In prior posts (here and here), I discussed two recent decisions in which courts held that D&O insurance coverage was precluded for settlements the insureds entered without first obtaining the insurers’ consent as required under the applicable policies. An August 19, 2008 Second Circuit opinion (here) addressed the related question of what happens when the insured seeks but the insurer withholds settlement consent.
Based on the somewhat strained circumstances involved, the Second Circuit affirmed a jury verdict holding two excess carriers liable under their policies to fund their portion of a settlement, even though the insured had requested settlement consent on a Sunday evening at 10:00 PM and givn the carriers only eleven hours to respond.
The underlying claim arose out of the Globalstar Telecommunications securities litigation (about which refer here). After the corporate defendants sought bankruptcy protection, the case went forward solely as to Globalstar’s former CEO, Bernard Schwartz. There were various pretrial mediation and settlement conferences, but the case did not settle and proceeded to trial.
The first four layers of Globalstar’s D&O insurance program consisted of a primary $10 million layer and three successive excess layers of $5 million each. Prior to trial, the plaintiffs’ latest settlement demand was $15 million. The primary insurer’s last pretrial settlement offer was $5 million. The plaintiffs reportedly warned that once trial began, their demand would rise to $20 to $25 million.
After two weeks of trial and on the day before he was scheduled to testify, Schwartz agreed to a $20 million settlement. Schwartz’s defense counsel sought the insurers’ consent to enter into the settlement. The request for consent was sent via email on a Sunday night at 10:00 pm. According to the Second Circuit’s later opinion, Schwartz’s defense counsel "offered to discuss the reasonableness of that figure later than night or between 8:45 am and 9:00 am on Monday." Over the next few days, all four insurers refused to consent. The court entered judgment approving the settlement. Schwartz later funded the $20 million settlement with a personal check.
The Coverage Litigation
Schwartz then sued the four insurers. Schwartz sued the primary carrier for bad faith refusal to settle and for breach of contract. Schwartz sued the three excess carriers for breach of contract. (The third layer excess carrier was involved because at the time Schwartz agreed to settle the case, defense fees had eroded the first $3 million of the primary policy, so the $20 million settlement implicated the third layer excess policy.) The second and third layer excess insurers also cross claimed against the primary insurer alleging bad faith, on the theory that as excess insurers they were equitably subrogated to Schwartz’s bad faith claims against the primary insurer.
Before the coverage lawsuit went to trial, both the primary insurer and the first level excess insurer settled with Schwartz by paying their full policy limits. The coverage trial went forward on Schwarz’s claims against the second and third level excess insurers, and on these two excess insurers’ cross claims against the primary insurer.
Following trial, the jury found in favor of Schwartz and awarded damages of $5 million against the second level excess insurer, and $4 million against the third level excess insurer (the full amount that Schwartz had sought).
On the excess insurers’ cross claims against the primary insurer, the jury awarded the second level excess insurer damages of $2 million and the third level excess insurer damages of $3 million. However, the jury also specifically found that the primary insurer had not acted in "gross disregard" of Schwartz’s rights. In a post-trial ruling, the district court dismissed the excess insurers’ cross claims, holding that New York law applied to the cross claims and that under New York law there could be no recovery for bad faith in the absence of a finding of "gross disregard."
The Second Circuit Opinion
On appeal, the excess insurers argued "Schwartz’s failure to satisfy the condition precedent of consent to settlement absolved them of their contractual duties." The excess insurers contended that Schwartz’s settlement request "gave them mere hours (over a Sunday night and Monday morning) to decide whether to settle." The Second Circuit characterized these arguments as contending that the 11-hour period represented "the interval in which the Excess Insurers had to assess – for the first time – the risks, opportunities and settlement demands at play."
The Second Circuit, in an opinion by Chief Judge Dennis Jacobs, said that "the insurers’ opportunity to consider settlement extended over a prolonged course of consultation, monitoring and negotiation, so that the settlement was in the nature of anticlimax rather than surprise." The Second Circuit found the jury appropriately considered this evidence and concluded that the excess insurers "had an adequate opportunity to consider and evaluate the settlement opportunities; that $20 million was a reasonable sum; and that [the excess insurers] unreasonably withheld consent." The Second Circuit held that there was sufficient evidence to support the jury’s verdict in Schwartz’s favor.
The Second Circuit also rejected the excess insurers’ argument that the trial court inappropriately applied New York law to the excess insurers’ equitably subrogated bad faith claims against the primary insurer.(Under New York law, but not under California law, a finding of "gross disregard" is required to support the imposition of bad faith liability.) Among other things, the excess insurers argued that it was not appropriate to apply California law to Schwartz’s breach of contract claims but New York law to their equitably subrogated bad faith claims.
The Second Circuit found that applicable choice of law principles allowed different jurisdictions’ laws to apply to different aspects of the same dispute. The Second Circuit also rejected the excess insurers’ argument that application of different law to their cross-claims inappropriately deprived them of the same right of recovery as the person to whom they were equitably subrogated.
The most critical fact in these strained circumstances may be that in the absence of the insurers’ consent Schwartz accepted personal liability for the settlement and funded it out of his own assets. That step substantially undercut the insurers’ ability to argue that the settlement amount was unreasonable, and by extension that their withholding of consent was reasonable.
These circumstances nevertheless present some very troublesome aspects. One particularly questionable part is the settlement consent request that was presented in an email at 10 pm on a Sunday evening with an 11-hour response time. However one might characterize this communication, it was hardly calculated to provide the insurers with what most people would consider a reasonable opportunity to consider the request and respond.
In seemingly overlooking the unorthodox nature of these communications, the Second Circuit placed great weight on the excess insurers’ prior attendance at mediation and settlement conferences, and at trial. During these proceedings there were opportunities to settle the case for $15 million. To be sure, the plaintiffs had indicated that the settlement demand would rise once trial started. The second and third level excess insurers had demanded that the primary and first level excess insurers settle the case for the $15 million amount. Had the case settled for that amount, the second level insurer would only have paid a portion of its limits and the third level excess insurer’s limit would not have been implicated at all.
Under these circumstances it seems that what this case really was about was the question of who ought bear the costs of the $20 million settlement. In that regard, it is significant to note that the jury specifically awarded substantial damages in favor of the second and third level excess insurers against the primary insurer, notwithstanding the jury’s finding that the primary insurer had not acted in "gross disregard" of Schwartz’s interests.
The amount of the cross claim awards seems to be explained by the fact that at the time of the settlment, the first $3 milion of the primary policy had been eroded by defense expense. The sum of the $7 million remaining on the primary policy, the $5 million under the first level excess policy, and the first $3 million of the second level excess policy collectively represented the $15 million amount at which the case could have been settled before trial. The jury shifted to the primary insurer responsibiltiy for the incremental $5 million difference between the $15 million for which the case could have been settled before trial and the $20 million for which it actually settled, by awarding damages of $2 million to the second level excess insurer and $3 million to the third level excess insurer.
However, the trial court negated these cross claim damage award in its post-trial choice of law decision, which the Second Circuit affirmed. I am insufficiently steeped in "decapage" and other rarified choice of law principles to have any informed opinion about the merits of the Second Circuit’s analysis of the law to be applied to excess insurers’ cross claims. The excess insurers undoubtedly are frustrated that they were found liable to Schwarz (to whom they were equitably subrogated) under California law, but that the primary insurer was not liable to them (despite the jury verdict in their favor on the cross claims) because New York law rather than California law applied to their cross claims.
The net effect is that the excess insurers are left holding the responsibility for amounts that the jury assigned to the primary carrier. The primary insurer of course would that in the absence of a finding of "gross disregard" it would be inappropriate for it to have to bear liability for these amounts.
In the end, the outcome of this case may be best understood as the result of the strained circumstances. It should probably be emphasized that demanding insurer consent on a Sunday evening with an 11-hour deadline does not, shall we say, represent an advisable approach. Of course there may be sufficiently pressing circumstances (including, it should be noted, during the constraints of trial) where rushed communications may be unavoidable. But in general, complete, timely and business-like communications are to be preferred, and are likelier to avoid disputes with the carrier.
Special thanks to a loyal reader for providing a link to the Second Circuit opinion.
When Introducing Her, McCain Did Say Something Like "And Now For Something Completely Different": Prior to this past Friday, the only person I had every heard of with the last name of "Palin" was Michael Palin, of Monty Python fame.