To Settle or Not

Which Party Controls the Settlement Decision?

Policy language is an important factor in assessing the rights of insurers and policyholders. Some policies provide that the insurer has the right 'to make such investigation and such settlement of any claim or suit as it deems expedient' or the insurer 'shall have the right … to settle any 'accident,' claim, or suit.' When a policy has this language, some courts have held an insurer has the authority to settle without the consent of the policyholder. See, e.g., Am. Prot. Ins. Co. v. Airborne, Inc., 476 F. Supp. 2d 985, 990 (N.D. Ill. 2007). On the other hand, sometimes a liability policy contains explicit language requiring the policyholder's consent. Courts usually enforce such provisions. See, e.g., Brion v. Vigilant Ins. Co., 651 S.W.2d 183, 184 (Mo. Ct. App. 1983). No matter what the policy language states, applicable state law should be reviewed to determine whether there is any additional guidance on the issue of which party controls the decision of whether to settle within a deductible or retention.

Some Courts Have Required The Policyholder's Consent to Any Settlement Impacting the Policyholder

Even where the policy appears to give the insurer the unequivocal right to settle all claims, some courts recognize that this right is not unlimited. These courts recognize several distinct scenarios when a policyholder's consent will be required to settle a claim against the policyholder.

Direct Financial Stake

Some courts have held that control of the settlement rests with the policyholder if the policyholder would be required to contribute to the settlement. For example, in St. Paul Fire & Marine Ins. Co. v. Edge Mem'l Hosp., 584 So.2d 1316, 1325 (Ala. 1991), the policy contained a provision giving the insurer the right to 'settle any suit or claim if we believe that it is proper.' While the insurer argued that this language gave the insurer the authority to settle unilaterally, the court found that where the policyholder 'has a direct financial stake in the litigation, the law generally requires that the insured have control over acceptance or rejection of settlement offers.' Id. at 1326. Because the policyholder in that case would have been required to pay the deductible amount in the event of a settlement under the policy, it had a direct financial stake in the outcome. Id. The insurer was unable to collect the deductible amount stated in the policy because the policyholder had not consented to the settlement. Id. at 1327; see also Employers' Surplus Line Ins. Co. v. Baton Rouge, 362 So.2d 561, 565 (La. 1978); compare Am. Prot. Ins. Co. v. Airborne, Inc., 476 F. Supp. 2d 985, 990 n.4 (N.D. Ill. 2007) (rejecting this analysis and relying solely on policy language).

Equal Consideration Rule

Other courts have held the proper inquiry with respect to an insurer's duty to obtain the policyholder's consent to settlement is whether the insurer gave equal consideration to the interests of the policyholder. In Nat'l Serv. Indus., Inc. v. Hartford Accident & Indem. Co., 661 F.2d. 458, 461 (5th Cir. 1981), the U.S. Court of Appeals for the Fifth Circuit upheld a jury finding for the policyholder where the insurer's settlement decision subordinated the interests of the policyholder to the insurer's interests. Id. Despite language in the policy giving the insurer the right to settle, the Fifth Circuit stated that as part of its obligation to defend the policyholder, 'an insurance company must give equal consideration to the interests of the policyholder in making decisions concerning the litigation and the settlement of a claim under the policy.' Id. at 462.

Bad Faith

It is widely recognized that an insurer is bound by an implied duty of good faith and fair dealing in defending a claim against the policyholder. This duty may influence the interpretation of policy language that appears to give the insurer the unconditional right to settle without consent of the policyholder. Courts have expressed the concept that an insurer's good faith influences its ability to settle a claim in a variety of ways. Some courts simply state that an insurer may settle a claim as the policy permits 'absent bad faith.' See Boral Indus., Inc. v. Cont'l Casualty Co., 144 Fed. Appx. 36, 37 (11th Cir. 2005). Other courts simply restate the duty of good faith and fair dealing: 'the doctrine of good faith then requires the party vested with contractual discretion to exercise that discretion reasonably and with proper motive, not arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectation of the parties.' Am. Prot. Ins. Co v. Airborne, Inc., 476 F. Supp. 2d 985, 995 (N.D. Ill. 2007) (citing Citicorp Sav. v. Rucker, 692 N.E. 2d 1319, 1324 (Ill. App. 1998)). The problem is that courts apply varying standards for determining whether there has been a breach of the duty of good faith and fair dealing or bad faith.

For example, to prove bad faith under New York law, the policyholder must show that the insurer's conduct constituted a 'gross disregard of the insured's interests ' that is, a deliberate or reckless failure to place on equal footing the interests of its insured with its own interests when considering a settlement offer.' Commerce & Indus. Ins. Co v. North Shore Towers Mgmt. Inc., 617 N.Y.S.2d 632, 635 (N.Y. Civ. Ct. 1994) (citing Pavia v. State Farm Mut. Auto. Ins. Co., 626 N.E.2d 24 (N.Y. 1993). The standard for analyzing bad faith varies state to state and has to be analyzed under potentially applicable law in order for a policyholder to assess whether an insurer acted in bad faith in settling a case within a retention and deductible.

Not all courts allow a bad faith inquiry into an insurer's decision to settle. Some courts have refused to recognize an implied duty of good faith and fair dealing impacts an insurer's right to settle a case. In New Hampshire Ins. Co. v. Ridout Roofing Co., Inc., 80 Cal. Rptr. 2d 286, 291 (Cal. Ct. App. 1998), the policy at issue expressly gave the insurer the right to settle claims within the policy limits. The court was unwilling to limit this express grant of authority with an implied covenant of good faith. Id.; Stevens Transport, Inc. v. Nat'l Cont'l Ins. Co., 2000 Tex. App. LEXIS 3070, *10 (Tex. App. May 11, 2000).

Unequal Bargaining Power

Several courts have recognized that equal bargaining position is a consideration in whether to enforce policy language giving the insurer the right to settle without the consent of the policyholder. Even in cases in which the courts have found in favor an insurer, the courts have held that the result may have been different if the policyholder had presented a claim of unequal bargaining power. See, e.g., Boral Indus., Inc. v. Cont'l Casualty Co., 144 Fed. Appx. 36, 37 (11th Cir. 2005) ('Boral, as a sophisticated corporate entity, had the opportunity to bargain for insurance without a provision that granted the insurer an 'unfettered right to settle claims”); Casualty Ins. Co. v. Town & Country Pre-Sch. Nursery, Inc., 498 N.E.2d 1177, 1179 (Ill. App. Ct. 1986) ('T&C made no claim that it was in an unequal bargaining position' when agreeing to the policy language). Therefore, if a policyholder lacked the power to negotiate the terms of the insurance policy, this lack of power to negotiate may be a material consideration in whether the policyholder may contest the insurer's decision to settle a claim.

Remedies Available to Policyholder

Where the court finds an insurer has improperly failed to obtain consent from the policyholder, one remedy is a finding that the policyholder is not required to reimburse the insurer for the deductible or retention amount. See St. Paul Fire & Marine Ins. Co. v. Edge Mem'l Hosp., 584 So.2d 1316, 1325 (Ala. 1991). In addition, where the court finds that the insurer has failed to adequately consider the interests of the policyholder, some states allow a policyholder to sue for extra-contractual damages. For example, under Georgia law, where the insurer fails to give proper consideration to the interests of the policyholder, the policyholder may recover any damages arising as a result of that failure. Nat'l Serv. Indus., Inc. v. Hartford Accident & Indem. Co., 661 F.2d. 458, 462 (5th Cir. 1981); see also Brion v. Vigilant Ins. Co., 651 S.W.2d 183, 185 (Mo. Ct. App. 1983) (recognizing that such a breach may 'give rise to damages not generally recoverable in a conventional breach of contract action' such as damages for harm to reputation).

Conclusion

In sum, even if the insurer insists that is has the right to settle a claim within the policy deductible or retention, the policy language or the applicable law might require the consent of the insured to settle a claim.

Andrew M. Reidy is a partner and Keara Kelley is an associate with Howrey LLP, a law firm in Washington, DC, that represents insureds in disputes with insurance companies.

Many policyholders have large deductibles or retentions in their liability policies. Insurers that agree to defend policyholders against a claim falling within the coverage of a liability policy typically also want to control the litigation strategy and/or settlement discussions. What happens when the insurer wants to settle a claim within the deductible or retention amount, making the policyholder liable for the entire settlement, but the policyholder does not want to settle? Does the insurer have to obtain consent of the policyholder before settling the claim? While the scenario seems to present an academic question, the reality is that given the large amount of retentions and deductibles that are common today, policyholders and insurers often disagree about whether a case should be settled. As described below, the answer to the question of who decides whether to settle a case within a policy retention or deductible will depend upon the specific policy language at issue and the applicable state law.

The Effect of a Reservation of Rights

In analyzing the issue of whether an insurer may settle a claim without the policyholder's consent, the first question to ask is whether the insurer is defending under a reservation of rights. If the insurer has agreed to defend the claim against the policyholder under a reservation of rights, in some states the control of the defense and the control of the decision of whether to settle rest solely with the policyholder. See, e.g., Cay Divers, Inc. v. Raven , 812 F.2d 866, 810 (3d Cir. 1987). On the other hand, in other states, an insurer's reservation of rights does not vest the policyholder with control of the defense and settlement. If the applicable law does not vest the policyholder with control of the decision-making, the next step is to analyze the policy language.

Which Party Controls the Settlement Decision?

Policy language is an important factor in assessing the rights of insurers and policyholders. Some policies provide that the insurer has the right 'to make such investigation and such settlement of any claim or suit as it deems expedient' or the insurer 'shall have the right … to settle any 'accident,' claim, or suit.' When a policy has this language, some courts have held an insurer has the authority to settle without the consent of the policyholder. See, e.g., Am. Prot. Ins. Co. v. Airborne, Inc., 476 F. Supp. 2d 985, 990 (N.D. Ill. 2007). On the other hand, sometimes a liability policy contains explicit language requiring the policyholder's consent. Courts usually enforce such provisions. See, e.g., Brion v. Vigilant Ins. Co., 651 S.W.2d 183, 184 (Mo. Ct. App. 1983). No matter what the policy language states, applicable state law should be reviewed to determine whether there is any additional guidance on the issue of which party controls the decision of whether to settle within a deductible or retention.

Some Courts Have Required The Policyholder's Consent to Any Settlement Impacting the Policyholder

Even where the policy appears to give the insurer the unequivocal right to settle all claims, some courts recognize that this right is not unlimited. These courts recognize several distinct scenarios when a policyholder's consent will be required to settle a claim against the policyholder.

Direct Financial Stake

Some courts have held that control of the settlement rests with the policyholder if the policyholder would be required to contribute to the settlement. For example, in St. Paul Fire & Marine Ins. Co. v. Edge Mem'l Hosp. , 584 So.2d 1316, 1325 (Ala. 1991), the policy contained a provision giving the insurer the right to 'settle any suit or claim if we believe that it is proper.' While the insurer argued that this language gave the insurer the authority to settle unilaterally, the court found that where the policyholder 'has a direct financial stake in the litigation, the law generally requires that the insured have control over acceptance or rejection of settlement offers.' Id. at 1326. Because the policyholder in that case would have been required to pay the deductible amount in the event of a settlement under the policy, it had a direct financial stake in the outcome. Id. The insurer was unable to collect the deductible amount stated in the policy because the policyholder had not consented to the settlement. Id. at 1327; see also Employers' Surplus Line Ins. Co. v. Baton Rouge , 362 So.2d 561, 565 (La. 1978); compare Am. Prot. Ins. Co. v. Airborne, Inc. , 476 F. Supp. 2d 985, 990 n.4 (N.D. Ill. 2007) (rejecting this analysis and relying solely on policy language).

Equal Consideration Rule

Other courts have held the proper inquiry with respect to an insurer's duty to obtain the policyholder's consent to settlement is whether the insurer gave equal consideration to the interests of the policyholder. In Nat'l Serv. Indus., Inc. v. Hartford Accident & Indem. Co. , 661 F.2d. 458, 461 (5th Cir. 1981), the U.S. Court of Appeals for the Fifth Circuit upheld a jury finding for the policyholder where the insurer's settlement decision subordinated the interests of the policyholder to the insurer's interests. Id. Despite language in the policy giving the insurer the right to settle, the Fifth Circuit stated that as part of its obligation to defend the policyholder, 'an insurance company must give equal consideration to the interests of the policyholder in making decisions concerning the litigation and the settlement of a claim under the policy.' Id. at 462.

Bad Faith

It is widely recognized that an insurer is bound by an implied duty of good faith and fair dealing in defending a claim against the policyholder. This duty may influence the interpretation of policy language that appears to give the insurer the unconditional right to settle without consent of the policyholder. Courts have expressed the concept that an insurer's good faith influences its ability to settle a claim in a variety of ways. Some courts simply state that an insurer may settle a claim as the policy permits 'absent bad faith.' See Boral Indus., Inc. v. Cont'l Casualty Co., 144 Fed. Appx. 36, 37 (11th Cir. 2005). Other courts simply restate the duty of good faith and fair dealing: 'the doctrine of good faith then requires the party vested with contractual discretion to exercise that discretion reasonably and with proper motive, not arbitrarily, capriciously, or in a manner inconsistent with the reasonable expectation of the parties.' Am. Prot. Ins. Co v. Airborne, Inc. , 476 F. Supp. 2d 985, 995 (N.D. Ill. 2007) (citing Citicorp Sav. v. Rucker , 692 N.E. 2d 1319, 1324 (Ill. App. 1998)). The problem is that courts apply varying standards for determining whether there has been a breach of the duty of good faith and fair dealing or bad faith.

For example, to prove bad faith under New York law, the policyholder must show that the insurer's conduct constituted a 'gross disregard of the insured's interests ' that is, a deliberate or reckless failure to place on equal footing the interests of its insured with its own interests when considering a settlement offer.' Commerce & Indus. Ins. Co v. North Shore Towers Mgmt. Inc. , 617 N.Y.S.2d 632, 635 (N.Y. Civ. Ct. 1994) (citing Pavia v. State Farm Mut. Auto. Ins. Co. , 626 N.E.2d 24 (N.Y. 1993). The standard for analyzing bad faith varies state to state and has to be analyzed under potentially applicable law in order for a policyholder to assess whether an insurer acted in bad faith in settling a case within a retention and deductible.

Not all courts allow a bad faith inquiry into an insurer's decision to settle. Some courts have refused to recognize an implied duty of good faith and fair dealing impacts an insurer's right to settle a case. In New Hampshire Ins. Co. v. Ridout Roofing Co., Inc., 80 Cal. Rptr. 2d 286, 291 (Cal. Ct. App. 1998), the policy at issue expressly gave the insurer the right to settle claims within the policy limits. The court was unwilling to limit this express grant of authority with an implied covenant of good faith. Id.; Stevens Transport, Inc. v. Nat'l Cont'l Ins. Co., 2000 Tex. App. LEXIS 3070, *10 (Tex. App. May 11, 2000).

Unequal Bargaining Power

Several courts have recognized that equal bargaining position is a consideration in whether to enforce policy language giving the insurer the right to settle without the consent of the policyholder. Even in cases in which the courts have found in favor an insurer, the courts have held that the result may have been different if the policyholder had presented a claim of unequal bargaining power. See, e.g., Boral Indus., Inc. v. Cont'l Casualty Co., 144 Fed. Appx. 36, 37 (11th Cir. 2005) ('Boral, as a sophisticated corporate entity, had the opportunity to bargain for insurance without a provision that granted the insurer an 'unfettered right to settle claims”); Casualty Ins. Co. v. Town & Country Pre-Sch. Nursery, Inc. , 498 N.E.2d 1177, 1179 (Ill. App. Ct. 1986) ('T&C made no claim that it was in an unequal bargaining position' when agreeing to the policy language). Therefore, if a policyholder lacked the power to negotiate the terms of the insurance policy, this lack of power to negotiate may be a material consideration in whether the policyholder may contest the insurer's decision to settle a claim.

Remedies Available to Policyholder

Where the court finds an insurer has improperly failed to obtain consent from the policyholder, one remedy is a finding that the policyholder is not required to reimburse the insurer for the deductible or retention amount. See St. Paul Fire & Marine Ins. Co. v. Edge Mem'l Hosp. , 584 So.2d 1316, 1325 (Ala. 1991). In addition, where the court finds that the insurer has failed to adequately consider the interests of the policyholder, some states allow a policyholder to sue for extra-contractual damages. For example, under Georgia law, where the insurer fails to give proper consideration to the interests of the policyholder, the policyholder may recover any damages arising as a result of that failure. Nat'l Serv. Indus., Inc. v. Hartford Accident & Indem. Co., 661 F.2d. 458, 462 (5th Cir. 1981); see also Brion v. Vigilant Ins. Co., 651 S.W.2d 183, 185 (Mo. Ct. App. 1983) (recognizing that such a breach may 'give rise to damages not generally recoverable in a conventional breach of contract action' such as damages for harm to reputation).

Conclusion

In sum, even if the insurer insists that is has the right to settle a claim within the policy deductible or retention, the policy language or the applicable law might require the consent of the insured to settle a claim.

Andrew M. Reidy is a partner and Keara Kelley is an associate with Howrey LLP, a law firm in Washington, DC, that represents insureds in disputes with insurance companies.