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Second Circuit Liberalizes California Bad Faith Law

By: Kurt W. Melchior
10/27/08

California readers might have missed a Second Circuit opinion which has significantly expanded a policyholder's right to bad faith damages under California law. In Schwartz v. Liberty Mutual Insurance Company (2008) 539 F. 3d 135, the court affirmed a jury verdict for damages for the carriers' failure to consent to a settlement. That settlement was negotiated in the middle of the night and the insured negotiated and funded it with his own money. He had given his insurers only a few hours' overnight notice of the impending settlement. Though the events took place in New York, California law controlled the insurers' conduct. No prior decision had ever affirmed that an insurer's failure to act in such a short time could amount to bad faith.

Of course, this was not a simple case. Schwartz had been the CEO of a publicly owned corporation which had become defunct. Investors sued him and others for violation of the securities laws, and he notified his directors' and officers' liability insurers of the action. He had four levels of coverage. The primary insurer, Twin City Fire Ins. Co., approved Schwartz's choice of defense counsel. That lawyer then worked for the next two years with the four carriers to try to settle the case but failed to achieve a settlement. During those years, several excess carriers indicated their intent to participate after the primary coverage had been committed, but Twin City never agreed to commit its policy limits.

The case then went to trial, closely monitored by all insurers. After plaintiffs had rested and the only remaining witnesses were Schwartz and his damages expert, Schwartz negotiated a $20 million settlement at 10 p.m. on a Sunday night. He notified the insurers, suggesting that he had exposure for damages in nine figures. All refused consent. At 9 a.m. on the next morning, Schwartz then funded the settlement with his own money, and the jury was dismissed.

Suing his insurers, Schwartz claimed bad faith on their part for not approving the settlement overnight on the weekend. The trial court allowed that issue to go to the jury, which found for Schwartz – that each of the insurers had enough information and was given enough time, in view of the exigent circumstances of the underlying trial, to evaluate the settlement and to participate in it.

The court addressed what it called the carriers' "simple argument," that Schwartz had not given the insurers sufficient time to evaluate the situation and to give their required advance consent to the settlement. (Each policy had a clause forbidding settlement without the insurer's prior consent.) Relying on well known California insurance bad faith cases mostly from the 1960s and 1970s, the court ruled that "whether the insurer has acted unreasonably, and hence in bad faith, in rejecting a settlement offer is a question of fact to be determined by the jury." Thus the issue on appeal was ultimately whether the insurers were given a reasonable opportunity to evaluate and accept the settlement during the night hours of a Sunday in the midst of trial. If the evidence could support that interpretation and if any carrier's refusal was unreasonable under the circumstances, its conduct would constitute bad faith refusal to settle under California law.

Looking at the evidence of the insurers' long and close oversight of the trial, the court ruled that the jury could find that all of the insurers, including excess carriers who had no duty to defend, had in fact been close enough to the picture and aware enough of the insured's enormous exposure, so that they had been given a reasonable opportunity to settle. Of course, the fact that each insurer declined to participate in the settlement over the next few days, after there had been the opportunity to evaluate at greater length what had happened, helped to establish that the insurers knowingly declined to participate.

Under those circumstances, the court also rejected the argument that Schwartz's payment was "voluntary." Though the carriers had argued that they had only a few hours in the middle of the night to evaluate the insured's unilateral settlement demand, the court ruled that there had been "a prolonged course of consultation," and thus the settlement "was in the nature of anticlimax rather than surprise." The court found that the jury was within its discretion in finding that the insurers were not "blindsided" and that each of them had acted in bad faith in not supporting the settlement.

Surely, this case had exceptional facts. But it is a landmark decision because it carefully reviewed California law and ruled that under it, a properly instructed jury may find that an insured's unilateral settlement payment is "involuntary" and that the carrier may have refused settlement in bad faith if with adequate knowledge of the situation, it does not respond to settlement opportunities with alacrity, even in the middle of the night.

Kurt W. Melchior is a litigation partner with Nossaman in San Francisco, where he chairs the Firm's insurance coverage practice group. He has over 50 years' experience litigating complex commercial matters, including class actions, antitrust, insurance coverage, health care, and professional responsibility cases. He can be reached at (415) 438-7279 or kmelchior@nossaman.com.

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