Published in the ABTL Report, Vol. 22, No. 3, Winter 2013.

Insurers and insureds have long disagreed whether an insurer’s duty to settle is limited to the duty to accept a reasonable settlement offer made by a plaintiff, or whether the insurer has a duty to affirmatively seek a settlement within limits.  This issue was recently addressed in Reid v Mercury Insurance Co., 220 Cal.App.4th 262 (2013).  In Reid, the insurer recognized shortly after the accident that the exposure exceeded the $100,000 policy limits, but decided it needed a witness interview and the claimant’s medical records before making a policy limits offer.  It requested this information, but didn’t tell the claimant it was considering a policy limits offer.  While the claimant later testified he would have accepted $100,000 to settle at that time, his counsel did not make a policy limits demand.  A few months later, after getting the medical information, the insurer offered policy limits,  which the claimant promptly rejected. The matter went to trial and judgment was entered for $5.9 million, forcing the insured into bankruptcy.  

The Court found the insurer was not liable for the judgment. The Court stated:
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. 

Id. at 266.

In reaching this conclusion, the court surveyed prior cases, and concluded that most of the prior cases treated the insurer’s obligation as a duty to accept a reasonable settlement, and that no conflict between insurer and insured arose until there was a demand within limits.

The Court did acknowledge that other California decisions have disagreed and “have found a conflict of interest can arise, and an insurer may be liable for bad faith refusal to settle, without a formal settlement offer.” Id. at 273. In one case, the insurer had an internal policy not to disclose limits, effectively foreclosing early settlements within limits. The court cited other cases were a formal settlement demand was not required, stating they “involved evidence the insurer knew of the claimant's interest in settlement, and the insurer has rejected or ignored the opportunity to negotiate a settlement.” Id. at 274. After reviewing these various cases, the Court concluded that liability could arise not only for failure to accept a reasonable settlement but also:

when a claimant clearly conveys to the insurer an interest in discussing settlement but the insurer ignores the opportunity to explore settlement possibilities to the insured's detriment, or when an insurer has an arbitrary rule or engages in other conduct that prevents settlement opportunities from arising.

Id. at 278.

This standard is much more favorable to insureds that the passive “duty to accept a settlement limit within limits” often advocated by insurers. If a claimant conveys an interest in discussing settlement, the insurer can breach its duty to its insured if “the insurer ignores the opportunity to explore settlement possibilities…” Id. Thus, if a plaintiff makes an above-limits demand, the insurer is now under an duty to explore whether it is possible to settle within limits by making a within-limits counter-offer. In addition, even if there is no demand from plaintiff, if plaintiff has given some indication of a willingness to consider settlement, that will also trigger an affirmative obligation on the insurer to pursue a settlement within limits.

This raises the question, of course, of what an insured can do to protect itself from excess exposure, in cases where the claimant has not made any unprompted indication of interest in settlement. That was the situation in Reid, and the insured suffered a $5.9 million judgment as a result, with no recourse against the insurer for the excess portion. The solution, of course, is for the insured, or his counsel, to explore that question directly with the claimant, and then to quickly advise the insurer if there has been any expression of interest in settlement by the claimant.

Interestingly, this highlights a conflict of interest which the court in Reid seems to have overlooked. The rule set out by Reid creates a potential conflict of interest because the insurer would prefer that the claimant not be contacted regarding its interest in settlement, since the absence of an expressed interest in settlement could insulate the insurer from bad faith; the insured, on the other hand, would want the claimant to be contacted immediately, to seek to establish the claimant’s interest in settlement. Given this divergence in interest—and the serious potential consequences—this conflict would seem to be the type that gives the insured the right to hire independent counsel of his own choice, paid for by the carrier. See San Diego Navy Federal Credit Union v. Cumis Insurance Society, Inc. 162 Cal.App.3d 358 (1984).

This also raises the equally interesting question of whether an insurer has a duty to advise its insureds of the right to independent counsel, and whether the failure to advise of this right is “conduct that prevents settlement opportunities from arising” under Reid.