Opinion ID: 2027720
Heading Depth: 1
Heading Rank: 3

Heading: The Issue and the Two Lines of Authority.

Text: The commercial general liability policy Coyle had obtained from LeMars provides in pertinent part: COVERAGE A. BODILY INJURY AND PROPERTY DAMAGE LIABILITY 1. Insuring Agreement. a. We will pay those sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage to which this insurance applies. (Emphasis added.) In determining that summary judgment for LeMars and Lawlor was proper, the district court focused on the policy language legally obligated to pay and relied on two federal cases: Freeman v. Schmidt Real Estate & Insurance, Inc., 755 F.2d 135 (8th Cir.1985), and Roach v. Estate of Ravenstein, 326 F.Supp. 830 (S.D.Iowa 1971). In Freeman, the facts were similar to those here. Freeman and Mrs. Catron were involved in an automobile collision. Mrs. Catron was operating a vehicle owned by her husband. In settlement of the resulting litigation, the Catrons confessed judgment and assigned to Freeman their rights against their insurance agent and insurer for failing to procure insurance that would have covered the liability that Freeman asserted against the Catrons. In consideration, Freeman promised not to execute on the judgment. Thereafter, Freeman sued the insurance agent and insurer allegingas the Catrons' assigneethat the insurance agent and insurer were negligent and breached an oral contract in failing to obtain additional insurance that would have covered the full judgment. (The Catrons had $50,000 of liability insurance and confessed judgment for $350,000 and costs.) The trial court sustained the defendants' motion for summary judgment. It concluded that because the Catrons never became legally obligated to make any payments to Freeman because of the covenant not to execute, the Catrons would have been entitled to nothing under the policy and for that reason suffered no damages. The trial court further concluded that as a result Freeman received no enforceable rights from the Catrons against either the agent or the insurer. (In reaching this conclusion, the trial court was obliged to follow Iowa law but acknowledged there was no Iowa case directly on point.) The issue on appeal was whether an insurer may be liable to the injured party when the insured before judgment is protected by an agreement not to execute. Id. at 137. This is precisely the issue in this appeal. In deciding the issue, the Freeman court recognized there were two lines of authority on whether an insurer may be liable to the injured party when the insured before judgment is protected by an agreement not to execute. Both lines of authority focus on the policy language that requires an insurer to pay only such amounts that the insured shall become legally obligated to pay as damages. Id. Courts following the first line of authority reason that a covenant not to execute ... is merely a contract, and not a release, such that the underlying tort liability remains and a breach of contract action lies if the injured party seeks to collect his judgment. Thus, the tortfeasor is still legally obligated to the injured party, and the insurer still must make good on its contractual promise to pay. An uninsured party would then be injured by the agent's negligence in failing to procure a policy because he would have the outstanding liability against which he sought to insure. Id. at 137-38 (citations omitted); see also Gray v. Grain Dealers Mut. Ins. Co., 871 F.2d 1128, 1133 n. 7 (D.C.Cir.1989); State Farm Mut. Auto. Ins. Co. v. Paynter, 122 Ariz. 198, 203, 593 P.2d 948, 953 (Ariz.Ct.App.1979); Globe Indem. Co. v. Blomfield, 115 Ariz. 5, 8, 562 P.2d 1372, 1375 (Ariz.Ct.App.1977); Miller v. Shugart, 316 N.W.2d 729, 732 (Minn.1982). Cf. Critz v. Farmers Ins. Group, 230 Cal.App.2d 788, 804, 41 Cal.Rptr. 401, 410 (1964) (agreement holding tortfeasor harmless as to judgment in excess of tortfeasor's insurance coverage does not foreclose suit against insurer for bad faith failure to settle). The Freeman court recognized that there are other cases which simply ignore the distinction between covenant and release. Rather, these cases rely primarily on the right of the insured to protect himself from bad faith conduct of his insurer. Freeman, 755 F.2d at 138. The leading case following this rationale is Metcalf v. Hartford Accident & Indemnity Co., 176 Neb. 468, 126 N.W.2d 471 (1964). Metcalf holds that insuredsand thus insurersare legally obligated to pay within the meaning of the policy despite an agreement not to execute when the insureds enter into such agreements to protect themselves from insurers' denial of coverage and refusal to defend under the policy. Id. at 475, 126 N.W.2d at 476. Other courts following the Metcalf rationale include Coblentz v. American Surety Co., 416 F.2d 1059, 1062-63 (5th Cir.1969); American Family Mutual Insurance Co. v. Kivela, 408 N.E.2d 805, 812-13 (Ind.Ct.App.1980). The second line of authorityand the one urged by the agent and insurer in Freeman gives the legally obligated to pay language a practical construction: An insured protected by a covenant not to execute has no compelling obligation to pay any sum to the injured party; thus, the insurance policy imposes no obligation on the insurer. An individual who is uninsured due to an agent's negligence then will have suffered no damages, as he would have had no rights under the policy anyway. Freeman, 755 F.2d at 138 (citations omitted). Some of the courts following this line of authority are primarily concerned about possible collusion between the insured and the injured party assignee. Freeman, 755 F.2d at 138-39; Steil v. Florida Physicians' Ins. Reciprocal, 448 So.2d 589, 592 (Fla.Dist.Ct.App.1984) (suspicion of collusion and fraud led court to deny effect to settlement and assignment; in addition, court indicated that such an agreement may be upheld where free from taint). Other courts have, without further analysis, simply relied on the practical construction of the legally obligated to pay language, concluding that because the insured has no obligation to pay, neither does the insurer. See, e.g., Bendall v. White, 511 F.Supp. 793, 795 (N.D.Ala.1981) (mem.); American Casualty Co. v. Griffith, 107 Ga.App. 224, 227, 129 S.E.2d 549, 551-52 (1963); Huffman v. Peerless Ins. Co., 17 N.C.App. 292, 293, 193 S.E.2d 773, 774, cert. denied, 283 N.C. 257, 195 S.E.2d 689 (1973); Stubblefield v. St. Paul Fire & Marine Ins. Co., 267 Or. 397, 400, 517 P.2d 262, 264 (1973) (en banc). While pointing out that the second line of authority prevents the use of settlements used by Freeman and the Catrons, the court nevertheless believed that Iowa public policy would prohibit such agreements. Freeman, 755 F.2d at 138-39. The court gave several reasons why it thought that way. First, an Iowa injured party who has an uncollectible judgment has other means to gain an insured's rights against the insurer. Id. at 139. For example, the injured party could sue the insurer under Iowa's direct action statute. See Iowa Code § 516.1 (1991) (permitting such an action in event an execution on a judgment against insured is returned unsatisfied in suit by injured party against insured). Second, the additional procedure of prejudgment assignment in return for a promise not to execute should not be available because of possible collusion. Freeman, 755 F.2d at 139. As to this reason, the court relied heavily on a local federal district court's decision in Roach, 326 F.Supp. at 834. In Roach, the federal district court denied a motion for a consent judgment on a settlement. The settlement involved an assignment by the administrator of the deceased insured's rights against the insurer in exchange for the injured party's agreement to seek satisfaction of the judgment only from the estate's rights in the insurance policy. The court held that the agreement was beyond the authority of the administrator because of the administrator's failure to (1) investigate the merits of the claim against the insurer, or (2) seek necessary probate court approval. Id. The court additionally held that the agreement was unconscionable because it forced the insurer either to forgo a good faith denial of coverage or risk being bound by any settlement the insured may choose to make. Id. at 837. The plaintiff's counsel had actually been directing the administrator's actions. Id. This led the federal district court to find that the purpose of the agreement had been to relieve the plaintiff from the burden of proving its claim and establishing the liability of the defendant estate and to prevent a defense by the insurer. Id. at 834. The Freeman court believed this type of collusion was possible any time the insured is protected by an agreement not to execute before entry of judgment. It is possible, the court reasoned, because the insured loses the incentive to contest liability or the extent of the injured party's damages either in negotiations or at trial. Freeman, 755 F.2d at 139. Last, the policy concerns that cause some states to permit such settlements are less pressing when the claim against the insurer is to be negligent failure to procure insurance rather than bad faith refusal to settle or to defend. Insureds and injured parties alike may need the possibility of an assignment and covenant not to execute as a weapon against insurer misconduct surrounding claims made under the policy. When the insurer's breach of its obligations, however, is merely negligent and is removed in time and nature from the settlement context, such agreements will have less deterrent effect on insurer practices, and their possible usefulness in this regard is outweighed by the concern with collusion. Id. The court in Freeman went on to agree with the magistrate's prediction that Iowa courts would read the `legally obligated to pay' policy language to protect insurers when their insureds are protected by prejudgment covenants not to execute. Id. There was a dissent in Freeman. The dissent predicted our courts would be more likely to follow the view of those cases that would permit recovery than those that would not. The dissent however suggested the following: Of course, in any action, the insured would have to prove his damages and the insurer would have a right to assert any defense that it might have had if the insurance had been purchased as requested. This simple safeguard would prevent any collusive settlement. Id. at 141 (Heaney, J., dissenting). The dissent saw no policy reasons to deny relief; to the contrary, the dissent believed that the negligent insurerrather than the innocent plaintiffshould bear the responsibility for the loss. Id.