Source: http://dutytodefend.com/compendium-of-collusion-cases/
Timestamp: 2019-04-22 08:58:11+00:00

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3 Substance Over Form – Has Due Process Been Served?
Collusion is a species of fraud that is difficult to define, creates a limited defense, but is easily distinguished from proper cooperation. While perhaps hundreds of reported opinions mention in passing that the law will not tolerate collusion, a more limited but manageable body of California law describes the utility and boundaries of collusion. Collusion is usually a question of fact. It appears that often triers of fact, trial courts and courts of appeal are as influenced by a party’s lack of courtesy and decorum as they are with what actually happened.
A policyholder whose liability insurer wrongfully fails to defend is free to resolve a plaintiff’s lawsuit without the consent or participation of the defaulting insurer. Numerous reported California opinions have examined a wide variety of resolution options that illuminate whether a defaulting insurer may assert the collusion defense, and if so, under what circumstances the defense has been successful. The picture that emerges from this vast body of law seems to be that there is a continuum of resolution options ranging from a vigorously contested trial at one end of the spectrum all the way down to fabricated liability and damages at the other end of the spectrum. The more objectively trustworthy the mode of resolution of the plaintiff’s lawsuit appears to be, the more likely it is that the court in a coverage fight will find the defaulting insurer to be bound by it. On the other hand, the more suspicious the circumstances of settlement of the plaintiff’s lawsuit appears to be, the more likely it is that the court in a coverage fight will require a trial on the issues of the policyholder’s liability to the plaintiff and/or the amount of the plaintiff’s damages. More severely, the court in the coverage fight may deny any recovery for a collusive settlement.
The law seems clear that an abandoned policyholder and a plaintiff are afforded free latitude to communicate with one another and to cooperate with each other. However, they may not hold an insurer (notwithstanding its wrongful failure to defend) responsible to pay if the policyholder’s legal liability to the plaintiff is not genuine or if the amount of damages to which the parties agree is determined to be unreasonable. Even a defaulting insurer will be permitted to avoid liability for a collusive settlement because any other result would operate as a fraud – not just against the insurer, but also against the justice system.
The following collection of “collusion” cases surveys the spectrum of resolution options available to an abandoned policyholder.
Substance Over Form – Has Due Process Been Served?
The courts tend to honor a genuine adjudication of issues over a fast and loose settlement. Also a settlement that results in a stipulated judgment is not likely to garner any greater respect from the courts than a lone settlement agreement that omits the procedural formality of a judgment. The courts do not hesitate to look beyond the form of a judgment to dissect the substance of the agreement to reach the merits of the outcome. “The facts and circumstances which will lead a court to conclude that either [fraud or collusion] are present are limited only by the imagination of those who would cheat and deceive.” In one case, a plaintiff recovered nothing where a jury found a settlement to be collusive.
A default judgment requires the plaintiff to present evidence proving the elements of a cause of action but lacks the presentation of contrary evidence usually available in a fully contested trial. Nonetheless, courts tend to enforce default judgments against insurers that wrongfully failed to defend because any shortcomings of this procedure are a direct result of the insurer’s failure to defend. Thus, where the policyholder suffers a default judgment because the insurer fails to defend, the courts are not likely to grant relief to an insurer for a result of its own making.
In Clemmer, the Supreme Court held that an insurer that disclaimed coverage was bound by a default judgment thereafter entered notwithstanding the fact that the insurer was first notified “on the day before the hearing on default judgment.” The Court specifically found that the insurer failed to demonstrate that it was prejudiced by late notice.
However, a default judgment is not always honored by the courts. In Xebec, the court expressed concern over the binding effect on an insurer of a stipulated judgment with a covenant not to execute. The court stated that such a judgment “should bind the insurer only to the extent it represents a true independent adjudication of the insured’s liability.” The court observed that a “default [judgment] proving-up proceeding preserve[s] a semblance of independent adjudication under court supervision which is wholly lacking” in the context of a stipulated judgment for a covenant not to execute.
Several reported opinions have addressed cases where the terms of settlement called for some form of judicial hearing at which little or no defense was presented. While this procedure may be quite similar to a default prove-up, the results are mixed.
In Samson, a primary insurer defended and paid its policy limits to settle litigation against its insured. The settlement included a covenant not to execute and an assignment of rights from the policyholder to the plaintiff. Another insurer, Transamerica, failed to defend and refused a policy limit settlement demand. At a short cause trial, no defense was presented and a judgment was entered in excess of Transamerica’s limits. Transamerica was held liable for the entire judgment.
However, an uncontested trial does not guarantee that a settlement is free of collusion. In Andrade, the defendant had a primary liability policy with limits of $1 million. However, the primary insurer was insolvent and did not participate in the defense nor settlement of the third party liability suit. The defendant also had an excess liability policy. The excess policy did not require the insurer to defend its policyholder. The excess insurer was only obligated to pay for liability in excess of $1 million. The third party plaintiff suffered bodily injuries that the court concluded were objectively valued in the range of $200k to $350k. During the pendency of the liability suit, the plaintiff offered to settle for $950k, a sum that was insufficient to trigger the excess insurer’s duty to indemnify. The plaintiff and defendant ultimately negotiated settlement for $1.5M. Significantly, this negotiated figure exceeded both the objective valuation of the plaintiff’s injuries and the sum for which the plaintiff was previously willing to settle, but it invaded the excess insurer’s limits. A jury found that the settlement for $1.5M was collusive. As a result, the injured plaintiff recovered nothing and the excess insurer paid nothing.
Some liability policies include a provision that prohibits resolution by arbitration unless the insurer consents to this form of alternative dispute resolution. However, this contractual provision may be abrogated when the insurer refuses to defend. In Parks, an insurer failed to defend an insured who was sued by a badly injured bodily injury plaintiff. The abandoned policyholder resolved the matter by binding arbitration that was vehemently defended by counsel. The arbitration award was confirmed as a court judgment. In a subsequent action to recover the judgment from the defaulting insurer, the court held that it was not error to refuse to give a jury instruction on collusion where the insurer presented “no viable evidence to support” collusion.
While an abandoned policyholder is not required to submit the dispute with the plaintiff to judicial resolution, settlements appear to be subject to greater judicial scrutiny than are adjudicated resolutions in subsequent coverage litigation against the insurer.
There is a split of authority whether a good faith settlement that passes muster pursuant to Code of Civ. Proc. §877.6 will conclusively bind a defaulting insurer. However, the correct rule is likely to be that a settlement approved under §877.6 does not conclusively bind a defaulting insurer.
Some reported opinions have approved settlements that included a covenant not to execute. Zander held that a settlement including a covenant not to execute that resulted in an uncontested trial “does not establish fraud.” Samson found “nothing fraudulent or collusive ” in a settlement that included a covenant not to execute.
In a suit against a defaulting insurer to recover a judgment or settlement of a third party liability action, the policyholder’s burden should be satisfied by proof of: 1) a policy; 2) notice of suit to the insurer; 3) the insurer’s wrongful failure to defend, and 4) the fact of liability and damage pursuant to the terms of the judgment or settlement. In the case of an adjudicated judgment in the liability suit, the insurer’s liability is usually conclusively established. In the case of a settlement, the insurer’s liability is subject to a defense of collusion, for which the insurer carries the burden of proof. In contrast, a judgment debtor’s burden should be satisfied by proof of: 1) the insurer’s wrongful failure to defend; 2) a duty to indemnify pursuant to the terms of a policy; and 3) the fact of liability and damage pursuant to the terms of the judgment or settlement.
 Xebec Development Partners, Ltd. v. National Union Fire Ins. Co. (1993) 12 Cal. App.4th 501, 535-536 (Xebec).
 In addition to the cases summarized here, there are many more reported California opinions that mention the law of “collusion”, which are “peculiar” to their own facts, or simply recited principles of collusion in dicta without illumination of the subject matter.
 Andrade v. Jennings (1997) 54 Cal.App.4th 307 (Andrade).
 Lamb v. Belt Casualty Co. (1935) 3 Cal.App.2d 624, 631 (Lamb).
 Xebec, supra, 12 Cal. App.4th 501.
 Lipson v. Jordache Enterprises, Inc. (1992) 9 Cal. App.4th 151 (Jordache).
 Rose v. Royal Ins. Co. of America (1991) 2 Cal.App.4th 709.
 Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825, 829 (citations, ellipses, and quotations marks omitted).
 Clemmer v. Hartford Ins. Co. (1978) 22 Cal.3d 865, 884-885.
 Editorial Note: Compare the result of short notice with Jordache, above.
 Xebec, supra, 12 Cal. App.4th at 544.
 Garamendi v. Golden Eagle Ins. Co. (2004) 116 Cal.App.4th 694, 710, fn. 7.
 Ins. Code § 11580 et. seq., known as the direct action statute, permits third party plaintiffs who have obtained a judgment against the policyholder for bodily injury or property damage to sue the defendant’s insurer directly, even though the judgment creditor is not a party to the policy contract.
 Zander v. Texaco, Inc. (1968) 259 Cal.App.2d 793 (Zander).
 Samson v. Transamerica Ins. Co. (1981) 30 Cal.3d 220, 228.
 National Union Fire Ins. Co. v. Lynette. C. (1994) 27 Cal.App.4th 1434, 1449.
 Andrade, supra, 54 Cal.App.4th 307.
 Safeco Ins. Co. of America v. Parks (2009) 170 Cal.App.4th 992.
 Lamb, supra, 3 Cal.App.2d at 631-632.
 Kershaw v. Maryland Casualty Co. (1959) 172 Cal.App.2d 248, 257.
 Ritchie v. Anchor Casualty Co. (1955) 135 Cal.App.2d 245.
 Xebec supra, 12 Cal. App.4th at 544-545.
 Roman v. Unigard Ins. Group (1994) 26 Cal. App.4th 177.
 Diamond Heights Homeowners Assn. v. National American Ins. Co. (1991) 227 Cal.App.3d 563.
 Pacific Estates, Inc. v. Superior Court (1993) 13 Cal.App.4th 1561.
 Id. at 1576. Editor’s Note: The court may have found this settlement to be “trustworthy” because of the active participation of primary insurers.
 Pruyn, supra, 36 Cal.App.4th 500.
 Sanchez v. Truck Ins. Exchange (1994) 21 Cal. App.4th 1778.
 Zander, supra, 259 Cal.App.2d at 806.
 Samson, supra, 30 Cal.3d at 241.
 Doser v. Middlesex Mutual Ins. Co. (1980) 101 Cal. App. 3d 883, 890.
 Xebec supra, 12 Cal. App.4th at 544.
 Pruyn, supra, 36 Cal.App.4th at 526.
 Smith v. State Farm Mut. Auto. Ins. Co. (1992) 5 Cal. App. 4th 1104.
 Amato, supra, 53 Cal.App.4th at 829.

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