For decades, California insurers have been told they have a duty to accept reasonable settlement demands within their policy’s limits. As the California Supreme Court emphasized in Johansen v. Cal. State Auto. Assn. Inter-Ins. Bureau, 15 Cal.3d 9, 16 (1975), 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.” Any other factor, such as “a belief that the policy does not provide coverage, should not affect a decision as to whether the settlement offer in question is a reasonable one.”
Often, a policy limits settlement demand puts carriers who believed they were defending a claim or suit that was not covered between a rock and a hard place. They could refuse to settle and risk liability for the entire adverse judgment if their coverage assessment turns out to be wrong. Or, despite the apparent absence of coverage, they could pay the settlement demand and close the file.
But California liability insurers have a way out – a way to avoid bad faith failure to settle exposure for amounts above policy limits while simultaneously securing the right to pursue reimbursement of an uncovered settlement payment from the insured. Since Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489 (2001), was decided, California liability insurers have been able to accept reasonable settlement demands within limits, subject to right of reimbursement, if the carrier can subsequently establish that the settled claims were not actually covered under the policy.
It sounds simple. But even well-intentioned insurers armed with experienced claims attorneys can have difficulty perfecting the Blue Ridge style reservation of rights. Unlike other types of insurer reservations, so-called Blue Ridge reservations are more complex, multi-faceted, and easier to botch.
The standard reservation of rights that works so well for most purposes is not enough to reserve Blue Ridge rights. When an insurer receives a defense tender, all it generally needs to do to reserve rights is to prepare and send a simple letter that points out some of the reasons why the claims against the insured may not be covered and indicate in some general way that it is reserving the right to decline coverage. As cases such as State Farm Fire & Cas. Co. v. Jioras, 24 Cal.App.4th 1619, 1627 (1994) confirm, a reasonably timely letter that generally (or even globally) alerts the insured to the fact that the insurer believes there may not be coverage is more than enough to adequately reserve the right to challenge coverage at some later point in time.
Reserving the right to seek reimbursement of defense fees and expenses that are solely attributable to claims or causes of action that are not even potentially covered is also relatively easy. Since the California Supreme Court decided Buss v. Superior Court, 16 Cal.4th 35, 61, fn. 27 (1997), California liability insurers have been able to seek reimbursement of defense fees and expenses if they defend the entire suit and can subsequently establish that specific defense fees and expenses were solely allocatable to claims that were never potentially covered.
To properly reserve Buss reimbursement rights, an insurer merely sends a letter telling the insured that when the case is over the insurer may seek reimbursement of defense fees and expenses that were incurred solely to defend claims that were not even potentially covered.
But an adequate Blue Ridge reservation of rights is a different, or at least more complicated, animal. When the insurer plans to pay the third party’s settlement demand and sue its own insured to get the money back, things get more complex. There are several ways liability insurers can end up losing their right to seek reimbursement of uncovered settlement amounts (or perhaps even worse, forfeiting an opportunity to settle a serious claim within limits). Sticking with a standard reservation of rights approach is not enough to properly reserve rights under Blue Ridge. And demanding too much from the insured may also jeopardize the attempt to implement a Blue Ridge reservation.
To understand the unique aspects of a Blue Ridge reservation of rights addresses, it helps to re-visit Blue Ridge’s facts. A very serious personal injury took place (due to a dog mauling). The insured defendants had been involved in the plaintiff’s acquisition of the dog, and they thought liability was fairly thin. But if the plaintiff prevailed at trial, the damages were likely to be very big.
Coverage was debatable. The insured defendants had been in the dog business for many years before the incident. And the pertinent policies excluded business pursuits.
When the injured plaintiff made a settlement demand within policy limits (for the express purpose of opening the limits if the demand was not accepted), the insurer faced a dilemma. It could avoid excess liability by accepting the settlement demand. But unless there was a way to establish the absence of coverage and seek reimbursement, the insurer might be paying hundreds of thousands of dollars to settle an uncovered claim.
So the insurer asked its insureds what they wanted to do. Naturally, the insureds wanted their insurer to settle the claim and close the file. However, the insureds did not want to settle the lawsuit only to find themselves defending their insurer’s settlement recovery lawsuit. Could the insurer unilaterally reserve rights and settle the case over the insured’s objection? Could it pay the settlement demand to eliminate possible exposure above policy limits while unilaterally reserving the right to establish non-coverage and get reimbursed by the insureds, even though the insureds objected to that approach?
The California Supreme Court decided that the insurer could unilaterally reserve rights, settle with the third party, and sue its own insured for reimbursement. The Blue Ridge Court articulated a three-part reservation process – a process that typically requires the insurer to take different actions at different points in time. These three “prerequisites for seeking reimbursement for noncovered claims” are:
(1) a timely and express reservation of rights;
(2) an express notification to the insureds of the insurer’s intent to accept a proposed settlement offer; and
(3) an express offer to the insureds that they may assume their own defense when the insurer and insureds disagree whether to accept the proposed settlement.
Generally speaking, insurers will be better able to properly reserve and exercise their reimbursement rights under Blue Ridge if they stick to a simple formula that faithfully adheres to Blue Ridge’s mandate, without adding frills or extras. The first step to a proper Blue Ridge reservation of rights is the initial, somewhat standard, reservation of rights most liability insurers would send out early in the claims process, as soon as they see that a lawsuit includes claims the policy may not cover. This standard reservation of rights letter is likely to tell the policyholder that a certain coverage requirement does not appear to be satisfied or that a particular exclusion appears to bar coverage. In this standard reservation of rights letter, the insurer typically alerts the insured to the fact that it is reserving a right to decline indemnity coverage. And since Blue Ridge was decided in 2001, insurers have frequently added that the insurer may also seek reimbursement of settlement payments.
This initial letter is one of three steps that have to be taken to perfect a Blue Ridge reservation of rights. In Golden Eagle Ins. Co. v. Foremost Ins. Co., 20 Cal.App.4th 1372, 1391-92 (1993), a pre-Blue Ridge case, the court held that reserving rights just two months before trial was too late and not enough to enable the insurer to seek reimbursement of a settlement payment it made on a claim it saw as uncovered. On the other hand, any liability insurer that assumes this type of initial reservation of rights letter alone will adequately protect the carrier’s right to fund an uncovered settlement and then seek reimbursement from the insured, is in for a rude awakening.
End of Part 1. Part 2 of this article will be published on Wednesday, November 30, 2016.
David Ezra is a shareholder with Berger Kahn, ALC. He was named Best Lawyers 2016 Insurance Litigation “Lawyer of the Year” and has litigated and counseled clients in handling countless insurance claims.