Assigned policy rights can increase compensation.

Liability insurance is supposed to provide "the benefits and security of coverage," not just "the pieces of paper constituting a policy."(1) When an insurer wrongfully denies coverage, the policyholder has only useless pieces of paper to fend off debt, litigation, or personal liability. The policyholder may have paid premiums for years but bought only illusory protection and must now face the expense and risk of fighting on two fronts --against the tort plaintiff and against the insurer.

Left stranded in this predicament, an insured defendant often is willing to consider assigning rights held against the liability insurer to the plaintiff in exchange for reducing or eliminating the risk of personal liability. These assignable rights typically include the insurer's contractual obligation to defend and indemnify the insured or the fiduciary obligation to settle the plaintiffs claim within the limits of the liability policy.

A plaintiff who acquires and enforces a defendant's contractual or bad faith claims against a liability insurer may actually enhance the value of the underlying tort claim. For example, where the defendant's liability insurer wrongfully denies coverage, the plaintiff who settles with the defendant and then establishes coverage on an assigned claim against the defendant's insurer may be able to obtain a tort settlement from the defendant as well as supplemental damages for indemnity, litigation costs, and attorney fees from the insurer. A plaintiff who prevails on an assigned bad faith claim against the insurer may be able to recover full compensation in excess of the defendant's liability coverage limits.

Breach-of-Contract Claims

The recent case of Warren v. St. Paul Fire & Marine Insurance Co.,(2) illustrates how a tort recovery can be enhanced through a supplemental breach-of-contract action against the defendant's liability insurer. Richard Warren, a 64-year-old master painter, was seriously injured and permanently disabled when he fell into the pit of a freight elevator in his workplace. When he opened the elevator door, the car was not at the adjacent landing. He stepped or tripped into the open elevator shaft and fell 16 feet.

Warren brought suit against the elevator manufacturer, the maintenance contractor, and his employer's elevator consultant, alleging manufacturing defects and safety code violations. Because of workers' compensation immunity, Warren's employer was not a defendant, even though the employer had twice been ordered to fix safety code violations. Claims against the elevator manufacturer and maintenance contractor were dismissed, leaving the elevator consultant, Lerch Bates, as the only defendant.

Warren's tort claim was adversely affected by dismissal of the two defendants and by defenses of no duty, employer fault, and contributory negligence. There was also a large workers' compensation lien, which his employer refused to compromise. To make matters worse, Lerch Bates's insurer, St. Paul Fire & Marine insurance Co., had denied coverage based on the "professional services" exclusion in the comprehensive general liability (CGL) policy it had issued to the consultant. St. Paul declined to defend Lerch Bates or to contribute to the settlement that the company agreed to pay--most of which went to satisfy the lien, litigation costs, and attorney fees.

When Lerch Bates settled the tort claim, the company also agreed to assign its rights under St. Paul's CGL policy. Warren then brought a breach-of-contract action against St. Paul to establish that it should have provided coverage for his tort claims against Lerch Bates because St. Paul's professional services exclusion did not apply. Warren moved for summary judgment under Colorado law (the state where St. Paul had delivered the CGL policy to Lerch Bates) to recover the consultant's defense costs and settlement payment in the underlying tort action.

Under Colorado law, ambiguities in insurance policies are construed in favor of the insured and against the insurer. The insurer has the burden of establishing that an exclusion applies and is not subject to any other reasonable interpretation that might provide coverage.(3)

An insurer who wrongfully denies coverage and fails to defend or indemnify is obligated to pay the insured's defense costs and indemnify the insured up to the amount of the policy.(4) Warren also sought reimbursement of his own attorney fees under Washington law, which holds that an insured forced to sue to recover benefits under his policy is entitled to recover attorney fees from his insurer.(5)

Based on these authorities, in May 1995, a U.S. district court ruled that St. Paul's coverage exclusions were invalid. The court entered a judgment requiring the insurer. to reimburse Warren for Lerch Bates's defense costs and settlement payment and for his own litigation costs and legal fees in the coverage action. By bringing an assigned claim against the defendant's insurer, Warren obtained satisfactory compensation even though his underlying tort claim had been whittled away by affirmative defenses, liens, and other factors.

Bad Faith Claims

The law of bad faith is the great equalizer of insurance coverage litigation. It exposes insurers who do not act in good faith to the risks of extracontractual liability and damages in excess of policy limits. Bad faith actions promote equal treatment by requiring insurers to face the same risks of unlimited liability, costs, and attorney fees that their polilyholders face when coverage is wrongfully denied or when cases are not settled within policy limits.

While breach-of-contract actions are based on an insurer's wrongful denial of coverage, bad faith failure-to-settle actions arise from an insurer's erroneous prediction that the defendant either will will the case or will have enough liability coverage to pay an adverse judgment. A liability insurer's refusal to settle the plaintiffs claim within policy limits may create unlimited liability coverage by operation of law.(6)

A plaintiff who wishes to preserve excess liability claims against the defendant's insurer should make an offer to settle at or within policy limits. Most courts hold that an insurer is not subject to excess liability unless it has refused a reasonable settlement offer that is within the policy limits.(7)

This rule is based on principles of causation. Even if an insurer denies coverage or refuses to defend in bad faith, that action alone may not cause an excess judgment. Once the insurer receives a policy limits offer, however, it can prevent an excess judgment by paying policy limits to settle the claims. Therefore, an insurer who refuses to settle a covered claim within policy limits is subject to excess liability, because the refusal causes the insured to incur the risk of an excess judgment.

An insurer who is not given an opportunity to prevent an excess judgment by settling the underlying claim usually is liable only up to the policy limit. This is so regardless of the amount of the judgment ultimately entered against the insured.

For example, in Greer P. Northwestern National Insurance, the plaintiff, Lynda Peterson, was seriously injured while riding as a passenger on a motorcycle driven by John Greer.(8) Greer had a $15,000 liability policy with Northwestern. Peterson brought suit against Greer, but Northwestern refused to defend Greer based on a guest liability exclusion. Peterson and Greer then resolved her personal injury claims at a hearing in which the trial court entered a $555,000 default judgment against Greer.(9)

Greer brought a bad faith action against Northwestern to recover the amount of the underlying default judgment plus his attorney fees and additional emotional distress damages. The Washington Supreme Court found that Northwestern had wrongfully denied coverage, but the court limited liability to the $15,000 policy limit:

Insurance companies that wrongfully

refuse to defend are generally liable for

the amount of the judgment entered

in the underlying action. The liability,

however, usually extends only to the

policy limits.... One exception to this

rule exists, but it is inapplicable in the

present case. An insurance company

can be held liable beyond its policy limits

if it in bad faith refuses to settle

within the policy limits with the injured

party. [Citation omitted.](10)

The plaintiff's settlement offer must allow a defendant's insurer a fair opportunity to evaluate the underlying liability claim. A bad faith claim may be defeated if the policy limit settlement demand is made improperly or for the ulterior purpose of setting up the insurer for excess liability.

In Glenn v. Fleming, the plaintiff made a policy limit settlement offer when the case was less than four months old, discovery had scarcely begun, there were several defendants, inadequate information existed to investigate the merits of the underlying claim, and the insurer believed it would be permitted to settle for the policy limits after enough information became available to evaluate the claim.(11) The Kansas Supreme Court upheld a summary judgment dismissing the resulting bad faith failure-to-settle claim, because the settlement offer was "unreasonable because it was premature, had conditions attached to it, and was only open for two weeks."(12)

Assignments of Claims and Covenants Not to Execute

A plaintiff must obtain an assignment of rights under the defendant's liability policy to bring a breach-of-contract or bad faith claim against the defendant's insurer. Generally, an insurer's duty of good faith runs to its insured and to third-party beneficiaries of the insurance contract, but not to third-party claimants.(13)

Since tort plaintiffs are third-party claimants, they do not have standing to sue a liability insurer for bad faith unless they obtain an assignment of the insured defendant's rights against the insurer as part of a settlement.

The plaintiff usually obtains an assignment of contractual and bad faith claims against an insurer as an adjunct to the defendant's settlement payment or in exchange for a covenant not to enforce a judgment against the defendant personally. Through the assignment, the plaintiff acquires the same rights that the defendant policyholder had against the liability insurer. As one court recently explained,

"[A] claim by an insured against his insurer

may be assigned to the injured

party." Kagele v. Aetna Life & Cas. Co.,

40 Wn. App. 194, 197, 698 P.2d 90,

rev. denied, 103 Wn. 2d 1042 (1985).

"The assignee of a chose in action takes

only those rights held by his assignor."

Home Indem. Co. P. McClellan Motors,

Inc., 77 Wn. 2d 1, 3, 459 P.2d 389

(1969). "The assignee's rights are coextensive 

with those of the assignor at

the time of the assignment." Home Indemnity,

77 Wn. 2d at 3-4. "[A] covenant

not to execute coupled with an

assignment and settlement agreement

is not a release permitting the insurer

to escape its obligation." Kagele P. Aetna

Life & Cas. Co., 40 Wn. App. at

198.(14)

In the case of Metcatcalf v. Hartford Accident & Indemnity Co., the Nebraska Supreme Court set forth the justification for assignments and covenants not to execute:

[W]ith the insurance company denying

liability, [the insured] was entitled

to use all reasonable means of avoiding

personal liability... [The insurer]

repudiated its obligation to assume

and carry the defense to final judgment,

and, having abandoned the case,

it left the assured at liberty to take up

the defense and contest the claim to

final judgment, or, if so advised, to

make the most favorable settlement

possible.(15)

Nevertheless, the plaintiff should check local law before accepting an assignment in exchange for a covenant not to execute against the defendant's personal assets. Most courts hold that it is not necessary for a plaintiff to obtain an adverse judgment against a defendant to maintain a bad faith failure-to-settle claim against the defendant's insurer on an assigned cause of action.(16)

Most courts also permit an injured plaintiff to recover from the defendant's insurer on an assigned claim despite the covenant to seek relief only from the insurer.(17) Some courts, however, hold that a covenant not to execute coupled with an assignment and settlement agreement releases the insurer from any liability on the assigned bad faith claim.(18)

Excess Damages and Stipulated Judgments 

Where the plaintiff's damages exceed the defendant's policy limits, most jurisdictions permit an excess recovery on the assigned claim despite a covenant not to execute on the insured defendant's personal assets.(19) The measure of damages on a bad faith failure-to-settle claim may be the judgment entered on the verdict in the underlying action(20) or, in the case of a stipulated judgment, an amount reflecting either the reasonable settlement value or the probable jury verdict on the underlying tort claim.(21)

In addition to exchanging assignments of bad faith claims for covenants not to execute, parties sometimes enter into stipulated judgments or default judgments to set the amount of damages the plaintiff supposedly would have received had the case been tried instead of settled. These stipulated judgments are then offered as proof of damages on the assigned bad faith claim against the defendant's insurer.

The reasonable settlement value or probable jury verdict on the underlying fort claim is determined by expert testimony in the bad faith trial. In some jurisdictions, the plaintiff has the burden of making a prima facie showing that die stipulated judgment is reasonable. The burden of persuasion then shifts to the insurer, who must show that the stipulated judgment is unreasonable because of fraud or collusion between the plaintiff and the insured defendant.(22)

In other jurisdictions, the plaintiff has the entire burden of proving that the stipulated judgment was reasonable, nonfraudulent, and noncollusive.(23) In California, bad faith failure-to-settle claims apparently cannot be based on a stipulated judgment at all, but only on an excess judgment in the underlying liability action.(24)

The peril of relying on a stipulated judgment in lieu of expert testimony for proof of damages is illustrated in Chaussee v. Maryland Casualty Co., a case that one of my partners and I tried several years ago.(25) In Chaussee, the plaintiff in the underlying tort action, Scott Nodell, a minor, was rendered quadriplegic when his car skidded on an icy road and hit a telephone pole. The Nodells brought suit against King County and Chaussee, the owner of land adjoining the accident site, for negligence in allowing ice to form and remain on a county highway.

During discovery, the Noders were informed that Chaussee had $2.5 million in liability coverage. They settled with King County for $1.15 million and demanded the policy limits of $2.5 million from Chaussee. The Nodells then were advised that Chaussee only had $500,000 in liability coverage.

When the insurer, Maryland Casualty, refused to pay the $2.5 million, the Nodells and Chaussee entered into a $7.5 million stipulated judgment in exchange for a covenant not to execute and in assignment of Chaussee's contractual and bad faith claims against his insurer, broker, and insurance defense counsel. In an ex parte hearing to validate the settlement with the minor plaintiff, the trial court approved the $7.5 million stipulated judgment as reasonable.(26)

The Nodells then brought suit on the assigned claims against Chaussee's insurer, broker, and insurance defense counsel. The Nodells contended that the $7.5 million stipulated judgment was a presumptively reasonable measure of damages unless the defendants could show unreasonableness, bad faith, or collusion. Alternately, the Nodells maintained that an insurance defense counsel's case evaluation letter, which predicted in 80 percent to 90 percent risk of liability and a verdict ranging between $2 million and $7.5 million, provided sufficient evidence of damages.

The court held that, notwithstanding the ex parte determination of reasonableness, the $7.5 million stipulated judgment was not evidence of a reasonable settlement value. The court said that "an insured man, settle for an inflated amount to escape [personal liability] exposure" where a consent judgment is coupled with a covenant not to execute.(27) The court held that insurance defense counsel's evaluation did not satisfy plaintiffs' proof requirements because it did not assess the risks or costs of going to trial that a reasonable person would consider in determining a reasonable settlement "... [or] include indication of an assessment of Chaussee's ability to pay."(28)

The lesson is that a plaintiff should not rely on a stipulated judgment alone as proof of damages in these cases but should furnish expert testimony as to the reasonable settlement value or probable jury verdict for the underlying case.

Several v. Joint and Several Liability

In recent years, many states have enacted liability statutes that limit each defendant's liability to its percentage share of fault in causing the plaintiff's damages. When several liability applies, the insurer may be able to limit its liability on a bad faith failure-to-settle claim to the insured's percentage share of responsibility for the damages involved.

For example, even if the plaintiffs total damages exceeded a defendant's liability, limits, the defendant's liability insurer will not be subject to excess liability for refusing a policy limit demand if the limits are sufficient to cover the defendant's percentage share of fault.(29)

Whether the insured defendant is jointly and severally or only severally liable may also affect the reasonableness of a stipulated judgment between the plaintiff and a defendant in the underlying liability case. For example, if one defendant in a multi-defendant case is only severally liable for a small percentage share of a potential adverse judgment but --in exchange for a covenant not to execute--stipulates to a judgment reflecting the total value of the case against all the defendants, the reasonableness of the stipulated judgment will be subject to attack.

To summarize, in major damages cases a liability insurer has a powerful financial temptation to deny coverage if there is any defensible basis for doing so. The plaintiff should not accept an insurer's coverage disclaimer at face value, even if the insured defendant has done so, especially since rules of policy construction usually favor coverage and disfavor exclusions. If the insurer has improperly denied coverage, the plaintiff may then be able to enhance the tort recovery by bringing an assigned breach-of-contract claim against the defendant's liability insurer.

Tort recovery also may be enhanced when a liability insurer spurns a policy limits offer and gambles the defendant's fortunes on a verdict. The plaintiff who pursues an assigned cause of action based on bad faith failure-to-settle must beware the many perils associated with assignments, settlement offers, covenants not to execute, stipulated judgments, joint and several liability, and proof of damages. Any of these can destroy an excess liability claim.

Notes

(1) Salois v. Mutual of Omaha, 581 P.2d 1349, 1351 (Wash. 1978). (2) No. C95-0087 (W.D. Wash. Apr. 11, 1995). (3) Hecla Mining Co. v. New Hampshire Ins. Co., 811 P.2d 1083 (Colo. 1991). (4) Wheeler v. Reese, 835 P.2d 572, 577-8 (Colo. Ct. App. 1992). (5) Olympic S.S. Co. v. Centennial Ins. Co., 811 P.2d 673 (Wash. 1991). (6) Greer v. Northwestern Nat'l Ins., 743 P.2d 1244 (Wash. 1987). (7) See, eg., Rogan v. Auto Owners Ins. Co., 832 P.2d 212 (Ariz. Ct. App. 1991); Cooper v. Automobile Club Ins. Co., 638 S.W.2d 280 (Ky. Ct. App. 1981). (8) 743 P.2d 1244 (Wash. 1987). (9) Id. at 1246. (10) Id. at 1250; but see Florida Farm Bureau Ins. Co. v. Rice, 393 So. 2d 552, 556 (Fla. Dist. Ct. App. 1980) ("once a company has denied coverage and refused to defend, the existence of settlement offers is not a prerequisite to the establishment of a cause of action for excess"). (11) 799 P.2d 79 (Kan. 1990). (12) Id. at 86; see also Manchester Ins. & Indem. Co. v. Grundy, 531 S.W.2d 493 (Ky. Ct. App. 1975), cert. denied, 429 U.S. 821 (1976) (no bad faith claim where last-minute settlement offer denied insurer adequate opportunity to evaluate underlying liability claim); but see Lozier v. Auto Owners Ins. Co., 951 F.2d 251 (9th Cir. 1991) (under Arizona law, plaintiffs 10-day time limit on policy limits settlement offer found reasonable where plainfiff agreed to extend offer for 10 days, but insurer failed to take action until its own money was at stake in the bad faith suit). (13) See, eg., Gould v. Mutual Life Ins. Co., 683 P.2d 207 (Wash. 1984) (tird-party, beneficiaries have a cause of action against the insurer for breach of good faith under the Consumer Protection Act); Tank v. State Farm, 715 P.2d 1133 (Wash. 1986) (third-party claimants may not sue the insurer directly for alleged breach of duty of good faith). (14) Steinmetz v. Hall-Conway-Jackson, Inc., 741 P.2d 1054, 1056 (Wash. Ct. App. 1987). (15) 126 N.W.2d 471, 475 -76 (Neb. 1964). (16) See, eg., Lough v. Insurance Co. of N. Am., 789 P.2d 576 (Mont. 1990); but see Moradi-Shalal v. Fireman's Fund Ins. Cos., 758 P.2d 58 (Cal. 1988) (final judicial determination of insured's liability is condition precedent to any action that is taken by third-party claimant to recover for insurer's alleged bad faith failure to settle the case). (17) See, eg., Coblentz v. American Sur. Co., 416 F.2d 1059, 1063 (5th Cir. 1969) (Florida law); State Farm Mut. Auto Ins. Co. v. Paynter, 593 P.2d 948, 95 3 (Ariz. Ct. App. 1979). (18) See, eg., Bendall v. White, 511 F. Supp. 793 (N.D. Ala. 1981); Stubblefield v. St. Paul Fire & Marine Ins. Co., 517 P.2d 262 (Or. 1973). (19) See, eg., Chaussee v. Maryland Cas. Co., 803 P.2d 1339 (Wash. Ct. App. 1991); Lozier, 951 F.2d 251, 256. (20) Johansen v. California State Auto Ass'n Inter-Ins. Bur., 538 P.2d 744 (Cal. 1975). (21) Compare United Services Auto Ass'n v. Morris, 741 P.2d 246, 253 (Ariz. 1987) (reasonable settlement value) with Manchester Ins. Indem. Co., 531 S.W.2d 493 (probable jury verdict). (22) Griggs v. Bertram, 443 A.2d 163, 175 (N.J. 1982). (23) United Services, 741 P.2d 246. (24) Moradi-Shalal, 758 P.2d 58, 69, 73. (25) 803 P.2d 1339. (26) Id. at 1341. (28) Id. at 1343. (28) Id. at 1344. (29) Cooper, 638 S.W.2d 280, 282.