Avoiding the Pitfalls of Stipulated Settlements

Upon receipt of the insurer's reservation of rights letter, the officer becomes concerned that, if the insurer later contests coverage, he may face significant personal exposure. To eliminate this risk, the officer explores the possibility of entering into a settlement with the plaintiff. The plaintiff suggests that the parties stipulate to the entry of a judgment, which is vastly in excess of the suit's true value, and the plaintiff will provide the officer with a 'covenant not to execute,' which protects the officer from personal exposure. In return, the officer will assign to the plaintiff his rights under the policy, including any claims that the insurer acted in bad faith. Armed with the stipulated judgment and an assignment from the insured, the plaintiff files a direct action against the insurer to reach and apply the insurance proceeds to satisfy the outstanding judgment and, pursuant to the assignment, seeks extra-contractual damages on the basis that the insurer acted in bad faith. Suddenly, the insurer is faced with not only litigating whether coverage exists for the inflated judgment, but also defending against a bad faith claim.

This scenario has become more prevalent in the directors and officers' context as plaintiffs have recognized the benefits of a stipulated judgment and non-recourse agreement whereby the plaintiffs can maximize, if not increase, the value of their claims without ever having to fully litigate the merits. Additionally, a stipulated judgment moves the litigation directly into a collection phase; a phase where the insurer's defenses are more limited than in the liability action since liability has been conceded. Given both the frequency of stipulated settlements and the fact that the law in this area has become increasingly conflicting, an insurer needs to be aware of the legal tools that it has available to implement either an offensive or defensive strategy to respond to stipulated settlement situations.