Ninth Circuit Court of Appeals Expands Insurer’s Duty to Settle Under California Law

California courts recognize that every insurance policy issued in the state of California contains an implied in law covenant of good faith and fair dealing. See, e.g., PPG Industries, Inc. v. Transamerica Ins. Co., 20 Cal.4th 310, 84 Cal.Rptr.2d 455, 975 P.2d 652, 654 (1999).

Under the implied covenant of good faith and fair dealing, insurance companies have a duty to settle third-party liability claims within policy limits in those situations where there is a substantial likelihood in recovery in excess of the limits. See, e.g., Kransco v. American Empire Surplus Lines Ins. Co., 23 Cal.4th 390, 97 Cal.Rptr.2d 151, 2 P.3d 1 (2000).

In cases where there is a substantial risk of exposure to the insured in excess of the policy limits, an inherent conflict of interest arises between the insurance company and its insured. Because of this conflict of interest, the California courts imposed a duty upon insurance companies to give equal consideration to the interests of the insured when evaluating settlement offers within policy limits. See, e.g., Merritt v. Reserve Ins. Co., 34 Cal.App.3d 858, 110 Cal.Rptr. 511, 520 (1973).

Under the equality of consideration rule, insurers must treat settlement offers within policy limits as though the insurer alone was required to pay the entire risk of loss.

California courts routinely apply the duty to settle to those situations where a settlement offer had been made by the plaintiff which was within the insured’s policy limits. In Yan Fang Du v. Allstate Ins. Co., 681 F.3d 1118 (9th Cir. 2012), the Ninth Circuit Court of Appeals considered whether insurers had a duty to attempt to effectuate a settlement in the absence of a demand from the claimant. The Court answered this inquiry by affirmatively finding that insurers did have a duty to effectuate settlement where liability had become reasonably clear even in the absence of a settlement demand.

Central to the Ninth Circuit Court’s ruling was that the conflict of interest which animates the duty to settle exists regardless of whether a settlement demand is made by the injured party. In those situations where there is a significant risk of a judgment in excess of policy limits and there is a reasonable opportunity to settle within those limits, the insurer is required to initiate settlement where liability has become reasonably clear.

As support for its holding, the Court noted that the broader duty to settle is supported by CAL. INS. CODE § 790.03(h) which enumerates the obligations insurers owed to their insureds. The statute identifies as unfair claims settlement practice an insurer’s “not attempting in good faith to effectuate prompt, fair, and equitable settlements of claims in which liability has become reasonably clear.” See § 790.03(h)(5).

Previously, the Court in Pray ex. rel Pray v. Foremost Ins. Co., 767 F.2d 1329, 1330 (9th Cir. 1985) observed that it was reasonably clear that California courts would interpret the California statute as imposing upon insurance companies a duty to actively investigate and attempt to settle claims by making, and by accepting, reasonable settlement offers once liability had become reasonably clear. The Court also noted that the Judicial Council of California Civil Jury Instructions added CACI 2337 (2008), which tracks section 790.03(h). The instruction did not require that a bad faith claim be predicated on an insurer’s rejection of a claimant’s demand.

For the foregoing reasons, the Ninth Circuit Court of Appeals held that an insurance company, under California law, can violate the duty of good faith and fair dealing by failing to attempt to effectuate a settlement within policy limits after liability has become reasonably clear even in the absence of a settlement demand from the claimant.