Opinion ID: 2636865
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Heading: AES Breached the Covenant of Good Faith and Fair Dealing by Unreasonably Failing to Settle the Underlying Action on Kransco's Behalf Within Policy Limits

Text: It has long been recognized in California that [t]here is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement. ( Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 658, 328 P.2d 198.) This principle applies equally to insurance policies, which are a category of contracts. ( Ibid. ) Because the covenant is a contract term, in most cases compensation for its breach is limited to contract rather than tort remedies. ( Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 684, 254 Cal.Rptr. 211, 765 P.2d 373 ( Foley ).) But [a]n exception to this general rule has developed in the context of insurance contracts where, for a variety of policy reasons, courts have held that [an insurer's] breach of the implied covenant will provide the basis for an action in tort. ( Ibid. ) The availability of tort remedies in the limited context of an insurer's breach of the covenant advances the social policy of safeguarding an insured in an inferior bargaining position who contracts for calamity protection, not commercial advantage. ( Foley, supra, 47 Cal.3d at pp. 684-685, 254 Cal.Rptr. 211, 765 P.2d 373; see also Egan v. Mutual of Omaha Ins. Co. (1979) 24 Cal.3d 809, 819-820, 169 Cal. Rptr. 691, 620 P.2d 141.) The scope of the duty of good faith and fair dealing depends upon the purposes of the particular contract because the covenant is aimed at making effective the agreement's promises. ( Foley, supra, 47 Cal.3d at p. 683, 254 Cal.Rptr. 211, 765 P.2d 373; Egan v. Mutual of Omaha Ins. Co., supra, 24 Cal.3d at p. 818, 169 Cal. Rptr. 691, 620 P.2d 141.) In the context of an insurance policy, [t]he terms and conditions of the policy define the duties and performance to which the insured is entitled. ( Western Polymer Technology, Inc. v. Reliance Ins. Co. (1995) 32 Cal.App.4th 14, 24, 38 Cal.Rptr.2d 78.) One of the most important benefits of a maximum limit insurance policy is the assurance that the company will provide the insured with defense and indemnification for the purpose of protecting him from liability. Accordingly, the insured has the legitimate right to expect that the method of settlement within policy limits will be employed in order to give him such protection. ( Commercial Union Assurance Companies v. Safeway Stores, Inc. (1980) 26 Cal.3d 912, 918, 164 Cal.Rptr. 709, 610 P.2d 1038.) Consistent with these principles, a liability insurance policy's express promise to defend and indemnify the insured against injury claims implies a duty to settle third party claims in an appropriate case. ( Commercial Union Assurance Companies v. Safeway Stores, Inc., supra, 26 Cal.3d at p. 917, 164 Cal.Rptr. 709, 610 P.2d 1038; Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425, 430, 58 Cal.Rptr. 13, 426 P.2d 173; Comunale v. Traders & General Ins. Co., supra, 50 Cal.2d at p. 659, 328 P.2d 198.) More specifically, the insurer must settle within policy limits when there is substantial likelihood of recovery in excess of those limits. [Citations.] [¶] The duty to settle is implied in law to protect the insured from exposure to liability in excess of coverage as a result of the insurer's gambleon which only the insured might lose. ( Murphy v. Allstate Ins. Co. (1976) 17 Cal.3d 937, 941, 132 Cal.Rptr. 424, 553 P.2d 584.) An insurer that breaches its implied duty of good faith and fair dealing by unreasonably refusing to accept a settlement offer within policy limits may be held liable for the full amount of the judgment against the insured in excess of its policy limits. ( Commercial Union Assurance Companies v. Safeway Stores, Inc., supra, 26 Cal.3d at pp. 916-917, 164 Cal.Rptr. 709, 610 P.2d 1038.) Here, the jury concluded AES breached its duty of good faith and fair dealing owed Kransco by rejecting Hubert's $750,000 settlement offer, which was within the $900,000 policy limits, despite a substantial likelihood of recovery in excess of those limits. AES did not challenge that conclusion on appeal, but instead argued it should not be liable for the full amount of the judgment because Kransco's own litigation misconduct or comparative fault contributed to the excess verdict. Specifically, AES claims the Wisconsin jury in the underlying Hubert action assessed $10 million in punitive damages to punish Kransco for its false and incorrect interrogatory responses made during pretrial discovery.