The Defense Rests

by Ernest D. Tinsley

Under what circumstances may a "primary" insurance carrier pay its limit of liability and thereby extinguish its duty to defend without obtaining a full and complete release of its insured? This question arises more often than one might imagine, most frequently when an individual is involved in an automobile accident while driving a vehicle owned by another. Under those circumstances it is quite likely that two insurance policies, one purchased by the owner of the vehicle, the other by the driver, will provide coverage for the driver. This duality of coverage raises several issues, some of which are resolved by statute while others are left for resolution by the courts.

What happens, for instance, when the primary carrier, having determined that the value of a claim exceeds its limits, desires to settle with the claimant, but the "excess" carrier refuses to participate? Until recently, the law seemed to afford the primary carrier no relief, instead requiring it to continue to incur defense costs in defending a claim on which it was quite willing to pay its limits. Case law throughout the country is uniform in holding that a carrier which merely tenders its limit of liability is not relieved of its defense obligation, and seems to imply that the defense obligation can be satisfied only when the insurer has either obtained a full and complete release for the insured or paid a judgment rendered against the insured. See, e.g., American Family Life Assurance Company v. United States Fire Company, 885 F.2d 826 (11th Cir. 1989) (and the cases collected at 27 ALR 3rd 1057, 1969).

In Continental Casualty Ins. Co. v. Farmers Ins. Co. of Arizona (180 Ariz. 236, 883 P.2d 473, 1994), the Arizona Court of Appeals analyzed this rule of law and the relationship between the primary carrier who is willing to pay its policy limits and the excess carrier who is unwilling to settle. There, Farmers, the primary carrier, evaluated the plaintiff’s claim as exceeding its $100,000 limit of liability. When Continental (CNA), the excess carrier, refused to contribute to or participate in settlement negotiations, Farmers partially settled plaintiff’s claim by paying its $100,000 limit of liability, in exchange for which plaintiff released Farmers and provided the insured/defendant with a covenant not to execute. Farmers then tendered the insured’s defense to CNA, and withdrew from the matter.

CNA defended the lawsuit for a period of time, and eventually settled with the plaintiff. CNA then sued Farmers for contribution, alleging that Farmers’ defense duty had not been extinguished by the payment of its policy limits, and that as a consequence Farmers was liable for a proportionate share of the defense costs CNA had incurred. In holding in favor of Farmers, the Court of Appeals reasoned as follows:

"In this case, the record is clear that Farmers had paid its policy limits and had complied with its duty to defend its insured by obtaining a covenant not to execute on his behalf. Although not a complete release, in view of the existence of excess coverage, it was as complete as Farmers could obtain under the circumstances... [U]nder the facts of the present case, Farmers’ duty to defend was discharged pursuant to its policy provision and therefore CNA had no right of subrogation for defense costs." (180 Ariz. at 239.)

Recently, the court’s ruling in Continental v. Farmers came under attack in the dissent in California Casualty v. State Farm, (211 Ariz. Adv. Rpt. 19, March 12, 1996). There, California Casualty apparently intended to settle a case along the same lines as had Farmers, but due to a mixup failed to obtain a covenant not to execute for its insured. Subsequently, the settlement documents were reformed to include "covenant not to execute" language. On those facts, and in reliance upon Continental v. Farmers, the court held that, as of the date of the reformation, California Casualty’s duty to defend was extinguished.

The dissent argued, in essence, that Continental v. Farmers was wrongly decided. The following language from the second paragraph of the dissent succinctly summarizes the position:

"In my view, the primary carrier does not discharge its duty to defend even when it obtains [a covenant not to execute]. Instead, the duty is extinguished only when the insurer either settles the claim while obtaining a complete release or pays a judgment against the insured."

211 Ariz. Adv. Rept. at 23.

In support of this position, the dissent cites several bases:

1. The insured remains subject to litigation despite the covenant.

2. The covenant does not protect the insured from entry of judgment.

3. The availability of excess coverage is absolutely irrelevant.

4. The rule as enunciated in Continental v. Farmers would allow primary carriers unfairly to shift defense costs to excess carriers.

5. Allowing the primary carrier to withdraw might disrupt litigation by shifting the defense to new counsel.

The majority opinion declined to address the concerns raised in the dissent, noting that Continental v. Farmers was not cited by the parties until Appellant’s Reply Brief. However, because this is a new area of law, and because this circumstance is certain to occur in the future, the arguments put forth by the dissent should not go unanswered.

The Insured Remains Subject to Litigation

While it is true that the insured remains subject to litigation after the partial settlement of a claim against him, it is also true that in the absence of the partial settlement the insured would remain subject to litigation. Thus, the partial settlement puts the insured in no worse position than he would have been in had the partial settlement not been achieved.

The Covenant Does Not Protect the Insured from Entry of Judgment

The covenant could easily be drawn so as to forbid the plaintiff from filing and/or recording his judgment against the insured.

The Availability of Excess Coverage is Irrelevant

The bald declaration that the availability of excess coverage is absolutely irrelevant ignores the realities of the situation and is based upon decisions that did not involve the precise issue in question here. Often, these decisions concern disputes involving "true" excess carriers, not primary carriers who find themselves in an excess position due to an accident of fate. These decisions, which invalidate the primary carrier’s attempts to relieve itself of its defense obligation, rightfully protect the true excess carrier from being saddled with providing a defense that the primary carrier should provide. Such protection is not necessary for the "excess" carrier involved in the typical case under consideration here, as that carrier fully contemplated providing a defense to its insured.

In fact, it is the presence of the "excess" carrier which necessitates the "covenant not to execute" procedure in the first place, inasmuch as but for its existence the primary carrier would be able to settle the case outright with the plaintiff, leaving him to pursue a UIM claim against his own carrier. Moreover, the presence of excess coverage provides the additional protection to the insured that legitimizes and validates the entire procedure. Under these circumstances, the availability of fortuitous excess coverage is absolutely relevant, as well as crucial to the analysis of the partial release procedure.

Unfair Shift of Defense Costs

Apparently, the primary carrier in California Casualty v. State Farm paid its $100,000 limit of liability on a case that ultimately was determined to be worth $20,000. In litigating the case, however, the excess carrier incurred $93,000 in defense costs. From these facts, the dissent concluded that the partial settlement procedure validated in Continental v. Farmers would allow primary carriers unfairly to shift defense costs to excess carriers.

It continues to be the case that bad facts make bad law. Normally, cases with a value of $20,000 do not necessitate $93,000 in defense costs; further, in the usual circumstance insurance carriers do not exhaust $100,000 policy limits on a case with a value of $20,000.

In fact, the rule enunciated in Continental v. Farmers, when applied to a more typical set of facts, protects the primary carrier from the excess carrier’s effort to "take a free ride" at the expense of the primary carrier. Normally, the defense cost issue arises when the value of the case exceeds the primary carrier’s limit and the excess carrier is unwilling to either settle or take on the defense. In the absence of the Continental v. Farmers rule, the excess carrier could shift to the primary carrier all of the defense costs in the case even though the primary carrier was absolutely willing to pay its policy limits, resulting in a situation in which the primary carrier is expending defense costs in order to protect the excess carrier’s policy. The "covenant not to execute" procedure protects the primary carrier from this unfair result.

Disruption of the Litigation

The California Casualty dissent expresses concern that the primary carrier may withdraw its defense during the course of actual litigation, and that the excess carrier might want to employ its own counsel, thereby disrupting the litigation process. While this certainly is a potential, academic concern, in the real world primary carriers normally evaluate cases early in the claim process, usually prior to the filing of the lawsuit. Further, if the decision were to come in the middle of the lawsuit, the excess carrier might very well choose to retain counsel already employed by the primary carrier. Finally, whatever small inconvenience might occur in a case in which the excess carrier demanded new counsel is far outweighed by the benefits of the partial settlement procedure as outlined below.

Continental v. Farmers is Good Law and Good Policy

The rationale underlying the court’s decision in Continental v. Farmers is consistent with Arizona’s policy favoring settlement and does not work a hardship to the excess carrier. Most important, the decision promotes fairness and makes sense.

Arizona Policy Favors Settlement of Lawsuits

It is well-established in Arizona that resolution of disputes by way of settlement is favored over litigation. Dansby v.Buck, (92 Ariz. 1, 373 P.2d 1, 1962). Here, the procedure sanctioned in Continental v. Farmers allows settlement between the injured party and one of the carriers representing the tortfeasor. History has shown that in the absence of such a procedure, settlements between the injured party and the primary carrier are thwarted in that it would not be in either the insured’s best interest or the carrier’s best interest to make a payment to the plaintiff without receiving any benefit. The Continental v. Farmers procedure promotes settlement in that all parties to the transaction receive a benefit.

The Continental v. Farmers Procedure is No Hardship to the "Excess" Carrier

The dissent in California Casualty v. State Farm seems preoccupied with protecting the excess carrier, State Farm. First, it should be noted that State Farm was not a true excess carrier, but in fact was a primary carrier which fortuitously found itself in an excess position because of the happenstance that on this particular occasion its insured was driving a vehicle owned by another. (See, endnote 4.) In fact, as is typical in these situations, State Farm was the driver’s primary carrier. Thus, requiring the "excess" carrier to defend the driver works no hardship upon that carrier for the following reasons:

1. As a true primary carrier, the insurer contemplated defense costs in calculating the premium it charged its insured, the individual being defended.

2. Requiring this carrier to defend this driver puts each of them in the position for which they originally contracted, in that this is the driver the insurer contracted to protect, and this is the carrier the insured chose to protect him.

Conclusion

The decision in Continental v. Farmers represents a reasonable response to the somewhat complicated situation presented when two or more carriers provide coverage for a defendant in a civil lawsuit. Given the existence of the second policy, the plaintiff simply cannot give the defendant a full and complete release in exchange for payment of the primary carrier’s limits. By holding that the primary carrier has satisfied its defense obligations by obtaining for the insured a covenant not to execute, the Arizona Court of Appeals has promoted the settlement of lawsuits both directly and indirectly. Approving partial compromises between injured parties and primary carriers directly promotes settlement; placing the cost of defense on recalcitrant excess carriers promotes settlement indirectly in that such carriers, no longer receiving a free ride, will be more willing to settle.

Further, the procedure is not unfair to the excess carrier for the reason that it has already received a premium that includes a charge for defending lawsuits, and in this instance it will be required only to defend the very individual it contracted to protect. For these reasons, the courts of this state should adopt the wise reasoning in Continental v. Farmers, the dissent in California Casualty v. State Farm notwithstanding.

Ernest D. Tinsley is a senior trial attorney with Burrell, Seletos & Tinsley and in-house counsel to Farmers Insurance Company.

ENDNOTES

1. For instance, A.R.S. §28-1170.01 sets forth bright line rules for which of the two policies will be deemed "primary" and which will be deemed "excess". In the non-commercial setting, the statutes provide that the owner’s policy provides primary coverage, which means that the owner’s carrier is primarily responsible for providing the insured with a defense.

2. Throughout this article, insurance carriers will be denominated "primary" and "excess" even though both carriers issued policies designed for primary application.

3. For instance, Bituminous Cas. Corp. v. Iowa Nat’l Mut. Ins. Co., 477 NE 2d 694 (Ill Ct App 1985), cited by the dissent, concerned a dispute between Bituminous, a "true" primary carrier, and Iowa, a "true" excess carrier. Bituminous tendered its limits to Iowa and withdrew from defending their mutual insured; Iowa rejected the tender. The court, noting that Iowa’s excess policy contemplated a limited and restricted defense obligation, held that Bituminous had not extinguished its defense obligation.

4. See, United Services Auto v. Empire Fire, etc., 134 Ariz. 64, 653 P.2d 712 (App. 1982), where the court succinctly discusses the legal significance of the distinction between a true excess carrier and a fortuitous excess carrier. There, Empire had issued an umbrella policy to the insured, while USAA had issued a primary policy which fortuitously had become an excess policy. In construing the other insurance clauses contained in the respective policies, the court held that because Empire was a true excess carrier, USAA’s policy would be exhausted prior to any payment under Empire’s policy, irrespective of USAA’s argument that under these circumstances it also was an excess carrier.

5. Anecdotal evidence suggests that in these circumstances excess carriers attempt to control the defense even though it is being paid for by the primary carrier.