The lid is off the policy . . .But what’s next?

Winning and collecting from an insurer a judgment that exceeds the policy limits

2015 August

You’ve sent your letter-perfect policy-limit demand, providing the other party’s insurer with a clear and unequivocal opportunity to settle within their policy limits. The demand was sent at a time when the other party’s liability was reasonably clear and any judgment was likely to exceed the amount of the demand. (Johansen v. California State Auto. Ass’n Inter-Ins. Bureau (1975) 15 Cal.3d 9, 16; CACI 2334.) And it provided the insurer with whatever information and documents (medical records, police reports, witness statements) were available at the time. Finally, it gave the insurer a reasonable time for acceptance – the longer the insurer had to investigate, the less time it needed to respond to the demand. (Coe v. State Farm Mut. Auto. Ins. Co. (1977) 66 Cal.App.3d 981, 994; Kelley v. British Commercial Ins. Co. (1963) 221 Cal.App.2d 554.)

But the insurer rejected the policy limit demand, or it failed to respond in a timely fashion. When an insurer “fails to accept a reasonable settlement offer within policy limits,” it “will be held liable in tort for the entire judgment against the insured, even if that amount exceeds the policy limits.” (Rappaport-Scott v. Interinsurance Exch. (2007) 146 Cal.App.4th 831, 836.) The “lid” is off the insurance policy. But how do you obtain and eventually recover an excess judgment? There are a number of important steps. One of the most critical is to obtain an assignment of rights from the insured – one assigning all of their assignable rights against the insurer to your client. After that, the options depend on one crucial detail – whether the insurer is providing a defense to their insured.

Obtain an assignment from the insured

An assignment is one of the only ways for the third-party claimant to proceed directly against the insurer to recover an excess judgment. In essence, an assignment of rights in exchange for a covenant not to execute “frees the insured from monetary liability and, in turn, allows the plaintiff to step into the shoes of the insured and bring suit against the insurance company for whatever claims the insured might have had.” (Executive Risk Indem., Inc. v. Jones (2009) 171 Cal.App.4th 319, 325.)

The assignment can be entered into at any time after expiration of the time to accept the offer within policy limits – even before judgment. This is true regardless of whether the insurer is defending or not. The failure to accept the reasonable settlement demand constitutes a change in the relationship between insurer and insured: “[w]hen the insurer breaches its obligation of good faith settlement, it exposes its policyholder to the sharp thrust of personal liability. At that point, there is an acute change in the relationship between policyholder and insurer.” (Critz v. Farmers Ins. (1964) 230 Cal.App.2d 788, 801 (emphasis added).) Although the insured must still cooperate in defense of the action (by appearing to testify and telling the truth), “he need not indulge in financial masochism,” nor “bare his breast to the continued danger of personal liability.” (Id. at 801.) As recognized by the California Supreme Court, “an insured breaches no duty to the insurance company when he assigns his rights against the company to the injured plaintiff for a covenant not to execute.” (Samson v. Transamerica (1981) 30 Cal.3d 220, 241.)

The major caveat

There is one major caveat to obtaining an assignment from the insured. In California, an insured can assign to a third-party claimant all assignable claims and causes of action against an insurer, except claims for emotional distress and punitive damages, which are not assignable as a matter of law, and are retained by the insured. (Murphy v. Allstate Ins. Co. (1976) 17 Cal.3d 937, 942.). When entering into an assignment agreement, it is important that both the third-party claimant (the assignee) and the insured (the assignor) have an understanding about whether the non-assigned claims for emotional distress and/or punitive damages will be pursued. This is to avoid an improper “splitting” of the bad-faith cause of action.

If an insured intends to pursue non-assigned claims for emotional distress and punitive damages, they must be brought in a joinder action along with the third party claimant’s prosecution of the assigned claims. If the assigned and non-assigned claims are pursued in separate actions, it would constitute an improper “splitting” of a cause of action and neither action could proceed. (Purcell v. Colonial Insurance Company (1971) 20 Cal.App.3d 807; Cain v. State Farm Mutual Automobile Insurance Company (1975) 47 Cal.App.3d 783.) Because of the rule established in Purcell and Cain, the assignment agreement should specifically address whether and how the non-assigned claims will be pursued. The assignment agreement should expressly state that the non-assigned claims will not be pursued, or if pursued, will be done in a joinder action to avoid an improper “splitting” of a cause of action.

Finally, some additional items to bear in mind when obtaining an assignment of rights in exchange for a covenant not to execute: (1) obtain the assignment before trial/judgment – insureds may be less cooperative after being subjected to cross-examination or after a large judgment has been rendered against them; (2) include an assignment by the insured of any Brandt attorney’s fees incurred to recover or obtain policy benefits; (3) be mindful that an assignment is not a “settlement agreement” or a “release agreement” and should not include language to that effect – it is merely an assignment in exchange for a covenant not to execute on any eventual judgment; and (4) before granting a covenant not to execute on any excess judgment, investigate the insured’s financial status to make sure there are no other assets to satisfy the judgment.

Control of the defense

When the insurer defends the action against its insured, the insurer retains the right to control the defense and settlement of that action. For the purposes of evaluating an insurer’s duty to accept a reasonable settlement demand, it makes no difference whether the insurer is defending the insured in the third-party claimant’s action. The California Supreme Court has held insurers liable for an excess judgment, without regard to policy limits, in either context. (See Johansen v. California St. Auto. Assn. Inter-Ins. Bur., 15 Cal.3d 9, (where the insurer was defending but refused to settle within policy limits), and Samson v. Transamerica Ins. Co., 30 Cal.3d 220, (where the insurer refused to either defend or settle).) The difference lies in the options available to the claimant and insured after the insurer’s failure to settle. When an insurer provides a defense, those options are much more limited.

Even where an insurer failed to accept a reasonable opportunity to settle within policy limits, so long as it continues to provide a defense to its insured, the insurer retains the right to control settlement and defense of the action. Thus, the insured has no right to settle directly with the injured party, no right to enter into a stipulated judgment, and no right to attempt to sabotage the insurer’s defense. (Hamilton v. Maryland Casualty Co. (2002) 27 Cal.4th 718, 726.) “[N]either the adequacy of the representation nor the effectiveness of the defense are relevant to the question whether the [insured] can enter into a binding settlement without the insurer’s consent.” (Safeco Ins. Co. v. Superior Court (McKinney) (1999) 71 Cal.App.4th 782, 789.)

In essence, this means that if the insurer is providing a defense, the third-party claimant must proceed to trial and obtain an excess judgment against the insured. The primary step for the third-party claimant to take then is to acquire the assignment of rights from the insured and prosecute the lawsuit. With the assignment in hand, the third-party claimant can proceed directly against the insurer upon the rendering of an excess judgment.

If the insurer refuses to provide a defense

If the insurer refuses to provide a defense, additional options are available. “An insurance company ‘bears a duty to defend its insured whenever it ascertains facts which give rise to the potential of liability under the policy.’ Wrongful failure to provide coverage or defend a claim is a breach of contract.” (Pruyn v. Agric. Ins. Co. (1995) 36 Cal.App.4th 500, 514-15, as modified on denial of reh’g (July 27, 1995), quoting Isaacson v. California Ins. Guarantee Assn. (1988) 44 Cal.3d 775, 791.) By breaching its contractual duty to defend the insured, the insurer forfeits its right to control the settlement and defense of the action. The insured, in addition to assigning his or her rights to the third-party claimant, has additional options for resolving the action brought against them, such as: (1) an uncontested trial, which is binding on the insurer; (2) a default judgment, also binding on the insurer; and (3) a stipulated judgment, which is subject to attack by the insurer in the subsequent bad-faith action.

• Undergoing an uncontested trial

In Samson v. Transamerica, (1981) 30 Cal.3d 220, one of the insured’s carriers, State Farm, agreed to defend the insured, while the other, Transamerica, denied a defense. Consequently, the insured and State Farm collectively entered into an agreement with the Samsons, the underlying plaintiffs, before the action went to trial. The agreement provided that, in exchange for State Farm’s payment of its $100,000 policy limit and the insured’s assignment of any rights against Transamerica, the Samsons would sign a covenant not to execute any judgment ultimately obtained against the insured. Moreover, the insured agreed to cooperate with the plaintiffs in the action against him. This agreement was reached without the knowledge of Transamerica.

At trial, the insured did not contest liability or damages, presented no defenses, and did not cross-examine witnesses. Although Transamerica had been informed of the pendency of the action, it was not informed of the trial date. The trial court ultimately awarded the Samsons $725,000. Thereafter, the Samsons, as judgment creditors and assignees, sued Transamerica.

The Samson court was called upon to “decide whether this insurance company is bound to pay the entire judgment entered against its insured in an action to which it was not a party, because it refused to defend its insured and rejected a settlement offer.” (Id. at 224.) Transamerica argued that “even if coverage is found Transamerica should have an opportunity to litigate the amount of damage,” and that it should only be liable up to its $300,000 policy limit. (Id. at 236.)

But Samson found that “an insurer who fails to accept a reasonable settlement offer within policy limits because it believes the policy does not provide coverage assumes the risk that it will be held liable for all damages resulting from such refusal, including damages in excess of applicable policy limits.” (Id. at 237.) Thus, the insurer was bound by the judgment, despite it being an uncontested trial. Similarly, in National Union Fire Ins. Co. v. Lynette C. (1994) 27 Cal.App.4th 1434, 1449, the court observed that a judgment entered by a court after an uncontested trial was an “independent adjudication of the facts based on an evidentiary showing” because “[the parties] did not resolve the issues of liability and damages in the [underlying] action. A court did.” (Ibid.)

The case law is clear that once an insurer refuses to defend in an underlying action, and refuses to intervene by filing a motion to vacate the judgment in the underlying action, it cannot later collaterally attack the evidence of damages which were introduced and proven in the underlying action. The controlling case is Clemmer v. Hartford Ins. Co. (1978) 22 Cal.3d 865, 885-886, a decision by the California Supreme Court. In Clemmer, the Court held that an insurer has standing to seek to set aside a judgment entered against its insured that it may be held responsible to pay. Clemmer further held that when an insurer declines to exercise this option, it is later precluded from re-litigating the issue of damages. (Id. at 888.)

The Clemmer Court noted that since the insurer had ample notice of the adverse judgment; it had six months to file a motion in the underlying action to set aside the judgment, and that its failure to do so precluded it from raising its defense in a collateral attack on the judgment. The Clemmer court explained that the insurer had standing to seek to move to set aside the judgment, but failed to do so. (Id. at 886.) The Court explained that because the insurer “chose to remain silent, resting on its claim of noncoverage” and “[h]aving failed to pursue remedies thus available to it, it cannot now claim prejudice or lack of opportunity to litigate damages.” (Id. at 886).

Based on the foregoing, in order to preclude a later attempt to collaterally attack the judgment, the recommended course is to have an independent adjudication of the underlying action and then give notice of the judgment to the insurer. This can be accomplished either through the uncontested trial, or the default judgment below. Both will be binding on the insurer.

Obtaining a default judgment

This route for obtaining an excess judgment was specifically approved in Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825. In Amato, the insured (Amato) tendered to his insurer, Mercury, but Mercury refused to defend. The plaintiff in that action offered to settle for the $15,000 policy limit, a demand that was also rejected by Mercury. The insured couldn’t afford to defend himself, so the plaintiff obtained a default judgment against Amato for $165,750. Mercury, similar to the example above in Clemmer, failed to do anything to set aside the default.

Amato considered that “[a] default judgment for personal injury results only after the court conducts a hearing to consider the plaintiff’s evidence and to award such damages as that evidence shows to be just.” (Id. at 838, citing Code Civ. Proc., § 585, subd. (b).) Thus, the judgment that resulted involved “significant independent adjudicatory action by the court, thus mitigating the risk of a fraudulent or collusive settlement between an insured and the claimant. Final judgments entered under ... these circumstances are binding on the insurer which has wrongfully abandoned its insured and may be enforced directly under Insurance Code section 11580.” (Amato, 53 Cal.App.4th at 838, quoting Pruyn, supra, 36 Cal.App.4th at 517, 523.)

Under Amato, the insurer who breaches the duty to defend, where the insured suffers a default judgment because they are unable to defend themselves, will be liable for the default judgment “which is a proximate result of its wrongful refusal to defend.” (Amato, at 829.) The “insured is not required . . . to conduct a ‘trial within a trial’ in order to recover the amount of the default judgment.” (Ibid.) The court in Xebec Development Partners Ltd. v. National Union Fire Ins. Co. (1993) 12 Cal.App.4th 501, made the same point, observing that the prove-up proceeding that is necessary to obtain a default judgment provides the requisite independent adjudication necessary to bind an insurer. (Id., 12 Cal.App.4th at 541, 544.)

Thus, when an insurer refuses to defend, a default judgment will be binding on the insurer in the subsequent bad-faith action as a consequential damage where the insured could not afford to defend the action.

Stipulated judgment subject to attack by insurer

A stipulated judgment can be subject to attack by the insurer − it only provides an evidentiary presumption in favor of the excess judgment and is not binding. When a “liability insurer wrongfully denies coverage or refuses to provide a defense, then the insured is free to negotiate the best possible settlement . . . including a stipulated judgment accompanied by a covenant not to execute.” (Pruyn, supra, at 509.) But when that agreement purports to fix the amount of damages suffered by the third-party claimant by way of a stipulated judgment or settlement, it calls into question whether the settlement properly represents the amount of damages sustained, or whether it was collusive. (Id., at 518.) The concern arises in this situation because it is in the insured’s interest to agree to damages in any amount as long as the agreement provides that the insured will not be personally responsible for payment. (Ibid.)

Pruyn specifically addressed whether a stipulated judgment between the insured and the third-party claimant would be binding on the insurer. The claimant argued that it should be binding because the stipulated judgment was found to constitute a “good-faith” settlement under Code of Civil Procedure section 877.6. But Pruyn surveyed the law and determined that the rule that a final judgment entered against an insured would be binding on the insurer did not apply when there was a stipulated judgment that had only been subject to approval under section 877.6.

Pruyn held that a stipulated judgment approved as a good-faith settlement would not be treated as the equivalent of a judgment entered after a default hearing or an uncontested trial. Instead, the insurer would be given an opportunity that is generally not available when there is a judgment entered after an adjudicatory proceeding – the opportunity to attack the amount of the settlement as the product of fraud and collusion. (Pruyn, at 526.)

But note that the settlement “will raise an evidentiary presumption in favor of the insured (or the insured’s assignee) with respect to the existence and amount of the insured’s liability.” (Id. at 509.) The effect of the presumption – and of the settlement – is to “shift the burden of proof to the insurer” to affirmatively show that the settlement was unreasonable or the product of fraud or collusion. (Ibid.)

As the previous decisions demonstrate, the underlying judgment is binding on the insurers when there was an independent adjudication of liability and damages. (Pruyn, 36 Cal.App.4th at 527; Amato, 53 Cal.App.4th at 838.). But where the adjudication is made by the parties, the judgment is only entitled to a rebuttable presumption. Accordingly, while a stipulated judgment is permissible when an insurer has refused to both defend and settle, the better practice is to proceed to judgment with an independent judicial adjudication.

The CCP 638 reference hearing

A preferable alternative that will be binding on the insurer when it refuses to defend? Undergoing a California Code of Civil Procedure section 638 reference hearing.

To be enforceable against an insurer, a ‘judgment need not be based on a contested or adversarial trial, but may rest upon a default hearing following a settlement or an uncontested trial where the insured settled with the claimant and thereafter provided no defense.

(Garamendi v. Golden Eagle Ins. Co. (2004) 116 Cal.App.4th 694, 739-740.)

These circumstances necessarily involve significant independent adjudicatory action by the court thus mitigating the risk of fraudulent or collusive settlement between an insured and the claimant. Final judgments entered under either of these circumstances are binding on the insurer which has wrongfully abandoned its insured…

(Id. at 740.)

One way to proceed with the “significant independent adjudicatory action” is to have, as part of the assignment, an agreement among all parties to appoint a referee pursuant to California Code of Civil Procedure section 638 (herein CCP 638). Under that section, “a referee may be appointed upon the agreement of the parties . . . (a) to hear and determine any or all of the issues in an action or proceeding, whether of fact or of law, and to report a statement of decision.” In addition, “[a] statement of decision reported by a referee under a voluntary general reference [CCP 638] is the equivalent of a statement of decision rendered by a superior court . . . .” (Central Valley General Hosp. v. Smith (2008) 162 Cal.App.4th 501, 513.)

Functionally, the way to proceed is to have the parties, as part of the assignment agreement, agree to undergo a CCP 638 reference by the referee of their choice (preferably a retired judicial officer), who will be appointed to determine all issues in the matter, including facts, law, liability, and damages. With the executed assignment agreement in hand, the parties jointly file a stipulation with the Superior Court to appoint the CCP 638 referee on the same terms as the assignment agreement and to determine all issues in the case. Once the referee is ap- pointed, the parties can select a mutually agreeable date for the CCP 638 reference hearing, preferably at a neutral site, or the referee’s office. The insurer should be invited to attend, in writing. Following the hearing, the referee will render a statement of decision, which can be confirmed by the Superior Court, with judgment entered pursuant to the terms of that decision.

This judgment, because it involved significant independent adjudicatory action by the court and its designated referee, will be binding on the insurer to the same extent as an uncontested trial or default judgment. This procedure provides greater autonomy, quicker resolution, and an independent statement of decision that establishes the facts, decision, law, and damages in the underlying action.

Final tips after failure to settle

An important consideration for the follow-up bad-faith action against the insurer is the matter of the plaintiff. With an assignment of rights, the third-party claimant can directly proceed against the insurer for the entire excess judgment, but cannot claim emotional distress or punitive damages without also including the insured as a plaintiff. And, as above, both the third-party claimant and the insured would have to proceed as plaintiffs against the insurer in the same action. It calls for a decision – does the insured, the tortfeasor in the underlying case, make a sympathetic and believable plaintiff? And are the emotional distress damages and punitive exposure sufficient to justify their inclusion and the added complexity? It calls for a case-by-case determination.

An alternative to the assignment of rights agreement is an assignment of proceeds agreement. There, the insured prosecutes the entirety of the bad-faith action against the insurer, and agrees to assign the proceeds of that action to the third-party claimant. But this raises issues of its own – including settlement control, consent to settle, how proceeds are shared, and the control of the litigation. Both approaches have their benefits and drawbacks.

But the importance of an assignment cannot be overstated – it is the only way for a third-party claimant to proceed directly against the insurer for the excess judgment. That is not to say the third-party claimant lacks options though. Insurance Code section 11580(b)(2) provides that “whenever judgment is secured against the insured . . . in an action based upon bodily injury, death, or property damage, then an action may be brought against the insurer on the policy and subject to its terms and limitations, by such judgment creditor to recover on the judgment.”

The import of Insurance Code section 11580 is that an adjudicated claimant becomes a third-party beneficiary under the policy. They can then file an action to collect the judgment that is “on the policy” – i.e., the amount of the judgment within the policy limits. This can be initiated even without an assignment. Should the insurer refuse to pay the judgment on the policy, an action against the insurer for bad faith failure to pay can be directly brought by the third-party claimant. But to collect any “excess” judgment over the amount “on the policy,” the third-party claimant must have an assignment from the insured. (Murphy v. Allstate (1976) 17 Cal.3d 937; Hand v. Farmers (1994) 23 Cal.App.4th 1847.)

Finally, regardless of the route taken to obtain the excess judgment, be it CCP 638 reference, uncontested trial, or default judgment, be certain to take the necessary steps to work up the case. Hire the proper experts, obtain the necessary testimony, and collect the relevant evidence and workup to maximize the value of the underlying case. The excess judgment is the foundation for the future bad-faith case. Notably, the judgment provides presumptive proof of the value of the claim. “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.” (Crisci v. Security Ins. Co. of New Haven (1967) 66 Cal.2d 425, 430.)

Conclusion

Perfecting an excess judgment and working to recover the entire amount from the insurer takes practice, but generally follows the same series of steps. After the insurer has rejected a reasonable opportunity to settle within policy limits, begin discussions for an assignment in exchange for a covenant not to execute. With the assignment in hand, the determining factor is then whether the insurer is defending the underlying action. If so, prosecute your case and strive for an excess judgment. If not, engage in one of the options above that requires substantial judicial intervention and management – a default judgment, uncontested trial, or preferably, a CCP 638 reference – and obtain an excess judgment. At that point, with an assignment and excess judgment in hand, you’re ready to proceed with an action against the insurer to recover the entire amount of the excess judgment.