Excess Insurers Breached Duty Of Good Faith And Their Bad Faith Cross-Claims Dismissed
November, 2008
The Second Circuit, in Schwartz v. Liberty Mut. Ins. Co., 539 F.3d 135 (2d Cir. 2008), affirmed a jury verdict finding that certain excess insurers breached the duty of good faith and fair dealing by refusing to consent to a $20 million settlement mid-trial. The Court also applied New York law, rather than California law, to dismiss the excess insurers’ bad faith cross-claims against the primary insurer, who did not act in “gross disregard.” Id. at *1.
Plaintiff Bernard L. Schwartz (“Schwartz”), the CEO of a satellite telephone business, was insured under a directors and officers liability policy, which provided $10 million in the primary layer issued by Twin City Fire Insurance Company (“Twin City”) and $5 million in each of the first three excess layers issued by Royal Indemnity Company (“Royal”), Liberty Mutual Insurance Company (“Liberty”), and North American Specialty Insurance Company (“North American”) (collectively the “Insurers”). In 2001, a securities class action was filed against Schwartz, his company and a related investor alleging violations of the Securities Exchange Act of 1934 (the “Securities Action”). After Schwartz’s company and the related investor filed for bankruptcy in 2002, the Securities Action proceeded solely against Schwartz. Id. at *1-2.
Prior to trial, Schwartz’s attorney attempted to negotiate settlements between the Insurers and the Securities Action plaintiffs for $15 million; however, Twin City’s counteroffers never exceeded $5 million despite warning to the Insurers’ attorneys that the demand would rise to $20-25 million once trial commenced. As the Securities Action trial began, the Insurers’ attorneys monitored the proceedings and after two weeks of testimony, Schwartz settled the case for $20 million. Schwartz’s attorney wrote to the Insurers via e-mail at 10:04 p.m. on Sunday, July 17, 2005, seeking their consent to the settlement. The trial court approved the settlement the following Monday morning. Subsequently, the Insurers denied the settlement, leaving Schwartz to personally fund the $20 million settlement. Id.
Schwarz commenced this lawsuit seeking recovery of the settlement amount, alleging breach of contract against the Insurers and bad faith against Twin City. Liberty and North American (the “Excess Insurers”) brought bad-faith cross-claims against the primary insurer, Twin City. Before trial, Twin City and Royal settled with Schwartz, paying their policy limits of $10 million and $5 million, respectively. The jury ruled in favor of Schwartz, awarding him the full amount sought against the Excess Insurers and bad faith damages against Twin City. The jury also awarded damages to the Excess Insurers on their cross-claims; however, the jury specifically found that Twin City did not act in “gross disregard” of Schwartz’s rights. In a post-trial ruling, the trial court determined that New York law applied to the Excess Insurers’ cross-claims, which were thereby dismissed as there was no finding of “gross disregard” by Twin City. Id. at *2-3.
Notably, the Excess Insurers argued on appeal: (1) for judgment on Schwartz’s breach of contract claims based on his failure to obtain their consent to settle, thus absolving them of their contractual duties; and (2) that California law, rather than New York law, applied to their cross-claims against Twin City, which does not require a finding of “gross disregard.” Id. at *3.
The Second Circuit decided Schwartz’s breach of contract claim under California law, which states that an insurer has an “implied obligation of good faith and fair dealing” to settle when appropriate and must consider its insured’s interests as its own. Id. at *4. The Excess Insurers argued that the policies, as a condition precedent to coverage, required Schwartz to obtain their consent before settling the Securities Action. Id. at *5. Moreover, they asserted that the 11-hour window (from 10:04 p.m. Sunday night until the following Monday morning) to consider Schwartz’s $20 million settlement offer did not provide a reasonable opportunity to consider the settlement. Id. at *10. The Court rejected these arguments and affirmed the jury’s verdict in favor of Schwartz, focusing heavily on the Excess Insurers’ active role in the Securities Action, which included monitoring the courtroom proceedings, evaluating settlement offers, and participating in mediation sessions and settlement conferences. Id. at *5. The Court found 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.” Id. at *10. Accordingly, the Court determined that there was sufficient evidence to support the jury’s verdict that the Excess Insurers breached the duty of good faith and fair dealing by unreasonably withholding consent to the settlement. Id.
With respect to the Excess Insurers’ bad-faith cross-claims against Twin City, the Second Circuit held that New York law, rather than California law, applied, and absent “gross disregard,” there can be no imposition of bad faith liability. Id. at *15. To establish bad faith, New York law requires that an excess insurer demonstrate that the primary insurer’s conduct constituted “gross disregard” of the excess insurer’s interests. By contrast, California law does not require “gross disregard” to establish a breach of good faith and fair dealing. Id. at 14. The Excess Insurers asserted that it would be confusing to apply different state laws for the breach of contract and bad-faith claims and that applying New York law would deprive them of the same right that Schwartz had to recover bad faith damages under California law. The Second Circuit rejected these arguments and determined that the location of the subject matter of the cross-claims (i.e., Twin City’s alleged misconduct in refusing to settle the Securities Action) favored New York law. The Securities Action was filed, tried and settled in New York, and the parties participated in mediations and a settlement conference in New York. Id. at 15. Moreover, the Court noted that Schwartz and Twin City settled before any choice of law issues were litigated and it was unclear whether equitable subrogation extended to the choice of law issue. Id. at 16. As such, since the jury found that Twin City did not act with “gross disregard,” as required under New York law, the Second Circuit amended the Judgment to dismiss the Excess Insurers’ cross-claims. Id.
Learning Point
In New York, an excess insurer’s role in settlement negotiations is a strong factor in assessing a breach of the duty of good faith and fair dealing. Moreover, equitable subrogation does not clearly extend to choice of law issues and thus, one state’s laws may apply to bad-faith cross-claims while another state’s laws may apply to the underlying breach of contract claims.
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