Bad Faith - Kentucky Court Of Appeals Adopts New Standard To Govern Claim That Liability Insurer Acted In Bad Faith By Settling Suit Against Insured For Excessive Amount
The Kentucky Court of Appeals recently established a three-part test for a bad faith claim that the court found had not been previously addressed under Kentucky law. In United Propane Gas, Inc. v. Federated Mutual Insurance Co., Nos. 2005-CA-001101-MR and 2005-CA-001111-MR (March 16, 2007), the court applied this test to a claim alleging that a liability carrier unreasonably settled a claim against its insured for an excessive amount, and held that the insurer
had not acted in bad faith.
In the underlying suit, United Propane Gas (“UPG”) and a subsidiary were sued by the plaintiff for injuries sustained in an explosion and fire shortly after delivery of propane gas. The plaintiff sought almost $10 million
in damages from the defendants, which were insured by Federated Mutual Insurance Company (“Federated”). Upon receipt of the complaint, Federated hired counsel to defend UPG, but UPG also hired its own counsel. The case
went to mediation, and Federated settled for $2.5 million. Following settlement, Federated canceled UPG’s policy, and UPG’s replacement coverage with another carrier was at a significantly higher premium because of
the settlement.
Thereafter, UPG sued Federated, among others, for breach of contract and bad faith for allegedly failing to properly investigate its claim, improperly refusing UPG’s request to retain independent counsel, and unreasonably
settling a claim for an amount far in excess of its value knowing that UPG would be damaged when future coverage was obtained. The trial court granted summary judgment in favor of Federated.
On appeal, the Court of Appeals cited the policy’s right to settle clause and held that Federated had not breached the policy because Federated had a right to settle the claim according to its best judgment. The court then
examined whether Federated’s decision to settle the claim was in bad faith. Noting that it could “find no Kentucky case corresponding to the claim as raised by UPG,” the court set out the following test for bad
faith failure to settle:
“An insured must prove three elements in order to prevail against an insurance company for alleged settlement in bad faith of a claim against the insured over its objection: (1) the insurer must have settled the claim over
the insured’s objection; (2) the insurer must have lacked a reasonable basis in law or fact for settling the claim, both as to liability and amount; and (3) it must be shown that the insurer either knew there was no reasonable
basis for settling the claim, both as to liability and amount, or acted with reckless disregard for whether such a basis existed.”
Applying this test, the court held that Federated had a reasonable basis for settling the underlying case based upon the alleged liability of UPG in the underlying action, as well as concerns expressed by UPG’s own counsel
that UPG could be found liable for punitive damages. The court also found that the $2.5 million settlement amount was reasonable because the plaintiff’s injuries were extensive. The court reasoned that there was an inherent
safeguard against excessive settlement because of Federated’s interest in not entering into a settlement unless it was financially advantageous.