Does an insurer’s defense of its insured under one policy excuse its breach of the duty to defend under another?  A California Court of Appeal recently concluded:  Not if the insured is potentially liable for an amount in excess of the policy limits.  Risely v. Interins. Exch. of the Auto. Club, 183 Cal. App. 4th 196 (2010).

In Risely, the insurer (Auto Club) issued its insured (Turner) two policies:  (1) an automobile policy with a limit of $50,000; and (2) a homeowner’s policy with a limit of $300,000.  Turner was sued for false imprisonment, among other claims, after he refused to allow the plaintiff (Risely) out of his car.  Turner tendered the defense of the action to Auto Club.  Auto Club defended Turner under the auto policy, which did not cover claims for false imprisonment.  But Auto Club denied coverage and refused to defend under the homeowner’s policy, even though that policy expressly covered claims for false imprisonment. 

Risely offered to settle for $300,000, within the limits of Turner’s homeowner’s policy.  Auto Club rejected the settlement demand.  Turner then agreed to entry of a stipulated judgment against him in the amount of $434,000 in exchange for a covenant not to execute from Risely.  Turner assigned to Risely his claims for breach of contract and bad faith against Auto Club.  Risely then sued Auto Club.

Auto Club moved for summary judgment, contending that it was not liable for the settlement because it did not consent to it.  Auto Club did not dispute that it breached its duty to defend under the homeowner’s policy and acknowledged that a non-defending insurer may be liable for a settlement, including a stipulated judgment, to which it did not consent.  See Pruyn v. Agricultural Ins. Co., 36 Cal. App. 4th 500 515-516 (1995); Diamond Heights Homeowners Assn. v. Nat’l American Ins. Co., 227 Cal. App. 3d 563, 581 (1991).  But Auto Club argued that Turner suffered no damages as a result its refusal to defend under the homeowner’s policy because it had provided a full defense under the auto policy.  Since its breach of the homeowner’s policy “was of no consequence,” its consent to the settlement was still required.

To support its argument that its consent to the settlement was required despite its breach, Auto Club relied on Hamilton v. Maryland Casualty Company, 27 Cal. 4th 718 (2002) and Ceresino v. Fire Insurance Exchange, 215 Cal. App. 3d 814 (1989).  Hamilton held that an insured’s settlement of the underlying case, without the consent of a defending insurer, cannot be used in a subsequent coverage action as evidence of the existence or amount of the insured’s liability.  Ceresino held that one insurer’s failure to defend “was of no consequence” if another insurer had provided the insured with a defense.  According to Auto Club, Hamilton prevented Risely from using the stipulated judgment to prove that its breach of the homeowner’s policy damaged Turner because it defended the underlying case, if only under the auto policy.  And in any event, under Ceresino, Auto Club’s defense under the auto policy shielded it from liability for its breach of the homeowner’s policy.

The trial court agreed and granted Auto Club’s summary judgment motion.  It concluded that Turner had not been damaged by Auto Club’s breach of the homeowner’s policy for two reasons.  First, Turner was not forced to settle because he faced the prospect of financing his own defense – he was receiving a full defense under the auto policy.  Second, there was no need to resolve the underlying case by way of stipulated judgment to protect Turner from excess-of-limits liability.  Had Risely obtained an adjudicated judgment against Turner, she could have then sued Auto Club directly for the full amount of the judgment, even if in excess of policy limits, assuming that Auto Club’s denial of coverage under the homeowner’s policy was wrongful.

The Court of Appeal reversed, holding that “the mere fact that an insured did not incur defense costs does not necessarily demonstrate that the insured was not damaged.”  The Court of Appeal found that “an insured can demonstrate that he has suffered damages from an insurer’s breach of the duty to defend, apart from defense costs, in the form of exposure to personal liability.”  Here, assuming that the homeowner’s policy provided indemnity coverage, Auto Club’s breach of the duty to defend “denied Turner his right to have Auto Club accept a reasonable settlement demand of the claim within the limits of the homeowner’s policy” and thus “exposed Turner to a greater potential for personal liability.”  As a result, Auto Club failed to establish, as a matter of law, that its breach of the duty to defend had not damaged Turner.

The Court of Appeal distinguished Hamilton and Ceresino, the two cases on which Auto Club had relied.  The insurer in Hamilton, unlike Auto Club, had defended under all policies and thus properly could contend that its consent to any settlement was required.  In Ceresino, the non-defending insurer had obtained a ruling that the claims asserted against its insured were not covered by the policy, and Auto Club had obtained no such ruling. 

The Court of Appeal analogized Auto Club’s conduct to that of the insurer in Wint v. Fidelity & Casualty Company, 9 Cal. 3d 257 (1973).  In Wint, an insurer with $100,000 in limits wrongfully refused to defend its insured, while another insurer with $10,000 in limits provided a defense.  The Wint court held the non-defending insurer liable for a stipulated judgment because “where more than one insurer owes a duty to defend, a defense by one constitutes no excuse of the failure of any other insurer to perform.”  The Risely court saw no difference between the situation in which one insurer refuses to defend while another provides a defense and Auto Club’s decision to defend under one policy and not another.

Auto Club’s conduct must have troubled the Risely court.  Auto Club clearly was angling to avoid providing coverage under the homeowner’s policy, which happened to have a limit six times greater than that of the auto policy.  Its conduct appears all the more audacious in light of the fact that the auto policy did not cover false imprisonment claims, whereas the homeowner’s policy did.

Even if Auto Club’s conduct was a bit extraordinary, Risely is significant for insureds.  Risely reinforces the rule that an insurer’s breach of its duty to defend may result in harm beyond its mere failure to pay defense costs.  A defending insurer takes on the risk of an excess-of-limits judgment when it refuses to accept a reasonable settlement demand within the policy limits.  As Risely shows, when the insured has another source from which to pay its defense costs, an insurer cannot avoid the risk of excess-of-limits liability simply by refusing to defend.  It must defend and consent to a reasonable settlement within limits.  This gives insureds some additional security in knowing that accepting a defense from one insurance source will not compromise their rights to another.