Is That Bad Faith?
Liability insurance policies promise to pay for the cost to defend the insured in a covered lawsuit and to fund the judgment or settlement in that suit, up to the limits of insurance. In most cases, the policy limits are exclusive of defense costs and only apply to the ultimate judgment or settlement. In these circumstances, insurers retain the right to control the defense and settlement of the action, subject to the implied covenant of good faith and fair dealing. That covenant requires insurers to act reasonably and consider the insured's interests equal to their own. If an insurer breaches the implied covenant, an insured may sue the insurer in tort for acting in “bad faith.”
A common scenario that gives rise to a claim of bad faith in the liability insurance context is when an insurer unreasonably rejects an offer to settle the case within the policy limits, also known as a "policy limits demand." Doing so may be bad faith and subject the insurer to a lawsuit, including punitive damages. California law anticipates that insurance companies will be motivated to reject settlement offers within the policy limits even when reasonable because the insurer has little left to lose by "rolling the dice" at trial. If the insured is hit with a judgment exceeding the policy limits, the insurer would still only be on the hook for the amount up to the limits if the contract was applied as written. The insured would need to pay the rest.
California law precludes insurers from gambling with insureds' money in this way. Thus, the implied covenant of good faith and fair dealing imposes a duty on a liability insurer to accept reasonable settlement offers within the policy limits. That is true even though not written down in the policy itself.
To prove that an insurer's rejection of an offer to settle within the policy limits was in bad faith, an insured must prove (1) that the insurer failed to accept a reasonable settlement demand for an amount within the policy limits, and (2) that a monetary judgment was entered against the insured for a sum greater than the policy limits.
In determining the “reasonableness” of the settlement offer, the only permitted consideration becomes whether, in light of the plaintiff's injuries and the probable liability of the insured, the ultimate judgment is substantially likely to exceed the amount of the settlement offer. That determination must be made given the information the insurer knew or should have known at the time of the offer, and not based on what it subsequently learned. The offering party must have also provided the demand in a clear way, given the insurer sufficient time to review the demand, and of course, the insurer must have actually received it. The determination of the reasonableness of the insurer’s decision to reject the offer should not be affected by such factors as the limits imposed by the policy, a desire to reduce the number of future settlements, or a belief that the policy does not provide coverage.
The second factor -- the requirement that there has been a judgment in excess of the policy limits -- forms the basis for the minimum level of damages the suing insured would be entitled to. If the insurer acted in bad faith, but the ultimate judgment was equal to or less than the policy limits, the insured has not been subjected to any uncovered liability. When the judgment does exceed the limits, a suing insured may be entitled to additional damages on top of the excess liability, including consequential damages, attorney fees, and punitive damages.
In very rare circumstances, an insurer’s bad faith refusal to settle may be actionable even without an excess judgment. “An insured may recover for bad faith failure to settle, despite the lack of an excess judgment, where the insurer’s misconduct goes beyond a simple failure to settle within policy limits or the insured suffers consequential damages apart from an excess judgment.” Howard v. American National Fire. Ins. Co., Cal.App.4th 498 (2010). For example, an insured has recovered for the bad faith failure to settle without an excess judgment when an insurer used the insured’s fear of punitive damages to coerce the insured to contribute to the settlement. J.B. Aguerre, Inc. v. Am. Guarantee & Liability Ins. Co., 59 Cal.App.4th 6, 13-14 (1997). Again, however, this is rare and is the exception rather than the rule.
These considerations are equally important to heed if you are a plaintiff suing a defendant who is being defended by their liability carrier. A plaintiff who makes a proper policy limits demand to an insurer and then obtains an excess judgment may have the opportunity to pursue the insurer for the excess amount, instead of the insured. In California, insureds can "assign" (i.e. give away) their right to sue their insurance company for bad faith (but not punitive or emotional distress damages). A plaintiff with an excess judgment against an insured may agree to refrain from pursuing the judgment against the insured in exchange for the insured's right to sue the insurer for bad faith.
Whether you are a plaintiff or an insured, there are many factors to consider, and getting professional advice is the best avenue. Other factors that may play a significant role include whether there are multiple insureds involved in the suit; whether the insurer has only accepted coverage for some claims in the suit; whether the insurer has expressed willingness to accept the offer with a reservation of rights to the insured; and others.