Most D&O insurance policies specify that the insurer’s advance written consent is required for claim settlement, such consent not to be unreasonably withheld. A frequent insurance coverage battleground issue is whether an insurer’s decision to withhold consent is or is not unreasonable. In the long-running insurance coverage dispute between for-profit education firm Apollo Education Group and its D&O insurer, Apollo contends that the insurer’s refusal to consent to Apollo’s $13.125 settlement of an options backdating-related securities suit was unreasonable. The coverage dispute eventually made its way to the Ninth Circuit, which certified a question of law to the Arizona Supreme Court on the question of the standard of law to be applied to the consent to settlement provision.

In an interesting February 17, 2021 split decision that could have important implications, the Arizona Court held that the objective reasonableness of the insurer’s decision to withhold consent is to be assessed from the perspective of the insurer, not that of the insured. A copy of the Arizona Supreme Court’s opinion can be found here.

Background

In November 2006, a plaintiff shareholder sued Apollo and certain of its directors and officers in a securities suit based on options backdating allegations. The defendants filed a motion to dismiss, which the district court granted. The plaintiff shareholder filed an appeal of the dismissal. While the appeal was pending, Apollo reached an agreement with the plaintiff to settle the securities suit for $13.125 million.

Apollo sought its D&O insurer’s consent to the settlement under the terms of its D&O insurance policy. The insurer denied consent. Apollo paid the settlement amount out of its own funds and filed a separate action seeking a judicial declaration that the insurer had breached the insurance contract and committed bad faith. In the coverage lawsuit, Apollo contended that the insurer’s refusal to consent to the settlement was unreasonable and therefore constituted a breach of duty under the terms of the policy. The insurer filed a motion for summary judgment.

As detailed here, on October 26, 2017, District of Arizona Judge Stephen Logan, applying Arizona law, granted the insurer’s summary judgment motion. Judge Logan noted the steps the insurer had taken to consider the settlement and concluded that in light of the insurer’s “extensive analysis weighing the Teamsters’ settlement, taken in conjunction with the express terms of Plaintiff’s policy, it is clear that Defendant fulfilled its obligation to Plaintiff by considering the terms of the Teamsters’ settlement and that Plaintiff’s breach of contract claim must fail as a matter of law.”

Judge Logan also stated that the insurer “concluded that the settlement was premature – and likely unnecessary – because of the probability that Plaintiff would prevail on appeal.” He also noted the insurer concluded that in the unlikely event that Apollo did not prevail on appeal, there would be “a variety of other hurdles that Teamsters would have to overcome in order to recover a ‘substantial judgment’ against Plaintiff.”

Apollo appealed the district court’s ruling to the Ninth Circuit. As discussed here, on August 15, 2019, a three-judge panel of the Ninth Circuit certified to the Arizona Supreme Court the question of the legal standard to be applied in determining the reasonableness of an insurer’s withholding of consent to settle. The question certified, as later clarified and as later re-stated by the Arizona court was “Should the federal district court assess the objective reasonableness of [the D&O insurer’s] decision to withhold consent from the perspective of an insurer or an insured?”

The relevant provision of Apollo’s D&O insurance policy provides as follows:

The Insureds shall not … enter into any settlement agreement … without the prior written consent of the Insurer. Only those settlements … which have been consented to by the Insurer shall be recoverable as Loss under the terms of this policy. The Insurer’s consent shall not be unreasonably withheld…

The February 17, 2021 Opinion

In a February 17, 2021 opinion written by Justice Clint Bolick for a majority of five justices, and over a dissenting opinion in which two justices joined, the Arizona Supreme Court answered the certified question by stating that “the objective reasonableness of the insurer’s decision to withhold consent is assessed from the perspective of the insurer, not the insured,” adding that the insurer “must independently assess and value the claim, giving fair consideration to the settlement offer, but need not approve a settlement simply because the insured believes it is reasonable.”

In reaching this conclusion, the Court said that the “contract terms speak clearly and directly to whether the perspective of the insurer or insured should guide the determination.” The consent to settle provision, the Court said, “speaks entirely to the insurer’s perspective,” as it refers three times to the insurer’s consent.” The Court noted further that “it makes sense that the reasonableness of such consent would not be from the perspective of the insured,” with respect to a D&O insurance policy where the insured, not the insurer, controls the defense. The Court drew a strong contrast with the circumstances where an insurer is defending under a duty-to-defend, where the insurer controls the defense.

The majority rejected the position advanced by the dissenting justices that the interests of the insurer and the insured should be given “equal consideration,” as that “might force an insurer to accept a settlement controlled entirely by the insured, for the full amount of the policy limit, even if the insurer fairly valued the claim at zero or an amount below the policy limit.”

The Court went on to examine how reasonableness from the insurer’s perspective is to be determined, taking into account the insured’s contractual interests. The inquiry, the Court said, it to be an objective one, that asks “did the insurance company act in a manner consistent with the way a reasonable insurer would be expected to act under the circumstances.?” Among other things, an insurer is “obligated to conduct a full investigation” and to must “fairly value the claim,” but the insurer may also “discount considerations that matter only or mainly to the insured – for example, the insured’s financial status, public image, and policy limits.”

An insurer may also choose to withhold consent if the settlement “exceeds the insurer’s reasonable determination of the value of the claim, including the merits of the plaintiff’s theory of liability, defenses to the claim, and any comparative fault.” The court “should sustain the insurer’s determination if, under the totality of the circumstances, it protects the insured’s benefit of the bargain, so that the insurer is not refusing, without justification, to pay a valid claim.”

In a dissenting opinion in which Justice John Lopez joined, Justice Andrew Gould wrote that “because there is no standard set forth in the policy itself, based on the implied covenant of good faith and fair dealing, [the D&O insurer] was required to give equal consideration to the interests of Apollo in deciding whether to consent.” Justice Gould added that Arizona has “spend several decades carefully developing the equal consideration standard to protect insureds from the potential financial ruin they face in third-party claims.” The majority, he said, “has decided to depart from that jurisprudence.” This, he said, “will undoubtedly create confusion and generate litigation for years to come.”

Discussion

As I noted at the time that the Ninth Circuit certified the questions of law to the Arizona Supreme Court, the whole certification process has always fascinated me. In this process, the certified question is presented like a highly stylized law school exam question, with the added proviso that the court receiving the certification must answer the question that the presenting court itself was not able to answer. Given that context, it arguably comes as no surprise that there might have been a split among the Arizona Justices on the question; the very reason the question was certified in the first place is because it did not appear clear cut.

It is important to note that though the Arizona court’s majority opinion came down in the insurer’s favor, this long-running dispute is far from done. The case will now return to the Ninth Circuit, which must again take up the case this time with its certified question answered. The Ninth Circuit will then consider the standard of duty as defined by the Arizona court in light of the existing case record. If the record is sufficient for the appellate court to determine whether the insurer’s decision to withhold consent was reasonable, the Ninth Circuit will proceed to rule on the issue. The Ninth Circuit could also determine that the record is not sufficient to permit a ruling and return the case to the district court for further proceedings.

The value to the insurer of this decision, and the value to insurers of this decision in other consent to settlement disputes, is not just that it held that the reasonableness of the insurer’s decision to withhold consent is to be assessed from the insurer’s perspective and not that of the insured; the value is also in the Arizona court’s discussion of what courts are to consider in determining the reasonableness from the insurer’s perspective. In particular, I can see insurers trying to make a great deal out of what the Arizona court said insurers may disregard – that is, that an insurer “may discount considerations that matter only to the insured – for example the insured’s financial status, public image, and policy limits.” One may well question whether the reasonableness of disregarding these factors fairly ought to depend on the specific circumstances presented.

The Arizona court’s opinion is of course most relevant to insurance coverage disputes governed by Arizona law. However, as the pronouncement of a state’s highest court, the Arizona court’s opinion will carry persuasive weight even in disputes governed by the law of other jurisdictions. For that reason, the Arizona court’s opinion could prove influential in other coverage disputes. The opinion could have a more practical effect as well; in future circumstances in which insurers are presented with the need to determine whether or not they will consent to a settlement, insurers may well refer to the Arizona court’s opinion in deciding what their obligations are in determining consent.

In trying to decide how to think about this situation, there is at least one important consideration to keep in mind. It is, I think, worth emphasizing that, in granting summary judgment for the insurer, the district court considered specific considerations to be significant. That is, in withholding its consent, the insurer had undergone a review process that the district court judge characterized as involving “extensive analysis.” The insurer’s withholding of consent is likelier to be found reasonable where the insurer can substantiate the decision-making process behind the decision. In the absence of this type of showing, it is going to be harder for an insurer to establish that its withholding of the consent is reasonable.

These latter considerations make me question whether or not this undeniably insurer-favorable decision will have the effect of emboldening insurers to withhold settlement consent with greater frequency. Insurers must always consider that courts reviewing their decision-making process will second-guess their choices, with no assurances that a court will later conclude that the decision was reasonable.