Opinion ID: 802014
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Heading: The Duty to Settle Under the Implied Covenant of

Text: Good Faith and Fair Dealing Includes the Duty to Effectuate Settlement Even in the Absence of a Demand [1] “In each policy of liability insurance, California law implies a covenant of good faith and fair dealing.” PPG Indus., Inc. v. Transamerica Ins. Co., 975 P.2d 652, 654 (Cal. 1999). This implied covenant covers the duty to settle within policy limits “when there is substantial likelihood of recovery in excess of those limits.” Kransco v. Am. Empire Surplus Lines Ins. Co., 2 P.3d 1, 9 (Cal. 2000) (internal quotation 6584 DU v. ALLSTATE marks omitted). Where there is a substantial risk of an insured’s exposure in excess of the policy limits, the interests of the insurer and the insured diverge. In that circumstance, the insurer could choose not to settle and instead go to trial knowing that it would be liable only for the policy limits, exposing the insured to the risk of paying the excess judgment. To ameliorate this conflict of interests, the covenant of good faith and fair dealing “requires the carrier to consider in good faith the interests of the assured equally with its own and evaluate settlement offers within policy limits as though it alone carried the entire risk of loss.” Merritt v. Reserve Ins. Co., 110 Cal. Rptr. 511, 520 (Ct. App. 1973); see Johansen v. Cal. State Auto. Ass’n Inter-Ins. Bureau, 123 Cal. Rptr. 288, 292-93 (1975) (accord). [2] California courts have commonly applied the duty to settle to situations in which the insurer unreasonably rejects a settlement offer within policy limits. E.g., Kransco, 2 P.3d 1; Crisci v. Sec. Ins. Co. of New Haven, Conn., 426 P.2d 173, 176 (Cal. 1967). See PPG Indus., Inc., 975 P.2d at 655. At issue in this case is whether the duty more broadly requires an insurer to effectuate settlement when liability is reasonably clear, even in the absence of a settlement demand. For several reasons, we conclude that it does. [3] First, the conflict of interest that animates the duty to settle exists whenever there is a significant risk of a judgment in excess of policy limits and there is a reasonable opportunity to settle within those limits; this conflict obtains regardless whether a settlement demand is made by the injured party. If, as the general duty of good faith requires, the insurer “conduct[ed] itself as though it alone were liable for the entire amount of the judgment,” a rational party should attempt to settle if there is a “substantial likelihood of recovery in excess of those limits,” Kransco, 2 P.3d at 9, and there is a reasonable opportunity to settle within policy limits. [4] Second, although the California courts have not squarely addressed the question, this court has interpreted DU v. ALLSTATE 6585 California law to impose such a duty. In Gibbs v. State Farm Mutual Insurance Co., the insurer had failed to conduct any negotiations with the injured party even after the injured party repeatedly told the insured that he only wanted the limits of the insurance policy. 544 F.2d 423, 427 (9th Cir. 1976). Although no formal, written offer existed, this court held that the injured party’s informal statements gave the insurer “a reasonable opportunity to settle the claim within the policy limits.” Id. When the insurer failed to take any actions, it “neglect[ed] its good faith duty to take affirmative action in settling the claim.” Id. Third, the California courts have not ruled to the contrary. Deerbrook’s reliance on Merritt, 110 Cal. Rptr. 511, and Coe v. State Farm Mutual Automobile Insurance Co., 136 Cal. Rptr. 331 (Ct. App. 1977) is misplaced. In Merritt, the plaintiff claimed that the insurer breached the implied covenant of good faith and fair dealing owed to its insured when the insurer “failed to properly undertake, initiate, entertain or pursue discussions with plaintiff . . . for the disposition and settlement of said case at any stage of the proceeding prior to judgment.” 110 Cal. Rptr. at 513-14. The plaintiff argued that the insurer could be held liable for failure to initiate settlement overtures even in the absence of a demand by the claimant. Id. at 524-25. The court rejected this argument because “[t]his theory is supported by no evidence whatsoever.” Id. at 525. Because the workers’ compensation carrier’s lien greatly exceeded the insured’s policy limit of $100,000, “[n]o suggestion that settlement was feasible was ever made prior to judgment by anyone connected with the suit.” Id. The court’s refusal to find bad faith therefore rested not on a categorical rule that there is no legal duty to initiate settlement, but on the facts of that case: any settlement overtures would have been futile. See Boicourt v. Amex Assurance Co., 93 Cal. Rptr. 2d 763 (Ct. App. 2000) (holding that Merritt did not reject the plaintiff ’s claim “on the legal ground that an insurer need never ‘initiate settlement overtures,’ but 6586 DU v. ALLSTATE on the particular facts of the case before the court: There was no evidence at all to support the conjecture that ‘overtures’ might have been fruitful.”); Gibbs, 544 F.2d at 427 (holding that the insurer’s reliance on Merritt was “misplaced, for in that case no reasonable settlement opportunity existed”).2 In Coe, the court held that the trial court erred when it gave an instruction which stated, “The unwarranted failure or refusal of the insurance company to so settle constitutes a breach of the implied warranty of good faith and fair dealing.” 136 Cal. Rptr. at 339. The court stated that “actionable ‘bad faith’ arises, not from an insurance carrier’s obligation ‘to settle,’ but from unwarranted failure to accept a reasonable settlement offer.” Id. However, the central theory of the case concerned the insurer’s refusal to accept a deficient demand, not a failure to initiate settlement discussions. See id. at 33738. There was no claim at trial that the insurer acted in bad faith by failing to initiate further discussions. Coe‘s broad language was therefore dicta and not consistent with the more recent decision in Boicourt, 93 Cal. Rptr. 2d 768-69 (holding that an insurer can violate good faith duty without a settlement demand by the claimant, such as where insurer has a policy of never disclosing policy limits to injured parties). [5] Fourth, the breadth of an insurer’s duty to settle is substantiated by California Insurance Code section 790.03(h) which enumerates the obligations an insurer owes to its insured. Conduct that violates this section can be the basis for 2 Deerbrook’s citation to the court’s statement in Merritt that a conflict of interest “only develops when an offer to settle an excess claim is made within policy limits,” 110 Cal. Rptr. at 523-24, is misplaced. That passage must be taken in the context of the court’s exposition of the general policy considerations that underpin the good faith doctrine. It was not intended as a categorical rule excluding other aspects of the duty to settle. Indeed, in Boicourt, the court found that there was no reason for Merritt to find that a conflict of interest could develop “only” when an offer to settle is made, and that “Merritt’s use of the word ‘only’ must be deemed to be mere dicta.” 93 Cal. Rptr. 2d at 767. DU v. ALLSTATE 6587 a bad faith claim: Section 790.03(h)(5) specifically identifies as an “unfair claims settlement practice[ ],” “[n]ot attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” In Pray ex rel. Pray v. Foremost Insurance Co., this Court found that “[i]t is reasonably clear that California courts will interpret the California statute as imposing upon an insurance company the duty actively to investigate and attempt to settle a claim by making, and by accepting, reasonable settlement offers once liability has become reasonably clear.” 767 F.2d 1329, 1330 (9th Cir. 1985) (per curiam) (emphasis added). Although Pray was predicated on the assumption that section 790.03(h) was enforceable through a private right of action, id., an assumption no longer valid under Moradi-Shalal v. Fireman’s Fund Insurance Cos., 250 Cal. Rptr. 116 (1988), subsequent courts have found that violations of section 790.03(h) can serve as evidence that an insurer had breached the implied covenant of good faith and fair dealing, Shade Foods, Inc. v. Innovative Prods. Sales & Mktg., Inc., 93 Cal. Rptr. 2d 364, 412 (Ct. App. 2000); Jordan v. Allstate Ins. Co., 56 Cal. Rptr. 2d 312, 323 (Ct. App. 2007). Indeed, following Jordan, the Judicial Council of California Civil Jury Instructions added CACI 2337 (2008), which tracks section 790.03(h). In relevant part, CACI 2337 states: “In determining whether [name of defendant] acted unreasonably or without proper cause, you may consider whether the defendant did any of the following: . . . (e) Did not attempt in good faith to reach a prompt, fair, and equitable settlement of [name of plaintiff]’s claim after liability had become reasonably clear.” That instruction does not require that a bad faith claim be predicated on the insurer’s rejection of a claimant’s demand. [6] Thus, an insurer can violate the duty of good faith and fair dealing by failing to attempt to effectuate a settlement 6588 DU v. ALLSTATE within policy limits after liability has become reasonably clear. Du’s proposed instruction was a fair statement of the law. The district court’s rejection of that instruction on the ground that no such duty could exist in the absence of a settlement demand was in error. 2. The “Genuine Dispute” Doctrine Does Not Apply to Third-Party Claims [7] Deerbrook argues that the “genuine dispute” rule insulates it from bad faith liability because Deerbrook’s obligations as to whether it should settle were “unsettled.” However, the “genuine dispute” doctrine traditionally applies in the context of disputed coverage in first-party insurance cases, where the court must determine whether the insurer’s refusal to pay policy benefits was unreasonable or without cause. See Morris v. Paul Revere Life Ins. Co., 135 Cal. Rptr. 2d 718, 723 (Ct. App. 2003). In first party cases, “an insurer denying or delaying the payment of policy benefits due to the existence of a genuine dispute with its insured as to the existence of coverage liability or the amount of the insured’s coverage claim is not liable in bad faith.” Chateau Chamberay Homeowners Ass’n v. Associated Int’l Ins. Co., 108 Cal. Rptr. 2d 776, 784 (Ct. App. 2001); see also Tomaselli v. Transamerica Ins. Co., 31 Cal. Rptr. 2d 433, 440 (Ct. App. 1994); Feldman v. Allstate Ins. Co., 322 F.3d 660, 669 (9th Cir. 2003). [8] Settlement in third-party insurance cases is different. The California Supreme Court has held that the only permissible consideration in evaluating the reasonableness of the settlement offer becomes whether, in light of the victim’s injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the amount of the settlement offer. Such factors as the limits imposed by the policy, a desire to reduce the amount of future settlements, or a belief that the policy does not provide DU v. ALLSTATE 6589 coverage, should not affect a decision as to whether the settlement offer in question is a reasonable one. Johansen, 123 Cal. Rptr. 288, 292-93 (emphasis added). This court has recognized that, under California law, “a good faith belief in noncoverage does not insulate an insurer from liability for failure to settle a claim.” Gibbs, 544 F.2d at 427; see Howard v. Am. Nat’l Fire Ins. Co., 115 Cal. Rptr. 3d 42, 70 (Ct. App. 2010) (noting that while insurers in first-party cases may raise a reasonable dispute over coverage without being guilty of bad faith, “it has never been held that an insurer in a third party case may rely on a genuine dispute over coverage to refuse settlement”).3 [9] The district court’s rejection of Du’s proposed instruction cannot be sustained on the basis of the “genuine dispute” doctrine. 3. The District Court Did Not Abuse Its Discretion in Ruling That There Was No Foundation for Du’s Proposed Jury Instruction [10] As noted above, “a party is entitled to an instruction about his or her theory of the case if it is supported by law and has foundation in the evidence.” Mendez, 540 F.3d at 1117-18 (internal quotation marks omitted). In the instant case, the district court rested its decision to reject Du’s proposed jury instruction in part on its observation that, “in fact, the issue of settlement was broached at a sufficiently early time in the litigation that it vitiates any claim or effective claim insofar as a failure to initiate a settlement discussion.” 3 There is good reason to distinguish first-party claims from third-party claims in this context. The insurer’s good faith duty to settle with a third party can be accomplished without prejudicing its right to later assert noncoverage against the insured. If it defended under a reservation of rights, following settlement of the third-party claim, the insurer can seek a declaration of non-coverage and recover reimbursement of its expenditures from the insured. See Johansen, 538 P.2d 744, 750. 6590 DU v. ALLSTATE [11] There is no dispute that in June and July 2006, Deerbrook engaged with Du in settlement negotiations; it made a $100,000 policy limits offer to Du, which Du rejected. The bad faith claim asserted here is that the case would have been settled within policy limits had Deerbrook initiated earlier settlement negotiations. Deerbrook contends that if there was a duty to initiate settlement talks, it did so in a timely fashion in view of the circumstances. The record supports Deerbrook’s contention. First, Deerbrook could not make an earlier offer because Deerbrook lacked corroborating proof of the extent of Du’s injuries and medical expenses. Prior to June 23, 2006, the only information Deerbrook had regarding Du’s injuries and medical bills were the uncorroborated and conflicting assertions by Du and her counsel. Du’s expert conceded that Deerbrook could not base a settlement offer solely on the representations of claimant and claimant’s lawyer. Du’s expert also conceded that it was reasonable for Deerbrook to rely on Katzman’s promise to provide Harcharik with the medical information, a promise that remained unfulfilled until June 2006. Du’s expert further admitted that Deerbrook could not have obtained Du’s medical records without getting them from Du’s lawyers. The record shows that Deerbrook made repeated efforts to obtain the information. Second, prior to June 2006, Deerbrook had no proof of the injuries of the other three individuals injured in the accident. Paying Du $100,000 could have left Kim underprotected if the remaining three claims exceeded $200,000, especially as prior counsel had asserted that the Fengs suffered “life threatening” injuries. [12] In sum, there was no evidence that Deerbrook should or could have made an earlier settlement offer to Du. Accordingly, the district judge did not abuse his discretion in finding there was no evidentiary basis for Du’s proposed instruction. DU v. ALLSTATE 6591