Dilution: Plaintiff’s Monetary Curse – PP

 

INTRODUCTION

Doubtfully insured litigation threatens to reduce significantly the net recovery collected by a deserving victim, and by extension, diminish confidence in our judicial system. Multiple lawsuits means multiple attorneys fees which often dilutes the actual collected recovery by the victim. The impact of dilution may be illustrated by a series of hypothetical examples. Each example assumes that a victim wins a $1 million civil judgment against an impecunious defendant with doubtful insurance coverage and hires multiple lawyers for multiple lawsuits agreeing to pay 40% of money actually collected. If the defendant had assured liability coverage of $1M, the plaintiff would expect a net recovery of $600k. In the examples below, the plaintiff recovers as little as $0. In all of the examples below, the plaintiff recovers of less than $600k, even though the insurer pays as much as $1.5M.

THE PURPOSE OF CIVIL JUSTICE

Civil litigation is almost always about money. Liability insurance serves three beneficiaries in this arena: the policyholder, the plaintiff and the judicial system. The promise to defend protects the policyholder from false and inflated claims, while the promise to indemnify relieves the insured from the financial ruin of a large adverse judgment. The plaintiff benefits by a reliable source of collection for a genuine loss. Civilized society generally and the courts specifically benefit when victims may reasonably expect to actually collect the dollar value of the loss and associated expenses, and therefore elect to trust the judicial process, in lieu of the rough street justice. But doubtfully insured civil litigation threatens these expectations where victims must prosecute multiple lawsuits and pay multiple attorney fees, producing a disheartening outcome with little for the plaintiff to put in the bank.

CONTINGENT – PERCENTAGE RETAINER

Contingent fee agreements give indigent victims a realistic hope to sue and collect for a genuine loss.[1] Contingent fees reward the lawyer for four services: 1) successful legal work; 2) deferred recovery; 3) financing the lawsuit; and 4) accepting the risk of collection. Therefore, contingent fee may be higher than those calculated by other measures and are often measured as a percentage of sums actually collected.[2]

ASSIGNMENT WITH COVENANT NOT TO EXECUTE

Even an impecunious defendant may have a valuable asset in legal rights against a defaulting insurer. The policyholder may properly sell some of these rights to the plaintiff and often does in exchange for a covenant not to execute.[3] The plaintiff receives an opportunity to collect more than the amount of the judgment and gives the policyholder immunity that the plaintiff will not collect from any other assets owned by the defendant. The plaintiff and policyholder may properly cooperate to achieve their shared goals.[4] An assignment does not normally violate the cooperation clause of the policy.[5] The law permits the parties to strike this bargain even though it may represent of reversal of alliances.[6]

If emotions run high between the plaintiff and defendant, negotiating an assignment may be difficult.[7] But often, the plaintiff and the policyholder need each other. The plaintiff may not avoid painful dilution without acquiring the policyholder’s rights to recover more than the amount of the judgment from the insurer. The defendant may not get out from under a crushing judgment without a covenant not to execute. If the policyholder is seriously contemplating bankruptcy to avoid the judgment, the insurer is likely to be the beneficiary. In bankruptcy, a trustee will control the policyholder’s rights against the insurer who may choose to compromise them without regard to the loss suffered by the plaintiff or the policyholder.

EXAMPLES OF DILUTION

            # 1: Plaintiff Wins vs. Defendant – Nets $0

The plaintiff hires lawyer-1 who financed the lawsuit, won a $1M judgment, and suffered delayed recovery, but receives nothing because the defendant is poor. The plaintiff and lawyer-1 suffer a pyrrhic victory, recovering a paper win but collecting no cash.

The math: Lawyer-1 and the plaintiff collect nothing.

#2: Plaintiff Wins vs. Insurer – Nets $360k, not $600k

A plaintiff with a $1M judgment for bodily injury or property damage, may sue the insurer for the amount of the judgment under the direct action statute.[8] With limited exceptions, a winning plaintiff may collect the amount of the judgment, but no more. The plaintiff hires lawyer-2 who financed the coverage lawsuit, won a second judgment against the insurer, suffered delayed recovery, and collects from the insurer.

The math: Lawyer-2 has earned 40% of the $1M judgment collected, or $400k. The plaintiff’s share is 60%, or $600k. But this $600k sum must be split with lawyer-1, who has earned 40%, or $240k. By dilution, the plaintiff nets $360k, not $600k. Depending on the language of the retainer agreement, lawyer-1 may claim a fee of 40% of full $1M collected, leading to further dilution, netting only $200k, not $360k, nor $600k.  Expressed as a percentage, the plaintiff collects 24% of the $1.M paid by the insurer after paying two lawyers.

            #3: Policyholder Wins vs. Insurer – Nets $540k

A defendant who suffered a doubtfully insured, unpaid $1M judgment may sue the insurer by hiring lawyer-3. The policyholder may recover a lot more money that the plaintiff can: the amount of the judgment, the costs of defense, emotional distress, punitive damages, and maybe more. The plaintiff may impose a lien on the defendant’s lawsuit against the insurer. This lien bars enforcement of any settlement or judgment,[9] under penalty that a judgment may be entered against the party who fails to honor the lien.[10] The lien may create a disincentive for the defendant to prosecute an action against the insurer, since the plaintiff will likely be the primary or only beneficiary of favorable result. Still, the policyholder’s attorney may enforce an attorney’s lien on a settlement or judgment which is superior to the judgment creditor’s lien.[11] Assume that the policyholder wins $1.5M through lawyer-3.

The math: Lawyer-3 has earned 40% of the $1.5M collected, or $600k, leaving $900k for the plaintiff, who must share it with lawyer-1 who has earned 40% of the $900k, or $360. This leaves $540k for the plaintiff, a sum approaching the expected $600k. Expressed as a percentage, the plaintiff collects 36% of the $1.5M paid by the insurer after paying two lawyers.

#4: Both Plaintiff and Policyholder Win vs. the Insurer – $380k

If the plaintiff and the policyholder fail to negotiate an assignment and covenant not to execute, each may choose the hire separate counsel to sue the insurer, leading to the risk of further dilution. Assume that the plaintiff wins $1M through lawyer-2 and the policyholder wins another $500k through lawyer-3. Like in example #3, the total recovery is $1.5M.

The math:

Lawyer-3 has earned 40% of the $500k collected, or $200k. This leaves $300k for the plaintiff, who must share it with lawyer-1 who has earned 40% of the $300k, or $120k.

Lawyer-2 has earned 40% of the entire $1.5M collected, or $600k.

Lawyer-1 has earned 40% of the $1M judgment against the defendant which has now been collected, which is $400k.

The total recovery of $1.5M is thus diluted by lawyer-1’s $400k, lawyer-2’s $600k and lawyer-3’s $200k, for a total of $1.2M. This leaves a net recovery paid to the plaintiff of $300k. This sum represents a reduction of $200k from example #3, due to triple dilution. Expressed as a percentage, the plaintiff collects 20% of the $1.5M paid by the insurer after paying three lawyers.

LESSONS

1.   Winning a judgment against an impecunious defendant with doubtful insurance coverage yields $0.

2.   If the plaintiff wins a suit under the direct action statute, double dilution may reduce the net recovery from 60% to 36%.

3.   Because the policyholder may recover more categories of damage from a defaulting insurer, a plaintiff’s net recovery may be reduced from 60% to 54%, despite double dilution.

4.   If both the plaintiff and the policyholder sue the insurer, triple dilution may reduce the plaintiff’s net recovery from 60% to 38%.



[1] “The client may and often is very likely to be a person of limited means for whom the contingent fee arrangement offers the only realistic hope of establishing a legal claim.” (Fracasse v. Brent (1972) 6 Cal.3d 784, 792.)

[2] “A contingent fee must be higher than a fee for the same legal services paid as they are performed. The contingent fee compensates the lawyer not only for the legal services he renders but for the loan of those services. The implicit interest rate on such a loan is higher because the risk of default (the loss of the case, which cancels the debt of the client to the lawyer) is much higher than that of conventional loans. A lawyer who both bears the risk of not being paid and provides legal services is not receiving the fair market value of his work if he is paid only for the second of these functions. If he is paid no more, competent counsel will be reluctant to accept fee award cases. Such fee enhancements are intended to compensate for the risk of loss generally in contingency cases as a class.” (Ketchum v. Moses (2001) 24 Cal.4th 1122 1132-1133 (citations, quotation marks and ellipses omitted).

[3] See, Article: Assignment of Policyholder’s Claims to a Plaintiff. The policyholder’s rights to recover for emotional distress and punitive damages are not assignable.

[4] See, Article: Cooperation: A Strategic Choice.

[5] “The requirement of cooperation by the policyholder assumes that the insurer has complied in good faith with the conditions of the policy.” (Critz v. Farmers Ins. Group (1964) 230 Cal.App.2d 788, 801.)

[6] “As a potential target of personal liability exceeding the policy limit, his defensive interests were closely allied with the insurer’s. Having executed an assignment, he may relax into neutrality or even smile benevolently upon the plaintiff’s efforts.” (Ibid. (emphasis added, ellipses omitted).)

[7] See, Article: Prize: Price or Pride.

[8] See, Article: Direct Action Statute.

[9] “A judgment creditor who has a money judgment against a judgment debtor who is a party to a pending action may obtain a lien [and give notice] that no compromise, dismissal, settlement, or satisfaction of the pending action may be entered [without] prior approval by order of the court[,] The written consent of the judgment creditor[, or] [t]he money judgment of the judgment creditor has been satisfied. [U]nless the judgment creditor’s money judgment is first satisfied or the lien is released, the judgment recovered in the action in favor of the judgment debtor may not be enforced.” (Cd. Civ. Proc. §708.410, §708.440 (ellipses omitted).)

[10] “[T]he court shall render judgment against the party.” (Cd. Civ. Proc. §708.470 (ellipses omitted).)

[11] See, Article: Attorney’s Liens.

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