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Parties to a lawsuit may have vastly different perspectives on the validity and value of a claim, but as a matter of course, the issue of settlement will arise. Trial is an exceedingly expensive endeavor with an uncertain result. From a risk management perspective, the decision to settle is critical. Yet under liability policies that give the insurer sole control of the defense, the settlement decision often rests exclusively with the insurer as well.

The insurer’s exercise of this control becomes problematic when (1) the insured’s liability could exceed the policy limits, and (2) a settlement offer within the policy limits is on the table. Like an insurer providing a defense under a reservation of rights (discussed in Part 1), in this recurring situation, the insurer and the policyholder have conflicting incentives. The insurer may prefer to roll the dice for a judgment that’s less than the limit of liability. Settlement within the policy limits, on the other hand, is often in the policyholder’s best interest because it eliminates the risk of incurring uninsured liability.

Standoff at the Settlement Corral

Tensions between the policyholder and the insurer about a policy-limits settlement demand intensify as the trial date inches closer. At this point, the evidence and analysis developed in the litigation should be sufficient to fully assess whether uninsured liability is a real possibility. If the plaintiff’s demand is time limited, the policyholder-defendant’s window of opportunity for settlement could be missed. The potential impact of an excess verdict is suddenly front and center. What is the policyholder’s recourse?

With the stakes this high, the insurer’s duty to the policyholder rises to a fiduciary level in many jurisdictions. The insurer must seriously consider a settlement offer within policy limits as if the insurer itself would be liable for any excess judgment. The kicker is, if it fails to do so, the insurer actually can be held liable for the excess judgment, as well as consequential damages. In other words, the duty to settle within policy limits when warranted is backed up by a very big stick that can provide the policyholder with needed leverage at a time when it may feel most powerless.

Reasonableness Is the Watchword

States have different formulations of the level of insurer failure required to succeed on what’s known colloquially as a bad-faith-failure-to-settle claim, ranging from negligence to recklessness to intentional wrongdoing. However, in every case, reasonableness is the watchword. Was there a reasonable probability of an excess judgment based on the facts, applicable law, and what’s known about the jurisdiction? Given those circumstances, was the plaintiff’s policy-limits settlement offer reasonable? Did the insurer conduct a reasonable (i.e., good faith) evaluation in response to the offer? These are fact-intensive questions that generally cannot be decided as a matter of law and place the insurer’s conduct under a microscope.

A Formal Demand in Favor of Settlement Can Expedite Resolution

When faced with an insurer’s recalcitrance or delay in deciding whether to accept a pending settlement offer within policy limits, policyholders should make a formal demand in favor of settlement. Appointed defense counsel should provide any analysis and documentation generated during the litigation that the policyholder may need to show the insurer that the risk of an excess judgment is real, and that settlement is prudent. Reminding the insurer of its heightened duty to accept a reasonable settlement offer within policy limits can expedite a resolution that benefits all parties involved.

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This is the first in a series of discussions about issues that arise on a regular basis after policyholders file an insurance claim.

Many liability insurance policies require the insurer to defend the insured. This “duty to defend” usually includes the right to select defense counsel – typically “panel counsel” from a list of pre-approved law firms – and control the defense. The relationship between the insurer, defense counsel, and the policyholder is known the “insurance triangle” (think Bermuda triangle) because it is laden with pitfalls.

Specifically, when an insurer reserves its right to later deny coverage, the interests of the policyholder and insurer are not aligned. The policyholder is not only confronted with potentially uninsured liability, but the possibility that at any point, the insurer may cease paying attorneys’ fees and costs, and perhaps assert it is entitled to reimbursement of the fees and costs already paid.

Conflicts That Can Arise from a Reservation of Rights

A reservation of rights may also create a conflict of interest that entitles the policyholder to select its own counsel paid for by the insurer. Conflicts most frequently arise when a complaint alleges a mix of claims, with some claims covered and others not. Mutually exclusive claims are especially problematic – for example, if negligence is established, the insured has coverage, but if intentional conduct is proved, there is none. 

The crux of the problem is the insurer’s financial interest in a result supporting non-coverage. The chief concern is “steering” – the possibility that defense counsel could steer the litigation in favor of non-coverage by developing facts or pursuing a strategy that leads to judgment on an uncovered cause of action. The insurer and panel counsel likely have a long-standing relationship and panel counsel has a personal financial interest in continuing to get the insurer’s work. If the insurer believes there will ultimately be no coverage, defense counsel may mount a less than robust defense.

When Is Independent Counsel Required?

States have taken different approaches to determining when a reservation of rights triggers the right to independent counsel. In a few states, like Mississippi, the right arises automatically when an insurer reserves rights. On the opposite end of the spectrum, there is no right to independent counsel in Hawaii, where defense counsel are solely responsible for managing conflicts of interests under rules of ethics. Some states, like Washington and Alabama, impose an enhanced obligation of good faith on both appointed counsel and the insurer.

Most states, like Texas, require a case-by-case examination of the facts and a showing of an actual, present conflict of interest. The analysis focuses on how the potential coverage issues intersect with the issues of fact in the underlying litigation. Generally, if coverage depends on the same facts to be decided in the underlying suit, the insured is entitled to independent counsel. Another relevant factor is whether the insurer could obtain privileged information from defense counsel that could be used to defeat coverage. When there is a conflict of interest, the insured’s contractual duty to cooperate with the insurer does not require waiver of the attorney-client privilege.

Policyholders should routinely consider potential conflicts of interest upon receipt of a reservation of rights letter and reassess periodically as the underlying litigation progresses.  Insurers are unlikely to raise the issue unprompted.

Invoking the independent counsel rule, when warranted, not only prevents entanglement in a conflict of interest, but it may ultimately prevent a second litigation between the policyholder and insurer over coverage.

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It is long-standing law in Florida (and elsewhere) that an insurer can deny a claim when it was prejudiced by a policyholder’s failure to provide timely notice. However, there has been some debate in recent years about whose burden it is to prove that the insurer was prejudiced, especially in property insurance claims involving Citizens Property Insurance Corporation — one of the state’s largest homeowners insurance companies.

Traditionally, Florida courts have found that once an insurer can establish that notice of a claim was untimely, the burden shifts to the policyholder to show that the delay did not prejudice the insurer. If the policyholder can show that the insurer was not prejudiced by the delay, then the insurer cannot deny the claim based on untimely notice. 

In 2022, the Fourth District Court of Appeal entered an opinion analyzing a provision common to Citizens’ homeowners policies. The court determined that the policy language created an obligation for Citizens to prove that it was prejudiced by the late notice in order to deny the claim — shifting the burden of proof to the insurer (Perez v. Citizens Prop. Ins. Corp., 345 So. 3d 893 (Fla. 4th DCA 2022)). The specific policy language provided as a condition to coverage that “Citizens has ‘no duty to provide coverage under this Policy if the failure to comply with the following conditions is prejudicial to us.’” Citing a 2021 case involving similar language, the court ruled “the policy language . . . requires an express showing of prejudice by the insurer in order for the insured’s failure to comply with policy conditions to constitute a material breach and permit an insure to deny coverage for a claim.”Ultimately, the court held that the presumption of prejudice did not apply because of the policy language, reversing the trial court’s entry of summary judgment.

Perez has not been overturned and remains good precedent in the circuits in the Fourth District Court of Appeal. However, in a recent decision, the Third District Court of Appeal expressly rejected the policy interpretation in Perez and declared a conflict among the circuits (Arce v. Citizens Prop. Ins. Corp., 2024 WL 24945, — So. 3d — (Jan. 3, 2024)). The issue in Arce was a property damage claim on a homeowners policy that was not reported to the carrier for nearly three years.  The trial court had granted summary judgment in favor of the carrier, and the insured appealed arguing that Citizens had not presented evidence of prejudice, relying in part on Perez. The Arce court analyzed the same policy language as Perez but came to the opposite result. Interestingly, the Arce court determined that shifting the burden to show prejudice to the carrier would “frustrate[] the very purpose of the prompt notice provision.” This is interesting because typically the carrier is in the best position to show it was prejudiced by the late notice. The Arce court went on to look at the actual language itself and noted that the provision was silent as to the respective burden-shifting, and the court would not read such burden-shifting language into the policy..

It will be interesting to see when and if the Florida Supreme Court decides this conflict between the districts. The courts in Florida are typically required to read policies in a manner that most affords coverage, but that theory does not necessarily apply to the burden of proof. Under both Perez and Arce, if the carrier is not prejudiced by any late notice, then the carrier cannot avoid coverage — and the only question is who has the burden of proof. As it currently stands, the policyholder must establish the carrier’s lack of prejudice in the courts under the Third District Court of Appeal.

Of course, for policyholders, the best advice is to review your policy and be sure to submit a timely notice of any claims to avoid the issue altogether. But in cases where timely notice is not possible, then policyholders must be prepared to show lack of prejudice to the carrier caused by such late notice regardless of the policy language, especially in Miami-Dade and Monroe counties.