MEMORANDUM OF LAW

FAVORABLE EVIDENTIARY

PRESUMPTIONS FROM SETTLEMENT

INTRODUCTION

If a plaintiff and an insured defendant settle their liability dispute without the consent of the defendant's insurer:1

1) they may not enforce an unadjudicated settlement against a performing insurer at all;

2) a mere agreement that the policyholder is liable to the plaintiff in a specified amount may be entitled to a rebuttable presumption2 that is vulnerable to the insurer's defense that the settlement was not reasonable or was collusive;3 and

3) an agreement to adjudicate the issues of the policyholder's liability and the amount of the plaintiff's damages may be entitled to a conclusive presumption of the policyholder's liability and the amount of the plaintiff's damages.4

Due process of law, statutes, and typical contractual terms require that the issues of the policyholder's liability and amount of the plaintiff's damages be adjudicated. Settling parties who adjudicate liability and damages in the liability dispute may do so in the absence of the defaulting insurer, while those who defer an adjudication of liability and damages must resist the defaulting insurer's collusion defense.5

THE NATURE OF INDEMNITY

Liability insurance is a form in indemnity6 that matures upon the indemnitee becoming liable to the claimant in a fixed amount. In coverage litigation, the policyholder has the burden7 to establish that the policyholder is in fact "legally obligated" to pay the plaintiff damages in a sum certain.8 If these two prerequisites are shown, the insurer's promise to indemnify ripens.9 Paradoxically, the policyholder often resists liability and damages in a liability dispute but must embrace liability and damages in a coverage dispute.10

SETTLING PARTIES MAY NOT COLLECT

ANYTHING FROM A PERFORMING INSURER

"[A] defending insurer cannot be bound to a settlement to which it has not agreed and in which it has not participated, even where the settlement has been approved under Code of Civil Procedure, section 877.6. . . . [T]he claimant may not maintain an action for breach of the duty to settle because, in light of the settlement before trial and the covenant not to execute against the insured, the stipulated judgment is insufficient to prove that the insured suffered any damages from the insurer's breach of its settlement duty."11 "[W]here the insurer has accepted defense of the action, no trial has been held to determine the insured's liability, and a covenant not to execute excuses the insured from bearing any actual liability from the stipulated judgment, the entry of a stipulated judgment is insufficient to show, even rebuttably, that the insured has been injured to any extent by the failure to settle, much less in the amount of the stipulated judgment. In these circumstances, the judgment provides no reliable basis to establish damages resulting from a refusal to settle, an essential element of plaintiffs' cause of action."12

A performing insurer is not obligated to pay the amount of a stipulated judgment in excess of policy limits. "No decision we have found holds that a stipulated judgment in excess of the policy limits, for which the insured is relieved from personal liability by a covenant not to execute, may be deemed even a presumptive determination of the insured's damages in an action against a defending insurer for breach of its settlement duty. ¶ Finally, plaintiffs argue that if a bad faith action could be presumptively based on a stipulated judgment like the present one, an insurer would nonetheless be protected against unfair inflation of the stipulated judgment by its ability to litigate, in the bad faith action, both the question of its own breach and 'the amount of its policyholder's damages from that breach.' Whether plaintiffs envision litigating the reasonableness of the stipulated judgment, or litigating the insured's actual liability to the claimant, is unclear. If the former, we repeat that reasonableness of the stipulated figure is insufficient to show the insured's damages where the insured, by agreement with the claimant, does not bear any actual liability for the stipulated figure. If the latter, plaintiffs do not explain how holding a trial on the insured's underlying liability within the trial of the bad faith action offers any legitimate advantage over the Safeco approach of trying liability in the underlying case after the exchange of an assignment for a covenant not to execute. . . . [T]he trial-within-a-trial approach threatens to unfairly prejudice the insurer, since 'the issue of the insured's liability and insurance coverage will be combined in the action against the insurer.'"13

The result is that a settling plaintiff and policyholder may collect nothing from the performing insurer. "[T]he stipulated judgment is insufficient to prove that the insured suffered any damages from the insurer's breach of its settlement duty."14

SETTLING PARTIES MAY COLLECT FROM A DEFAULTING INSURER

An insurer that wrongfully fails to faithfully defend abandons its policyholder, who is then free to negotiate a settlement and collect from the defaulting insurer. "If, after request, the [insurer] neglects to defend the [policyholder], a recovery against the [policyholder] suffered by him in good faith, is conclusive in his favor against the [insurer]."15 "If an insurer, with notice of the pendency of the underlying action, wrongfully denies coverage or improperly refuses to provide its insured with a defense, then 'the insured is entitled to make a reasonable settlement of the claim in good faith and . . . then maintain an action against the insurer to recover the amount of the settlement.'"16

1.	An Adjudication May Produce a Conclusive Presumption

An abandoned policyholder who defends a liability lawsuit to judgment is entitled to a conclusive presumption in a subsequent coverage fight against the defaulting insurer. The plaintiff may also sue the insurer under the direct action statute.17 An independent adjudication satisfies the requirements of procedural due process in a manner that a mere settlement does not. An adjudication permits the courts to balance "meaningful protection to an insured who is abandoned by a liability insurer wrongfully denying coverage or refusing a defense and at the same time provide to the insurer some measure of procedural due process in order to protect against the consequences of a fraudulent or collusive settlement."18

The foundation for the conclusive presumption is statutory.19 An independent adjudication serves to both protect the defaulting insurer from fraud and to uphold the integrity of the judicial process by minimizing the risk that an unscrupulous plaintiff and policyholder could defraud either the insurer or the court.20 The foundational facts required to invoke the conclusive presumption are that: 1) the insurer was notified of the action;21 and 2) the insurer had a duty to defend.22 "The judgment recovered in such a case is the mode by which the insured proves to the insurer that the intrinsic character of the accident was such that he was liable for the consequences of it, and the judgment is conclusive evidence that the insured was liable, and to the extent of the amount of the judgment.23 A result of the conclusive presumption is that the insurer may not raise "collusion"24 as a defense. However, a judgment against the policyholder does not conclusively bind the insurer if the policyholder "had a good defense upon the merits, which by want of ordinary care he failed to establish in the action."25

2.	A Settlement May Produce a Rebuttable Presumption

"[I]f an insurer wrongfully fails to provide coverage or a defense, and the insured then settles the claim, the insured is given the benefit of an evidentiary presumption. In a later action against the insurer for reimbursement based on a breach of its contractual duty to defend the action, a reasonable settlement made by the insured to terminate the underlying claim against him may be used as presumptive evidence of the insured's liability on the underlying claim, and the amount of such liability."26

An abandoned policyholder is not required to take the plaintiff's lawsuit to trial, but is instead free to settle third party liability litigation with the benefit of a rebuttable presumption in a subsequent coverage fight.27 The rationale for this rule is twofold. First, when the insurer refuses to defend, the policyholder has no choice but to defend as best one can. As a result, the court will not hear a defaulting insurer to complain about the terms of a settlement which was occasioned by its breach.28 Second, an insurer that itself wrongfully fails to defend cannot rely upon contract terms that would otherwise confer upon it the exclusive right to settle.29

If an abandoned policyholder foregoes an adjudication of the plaintiff's lawsuit, a lesser, rebuttable evidentiary presumption may arise from a negotiated settlement. "[W]here there is no trial and no judgment establishing the liability of the insured, but a settlement of the litigation has been made, the question whether the liability of the insured was one which the contract of insurance covered is still open, as is also the question as to the fact of liability and the extent thereof, and these questions may be litigated and determined in the action brought by the insured to recover the amount so paid in settlement."30

"[W]hen . . . a liability insurer wrongfully denies coverage or refuses to provide a defense, then the insured is free to negotiate the best possible settlement consistent with his or her interests, including a stipulated judgment accompanied by a covenant not to execute. Such a settlement will raise an evidentiary presumption in favor of the insured (or the insured's assignee) with respect to the existence and amount of the insured's liability. The effect of such presumption is to shift the burden of proof to the insurer to prove that the settlement was unreasonable or the product of fraud or collusion. If the insurer is unable to meet that burden of proof then the stipulated judgment will be binding on the insurer."31

The rebuttable presumption applies to the burden of proof32 and the burden of producing evidence. "[T]he evidentiary presumption given to the insured . . . is one which affects the burden of proof [because the rule] is established in order 'to implement some public policy.'"33

To establish the foundational facts necessary to invoke a rebuttable presumption, the policyholder will have to prove that: "(1) the insurer wrongfully failed or refused to provide coverage or a defense, (2) the insured thereafter entered into a settlement of the litigation which was (3) reasonable in the sense that it reflected an informed and good faith effort by the insured to resolve the claim."34 If the policyholder establishes these foundational facts, then the burden shifts to the insurer.35 To invoke the presumption, the policyholder is not required to have paid the settlement.36 Also, the policyholder is not required to conduct a trial within a trial to establish liability or damages.37

A trial court ruling approving a settlement as being in good faith pursuant to Code Civ. Proc. § 877.6 does not alone entitle a settling policyholder to a conclusive presumption. "If there has already been a determination of good faith made under section 877.6, then that fact would itself be substantial evidence of reasonableness [of the settlement] and would be sufficient to satisfy the insured's prima facie burden."38 Otherwise, "[t]he insured can satisfy its prima facie burden of showing that the settlement was reasonable by presenting the same kind of evidence which would support a determination of good faith under section 877.6."39

"We agree with Pruyn. By presenting prima facie evidence that it reasonably settled, the insured may obtain the benefit of a presumption of liability and of its amount. Court approval of the settlement during section 877.6 proceedings would satisfy the insured's prima facie burden and provide evidentiary value in the ultimate resolution of the bona fides of the settlement. Where the insurer wrongfully abandoned the insured, the evidentiary presumption in favor of the settlement would shift the burden of proof to the insurer. [Precedence does] not directly license other litigants to use section 877.6 proceedings offensively to force insurers to participate in section 877.6 hearings and to bind them to determinations of good faith made in those hearings."40

PRESUMPTION OF REASONABLENESS OF COSTS OF DEFENSE

When "the insurer has breached its duty to defend, it is the insured that must carry the burden of proof on the existence and amount of [defense costs], which are then presumed to be reasonable and necessary as defense costs, and it is the insurer that must carry the burden of proof that they are in fact unreasonable or unnecessary."41

PRACTICE POINTERS

1. When a liability insurer is faithfully providing a defense to its policyholder, the plaintiff and the policyholder should not negotiate a settlement without the insurer's approval. Such a settlement will likely violate language of the policy, exonerating the insurer of liability.

2. When a liability insurer has refused to defend, the plaintiff and the abandoned policyholder may negotiate a settlement without the insurer's approval.

3. The terms of such a settlement should include an independent adjudication of the issues of the policyholder's liability and the amount of the plaintiff's damages. The policyholder should raise valid defenses in the adjudication.42 Such an adjudication will likely satisfy due process concerns and should be entitled to a conclusive presumption. The settlement should be approved pursuant to Code Civ. Proc. § 877.6. The adjudication may take any of several forms: 1) a jury trial; 2) a bench trial before a sitting judge; 3) a general reference by the judge to an impartial referee; 4) an arbitration. So as to avoid the appearance of fraud or collusion, such an adjudication should be reported, the insurer should be advised of the procedure selected and invited to participate, and the policyholder should assert valid defenses.

4. The terms of a bilateral settlement without an adjudication should be negotiated very carefully. Because such a settlement earns only a rebuttable presumption, the insurer will be free to attack the settlement as collusive. To minimize the appearance and reality of a collusive settlement the record should be clear that: 1) truthful evidence supports the policyholder's liability for insured wrongful conduct; 2) truthful evidence supports the amount of the plaintiff's damages; 3) the settling parties treated the insurer fairly throughout, including keeping the insurer informed and inviting the insurer to participate; 4) no legitimate defense should be neglected; 5) the settlement should be supervised by a retired judge with impeccable credentials; 6) the settlement should be approved pursuant to Code Civ. Proc. § 877.6; and 7) if the plaintiff intends to file under the direct action statute, a judgment should be entered.

5. A policyholder with uncertain liability insurance coverage who anticipates settlement should not assert a sham defense43 nor verify discovery denying liability, which liability must be confessed in a later coverage dispute.

6. No California reported opinions test how severe the insurer's failure to defend must be. When an insurer agrees to defend but then fails to promptly44 and adequately fund45 the defense, the insurer may or may not be in default of its duty to defend, impacting the policyholder's freedom to settle.