Trying a bad faith case: The duty to settle

The duty to settle under liability coverage is the single most important bad-faith principle of insurance

2014 August

When trying insurance bad-faith cases there are fundamental differences between the type of insurance that is involved. While different policies cover different risks, from property and liability to life, health and disability, the common denominator of insurance is that it is the one product we buy that we hope we never have to use. You certainly don’t buy property insurance hoping that your home burns down. Rather, you buy insurance so that if your home burns down, you have coverage to rebuild it. To put it simply, insurance provides peace of mind.

 One of the most important coverages we buy is liability insurance. Whether it is auto, professional malpractice, or employment practices, liability insurance provides protection whenever mistakes are made. It follows that the most important bad-faith principle in the context of liability insurance is the duty to settle. This article will focus specifically on handling some of the nuances of trying a bad-faith case that arise out of the breach of the duty to settle.

Insurer’s duty

The duty of good faith and fair dealing requires a liability insurer to settle a lawsuit by a third party against its insured when there is a clear and unequivocal offer to settle within policy limits and liability is reasonably clear and a likelihood of a recovery in excess of the policy limits. In Comunale v. Traders & General Ins. Co., 50 Cal.2d 654, 328 P.2d 198, the Supreme Court held that, “the 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.” (Id. at 659.) In deciding whether a claim against an insured should be settled, 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.” (Ibid.) As stated in CACI 2334, the elements of the breach of the duty to settle include the following:

(1) That [plaintiff in the underlying case] brought a lawsuit against [Plaintiff Insured] for a claim that was covered by Defendant’s insurance policy;

(2) That [Defendant Insurer] failed to accept a reasonable settlement demand for an amount within policy limits; and

(3) That a monetary judgment was entered against [Plaintiff Insured] for a         sum greater than the policy limits.

Notably, the insurer’s obligation is to accept a “reasonable settlement demand.” A settlement demand is reasonable “...if the [Defendant Insurer] knew or should have known at the time the settlement demand was rejected that the potential judgment was likely to exceed the amount of the settlement demand based on [plaintiff in the underlying case’s] injuries or loss and [The Insureds’] probable liability.” (CACI 2334)

Voir dire

One of the key differences when trying a bad-faith failure-to-settle case and other bad-faith cases is that your plaintiff insured was previously the defendant in the underlying action. Moreover, the insured has already been found negligent or to have committed a wrongful act by a previous jury, resulting in a judgment that exceeds the policy limit. Whether your client was a negligent driver who caused injury or a doctor who committed malpractice in the underlying case, you need to address those issues with potential jurors in voir dire. As I like to say, you need to “get the skunk out on the table.”

For example, if your client negligently caused a wrongful death in the underlying case, you need to open up the discussion with jurors about any biases they may have about that. I have found that if you hit the liability aspects of the underlying case head on, most jurors understand that people make mistakes. This dovetails nicely into a discussion about why we buy liability insurance. After all, no one wants to commit a negligent act that triggers liability coverage. But the coverage is there to provide peace of mind when necessary.

I also think it is important to focus the jurors on their role in the bad-faith case. They need to understand that it is not their role to decide whether your client was negligent in the underlying case. Another jury has already decided that and you should embrace it. Rather, the focus is on the insurance company’s conduct and how it handled the underlying claim in refusing to settle within policy limits.

Another topic you must cover is punitive damages. You can never expect a jury to return with a punitive-damage verdict in a bad-faith case unless you’ve prepared them to do so during voir dire. As with all issues that you cover in voir dire, you want to get jurors to open up about how they really feel about the concept of punitive damages. Don’t be afraid to ask open-ended questions even if you might get answers that you weren’t hoping to get. Letting the jurors express themselves in their own words is the only way that you’ll truly get the honest answers you want. As my old college roommate used to say, “You have two ears and one mouth, so you should listen twice as much as you speak.” This is especially true during voir dire.

Before getting to the jurors’ feelings about punitive damages, I like to build up to it by asking a series of questions that get jurors talking about the difference between someone doing something negligently (like your client in the underlying case), and a defendant that has acted intentionally. Most people will agree that if conduct goes beyond mere negligence, it ought to be punished and deterred.

Now you have prepared the jurors for a discussion about punitive damages. Inevitably, there will be some jurors who have heard or read about punitive damages and have negative feelings about it. For example, I’ve had more than one juror describe their understanding of punitive damages as “windfall.” To help get jurors to understand the concept of punitive damages, I like to refer to them as “penalty damages” or “punishment damages.” One of the things I’ve noticed in the past several years is that jurors, generally speaking, are more receptive to the concept of punitive damages. I’ve found this to be true even in conservative jurisdictions. I think the reason is because most jurors have heard about corruption cases where people have cheated other people out of money. I bring up examples like, Bernie Madoff, Charles Keating, Jeffrey Skilling, and Enron to get jurors thinking about it. Examples like these bring up the notion that sometimes greed causes people and/or corporations to do bad things and in the process cause harm to others.

In a bad-faith case, the purpose of punitive damage is to punish and deter dishonest conduct. Ultimately, the goal in voir dire is to have jurors who are open to awarding punitive damages if they find the evidence establishes dishonest conduct. The jury should also understand that the purpose of punitive damages is not to compensate, but to punish and deter.

Cross-examination of the adjusters

The most important evidence you can develop in a bad-faith trial is during the cross examination of the claims’ adjusters. In a bad-faith trial arising out of the duty to settle, the manner in which you handle the cross examination of the adjuster will depend in large part on why the insurer decided not to settle the underlying case. There are really just two reasons why insurers refuse to settle. First, is because the carrier believed there was no coverage. Second, is that the carrier believed the underlying case just wasn’t worth the full policy limit.

•Failure to settle because of a coverage dispute

In some cases, an insurer’s decision not to settle is based on its belief that there is no coverage under the policy. In other words, the carrier takes the position that the claim may be worth more than the policy limit, but that there is no coverage available under the policy. In such cases, it is important to note that the California Supreme Court in both Comunale and Johansen v. Cal. State Auto Ass’n Interinsurance Exch. (1975) 15 Cal.3d 9, 123, specifically addressed the issue of considering a carrier’s “good faith” decision to not settle based on non-coverage. In both cases the court concluded such considerations were irrelevant. As the court stated in Johansen:

Defendant asserts, however, the Comunale principle does not apply to an insurer whose refusal to settle stems from a bona fide belief that the policy does not provide its insured coverage. In Comunale, the insurer asserted a virtually identical claim…This court nevertheless held the insurer liable for the excess judgment against its insured, stating: ‘an insurer who denies coverage does so at its own risk, and although its position may not have been wrongful it is liable for the full amount which will compensate the insured for all the detriment caused by the insurer’s breach of the express and implied obligations of the contract….accordingly, an 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.

(Id. at 16-17) (Emphasis added).

Moreover, in footnote 4, the Johansen Court made it clear that a “wrongful” decision in noncoverage in the above quote does not mean “culpable,” but rather, it simply means an “erroneous” decision:

FN4. Defendant seeks to avoid the import of this language by asserting that ‘wrongful’ must be equated with ‘culpable,’ a proposal for which there is absolutely no support in Comunale. Indeed, the language immediately preceding this portion of Comunale expressly states that the insurer denies coverage at its own risk. Viewed in context, it becomes apparent that a ‘wrongful’ denial of coverage as used in Comunale means merely an erroneous denial of coverage required by the policy.

(Id., at 16-17) (Emphasis added).

In addition, when a carrier is faced with the decision of whether or not to settle, it is not permitted to even consider coverage issues in making that decision. This is the standard that is clearly set forth in Johansen:

Moreover, in deciding whether or not to compromise the claim, the insurer must conduct itself as though it alone were liable for the entire amount of the judgment. [cite]. Thus, the only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim’s injuries and the probable liability of the insured, and ultimate judgment is likely to exceed the amount of the settlement offer. Such factors as the limits imposed by the policy, a desire to reduce the amount of future settlements, or 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.

(Id. at 16).

During the cross examination of the adjuster, you will be able to establish that insurer refused to settle based on a belief there is no coverage. Inevitably, the carrier will attempt to argue that its coverage position was reasonable and/or that it relied on the advice of its coverage lawyers in refusing to settle (i.e., the “advice of counsel” defense).

But this provides no defense to payment of the entire excess judgment since a carrier is not permitted to even consider coverage issues when deciding whether or not to compromise a claim in the first instance. The reasonableness of its coverage position is therefore irrelevant; it remains liable for the entirety of the underlying judgment so long as there is coverage.

For this reason, you should bring a motion in limine and/or a special instruction based on Johansen to preclude an advice of counsel defense because the reasonableness of the coverage position taken by the carrier is irrelevant so long as there is coverage. Also, by the time you get to trial the court will usually have decided coverage and a special instruction advising the jury of that is necessary. Finally, a special instruction, again based on Johansen, should be requested to tell the jury that a belief that the policy does not provide coverage should never have even been considered by the carrier in deciding whether or not to settle.

•Failure to settle because of a valuation dispute

In most cases, an insurer decides not to settle based on a belief that the underlying claim is not worth the full policy limit, even though there is no dispute that whatever damages are ultimately awarded are covered under the policy. As stated above, the duty of good faith and fair dealing requires an insurer to accept a “reasonable settlement demand” where “...in light of the claimed injuries or loss and plaintiff’s probable liability, the judgment in the lawsuit was likely to exceed the amount of the settlement demand.” (CACI 2334)

In light of this instruction, you will need to prove that the judgment in the underlying action was likely to exceed the amount of the demand. To some extent, this will require you to re-try the underlying action in the bad-faith case to prove that it was worth more than the policy limit. Of course, by the time you reach the bad-faith case the “proof is already in the pudding” since the underlying action will, necessarily, have resulted in a judgment that exceeded the policy limit. Notably, the actual judgment provides presumptive proof of the value of the claim. Consider the following taken from Crisci v. Security Ins. Co. of New Haven (1967) 66 Cal.2d 425:

The size of the judgment recovered in the personal injury action, although not conclusive, furnishes an inference that the value of the claim is the equivalent of the amount of the judgment and that acceptance of an offer within those limits was the most reasonable method of dealing with the claim.

(Id. at 430).

It is important that the jury receive this instruction. I also emphasize, particularly in closing, that the jury in the bad-faith case should give great deference to the verdict rendered in the underlying case and not second guess it. After all, the underlying case was decided by a jury that took the same oath that your jury was given. I also think it’s a good idea to read that oath during closing:

Do you, and each of you, understand and agree that you will well and truly try the cause now pending before this court, and a true verdict rendered according only to the evidence presented to you and to the instructions of the court.

(emphasis added).

I’ve found that generally, jurors respect the views of other jurors. I think emphasizing that the jury in the underlying case rendered a “true verdict” under the oath goes a long way toward the jury in the bad-faith case not disrupting their findings. However, because the judgment itself provides a presumption of the value of the claim that is “not conclusive,” you should still be prepared to prove that the underlying action was worth more than the amount offered.

During trial, the carrier will argue that it acted reasonably in handling the underlying claim. But the focus must be on the reasonableness of the settlement offer that was ultimately rejected, not the reasonableness of the insurers’ conduct leading up to that rejection. One helpful case in this regard is Betts v. Allstate (1984) 154 Cal.App.3d 688. Betts followed the Johansen and Comunale authorities and reinforced that the relevant inquiry is the reasonableness of the settlement offer, not the reasonableness of the insurers’ conduct when dealing with exposure for an excess judgment. In Betts, the court stated:

[In Comunale] the Supreme Court held an insurer in determining whether to settle a claim must give at least as much consideration to the welfare of the insured as it gives its own interest….An insurer may be held liable for a judgment against its insured in excess of its policy limits where it has breached the implied covenant of good faith and fair dealing by unreasonably refusing to accept a settlement offer within limits…. Allstate’s argument that liability for an excess judgment is not imposed unless there is a ‘bad faith’ breach of the contract is unsound. Liability is imposed ‘for failure to meet the duty to accept reasonable settlements, a duty included within the implied covenant of good faith and fair dealing.’

Recovery may be based on an 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.

(Id. at 706) (emphasis added).

The Betts court went on to state the standard for evaluating the reasonableness of a settlement offer:

Thus, the permissible considerations in evaluating the reasonableness of the settlement offer are whether in light of the victim’s injury and the probable liability of the insured the ultimate judgment is likely to exceed the amount of the settlement offer.

(Id., at 706-707)

Focusing on the reasonableness of the settlement offer, rather than the reasonableness of the insurer’s conduct, you should cross examine the claims adjuster on every facet of the underlying case that supports your argument that its value was greater than the policy-limit settlement demand. Go through the injuries, the past medical bills, the future medical bills, and any other aggravating factors. In some cases, you can cross the adjuster on the carrier’s own claims’ manual which usually classifies injuries and rates them in terms of severity.

In some cases the carrier should have known to accept a demand within policy limits but because of its own delay in investigating the claim, it did not obtain all of the necessary information or discovery it needed to properly respond to the demand. You want to show that the evidence was available if the carrier conducted a proper investigation. The following instruction should be given:

Defendant acted unreasonably or without proper cause if it failed to conduct a full, fair, and thorough investigation of all of the bases of the claim. When investigating plaintiff’s claim, defendant had a duty to diligently search for and consider evidence that supported coverage of the claimed loss.

(CACI 2332)

This instruction is helpful to prove that if the carrier followed the rules and “diligently searched for and considered evidence that supported coverage,” it would have known the underlying demand was reasonable and it should have settled.

Establishing ratification during cross-examination

In order to get to a second punitive damage phase, you will need to prove that the conduct constituted “malice, oppression, or fraud” in phase one. (See, CACI 3946.) In addition, you will also need to prove one of the following:

(1) That the conduct constituting malice, oppression, or fraud was committed by one or more officers, directors, or managing agents of defendant who acted on behalf of the defendant; or

(2) That the conduct constituting malice, oppression, or fraud was authorized by one or more officers, directors, or managing agents of defendants; or

(3) That one or more officers, directors, or managing agents of defendant knew of the conduct constituting malice, oppression, or fraud and adopted or approved that conduct after it occurred.

(Civ. Code, § 3294.)

Going into trial, you need to identify the witness or witnesses that have the managerial capacity to establish ratification. In most cases it is either the immediate supervisor of the adjuster or that person’s supervisor. Whomever the witness is, you need to establish ratification of the conduct in order to get to a punitive-damage phase.

In a failure-to-settle case, it is usually pretty easy to identify the person with managerial capacity: It’s the person who had the final authority to decide not to settle. It is usually a supervisor, and on cross- examination you will want to establish that given his/her role in the company, that he/she has managerial capacity. Once that is established, you need to confirm ratification and approval of the claim. I usually ask questions that establish that the supervisor received no criticism and that they acted consistent with how the company goes about handling claims.

These questions establish not only ratification but also “pattern and practice.” Inevitably, in phase I, the company and its witnesses will vigorously defend their conduct and stand behind it. Of course, if the jury finds that the same conduct was malicious, oppressive or fraudulent and there is a second phase, this testimony will be very helpful to address the amount of punitive damages the jury should award.

The punitive damage phase

Trying cases is like being in a boxing match. You’re fighting every day, whether you think it’s going well or not; you just don’t know if you’re ahead or behind on the jury’s scoring card. That’s why, like a boxer, no matter whether you had a good or bad day in trial, you must shake it off and go into the next day ready to fight again.

But all of that changes when the jury has made a finding of malice, oppression or fraud and you find yourself now in phase II of the bifurcated trial. You now know that the jury is on your side and has found, by clear and convincing evidence, that the insurance company’s conduct was “despicable.” You no longer need to be the aggressive fighter who is zealously arguing every issue. The jury has already found that the conduct is really bad, now is the time to calmly reason with the jury about what to do about it. I remind the jury that we are doing this collectively, on behalf of society, to make sure this bad conduct is both punished, and more importantly, not repeated.

•Evidence of financial condition

The only new evidence to present during the punitive damage phase is of the company’s financial condition. Getting the financial information of an insurance company is very simple because they are required to lodge that information with the Department of Insurance. I usually will obtain certified copies of at least five years of the company’s financial statements filed with the DOI. Also, because the financial documents are certified by the DOI, they are self-authenticating.

Usually, I will have retained a forensic economist to explain what the numbers in the financial documents mean to the jury. While there are many ways to evaluate the financial condition of the company, the most common way is to look at the company’s surplus. The documents obtained from the DOI will set forth the company’s assets, liabilities and surplus. Notably, the liability will list not only the actual losses paid but also reserved losses so that the remaining surplus is net of even potential claims the company has reserved for future payments. Once the financial condition evidence is presented, it is time for the final closing argument.

•The punitive damage closing

While you know that the jury thinks the company’s conduct was really bad by the second phase, you don’t know what they are willing to do about it. It is your job as the trial lawyer to motivate the jury to “send a message,” not just to the defendant in your case, but also to the insurance industry as a whole. The starting point is to make sure you explain the purpose of punitive damages which is twofold: to punish & deter. Cite the jury instruction as follows:

The purposes of punitive damages are to punish a wrongdoer for the conduct that harmed the plaintiff and to discourage similar conduct in the future.

(CACI 3949)

It is important that the jury understand that punitive damages are designed to protect the public, which includes the members of the jury. One way to accomplish this task is to refer the jury back to the law. For example, in California, one powerful jury instruction is the following:

The purpose of punitive damages is purely a public one. The public’s goal is to punish wrongdoing, and thereby protect itself from future misconduct, either by the same defendant or other potential wrongdoers. In determining the amount of punitive damages to be awarded, you are not to give any consideration as to how the punitive damages will be distributed.”

(Adams v. Murakami (1991) 54 Cal.3d 105, 110; Neal v. Farmers Ins. Group (1978) 21 Cal.3d 910, 928, fn 13) (emphasis added).

Thus, in the punitive phase, portray your role as being one of a public servant. You are advancing the “public’s goal” which is, in part, to punish the defendant’s misconduct. Ultimately, the jury should understand that their punitive verdict will protect not just an individual or some special interest group, but rather, will protect everyone from future abuses. The jury must understand the importance of their role of protecting the public in the punitive phase.

It is important that the jury understand that they have the power to send a warning to the insurance industry that misconduct will not be tolerated by the public. The jury can do this by setting an example of the defendant. Again, one way to accomplish this is to refer back to the jury instructions, such as the following from the United States Supreme Court:

In addition to actual or compensatory damages which you have already awarded, the law authorizes the jury to make an award of punitive damages in order to punish the wrongdoer for its misconduct or to serve as an example or warning to others not to engage in such conduct.

(TXO Production Corp. v. Alliance Resources Corp. (1993) 509 U.S. 443, 459, 463, 113 S.Ct. 2711, 2721-2722, 125 L.Ed.2d 366) (emphasis added).

The punitive damages that the jury awards will not only send a message to the defendant on how it should do business in the future, but it will also serve as an example or a warning to other competing companies that the public will not tolerate such misconduct. Give the jury examples of warnings they see every day: If a swimming pool is too shallow, it should have a warning; if a product is dangerous, it should have a warning; if a floor is slippery, it should have a warning, etc. Warnings like these must be prominently displayed in order to have an impact. In your case, the punitive damages award will serve as a warning to other insurance companies and so it must be a meaningful amount to be prominently displayed to the industry.

I like to emphasize the second purpose of punitive damages, which is deterrence. The jury’s verdict should not only deter future wrongdoing by the defendant, but also by the industry as a whole. Another effective jury instruction to establish this point is the following:

The object of [punitive] damages is to deter the defendant and others from committing like offenses in the future. Therefore, the law recognizes that to in fact deter such conduct, may require a larger fine upon one of larger means than it would upon one of ordinary means under the same or similar circumstances.

(TXO Production Corp. v. Alliance Resources Corp. (1993) 509 U.S. 443, 459, 463, 113 S.Ct. 2711, 2721-2722, 125 L.Ed.2d 366) (emphasis added).

Once the jury understands the “purely public” purpose of punitive damages, it is then time to turn to the amount of punitive damages to assess. The guidelines for the assessment of punitive damages include the following: (1) how reprehensible was the conduct? (2) is there a reasonable relationship between the amount of punitive damages and the harm? And, (3) in view of the financial condition of the defendant, what amount is necessary to punish and discourage future wrongful conduct? (See, CACI 3949.)

Naturally, the evidence under each of these guidelines will largely depend on the facts of a given case as to the reprehensibility of the conduct, the defendant’s financial condition, and the plaintiff’s actual injury. These facts must be presented in evidence and then argued specifically to the jury. In addition to these general guidelines, there are other authorities that speak more specifically to the amount of punitive damages. Take the following jury instruction:

In determining the amount of punitive damages to be assessed against a defendant, you may consider the following factors: One factor is the particular nature of the defendant’s conduct. Different acts may be of varying degrees of reprehensibility, and the more reprehensible the act, the greater the appropriate punishment. Another factor to be considered is the wealth of the defendant. The function of deterrence and punishment will have little effect if the wealth of the defendant allows it to absorb the award with little or no discomfort.

(Neal v. Farmers Ins. Exchange (1978) 21 Cal.3d 910, 928) (emphasis added).

These jury instructions convey credibility to your argument on the amount of punitive damages the jury should award. In other words, the jury should be told that the law requires a greater punitive damage award where the conduct is particularly reprehensible, and that the law requires that the amount the jury awards in punitive damages must cause some financial “discomfort,” in order to serve the public purpose of deterrence as discussed earlier. Naturally, determining what amount will cause the appropriate “discomfort” will depend on the financial condition of the defendant.

Conclusion

Trying a bad-faith case arising out of a breach of the duty to settle poses some unique issues. You can use the principles described here to get to the punitive-damages phase, and then to convince jurors of their critical role in deterring unacceptable conduct by insurers.