Liability Insurers and Third-Party Claimants: the Limits of Duty
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Liability Insurers and Third-Party Claimants: The Limits of Duty Liability insurance is a curious phenomenon. Originally a sim- ple contract to indemnify the insured, it has evolved into a com- plex undertaking to protect him from suit by deciding when and how much to pay persons he has injured. Originally an arm's length transaction between businessmen, it has become a relation- ship in which most insureds are unsophisticated consumers in need of protection from misrepresentation and overreaching. Originally an essentially private agreement, it has become the vehicle by which society achieves the dual goals of aiding victims of accidents and spreading the costs of accidents among people who derive ben- efit from accident-causing activities. As a result of these transfor- mations, most problems in liability insurance can no longer be solved by traditional contract analysis, but call for the application of tort doctrines, statutory construction, and considerations of public policy. This comment addresses one such problem in liability insur- ance law. An insurer that wrongfully refuses an injured party's of- fer to settle a claim against its policyholder for an amount within policy limits can be liable to the policyholder, if a judgment in ex- cess of policy limits is subsequently entered against him. The ques- tion is whether the same refusal of a settlement offer and the same judgment in excess of insurance coverage should also entitle the injured party to sue the liability insurer. Most states do not allow the third-party claimant to proceed against the insurer, once he has been paid the maximum recover- able on the policy, except as the policyholder's assignee. Some states, however, have altered this result either by using statutes to create an assignment where the policyholder has not voluntarily made one, or by fashioning a direct third-party suit against the insurer. This comment first examines the insured's bad-faith suit as the predicate on which third-party claims are based. It concludes that the action is fundamentally sound and necessary, but that it should be confined rather than expanded. The comment then ex- plores the theoretical justifications for the third-party suit and the 126 The University of Chicago Law Review [48:125 difficulties such an action can be expected to generate. It next surveys the efforts of courts and commentators to find a direct ac- tion based on preexisting law, none of which provide a coherent and rational basis for a system of claimants' remedies. Finally, it concludes that, if the third-party claimant is to have recourse to the liability insurer, it should be under a consensual or statutory assignment rather than in his own right. Garnishment laws, con- sistently applied, might provide the simplest and most logical form of claimant relief with the least dislocation of the liability insur- ance system or of federal bankruptcy law. I. THE INSURED's BAD-FAITH SUIT A. The Dimensions of the Suit The typical fact situation out of which an insured's bad-faith suit1 against the insurer arises is aptly illustrated by Crisci v. Se- curity Insurance Co. 2 Mrs. Crisci, the owner of an apartment building, had general liability coverage under a policy with Secur- ity against just such accidents as the one that occurred when Mrs. DiMare, a tenant in the building, fell through a stair tread. In the resulting lawsuit, the insurance company defended Mrs. Crisci, as its contract obliged it to do, and had exclusive control over all set- tlement negotiations, as its contract entitled it to do. The suit al- leged physical, psychological, and other injuries and damages of $400,000. Nonetheless, Mrs. DiMare and her husband first offered to settle for $10,000, the limits of the policy, then for $9,000 when Mrs. Crisci offered to contribute $2500. Convinced that the physi- cal injuries were worth no more than $3,000 and that its experts could persuade a jury to disbelieve evidence of the psychological injuries, Security refused both offers. The company also knew, however, that a jury might award damages in excess of $100,000 if it believed Mrs. DiMare's experts instead. The jury did just that, awarding the DiMares $101,000 for their combined claims. After the company had paid the $10,000 its policy required, Mrs. Crisci was left with a personal judgment of $91,000 to satisfy. By the time I The designation "bad-faith suit" is employed throughout this comment for the cause of action that alleges insurer misconduct in refusing an opportunity to settle within policy limits. The standards against which insurer conduct is measured are actually much more varied than "bad faith." See text and notes at notes 20-26 infra. 2 66 Cal. 2d 425, 426 P.2d 173, 58 Cal. Rptr. 13 (1967) (en banc). 1981] Liability Insurers she had done so,3 she was indigent, physically and mentally ill, and suicidal. Under circumstances like these, insured parties like Mrs. Crisci would have a lawsuit against insurers like Security Insurance in almost any jurisdiction in the country.4 Whether the action sounds in contract 5 or in tort,6 the company's conduct has harmed 3 Mrs. DiMare took $22,000 in cash, a 40% interest in a piece of property Mrs. Crisci owned, and an assignment of Mrs. Crisci's claim against Security, id. at 429, 426 P.2d at 176, 58 Cal. Rptr. at 16. 4 Rutter v. King, 57 Mich. App. 152, 158, 226 N.W.2d 79, 82 (1974). See generally An- not., 40 A.L.R.2d 168 (Later Case Supp. 1980). There apparently is no jurisdiction which denies the suit, although Mississippi requires a showing of insurer conduct that is virtual fraud, see Martin v. Travelers Indem. Co., 450 F.2d 542, 551 (5th Cir. 1971) (Mississippi law). The availability of redress for insureds in Mrs. Crisci's position was not novel when the Crisci case was decided. Illustrative of early cases are: Brassil v. Maryland Cas. Co., 210 N.Y. 235, 104 N.E. 622 (1914). The insurance company refused a settlement offer of $1,500 (the policy limit). Judgment was entered for $6,000. The company also declined to handle an appeal and in effect tried to preclude one by refusing to pay its insured the policy limits until he had satisfied the judgment in full. The insured recovered his costs, including attor- ney's fees, for prosecuting an appeal. Excess liability was not an issue, because the original judgment for the claimant was reversed and the claimant did not bring his suit a second time. The New York Court of Appeals found that the company had violated "a contractual obligation of universal force which underlies all written agreements . the obligation of good faith in carrying out what is written." Id. at 241, 104 N.E. at 624. Brown & McCabe, Stevedores, Inc. v. London Guarantee & Accident Co., 232 F. 298 (D. Or. 1915). The plaintiff carried a liability policy, covering injuries to its employees, with the defendant company. The policy limits were $5,000; the victim offered to settle for $3,000. The company refused unless the insured would contribute $1,500; damages of $12,000 were awarded at trial. The insured recovered the $7,000 difference between the judgment and the $5,000 which the company ultimately paid out. Hilker v. Western Auto. Ins. Co., 204 Wis. 1, 231 N.W. 257 (1930). The insurance com- pany offered to settle a serious injury claim against its insured for $1,500, adamantly refus- ing, despite policy limits of $5,000, to raise its offer to the $2,500 or $3,000 the plaintiff was willing to accept. It also conducted only a cursory investigation into the accident out of which the lawsuit arose. The court applied agency law to hold against the insurer: the con- trol of defense and settlement negotiations made the company the insured's agent, and the manner in which it conducted its agency violated its duties to its principal. Agency law is not, in fact, an appropriate analogy, because the insured cannot be considered a principal where the decision to accept or reject settlement offers is not his, but the insurer's, to make. R. KEL-roN, BASIC TEXT ON INSURAN cE LAW § 7.10(b) (1971). 6 The contract action is based on breach of an implied covenant of good faith and fair dealing: "that neither party will do anything which will injure the right of the other to receive the benefits of the agreement." Comunale v. Traders & Gen. Ins. Co., 50 Cal. 2d 654, 658, 328 P.2d 198, 200 (1958). See also Brassil v. Maryland Cas. Co., 210 N.Y. 235, 241, 104 N.E. 622, 624 (1914). 6 The tort action arises because the company, by insisting on controlling the defense of its insured and any settlement negotiations that will bind it to pay, has undertaken a duty to the insured that is breached. See, e.g., Keeton, Liability Insurance and Responsibility for Settlement, 67 HAv. L. REv. 1136, 1138 (1954). Keeton indicates that tort rather than contract is the prevalent theory. Id. at 1138 n.5. The University of Chicago Law Review [48:125 the insured. If he sues after having paid the judgment, his dam- ages are the difference between the policy limits and the judg- ment,7 supplemented by damages, if any, for physical harm, emo- tional distress, and causally connected financial injuries. In the egregious case, he can recover punitive damages.8 As a practical matter, however, the insured may not be able to pay the judgment before suing the insurer.