Shareholder David Ezra was featured by esteemed publication Claims Journal highlighting the options available to attorneys and claims professionals who may be navigating an effort to secure the right to pursue uncovered reimbursement. Read more (part 1)… Read more (part 2)…
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MASTERING THE BLUE RIDGE SETTLEMENT RESERVATION OF RIGHTS
By
David Ezra
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 allocable 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.
PART 2
A valid Blue Ridge reservation of rights requires more than the initial reservation of rights that warns the insureds that a later settlement payment may become subject to a reimbursement claim. In addition to that initial reservation of rights letter, to perfect a Blue Ridge reservation, the insurer must expressly notify the insureds that it is planning to accept a particular settlement demand and expressly offer the insureds the right to assume their own defense if they disagree with the insurer’s desire to accept the settlement demand.
Courts don’t always rigorously enforce these additional requirements. Some federal judges have suggested that some Blue Ridge prerequisites may be relaxed when an insured who is represented by independent counsel demands that the insurer accept a particular settlement demand. For example, in State Nat’l Ins. Co. v. Khatri, No. C 13-00433 LB, 2013 U.S. Dist. LEXIS 132167, at *29 (N.D. Cal. Sept. 13, 2013), the court emphasized that “State National alleges that Defendants demanded at the September 2012 mediation that State National pay the $125,000 settlement amount and threatened to sue it for breach of contract if it did not do so.”).
Similarly, in Markel Am. Ins. Co. v. G.L. Anderson Ins. Servs., 715 F.Supp.2d 1068, 1076 (E.D. Cal. 2010), the court emphasized that “the evidence is also undisputed” that independent counsel “demanded that plaintiff settle the claims for the policy limit four days before the settlement offer deadline.” And in Progressive W. Ins. Co. v. Dallo, No. 07CV1003 IEG (BLM), 2007 U.S. Dist. LEXIS 80216, at *23 (S.D. Cal. Oct. 30, 2007), the court concluded “that neither an express notification of Plaintiff’s intent to accept a policy limits settlement nor a specific offer by Plaintiff to Defendants that Defendants maintain their own defense was necessary for Plaintiff to preserve its reservation of rights.”
One federal judge has even suggested that an insured’s waiver of the right to independent counsel may also relax the Blue Ridge prerequisites. In Phillips & Assocs., P.C. v. Navigators Ins. Co., 764 F.Supp.2d 1174, 1177 (D. Ariz. 2011), the court held that even though “the Insureds allege they were not expressly given the opportunity to assume their own defense, they admit to signing a waiver on October 21, 2009 with respect to their right to select independent counsel.”
But insurers and their attorneys should not count on relaxed enforcement of the requirements Blue Ridge articulated. Other courts strictly enforce the Blue Ridge requirements more strictly. An example is Allstate Ins. Co. v. Baglioni, 551 F. App’x 351, 352 (9th Cir. 2014), where the Ninth Circuit held that “we are bound by Blue Ridge, and Allstate cannot state a claim for reimbursement against Baglioni without alleging compliance with each of Blue Ridge’s prerequisites.” As a result, insurers that cut corners will often lose the right to seek reimbursement of uncovered settlement payments.
Trying to formulate a standard form reservation of rights letter that can be sent out at the beginning of a case to adequately reserve Blue Ridge rights is probably a self-defeating proposition. It is not enough to generally alert the insured to the fact that at some later point in time the insurance company may want to accept some hypothetical future settlement demand and that the insured might have a right to object to the settlement and assume responsibility for funding its own defense.
Instead, a valid Blue Ridge reservation contemplates an initial proper reservation of rights that adequately alerts the insureds to the presence of coverage issues and later, when a particular settlement demand is made, an additional set of policyholder communications that identifies the settlement demand, alerts the insureds to the insurer’s desire to accept the particular settlement demand.
The final required step entails advising the policyholder that if they believe the case is defensible, they can object to the settlement and assume responsibility for their own defense. By offering the insured the right to take over their own defense funding, the carrier gives the insured a chance to avoid responsibility for damages that may be uncovered by securing a favorable verdict — a verdict that avoids liability or minimizes damages.
During the Blue Ridge reservation of rights process, things can get very contentious, very quickly. Policyholder attorneys may naturally resist putting their clients in a position where they were getting an insurance funded defense one day and the next they are paying money out of their own pocket to defend the insurance company’s lawsuit seeking hundreds of thousands of dollars in reimbursement.
When there is a sense of urgency and communications get heated, attorneys for the insurance company can get overly defensive or overly aggressive. And it is possible that an insurer may imperil what would be an otherwise valid Blue Ridge reservation by making too many demands. For example, a Blue Ridge reservation of rights letter that tells the insureds that the insurer will settle the case and seek reimbursement unless the insureds assume responsibility for their own defense and waive the right to seek indemnity may go way too far.
It is one thing to tell insureds, as Blue Ridge mandates, that the insurer will accept the settlement demand and seek reimbursement unless the insureds agree to assume their own defense. But it is something else to condition the right to object on the overt forfeiture of indemnity coverage.
Under the Blue Ridge “prerequisites,” the insureds may have to fund their own defense if they reject the insurer’s offered “settle and sue” approach, but if the insureds’ defense is unsuccessful, the duty to indemnify up to the limits remains an open question. If the insured can establish that the adverse judgment was partially or fully covered, the carrier would have to indemnify. The benefit for the carrier is that the indemnity is capped at policy limits and extra-contractual exposure is eliminated, not the complete elimination of coverage.
Another mistake tends to happen when the insurer sees both the claimant and the policyholder as a problem, or when the insured lacks financial resources. Some Blue Ridge reservation letters actually go so far as to say the carrier insurer will reserve the right to sue both the claimant and the insured for reimbursement. That approach appears to be invalid. While a claimant could theoretically agree to that suggestion, the insurer has no ability to unilaterally reserve a reimbursement right as to the claimant. And including the claimant in a letter that attempts to satisfy the Blue Ridge reservation prerequisites could backfire. It could prompt the claimant to withdraw the settlement demand and facilitate the insured’s argument that the insurer’s position toward the claimant squandered the opportunity to settle within limits. And that would enhance the likelihood that the carrier insurer ends up exposing itself to liability above and beyond the policy limits.
The logic behind Blue Ridge is that the insurance company should not be put in a position of having to either expose itself to bad faith liability for part of a covered judgment that exceeds the policy limits or lose the right to establish non-coverage. While this concept sounds simple, Blue Ridge reservations have proven to be difficult properly execute.
Under Blue Ridge, the insurer can stand on its “no coverage” position, refuse to settle, and potentially be exposed to excess liability if the coverage calculation turns out to be wrong. Or it can play it safe by accepting the settlement demand, while reserving the right to seek reimbursement from the insured. However, as Justice Mosk’s concurring Blue Ridge opinion explained, a third option may exist — allow the insured to refuse settlement, but retain the insurer-funded defense while waiving any right to pursue the insurance company for excess liability above policy limits based on a bad faith refusal to settle. Some insurers have successfully used this approach. For example, in American Modern Home Ins. Co. v. Fahmian, 194 Cal.App.4th 162, 164 (2011), the insurer’s “settlement advisement letter” warned that “it intended to accept the settlement demand unless [the insured agreed to] take over his own defense, or waive any later bad faith claim based on the failure to settle the action.”
It is important to remember that an insurance company and a policyholder can always agree to a different arrangement. Policyholders and their liability insurers can be as creative as they want to be, as long as they can reach an agreement. However, when agreement cannot be reached, an effective Blue Ridge reservation of rights will be needed.
Blue Ridge did not answer all the questions that can arise. For example, what happens if the insureds elect to undertake their own defense and they get a defense verdict (or a verdict below policy limits) at trial? Can the insureds then turn around and force the insurer to reimburse defense expenses the insureds incurred after the insurer forced a Blue Ridge election?
What if the insurer’s Blue Ridge reservation letter said the insurer wants to accept the settlement because the chances of getting a defense verdict are minimal and the exposure, whether covered or not, is likely to far exceed the policy limit? After the insured successfully defends the case, the insurer’s incorrect assumptions about the strength of the defense would certainly give the policyholder “I told you so” rights, but whether it shifts responsibility for the defense expenses back to the insurer remains a very debatable issue.
Experiences from the 15 years since Blue Ridge teach us that the circumstances surrounding Blue Ridge reservations can be tense, fast-paced, and contentious. Often, both insurers and their insureds need to make quick, but very important, decisions. As American Modern Home Ins. Co. v. Fahmian, 194 Cal.App.4th 162, 172 (2011), explained in holding that a five-day window for decision-making was adequate, insureds “cannot be permitted to derail the Blue Ridge process by failing to obtain separate coverage counsel until a request for consent to settle is received, and then claiming insufficient time to respond to that request due to lack of such counsel.” And in Haskins v. Emplrs Ins. of Wausau, 126 F.Supp.3d 1117, 1127 (N.D. Cal. 2015), the court approved a two-day time period for the insured’s decision-making.
To be sure, policy limit settlement demands in potential excess exposure cases can create some quick-reaction challenges for policyholders, liability insurers, and the attorneys who represent them. Counsel for insurers will want to make sure they protect their clients’ interests by taking proper steps to effectively reserve rights. Counsel for policyholders will want to do some advance planning and be ready to propose or evaluate alternatives that may be beneficial or less burdensome for their clients.