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What Happens When a Policyholder Settles Without Involving Its Insurer?

Nobody likes to get sued.  When a lawsuit or a demand letter comes in, the first thing that crosses the mind of the party being sued (or claimed against) is how can I resolve this quickly?  That may be a reasonable visceral reaction to the suit, but what happens when insurance is involved?​

Most insurance policies that provide primary coverage contain provisions that require the insurance company to defend and indemnify the policyholder for losses incurred because of a claim coming within the coverage grant of the insurance policy.  There are exceptions to that rule, especially with policies that have high self-insured retentions, where the duty to defend is left with the policyholder.

In a typical insurance policy containing a broad requirement that the insurance company defend and indemnify the policyholder, there is usually a provision that requires the policyholder to cooperate with the insurance company in the investigation of the claim.  Part of that cooperation often instructs the policyholder not to expend any funds defending or investigating the claim or settling the claim without the prior approval of the insurance company.

Even in polices where the policyholder controls the defense, there are often provisions that require the policyholder to obtain the insurance company’s permission before negotiating any settlement.

These types of provisions exist to allow the insurance company to investigate the claim properly and to determine whether settlement under the terms of the insurance policy is warranted.  Many courts have determined that if the policyholder refuses to cooperate or settles the claim without the insurance company’s knowledge or permission, the insurance company is released from its policy obligations.

This point was driven home in a recent decision from the Ninth Circuit Court of Appeals.  While the decision is unpublished and not precedent except as provided by court rule, it serves as a simple warning to policyholders on the ramifications of settling a case without the insurance company’s knowledge or consent.

In Amco Insurance Co. v. Morfe, No. 17-55383, (9th Cir. Sept. 20, 2018), a tort action was filed by an employee against her former employer and a shareholder of the employer for injuries allegedly caused by the shareholder.  The defendants tendered the claim to the insurance company.  But before the insurance company could issue a coverage decision, the policyholder settled the case without the insurance company’s knowledge or consent.

After it learned of the settlement, the insurance company brought a declaratory judgment action in federal court seeking an order that it no longer had a duty to defend or indemnify the policyholder. The district court granted partial summary judgment to the insurance company on three grounds, including that there was no coverage under the policy because the policyholder had breached the policy by settling without the insurance company’s knowledge or consent.

The Ninth Circuit affirmed.  The insurance policy had a “No Voluntary Payments” clause that provided “[n]o insured will, except at their own cost, voluntary make a payment, assume any obligation, or incur any expense, other than first aid, without [the insurance company’s] consent.”  The claimant argued on appeal that this provision was not enforceable because the insurance company abandoned the policyholder by failing to respond to the tender of the claim, the settlement was entered into under duress and fear of financial ruin, and that the insurance company breached its duty to provide an immediate defense by not rendering a coverage opinion within the time between the tender of the claim and the date of the settlement.  The court rejected each of these arguments.

Abandonment, held the court, was not applicable here because the insurance company had not expressly denied coverage and refused to provide a defense.  The court found that no evidence was in the record to support the claim of duress or that the settlement was involuntary based on the length of the insurance company’s investigation.  Because the claimant provided no evidence to rebut the facts in the record to create a genuine issue of material fact and because no valid exception to the “No Voluntary Payments” clause applied, the grant of partial summary judgment was affirmed.

The lesson here is that before a policyholder settles a case it must check with the insurance company to avoid losing coverage.

© Copyright 2018 Squire Patton Boggs (US) LLP

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About this Author

Larry P. Schiffer, Commercial Insurance, Reinsurance Litigation Lawyer
Partner

Larry Schiffer practices in the areas of commercial, insurance and reinsurance litigation, arbitration and mediation. He also provides advice on coverage, insurance insolvency, and contract wording issues for a wide variety of insurance and reinsurance relationships. 

In addition, Larry serves as a mediator for the mandatory commercial mediation program of the United States District Court for the Southern District of New York, and for the New York Supreme Court Commercial Division's Alternative Dispute Resolution Program.

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