Introduction

An insurer’s duty to settle is well recognized in California law.[1] The duty to settle arises from the implied covenant of good faith and fair dealing, not from an express contractual promise to settle. An insurer that refuses to settle because it believes that it has no coverage does to at its own risk. Even a reasonable believe that an insurer has no coverage provides no defense to bad faith liability for a failure to settle. However, an insure that declines a settlement offer on the perceived merits of the claim is subject to the prudent insurer standard.

The insurer has an affirmative obligation to investigate the merits of a claim, evaluate whether the policyholder may be exposed to excess liability and advise the policyholder.

No Contractual Promise to Settle

A typical liability insurance policy makes no express contractual promise to settle.[2] Accordingly, insurers usually have only the discretionary right, but no express contractual obligation to settle.

Statutory Obligation to Settle

It is an unfair business practices for a liability insurer to fail to attempt “in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear”, to fail “to settle under one portion of the policy in order to influence settlements under other portions of the policy”, or to fail “to provide promptly a reasonable explanation of the basis relied on in the insurance policy, in relation to the facts or applicable law, for the denial of a claim or for the offer of a compromise settlement.”[3] Insurance regulations require that “every insurer shall immediately accept or deny the claim, in whole or in part in writing and [explain] the factual and legal bases for denial. No insurer shall delay settlement on the basis that responsibility should be assumed by others [nor make] a settlement offer that is unreasonably low. Upon acceptance of the claim every insurer shall immediately tender payment.”[4]

Implied Duty to Settle

The duty to settle arises from the implied covenant of good faith and fair dealing, which obligates the insurer to accept reasonable settlement demands within policy limits in order to avoid exposing its policyholder to personal liability in excess of those limits. “[T]he implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty. The insurer must take into account the interest of the insured and give it at least as much consideration as it does to its own interest.¶ The insurer should not be permitted to profit by its own wrong. ¶ [A]n insurer, who wrongfully refuses to accept a reasonable settlement within the policy limits is liable for the entire judgment against the insured even if it exceeds the policy limits.”[5] The rationale for this duty is two fold. First, the duty arises because of conflicts of interest between the insurer and the policyholder that inevitably result when the injured party offers to settle within the policy limits. “When an offer is made to settle a claim in excess of policy limits for an amount within policy limits, a genuine and immediate conflict of interest arises between carrier and assured.”[6] Second, the duty arises because the insurer’s right to control the defense implies an obligation to avoid exposing the policyholder to a substantial risk of excess liability. “Thus the assured may find himself and his goods in the position of a passenger on a voyage to an unknown destination on a vessel under the exclusive management of the crew.”[7]

Elements of a Proper Policy Limit Settlement Offer

California courts have identified several required prerequisites of a proper policy limit offer to settle.

Clear Terms

“The offer satisfies this first element if (1) its terms are clear enough to have created an enforceable contract resolving all claims had it been accepted by the insurer.”[8]

All Claimants

“(2) all of the third party claimants have joined in the demand.”[9]

Complete Release

“(3) it provides for a complete release of all insureds.”[10]

Adequate Opportunity to Investigate

“(4) the time provided for acceptance did not deprive the insurer of an adequate opportunity to investigate and evaluate its insured’s exposure. . . . ‘Had the company needed more time for investigation, for a good faith assessment of the claim’s value or for consultation with its policyholder, it might have chosen neither to accept nor reject her offer, but rather to suggest additional time.’”[11]

Reasonable

“An insured’s claim for bad faith based on an alleged wrongful refusal to settle first requires proof the third party made a reasonable offer to settle the claims against the insured for an amount within the policy limits.”[12] “In short, so long as insurers are not subject to a strict liability standard, there is still room for an honest, innocent mistake.”[13]

Policyholder’s Compliance With Claim Procedure

“More particularly, without actual presentation of a claim by the insured in compliance with claims procedures contained in the policy, there is no duty imposed on the insurer to investigate the claim.”[14]

Same Standard for First and Third Party Claims

“[T]he controlling principles have equal applicability [to first and third party claims.] Although the question whether an insurer failed to accept a reasonable settlement offer within policy limits of a third party claim against its insured is analytically distinct from the question whether an insurer unreasonably withheld benefits due under the policy in a first party coverage context, both turn on the reasonableness of the insurer’s position.”[15]

Third Party Claimant’s Offer to Settle

“An insurer’s duty to settle is not precipitated solely by the likelihood of an excess judgment against the insured. 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.”[16] “For bad faith liability to attach to an insurer’s failure to pursue settlement discussions, in a case where the insured is exposed to a judgment beyond policy limits, there must be, at a minimum, some evidence either that the injured party has communicated to the insurer an interest in settlement, or some other circumstance demonstrating the insurer knew that settlement within policy limits could feasibly be negotiated. In the absence of such evidence, or evidence the insurer by its conduct has actively foreclosed the possibility of settlement, there is no “opportunity to settle” that an insurer may be taxed with ignoring.”[17]

Insurer Not Required to Initiate Settlement Offer

“An insured’s claim for ‘wrongful refusal to settle’ cannot be based on his or her insurer’s failure to initiate settlement overtures with the injured third party, but instead requires proof the third party made a reasonable offer to settle the claims against the insured for an amount within the policy limits. We conclude there is no substantial evidence [the underlying plaintiff] ever offered to settle her claims against [the policyholder] for an amount within [the policyholder]’s policy limits.[18]

Coverage Questions Is No Defense

“An insurer who denies coverage does so at its own risk. [A]n insurer’s ‘good faith,’ though erroneous, belief in noncoverage affords no defense. Such factors as a belief that the policy does not provide coverage, should not affect a decision as to whether the settlement offer in question is a reasonable one.”[19] Thus, if an insurer refuses to settle because it prudently believed that the offer was not reasonable and because it denies coverage, the at-your-own-risk standard should by applied.

Two Standards

“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.’ It has been noted, however, that these cases address the reasonableness of the insurer’s refusal to settle based on a dispute as to the value of the case, not a dispute as to coverage. Although an insurer may reasonably underestimate the value of a case, and thus refuse settlement, an insurer does not act reasonably in using its no-coverage position to refuse settlement altogether.”[20]

At Your Own Risk Standard

An insurer which rejects a reasonable policy limits offer on the ground of no coverage, does so “at its own risk.” If coverage is ultimately found to exist, it will be liable for the full amount of any ensuing judgment whether its decision to refuse to settle was objectively “reasonable” or not.[21] Thus, as a rule, an insurer which fails to settle within policy limits because it denies coverage may prevail in a subsequent bad faith suit only be establishing that it does not in fact have any coverage.

Prudent Insurer Standard

An alternative to the “at its own risk” standard is the “prudent insurer” standard. If an insurer fails to settle on the ground that the offer is not reasonable, the insurer which fails to settle may defend a subsequent bad faith case hoping to convince a jury that it acted as a “prudent insurer” should have acted in refusing to settle.[22] However, most reported opinions come very close to imposing an “absolute” obligation to accept a reasonable settlement offer.[23]

“In deciding whether the insurer’s refusal to settle constitutes a breach of its duty to exercise good faith, the following factors should be considered: the strength of the injured claimant’s case on the issues of liability and damages; attempts by the insurer to induce the insured to contribute to a settlement; failure of the insurer to properly investigate the circumstances so as to ascertain the evidence against the insured; the insurer’s rejection of advice of its own attorney or agent; failure of the insurer to inform the insured of a compromise offer; the amount of financial risk to which each party is exposed in the event of a refusal to settle; the fault of the insured in inducing the insurer’s rejection of the compromise offer by misleading it as to the facts; and any other factors tending to establish or negate bad faith on the part of the insurer.”[24]

“California courts look to the following criteria in deciding whether an insurer has struck an improper balance of its own and its insured’s interests: the strength of the injured claimant’s case on the issues of liability and damages; attempts by the insurer to induce the insured to contribute to a settlement; failure of the insured to properly investigate the circumstances so as to ascertain the evidence against the insured; the insurer’s rejection of advice of its own attorney or agent; failure of the insurer to inform the insured of a compromise offer; the amount of financial risk to which each party is exposed in the event of a refusal to settle; the fault of the insured in inducing the insurer’s rejection of the compromise offer by misleading it as to the facts; and any other factors tending to establish or negate bad faith on the part of the insurer.”[25]

At-Your-Own-Risk Standard Trumps the Prudent Insurer Standard

In one reported opinion, the Court of Appeal rejected numerous mitigation arguments by an insurer that refused to settle, including the following: 1) Having refused to settle on the ground of no coverage, the insurer was not allowed to defend itself against its failure to settle on the ground that the settlement offer was not reasonable; 2) A judgment in excess of policy limits alone justifies a conclusion that the value of the claim is the amount of the judgment; 3) Even absent an excess judgment, an insurer may be liable for other consequential damages caused by its failure to settle.

The insurer claims “that the settlement demands were excessive because the ultimate judgment was not likely to exceed the amount of the settlement offer. This is a difficult argument to make where, as here, the ultimate judgment did exceed the amount of the settlement offer. The size of the judgment recovered in [the liability] action furnishes an inference that the value of the claim is the equivalent of the amount of the judgment. Of course, the finder of fact must take into account that information available to the insurer at the time of the proposed settlement. ¶ [The insurer] argues that [the injured party]’s settlement demand seemed excessive at the time it was made and notes that the [the policyholder]’s defense counsel in the underlying case never valued [the injured party]’s case above $1 million [notwithstanding] a verdict range from $150,000 to $10 million. Counsel gave his estimated value of the [liability] case with the cautionary note that ‘[t]hese cases are difficult to evaluate.’ Others involved in the litigation warned [similar] cases could subject a [policyholder] to substantial jury verdicts. Substantial evidence supports the trial court’s finding that [the injured party] made a reasonable settlement offer in asking for $1.85 million and that the ultimate judgment was likely to exceed the amount of the settlement offer, which it did. ¶ Moreover, there is no evidence that [the insurer] ever relied on defense counsel’s valuation of the case in refusing to settle. [The insurer]’s position was that there was no coverage under its insurance policy, and thus it would contribute little or nothing in settlement, regardless of the reasonableness of the amount of the proposed settlement. Therefore, if [the insurer] means to suggest that it acted in good faith reliance on advice of counsel, the suggestion is refuted by the record. [The insurer] refused to settle because it claimed the [policyholder’s act] was not covered by its policy. Having taken that position and then rejecting a reasonable settlement offer, [the insurer] is liable for wrongful failure to settle. ¶ Although an excess judgment is the common way in which an insured establishes liability and damages in a failure to settle case, it is not the only way. ¶ An insurer’s wrongful failure to settle may be actionable even without rendition of an excess judgment. ¶ Damages were established by evidence that [the policyholder] suffered consequential damages. [The policyholder] was exposed to dire financial circumstances as a direct result of [the insurer]’s failure to defend, indemnify, or settle [the injured party]’s claim. The [the policyholder] did not have access to insurance funds for indemnification sufficient to satisfy the judgment. The [the policyholder] was forced to reach his own settlement with the [the injured parties], while the case was on appeal. The [policyholder] suffered damages from [the insurer]’s misconduct, including payments the [the policyholder] made to settle the case, and postjudgment attorney fee and accounting expenses incurred to protect his interests. The trial court properly found that [the insurer] breached its duty to settle.”[26]

Duty to Investigate and Advise Policyholder of Excess Exposure

“It is the duty of the insurer to keep the insured informed of settlement offers.”[27] “In addition to other obligations, the covenant to exercise good faith imposes upon the insurer the duty to communicate to the insured the results of any investigation indicating liability in excess of policy limits, and any offers of settlement which have been made, so that he may take proper steps to protect his own interest.[28] “The company, having the right to select counsel to defend the insured, had the duty to communicate to him the results of any investigation indicating liability in excess of policy limits, and any offers of settlement which were made, so that he might take proper steps to protect his own interest.”[29]

Damages

“Although an excess judgment is the common way in which an insured establishes liability and damages in a failure to settle case, it is not the only way. ¶ An insurer’s wrongful failure to settle may be actionable even without rendition of an excess judgment. An insured may recover for bad faith failure to settle, despite the lack of an excess judgment, where the insurer’s misconduct goes beyond a simple failure to settle within policy limits or the insured suffers consequential damages apart from an excess judgment.”[30]

Policyholder Need Not Contribute to Settlement

An insurer may not coerce its policyholder to contribute to a settlement to avoid a punitive damage award. “We conclude that an insurer potentially can be liable for unreasonably coercing an insured to contribute to a settlement fund.”[31]

Practice Pointer

Because there are two standards governing an insurer bad faith liability, it is important for both the plaintiff and defendant to elicit information from the insurer(s) why it may not settle.[32]

^[1] “We need not rehash the well-settled rules of bad faith liability for the refusal . . . to settle a case.” (Boicourt v. Amex Assur. Co. (2000) 78 Cal.App.4th 1390, 1394.)

^[2] Typical language is: “We may, at our discretion, investigate any ‘occurrence’ and settle any claim or ‘suit’ that may result.”

^[3] Ins. Code § 790.03(h)(5)(12)(13) (ellipses omitted) (http://www.leginfo.ca.gov/cgi-bin/displaycode?section=ins&group=00001-01000&file=790-790.15).

^[4] Cal. Code Regs § 2695.7(b)(d)(e)(g)(h) (ellipses omitted). (http://www.insurance.ca.gov/01-consumers/130-laws-regs-hearings/05-CCR/fair-claims-regs.cfm

^[5] Comunale v. Traders & Gen. Ins. Co. (1958) 50 Cal.2d 654, 659-61 (ellipses omitted).)

^[6] Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 870.

^[7] Ibid.

^[8] Graciano v. Mercury General Corp. (2014) 231 Cal.App.4th 414, 425 (Graciano).

^[9] Ibid.

^[10] Ibid.

^[11] Id. at 425-26 quoting Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425, 433 (Crisci).

^[12] Id. at 425.

^[13] Walbrook Ins. Co. Ltd. v. Liberty Mut. Ins. Co. (1992) 5 Cal.App.4th 1445, 1460.

^[14] California Shoppers, Inc. v. Royal Globe Ins. Co. (1985) 175 Cal.App.3d 1, 57; see also, Safeco Ins. Co. of America v. Parks (2009) 170 Cal.App.4th 992, 1003; Graciano, supra, 231 Cal.App.4th at 431.

^[15] Graciano, supra, 231 Cal.App.4th at 425, fn.9 (citation and quotation marks omitted).

^[16] Reid v. Mercury Ins. Co. (2013) 220 Cal.App.4th 262, 266.

^[17] Id. at 272.

^[18] Graciano, supra, 231 Cal.App.4th at 427 (citations and ellipses omitted, emphasis original).)

^[19] Johansen v. California State Auto. Assn. Inter-Ins. Bureau (1975) 15 Cal.3d 9, 15-16 (Johansen) (citations and ellipses omitted).

^[20] Howard vs. American National Fire Ins. Co. (2010) 187 Cal.App.4th 498, 529 (Howard) (citations omitted).

^[21] “[A]n 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. [fn.5: Although defendant asserts that its liability can only be predicated on a finding of specific instances of reprehensible conduct, we rejected this very contention in Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425, 430: ‘Liability is imposed not for bad faith breach of contract but for the failure to meet the duty to accept reasonable settlements, a duty included within the implied covenant of good faith and fair dealing. Moreover, . . . recovery may be based on unwarranted rejection of a reasonable settlement offer and . . . the absence of evidence, circumstantial or direct, showing actual dishonesty, fraud or concealment is not fatal to the cause of action.’” (Johansen, supra 15 Cal.3d at 16, fn.5.)

^[22] “In determining whether an insurer has given consideration to the interests of the insured, the test is whether a prudent insurer without policy limits would have accepted the settlement offer.” (Crisci, supra, 66 Cal.2d at 429.

^[23] “[A]n insurer should not be permitted to further its own interests by rejecting opportunities to settle within the policy limits unless it is also willing to absorb losses which may result from its failure to settle.” (Crisci, supra, 66 Cal.2d at 431.) “[T]here is more than a small amount of elementary justice in a rule that would require that, in this situation where the insurer’s and insured’s interests necessarily conflict, the insurer, which may reap the benefits of its determination not to settle, should also suffer the detriments of its decision.” (Ibid.)

^[24] Brown v. Guarantee Ins. Co. (1957) 155 Cal.App.2d 679, 689.

^[25] Allen v. Allstate Ins. Co. (9th Cir. 1981) 656 F.2d 487, 489 (applying Calif. law).

^[26] Howard, supra, 187 Cal.App.4th at 525-28 (citations, quotation marks and ellipses omitted).

^[27] Kinder v. Western Pioneer Ins. Co. (1965) 231 Cal.App.2d 894, 901.

^[28] Davy v. Public National Ins. Co. (1960) 181 Cal.App.2d 387, 396; see also, Ivy v. Pacific Automobile Ins. Co. (1958) 156 Cal. App.2d 652, 660.

^[29] Martin v. Hartford Accident & Indem. Co. (1964) 228 Cal.App.2d 178, 183-4.

^[30] Howard, supra, 187 Cal.App.4th at 527 (ellipses omitted); see also, Croskey et al., Cal. Practice Guide: Insurance Litigation (The Rutter Group 2014) ¶¶ 12:391 to 12:391.2; Camelot by the Bay Condominium Owners’ Assn. v. Scottsdale Ins. Co. (1994) 27 Cal.App.4th 33, 48; Larraburu Brothers, Inc. v. Royal Indemnity Co. (9th Cir. 1979) 604 F.2d 1208, 1214; J.B. Aguerre, Inc. v. American Guar. & Liab. Ins. Co. (1997) 59 Cal.App.4th 6, 13-14 (Aguerre); Bodenhamer v. Superior Court (1987) 192 Cal.App.3d 1472, 1478-1479; Barney v. Aetna Casualty & Surety Co. (1986) 185 Cal.App.3d 966, 978.

^[31] Aguerre, supra, 59 Cal.App.4th at 15.

^[32] Policy Limit Settlement Offer Made Properly; “Upon receiving any communication from a claimant, regarding a claim, that reasonably suggests that a response is expected, every [insurer] shall immediately, but in no event more than fifteen (15) calendar days after receipt of that communication, furnish the claimant with a complete response based on the facts as then known by the [insurer].” (Cal. Code Regs. § 2695.5(b).) “[E]very insurer shall immediately, but in no event more than forty (40) calendar days later, accept or deny the claim, in whole or in part. Where an insurer denies or rejects a claim, in whole or in part, it shall do so in writing and shall provide to the claimant a statement listing all bases for such rejection or denial and the factual and legal bases for each reason given for such rejection or denial which is then within the insurer’s knowledge. Where an insurer’s denial of a claim, in whole or in part, is based on a specific policy provision, condition or exclusion, the written denial shall include reference thereto and provide an explanation of the application of the provision, condition or exclusion to the claim.” (Cal. Code Regs. §2695.7(b)(1) (ellipses omitted).)