Opinion ID: 1712813
Heading Depth: 1
Heading Rank: 3

Heading: direct duty owed by primary insurer to excess insurer

Text: Courts have held that a primary insurer owes a good-faith duty to defend and attempt to settle a claim within policy limits directly to an excess insurer, in spite of the fact that no contractual relationship between the two carriers exists. The California courts' analyses of this problem is instructive, as they have considered the existence of duties outside those imposed by a contractual relationship. See Smith, supra . When the insured and the primary insurer conspired to fraudulently assign dates of loss to policy years other than those in which the losses actually occurred, the Second District of the California Court of Appeals held that the excess insurer had a direct cause of action against both the insured and the primary insurer for breach of the duty of good faith and fair dealing. Kaiser Foundation Hospitals v North Star Reinsurance Corp, 90 Cal App 3d 786, 792; 153 Cal Rptr 678 (1979). The court held that the covenant of good faith and fair dealing was not a one-way street but requires that `neither party'  not the insured, nor the insurer  `will do anything to injure the right of the other to receive the benefits of the agreement....' Id. (citations omitted). In the same year, the Third District of the Court of Appeals held that a primary insurer owes a duty directly to an excess insurer to defend and settle a liability claim in good faith. Transit Casualty Co v Spink Corp, 94 Cal App 3d 124; 156 Cal Rptr 360 (1979). In Spink, the insured had refused to settle under any circumstances, and the excess insurer was required to pay $175,000 to satisfy a jury verdict. The excess insurer also contributed $285,000 to settle other death and injury claims resulting from the insured's negligence, and it claimed that the failure to settle in the first case had ultimately increased the settlement outlay on the later claims. Because the insured had contributed to the primary insurer's failure to settle, the excess insurer gained nothing from stepping into the shoes of the insured under the doctrine of equitable subrogation. The court found that equitable subrogation failed to achieve evenhanded justice, and that [t]riangular reciprocity of obligations was the more rational rule of liability. Id., 132-133. The court reasoned that a theory of liability resting on reciprocal duties of reasonable care owed by each of the three parties to each other would promote the sharing of the loss according to the measure of each party's comparative fault. Id., 135-136. The court contrasted this result with that achieved through equitable subrogation, which it characterized as all-or-nothing litigation success or defeat according to the measure of conduct [by the primary insurer or the insured] over which the [excess insurer had no] control. Id., 134. Thus, a significant reason for Spink 's adoption of triangular reciprocity was the perception that an excess carrier might otherwise be unjustly denied recovery against a primary carrier when the insured had contributed to the bad-faith failure to settle. The First District of the California Court of Appeals disagreed with Spink 's theory of triangular reciprocity. Commercial Union Assurance Cos v Safeway Stores, Inc, 158 Cal Rptr 97 (Cal App, 1979), aff'd 26 Cal 3d 912; 164 Cal Rptr 709; 610 P2d 1038 (1980). In Safeway, the appellate court held that an insured contemplating settlement had no duty to give the excess insurer's financial interests equal consideration with its own. The court reasoned that the bargained-for expectations of the parties, and the disparity in bargaining power between the insured and its excess insurer, made it unnecessary to impose additional duties on the insured to protect the insurer from injustice. Id., 158 Cal Rptr 101-102. However, Safeway is distinguishable from the situation in Spink and the case at bar. In Safeway, there was no primary carrier because the insured was self-insured up to a certain limit. Therefore the conflict arose between the insured and its excess insurer (parties in privity), rather than between the primary insurer and the excess insurer. In addition, when the California Supreme Court affirmed the decision in Safeway, it adopted the opinion of the Court of Appeals, but deleted that portion of the Court of Appeals opinion which criticized Spink 's recognition of triangular reciprocity. Commercial Union Assurance Cos v Safeway Stores, supra, 26 Cal 3d 915, 920-921. From this we conclude that the California Supreme Court has not ruled upon the Spink doctrine of triangular reciprocity. CU's primary argument in favor of recognizing a direct duty of good faith running from the primary to the excess insurer is very similar to the Spink theory: CU believes that, absent such a duty, the excess insurer will be at the mercy of the conduct of its insured. It is true that the insured's breach of obligations owed to the primary insurer can defeat the subrogation claim of its excess insurer. However, the insured and the excess insurer share an ongoing contractual relationship as parties to their own contract. The excess insurer can bargain for any obligation it seeks to impose upon its insured. If the insured breaches a duty owed to the excess insurer, the excess insurer can refuse coverage or pursue an action against its own insured. In this way, legitimate expectations of all three parties, the insured, the primary insurer, and the excess insurer, can be traced to bargained-for agreements. Such an arrangement promotes certainty in the setting of rate structures, which in turn keeps insurance costs down and encourages policyholders to carry excess insurance, to the benefit of the insured and third-party judgment creditors alike. [4] Two other jurisdictions have addressed the direct duty theory, but without the depth or clarity of the California courts. In Estate of Penn v Amalgamated General Agencies, 148 NJ Super 419, 422-423; 372 A2d 1124 (1977), the New Jersey Superior Court apparently adopted the direct duty theory, although in doing so it relied on case authority recognizing the equitable subrogation theory. The New York Court of Appeals did not explicitly discuss the direct duty theory in Hartford Accident & Indemnity Co v Michigan Mutual Ins Co, 61 NY2d 569, 574; 463 NE2d 608 (1984), but held somewhat ambiguously that the primary insurer owed the excess insurer the same duty to act in good faith which [the primary insurer] owed to its own insureds.... While supportive of the increased interest in a direct duty rule, these cases nonetheless add little to our analysis. After an examination of the facts in the instant case, we conclude that it is not the most appropriate case on which to decide the application of the direct duty rule. CU is alleged to have participated in the settlement process because of its December 21, 1978, letter of protest to MP, its discussions with MP and Wulfmeier on the first day of trial, and its eventual payment of $125,000 of the $350,000 settlement. CU may argue for recognition of the direct duty theory, but it may be estopped from gaining the benefit. Thus, however appealing the theory of direct duty, this case does not present itself as the best vehicle for recognition of a direct duty cause of action in tort between a primary insurer and excess insurer. [5] There is also the argument that the excess insurer had the ability to protect itself from the insured's bad-faith conduct through a noncooperation clause. For these reasons, we would hold that in this case the primary carrier does not owe a direct duty to the excess carrier to act in good faith to defend and settle a claim within the former's policy limits. If the excess carrier is to proceed against the primary carrier, it must do so as the subrogee of the insured. Accord Bohemia, Inc v Home Ins Co, 725 F2d 506, 512, n 6 (CA 9, 1984).