Opinion ID: 486380
Heading Depth: 1
Heading Rank: 3

Heading: the two-tiered settlement

Text: 48 Under the terms of the settlement with Mrs. Soppe, HUP and the CAT Fund paid the initial $2.15 million in accordance with the first two levels of insurance. HUP paid $100,000 on behalf of HUP and $100,000 on behalf of Dr. Trotman, and the CAT Fund paid $1 million on behalf of each. HUP then agreed to pay an additional $4.8 million only if HUP was successful in its suit against Lexington; otherwise HUP would pay an additional $2.1 million and would cover Mrs. Soppe's lifetime medical expenses. Because the policy applies only to losses which the Insured shall become legally obligated to pay, Lexington claims that it need only assume the costs assumed by HUP and not the additional $4.8 million necessary to make up the $7 million settlement. 6 49 Courts have differed over the permissibility of two-tiered, or conditional, settlements where the insurance company has improperly denied coverage. Some courts have construed legally obligated language strictly and have refused recovery for the upper tier. See Stubblefield v. St. Paul Fire & Marine Ins. Co., 267 Or. 397, 517 P.2d 262 (1973); Huffman v. Peerless Ins. Co., 17 N.C.App. 292, 193 S.E.2d 773, cert. denied, 283 N.C. 257, 195 S.E.2d 689 (1973). To the same effect, other courts have argued that recovery of the upper tier should be impermissible because the insured's lack of incentive to limit any recovery for which it cannot be liable eliminates the likelihood of reasonableness. See Hitt v. Cox, 737 F.2d 421, 426 (4th Cir.1984) (applying Virginia law); Tidex, Inc. v. A.L. Commercial Blasting Corp., 567 F.Supp. 918, 923-24 (E.D.La.1983) (apparently applying Louisiana law). As the court stated in Hitt: 50 Once it agreed to settle by paying Hitt $350,000, it had no incentive to avoid an agreement to pay an additional $150,000 if Harleysville was found liable to indemnify. In this situation, the negotiating parties no longer have adverse interests, and their conditional settlement is presumptively unreasonable.... To allow the [insured] full recovery in this case would set a precedent allowing any insured left to defend himself not only to settle at a reasonable amount, but to give away an additional amount up to the liability limit of this policy conditional on a successful indemnity suit against the insurance company. (emphasis in original) 51 In contrast, several courts have held that an insurer may not hide behind the 'legally obligated to pay' language of the policy after it abandons its insured. American Family Mut. Ins. Co. v. Kivela, 408 N.E.2d 805, 813 (Ind.App.1980). These courts have reasoned that where an insurer abandons its obligation to defend despite proper notice, the insurer must be responsible for its share of the settlement absent fraud or collusion. See Coblentz v. American Sur. Co. of N.Y., 416 F.2d 1059 (5th Cir.1969) (applying Florida law); State Farm Mut. Auto. Ins. Co. v. Paynter, 122 Ariz. 198, 593 P.2d 948, 953 (Ct.App.1979); Metcalf v. Hartford Accident & Indem. Co., 176 Neb. 468, 126 N.W.2d 471 (1964). 52 The Pennsylvania cases are inconclusive. Lexington points to Dennis v. New Amsterdam Casualty Co., 216 Pa.Super. 320, 264 A.2d 436 (1970), which involved a suit by an insured against its insurer for indemnification of the insured's settlement obligations. Under the settlement, the insured agreed to pay $1,000 but to sue his insurer for the $17,500 on behalf of the original plaintiff. 53 The Superior Court refused recovery principally on the grounds that the original suit involved claims subject to workmen's compensation excluded by the policy. In the portion of its opinion relevant to this case, the court added, without elaboration, that recovery must be denied also because under the settlement agreement, Dennis is not obligated to pay the same, this being a secondary and minor consideration. 264 A.2d at 439. 54 In response, HUP cites Alfiero v. Berks Mut. Leasing Co., 347 Pa.Super. 86, 500 A.2d 169 (1985), which bears many similarities to this case. As in this case, Alfiero involved a personal injury suit settled by the insured with approval of its primary insurer despite the disclaimer of the excess carrier. Accompanying the settlement, the insured assigned its interests against its insurer to the original plaintiff in return for the plaintiff's promise not to expose the insured's assets to sale to satisfy the settlement. The excess insurer claimed that it was not liable because the agreement protecting the insured's assets extinguished the insured's liability and therefore its own. The court disagreed, reasoning that once the insurer had breached its contract of insurance, the insured could proceed to negotiate a settlement in an amount that was fair and reasonable.... The settlement was not unreasonable merely because Berks sought to protect the assets which it used in conducting business. 500 A.2d at 172 (citations omitted). 7 55 Neither Dennis nor Alfiero disposes of the issue in this case. The language in Dennis, although directly on point, was at most an alternative holding. It was so offhand and self-consciously minor that we cannot consider it controlling authority. In contrast, the language in Alfiero is more deliberate and reasoned. But the insured in that case did not escape all liability for the sum the insurer became obligated to pay. Protection of its assets from sale would not prevent satisfaction of the judgment from income. 56 Despite the fact that neither case conclusively controls, we consider Alfiero more apposite, as well as more reasoned, and hence a better prediction of the views of the Pennsylvania Supreme Court. The reasoning in Alfiero was that once the insured had repudiated its contract of insurance, its insured must be allowed to negotiate a settlement that protected the interests for which it purchased insurance--in that case, the threat that an accident would put it out of business. The court apparently believed that the obligation that the settlement be reasonable and in good faith provided sufficient protection for the interests of the insured. 57 The facts of this case are less compelling for HUP than they were for Alfiero: Lexington's misconduct was less reprehensible than that of the insurer in Alfiero; no evidence suggests that failure to protect HUP from this judgment would cause HUP to go out of business; and this agreement exempts HUP completely from liability for part of the settlement instead of merely protecting assets. We do not believe, however, that Pennsylvania would recognize a rule based on degree of need. 58 Insurance policies are risk-spreading devices. They exist primarily because the stakes of liability to an insured are greater than they are to the insurer, which can spread the loss across all of its customers. The impact of a settlement offer may be sufficiently great on an insured that it must risk the hazards of even greater liability after trial despite odds that make the settlement advantageous. Prohibiting two-tiered settlement may therefore force insureds to turn down advantageous settlement offers. This, apparently, is the policy rationale accepted by Alfiero, and we consider Alfiero the most persuasive indication of the position of Pennsylvania law. 59 We are not unmindful of the dangers presented by two-tiered settlements. At the margins, a settlement's good faith and reasonableness may be hard to disprove. In a settlement of the magnitude of this case, the insured will have an incentive to bargain down a few hundred thousand dollars of its own potential liability in return for several hundred thousand dollars extra potential liability for the insurer. Perhaps, for this reason, a trial court might properly instruct the jury that two-tiered settlements are fraught with the danger of self-dealing and should be scrutinized with extra care. And perhaps Pennsylvania courts might require insureds to meet a more onerous burden of proof when demonstrating the reasonableness of those portions of the settlement applicable only to the insurer, e.g., clear and convincing evidence. 8 However, no such issue is before us. We also note that an insurance company will face this problem only if it improperly disclaims. 60 In sum, we believe that Pennsylvania would uphold the validity of two-tiered settlements such as the one at issue here, subject to the requirements of good faith and reasonableness. We turn to the question of the good faith and reasonableness of the upper tier.