and Ambu reached a conditional settlement agreement under which Ambu would pay LMA $8.75 million for the patent claims while LMA would pay Ambu $4.75 million for the disparagement claims. The settlement was conditioned on LMA's ability to obtain approval and funding from CNA and National Union.

While CNA committed its full $1 million limit, National Union was reluctant to recognize that Ambu's counterclaims could invade its coverage layer. LMA's counsel provided National Union an analysis which concluded that "considering the risk of a damages award substantially in excess of $10 million, and not counting the substantial defense costs to defend against the product disparagement counterclaims through trial, and possible appeal, $4.75 million is a fair and reasonable settlement of Ambu's product disparagement counterclaims."

On March 25, 2011, National Union sent a list of questions and received a response advising National Union of its three options. National Union declined to consent to the proposed settlement without offering to take up the defense.

Having still not heard from National Union regarding taking over the defense, LMA finalized the settlement with Ambu on April 18. LMA promptly notified National Union.

The Insurance Coverage Litigation

Following execution of the insurance settlement, LMA sued National Union for breach of contract and bad faith. LMA sought contract damages, interest, attorney fees and costs, and punitive damages. After discovery, National Union moved for summary judgment, arguing that it had the absolute right to veto the settlement under the policy's "no voluntary payments" and "no action" clauses.

The case proceeded to trial, and the jury unanimously found for LMA on both the breach of contract and bad faith claims but decided not to award punitive damages. On April 7, 2014, the district court entered judgment in LMA's favor for $6,080,568.43, including $3,750,000 in contract damages; $1,216,580.99 in attorney fees, expert fees, and costs; and pre-judgment interest of $1,113,987.44.

The Diamond Heights Rule

The Diamond Heights court concluded that, consistent with its good-faith duty, the excess insurer does not have the absolute right to veto arbitrarily a reasonable insurance settlement and force the primary insurer to proceed to trial bearing the full costs of defense. A contrary rule would impose the same unnecessary burdens upon the primary insurer and the parties to the action, among others, as does the primary insurer's breach of its good-faith duty to settle.

The court held that opposing a contribution action by the insured, the excess insurers may challenge the settlement for fairness, reasonableness, and lack of fraud or collusion. An excess insurer does not have an absolute right to withhold its consent to a settlement while at the same time declining to participate in the action. The Ninth Circuit Court of Appeals, therefore, refused to conclude that the policies could be read to permit an excess insurer to hover in the background of critical settlement negotiations and thereafter resist all responsibility on the basis of lack of consent.

The court said that Diamond Heights is about how an insurance policy should be read in order to reconcile an excess insurer's contractual rights under "no action" and "no voluntary payments" clauses with the insured's rights under the implied covenant of good faith and fair dealing. The covenant of good faith underlying Diamond Heights is grounded on honoring the reasonable expectations created by the autonomous expressions of the contracting parties.

The wisdom of the Diamond Heights rule may not be beyond reasonable debate. But, for the implied covenant of good faith and fair dealing, the rule would be contrary to the language of the "no action" and "no voluntary payments" provisions. The court said the insured is entitled to make a reasonable settlement of the claim in good faith and then sue for reimbursement even though the policy prohibits settlements without the consent of the insurer.

Diamond Heights Is Not Distinguishable on Its Facts

CNA committed its policy limit over a month before settlement, which is earlier than the primary insurer in Diamond Heights. The primary insurer funded the defense up until settlement, and the excess insurer did not take over the defense. Regardless of who funds counsel, the insured and the primary insurer owe a duty of good faith that runs not only to each other but also to the excess insurer. The parties to the LMA case and the Diamond Heights cases settled before judgment, and the settlements were found to be reasonable assessments of potential liability.

The jury found the insurance settlement to be reasonable. The jury decided in LMA's favor. In fact, National Union's foot-dragging may reasonably be seen as more egregious than the excess insurer's conduct in Diamond Heights. The excess insurer in Diamond Heights had less than 2 weeks to consider the settlement, whereas National Union had months.

LMA's Bad Faith Claim

National Union challenged the judgment on the bad faith claim on two related grounds. The jury could and did rationally conclude that, based on these facts, National Union acted unreasonably by refusing to take over the defense or approve the reasonable settlement, knowing full well of its obligations under California law.

Conclusion

This is a breach of the covenant of good faith and fair dealing case. National Union—faced with a settlement that was fair, reasonable, and in good faith that required it to contribute money—refused to contribute, refused to take over the defense, and decided it was best to await suit from its insured. The suit resulted in a multimillion dollar judgment against National Union. National Union asked the Ninth Circuit to change California law and find it had the unquestioned right to require approval of any settlement. Its attempt was a failure because its actions were in bad faith. It could have saved multiple millions by taking over the defense or contributing to the insurance settlement. It did neither.

© 2017 Barry Zalma, Esq., CFE


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