Bad Faith - Second Circuit Holds That Excess D&O Carriers’ Refusal To Consent To Settlement Constituted Breach Of Duty Of Good Faith
Last week, in Schwartz v. Liberty Mutual Ins. Co.¸ Nos. 07-2794-cv and 07-2818-cv (August 19, 2008), the U.S. Court of Appeals for the Second Circuit held under California law that two excess carriers, who were given
11 hours to consent to settlement in mid-trial, breached the duty of good faith and fair dealing when they refused to consent. The court further held that the excess carriers’ bad faith cross-claims against the primary insurer
were governed by New York law (which requires a showing of “gross disregard) rather than California law (which does not).
Schwartz arose from an underlying securities class action filed in 2001 against Schwartz, who was insured under a $10 million primary D&O policy issued by Twin City, and $5 million excess D&O policies issued by Royal,
Liberty and North American in that order. The plaintiffs offered to settle for $15 million, but warned the demand would rise to $20 or $25 million once trial began. Twin City never offered more than $5 million, and the case went
to trial. After two weeks of trial, Schwartz decided to settle. Schwartz’s defense counsel wrote the insurers on Sunday, July 17, 2005, at 10:04 p.m. seeking their consent to settle for $20 million, and offering to discuss
the settlement that night or between 8:45 and 9:00 a.m. the next morning at the courthouse. On Monday, July 18, the court approved the settlement. Over the next few days, the insurers refused to consent. Schwartz subsequently paid
the settlement by personal check.
Schwartz then filed suit against the insurers for breach of contract and bad faith. Liberty and North American, pleading equitable subrogation, filed bad faith cross-claims against Twin City. Before trial, Twin City and Royal settled
with Schwartz for their policy limits. On the remaining claims, the jury awarded Schwartz $5 million against Liberty and over $4 million against North American (the full amounts sought), as well as $2 million to Liberty and $3 million
to North American on the cross-claims against Twin City. After post-trial briefing, the district court amended the judgment by dismissing the bad faith claims because the jury found that Twin City had not acted in gross disregard
of Schwartz’s interests, which is a pre-requisite to recovery under New York law (which the court found applied) but not under California law.
On appeal, Liberty and North American argued that because Schwartz failed to obtain their consent before settling and had given them a mere 11 hours over a Sunday night and Monday morning to decide whether to consent, Schwartz forfeited
any right to coverage. However, the jury also heard testimony that the excess carriers participated in mediations and settlement conferences; sent letters urging Twin City and Royal to settle in light of the risk that plaintiffs
would demand more than $15 million at trial; and monitored the trial in the courtroom. The Second Circuit ruled that the jury could hear this evidence and conclude that the excess carriers had unreasonably withheld consent, and therefore,
breached the duties of good faith and fair dealing under California law. On the cross-claims, the court rejected the argument that it would be confusing to apply different state laws to the bad faith and breach of contract claims.
The court also rejected the carriers’ argument that by applying New York law, they were denied the same right that Schwartz had [i.e., to recover in bad faith under California law], noting that Schwartz and Twin City
settled before choice of law was litigated or decided, and in any event, it was unclear whether equitable subrogation doctrine extended to the choice of law issue.