California Appellate Court Rules Excess Insurer May Sue Primary Insurer for Equitable Subrogation, Even in the Absence of an Underlying Judgment Against the Insured

August 9, 2016
Paul K. Schrieffer
P. K. SCHRIEFFER LLP

On August 5, 2016, the California Court of Appeal, Second District, Division Four, in a published decision, reversed the trial court’s sustaining of a demurrer brought by defendant Fireman’s Fund Insurance Company, a primary insurer, to a lawsuit brought by Ace American Insurance Company, an excess insurer. See Ace American Ins. Co. v. Fireman’s Fund Ins. Co., No. B264861 (Aug. 5, 2016) (http://www.courts.ca.gov/opinions/documents/B264861.PDF).

The lawsuit relates to an underlying lawsuit brought against the insurers’ mutual insured, Warner Brothers, by John Franco, a special effects worker. In July 2010, during the production of the film Green Lantern, Franco was injured on set when a truck rolled over, which caused debris to go flying. Franco allegedly suffered pelvic crush injuries, a broken hip, fractures to both femurs, crush injuries to both knees, broken tibias and fibulas, broken ribs, a punctured lung, and soft tissue injuries to his face. Franco also alleged that the incident left him with permanent nerve pain, an eye injury, urinary and sexual dysfunction, and fear and depression.

Franco and his wife sued Warner Brothers for damages and loss of consortium. Fireman’s Fund provided a defense to Warner Brothers. Fireman’s Fund issued a primary liability policy to Warner Brothers with a $2 million limit, and an umbrella policy with a $3 million limit. Ace American issued an excess policy to Warner Brothers with a $50 million limit. Ace American alleges that Franco made reasonable settlement demands in April and May 2012, each within the limits of the Fireman’s Fund policies. Fireman’s Fund refused to settle. In October 2012, the Francos settled their lawsuit for an amount “substantially in excess” of the limits of Fireman’s Fund’s policies.

Ace American then sued Fireman’s Fund for equitable subrogation and breach of the implied covenant of good faith and fair dealing. Fireman’s Fund, relying on RLI Ins. Co. v. CNA Cas. of Cal., 141 Cal. App. 4th 75 (2006) (a decision by Division Five of the Second Appellate District), argued that Ace American’s claims failed because there was no judgment against Warner Brothers in excess of the primary limits. The underlying case settled, and was not the subject of a judgment. Ace American, relying on Fortman v. Safeco Ins. Co., 221 Cal. App. 3d 1394 (1990) (a decision by Division One of the Second Appellate District), argued that it is not relevant whether the underlying action was resolved by a settlement or a judgment, as long as the excess insurer was liable for any amount beyond the limits of the primary policy as a result of the primary insurer’s bad faith refusal to settle within policy limits. The trial court sustained Fireman’s Fund demurrer without leave to amend. The Second District, Division Four, however, reversed.

The decision contains a lengthy analysis of the RLI and Fortman decisions. The appellate court explained that Ace American had alleged that it was damaged in an ascertainable amount as a direct result of Fireman’s Fund’s refusal to accept the Francos’ reasonable, within-limits, settlement demands. Ace American’s alleged damages were clear, liquidated, and certain, and there was no collusion involved because Fireman’s Fund participated in reaching the eventual settlement. The appellate court thus reasoned that “We see no persuasive reason to hold that either Warner Brothers or its assignee, Ace American, must suffer that loss with no remedy simply because the case reached an eventual settlement instead of being litigated through trial.” Slip Op., p. 22.

The appellate court, in deciding the issue, relied in part on the reasoning of the U.S. Court of Appeals for the Seventh Circuit in Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1181 (7th Cir. 1994). In that case, Judge Richard Posner, relying on Fortman, explained the temptation facing a primary insurer in deciding whether to settle a case within its limits:

Country Mutual [the primary insurer] argues that a breach of the insurer’s duty to act in good faith in settlement negotiations is not actionable unless, by refusing to settle, the insurer precipitates a trial that results in the entry of a judgment against the insured. This is not a ridiculous argument. If the temptation at which the duty is aimed is the temptation to gamble with the insured’s money, it is not obviously a violation merely to dawdle in settling until the golden moment of opportunity passes. * * * The basic temptation of the insurer comes from the fact that its liability is capped at the policy limits, so that it can shift many of the losses of a risky strategy to the insured (or any excess insurer). It may dawdle in settling, hoping to drive a harder bargain and knowing that if it fails and the case goes to trial and it loses big, still most of the loss will fall on the insured or on an excess insurer rather than on itself. The fact that on the eve of trial it may throw in the towel because it sees no hope of winning should not excuse it from having failed to settle earlier on better terms if it would have settled earlier on those terms had all the risks of loss lain on itself.

Id. at 1181 (Posner, J.).
The appellate court in Ace American concluded that an excess insurer that has settled and discharged its insured’s liability may recover from a primary insurer an amount in excess of the primary insurer’s limits if the excess insurer can show that the primary insurer’s unreasonable refusal to settle within primary limits resulted in a loss to the excess insurer it otherwise would not have had. See Slip Op., p. 27 (citing Northwestern Mut. Ins. Co. v. Farmers’ Ins. Group, 76 Cal. App. 3d 1031, 1050 (1978)).

We urge some caution regarding this decision. It arguably is in conflict with other California decisions discussed in the opinion, including RLI, supra. Thus, there still appears to be a split of authority on this issue within California, and Fireman’s Fund may seek review from the California Supreme Court.