Most standard liability policies contain a clause either as a condition of coverage or as an exclusion that the insured cannot make a “voluntary” payment to settle claims without the insurer’s consent. Sounds relatively simple, right? Not really. The paradigm case where an insurer will be well within its rights to deny coverage for the insured’s voluntary payment is where the insured settles a covered claim without tendering the claim to the insurer first but then demands that the insurer reimburse the insured for the settlement. Unlike other “notice” provisions, in California, the insurer is not required to show prejudice before standing on the voluntary payments clause to deny coverage. Because an insurer is not required to show prejudice from late notice of the tender of indemnity for voluntary settlement payments, California courts have denied coverage for voluntary payments and settlements made post tender and while the insurer was defending the claim.
One might think then that anytime an insured settles a claim, pre or post-tender, the insurer could deny coverage. The answer? Sort of. Why? It depends on what the insured is settling. The following example illustrates the problem. Say the insurer is defending covered and uncovered claims under a reservation of rights, and is also reserving its right to seek reimbursement for defending uncovered claims as authorized by the California Supreme Court’s Buss decision. A mediation is scheduled and the insured and the insurer are participating in the mediation. The insured is worried about a large uncovered judgment being entered against. You, the claims adjuster, believe you have a good chance of defensing the covered claims or obtaining a result far less than the plaintiff’s demand. You offer nothing towards the settlement of the non-covered claims. The insured ponies up his own dough to effect a settlement with plaintiff for all the non-covered claims because the insured is afraid of:
(1) A massive judgment for which there is no insurance coverage as per the insurer’s reservation of rights letter; and
(2) A second lawsuit by the insurer for reimbursement for the defense of the uncovered claims.
Presently, no California state court has addressed this exact factual scenario, despite this becoming a more common situation. Do you believe you could justifiably deny all coverage to the insured if the insured settled only the non-covered claims, thereby leaving only the covered claims to be litigated?
The Ninth Circuit Court of Appeals said no, in a case involving Tosco oil refineries in the context of worker’s compensation insurance for claim arising out of the Northern District of California. (See Travelers Prop. Cas. Co. of America vs. ConocoPhillips Co. [Tosco] (9th Cir. (Cal.) 2008) 546 F.3d 1142, 1146.) The Ninth Circuit recognized that in ever case where a California court denied coverage for the insured’s breach of the “no voluntary payments” clause of the policy, the insured was seeking reimbursement for the settlement of covered claims, thereby denying the insurer the right to defend the claim as the insurer saw fit. (Recall that though insurer’s have a duty to defend in liability insurance, it always described as the “right” and duty to defend.) In the Tosco case, the insurer denied coverage for the covered claims it was defending because the insured had settled the non-covered claims that the insurer was defending under a reservation of rights. Tosco was not seeking reimbursement for its settlement of the non-covered claims, but merely sought the continued defense and indemnity for the admittedly covered claims. The Ninth Circuit found that Tosco’s insurer could not rely on the no voluntary payments coverage provision to deny Tosco coverage for the insured claims. (The court also found that the insured didn’t technically “pay” money to the claimant but did not take an authorized “credit,” which the court also found did not technically qualify as a “payment” so as to amount to a breach of the policy’s “no voluntary payments” exclusion.)
Even the California state cases that have denied coverage for breach of the “no voluntary payments clause” recognize an exception to the insurer’s ability to lawfully deny coverage where the insured “faces a situation requiring an immediate response to protect [the insured’s] legal interests.” (Truck Ins. Exch. vs. Unigard Ins. Co. (2000) 79 Cal.App.4th 966, 977, fn. 15.)
The above fact pattern is snake pit to the unwary. Relying on the “no voluntary payments” clause to deny coverage for the covered portion of the claim is a high risk proposition. The insured will argue that he or she was forced to settle to avoid a large uncovered judgment and to avoid a subsequent Buss action. There is little equity in arguing to a judge or jury that the insurer has the legal right to:
(1) Bar the insured from capping the insured’s personal, non-covered liability exposure; and
(2) Run up defense costs and fees on the uncovered claims only to seek reimbursement for defending the non-covered claims in addition to the insured having to pay the claimant the uncovered portion of the judgment.
“That dog don’t hunt.” It will likely result in a successful breach of contract/insurance bad faith action because it won’t look like the insurer gave at least as much consideration to the insured’s interests as the insurer gave itself. The solution? Don’t deny all coverage if the insured wants to settle claims you are disclaiming coverage for. But, do remind the insured that the insurer has no obligation to reimburse the insured for settling non-covered claims. There may even be times when it would be worth making a small costs of defense contribution to resolve non-covered claims, thereby eliminating the need for independent or Cumis counsel.