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If Proposed Settlement Invades Excess Layer, Excess Insurer Can Either Approve Settlement, Reject It and Take Over Defense, or Face Suit for Reimbursement

If a proposed settlement of a covered claim would invade an excess insurer's layer of coverage, the excess insurer can either (1) approve the settlement, (2) reject the settlement and take over the defense, or (3) reject the settlement, decline to take over the defense, and face a potential lawsuit by the insured seeking contribution toward the settlement. (Teleflex Medical Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA (9th Cir. 2017) 851 F.3d 976)

Facts

LMA North America, Inc. (LMA) and Ambu A/S (Ambu) are business competitors who distribute competing medical devices. In 2007, LMA filed a federal court patent infringement lawsuit against Ambu. Ambu responded by filing counterclaims for trade disparagement and false advertising against LMA, based on allegations that LMA's advertisements contained false and disparaging statements about Ambu's products.

LMA had two insurance policies that covered LMA for disparagement claims. Specifically, LMA had a $1 million primary commercial general liability policy issued by Transcontinental Insurance Company (Transcontinental) and a $14 million excess liability policy issued by National Union Fire Insurance Company of Pittsburgh, PA (National Union). Transcontinental as primary insurer agreed to defend LMA against the counterclaims, and National Union as excess insurer monitored the litigation.

After extensive litigation, LMA and Ambu attended a two-day mediation. As a result of the mediation, LMA and Ambu reached a conditional settlement agreement pursuant to which Ambu would pay LMA $8.75 million in settlement of the patent claims and LMA would pay Ambu $4.75 million in settlement of the disparagement claims. The settlement was conditioned on LMA's ability to obtain approval and funding from Transcontinental and National Union.

LMA's defense counsel informed Transcontinental and National Union that LMA faced possible liability of more than $10 million on the disparagement counterclaims, and that $4.75 million would be a fair and reasonable settlement of the counterclaims. In response, Transcontinental agreed to contribute its $1 million primary limit on behalf of LMA toward the proposed settlement. However, after three months of "foot dragging," National Union ultimately declined to commit anything on LMA's behalf toward the settlement and did not offer to assume LMA's defense.

LMA proceeded to finalize the settlement with Ambu by agreeing to pay Ambu $4.75 million in settlement of the disparagement counterclaims. Immediately thereafter, National Union offered to assume LMA's defense if LMA could "undo" the settlement. LMA responded that the executed settlement could not be "undone."

Following execution of the settlement, LMA sued National Union in federal court for breach of contract and bad faith. The case proceeded to trial and the jury found for LMA on both the breach of contract and bad faith claims. The district court entered judgment in LMA's favor for over $6 million (including $3.75 million in contract damages; approximately $1.2 million in attorney fees, expert fees and costs; and approximately $1.1 million in prejudgment interest). National Union appealed.

Holding

The Ninth Circuit Court of Appeals, applying California law, affirmed the judgment against National Union.

The Ninth Circuit held that pursuant to the California Court of Appeal's decision in Diamond Heights Homeowners Association v. National Am. Ins. Co. (1991) 227 Cal.App.3d 563, an excess liability insurer has three options when presented with a proposed settlement of a covered claim that has met the approval of the insured and the primary insurer. Specifically, the excess insurer can either (1) approve the settlement, (2) reject the settlement and take over the defense, or (3) reject the settlement, decline to take over the defense, and face a potential lawsuit by the insured seeking contribution toward the settlement. Here, National Union had rejected the proposed settlement of the counterclaims against LMA without offering to assume LMA's defense. As such, LMA was free to settle the counterclaims and seek reimbursement from National Union in a separate suit. Neither the National Union policy's "no voluntary payment" clause nor the policy's "no action" clause prevented LMA from entering into a non-collusive settlement of the claims and then suing National Union for reimbursement.

Moreover, there was sufficient evidence from which a jury could find that National Union had acted in bad faith. According to the federal appellate court, "the jury could rationally conclude based on these facts that National Union acted unreasonably by refusing to take over the defense or approve the reasonable settlement, knowing full well of its obligations under California law."

Comment

The Ninth Circuit rejected National Union's argument that National Union as excess insurer had the right veto the proposed settlement. According to the federal appellate court, National Union's "no voluntary payment" and "no action" clauses did not give National Union the "absolute rights to veto settlements." Rather, under the Diamond Heights framework, National Union's ability to rely on the "no voluntary payment" and "no action" clauses was subject to the implied covenant of good faith and fair dealing. The Ninth Circuit suggested that while the wisdom of the Diamond Heights rule might be open to "debate," National Union had failed to show that the California Supreme Court would not follow the Diamond Heights decision.

The Diamond Heights and Teleflex cases are perhaps subject to some criticism. This is especially true considering that (1) an excess insurer generally does not calculate premiums with the idea that it will have a "duty to defend" an insured, (2) an excess policy's "no voluntary payment" and "no action" clauses do indeed prohibit the insured from settling without the insurer's consent, (3) these are not situations in which the excess insurer has "denied" coverage, and (4) if the excess insurer refuses a reasonable settlement offer within its limits and the insured then suffers a judgment in excess of those limits, the excess insurer would presumably be liable for damages for breaching its "implied duty to settle."

 

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