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By
Daven G. Lowhurst
Howrey LLP
The Scenario
Your
company has just been sued. You think the lawsuit is meritless
or that the claims against your company are overstated,
but you do the prudent thing nonetheless: You ask your insurer
to defend you under your commercial general liability policy.
And, the insurer does the right thing: It appoints defense
counsel to represent your company in the lawsuit.
Everything
is going well until you find out that the lawsuit has been
settled without your knowledge or consent. Now, on the one
hand, you are happy that the lawsuit is over and that the
insurer is funding the settlement. But, you are upset because
you never were told about the settlement, you feel the settlement
is far more than what the plaintiff deserved, you feel the
settlement reflects badly on your company's reputation,
and you are looking forward with trepidation to your insurance
premiums skyrocketing based on your loss record, which will
reflect the settlement -- assuming anyone now will insure
you.
Will
the law come to the rescue and give you a way to right this
wrong and to force the insurer to respect the rights of
your company -- for whose protection the insurance was purchased
in the first place? Probably not.
The Law
In
a recent case, a plumbing subcontractor had purchased a
CGL policy providing that the insurer "may at our discretion
investigate any 'occurrence' and settle any claim or 'suit'
that may result." When the subcontractor was sued in
a construction defect case, the insurer appointed a law
firm to defend the subcontractor.
The
construction defect case was settled within policy limits
but without notice to or the consent of the subcontractor.
The subcontractor sued the law firm appointed by the insurer,
alleging that the firm committed malpractice and breached
its fiduciary duties by settling the lawsuit without notifying
the subcontractor and by failing to properly defend the
lawsuit, which would have absolved the subcontractor of
any liability. As a result, the subcontractor was "damaged"
because its insurance premiums went up, its coverage went
down, its deductibles went up, and the financial strength
of insurers willing to issue coverage went down.
The
trial court dismissed the case by summary judgment, and
the 4th District Court of Appeal affirmed. New Plumbing
Contractors, Inc. v. Edwards, Sooy & Byron, 99 Cal.App.4th
799 (2002).
The
appellate court ruled that the policy, by providing the
insurer "may at our discretion... settle any claim
or 'suit'...," gave the insurer the right to control
settlement negotiations without interference from the subcontractor
and that the insurer could, therefore, settle the action
within policy limits with impunity. The court reasoned that
because the insurer could settle without consulting with
the subcontractor and even over its objection, the law firm's
settlement recommendation could not be a "cause"
of harm to the subcontractor.
Lessons
Most
CGL policies contain language giving the insurer the right
to settle any claim or suit against the insured. Thus, the
result in New Plumbing potentially has widespread
application. On the other hand, a contractor is not without
recourse.
There
are legal arguments the contractor could make that were
not addressed in New Plumbing. While the insurer
may have the right to settle over the contractor's objection,
the contractor is entitled to notice of the settlement negotiations
if for no other reason than to have the opportunity to withdraw
the request for coverage and to defend the lawsuit at its
own cost.
There
are a number of reasons why a contractor might choose to
excuse the insurer from the case, including wanting to protect
its reputation by fighting a baseless lawsuit, to discourage
similar lawsuits by other claimants who might view the contractor
as an easy mark, and to avoid premium increases or difficulties
in renewing coverage.
In
addition, the appellate court in New Plumbing jumped
to the conclusion that if the insurer had the right to settle
over the subcontractor's objection, the law firm was insulated
from liability. This ignores the different duties owed by
an insurer and the law firm hired to defend the contractor.
Unlike an insurer, the law firm owes independent professional
and fiduciary duties to the contractor, regardless of the
fact that the insurer is paying the legal bills. Further,
the law firm is obligated to disclose any conflicts of interest
created by its relationship with the insurer. Whether these
points will have any bearing on the liability of a law firm
appointed to defend a contractor will depend on the circumstances
of each case.
A
contractor can try to avoid this situation at the front
end by seeking an endorsement requiring the contractor's
informed consent to any settlement. An insurer willing to
provide such an endorsement likely will increase the premium
to reflect the endorsement.
Other
types of policies, such as professional liability policies,
may expressly provide that the insurer cannot settle a claim
without the insured's informed consent. However, even those
policies frequently provide that if the insured objects
to a settlement, the insurer's duty to defend ends, and
the insurer's obligation is limited to what the case could
have been settled for plus defense costs incurred up to
that point.
Conclusion
While
it is welcome news when an insurer agrees to provide a defense,
this protection generally comes at the expense of the contractor
giving up control over settlement. So, you must be careful
what you wish for.
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For more information about the issues covered in this report, please contact Daven G. Lowhurst in our San Francisco office at 415-848-3363 or at
lowhurstd@howrey.com or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
©2003 Howrey LLP
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