Fifth Circuit Permits Excess Carrier’s Bad Faith Claim Against Primary Insurer

Case: RSUI Indemnity Co. v. American States Ins. Co.
United States Fifth Circuit Court of Appeals
768 F.3d 374 (11/25/ 2014)

In this case, the United States Court of Appeals for the Fifth Circuit held an excess insurer (RSUI) could maintain a subrogated cause of action under Louisiana law against a primary insurer (American States) for alleged bad faith failure to adequately defend the common insured. The court concluded the primary carrier’s handling of the case allegedly caused an increase in the settlement value of the case above the primary policy limit, which the excess insurer was required to satisfy on the insured’s behalf, despite the lack of an adjudicated excess judgment in the underlying suit. In so holding, the Fifth Circuit reversed the district court’s grant of summary judgment for the primary insurer, finding that no excess judgment is required if the primary insurer’s alleged bad faith failure to sufficiently defend exposed the insured to excess liability and caused the excess settlement. In other words, the excess carrier has a subrogated cause of action against the primary insurer for any payment above what it otherwise would have been required to pay.

The case arose after a motor vehicle accident in which the driver allegedly at fault was working for Ameraseal, L.L.C., at the time of the accident. Ameraseal was covered by a $1 million primary liability policy with American States and a $4 million excess policy issued by RSUI. In June 2011, the victim of the accident filed suit against Ameraseal and the driver (collectively “the insured”), and American States undertook the defense. American States did not notify RSUI of the suit until December of 2011, two weeks before expiration of the discovery deadlines.

The original defense counsel appointed by American States took the position that Ameraseal’s exposure was no more than $500,000 – an amount well within American States’ primary policy limits. During discovery, the defense counsel failed to depose the plaintiff, her doctors, or potential witnesses who later claimed that the victim was at least partly at fault for speeding and failing to try and avoid the accident, nor did defense counsel obtain an independent medical evaluation of the plaintiff. Defense counsel also failed to oppose plaintiff’s motion for partial summary judgment on liability, which was granted.

After the court granted partial summary judgment on liability, American States notified RSUI of the suit and retained new defense counsel. The newly-appointed defense counsel’s analysis of Ameraseal’s potential liability indicated the settlement value of the claim was well in excess of American States’ $1 million primary policy and that it could exceed the full $4 million limits of RSUI’s excess policy. Thereafter, in response to a $5 million settlement demand from plaintiff, American States paid its $1 million primary policy limit in exchange for a release of American States from any and all claims and a release of the insured from liability for damages in excess of the policy limits provided by both American States and RSUI. In turn, RSUI settled with the plaintiff for $2 million and secured a full release. As a result of RSUI’s settlement, the case was never tried and no judgment was ever entered against the insured.

RSUI then filed suit against American States in federal court as a subrogee of the insured, “alleging a claim based on American’s bad faith failure to defend the insured properly in the underlying suit.” RSUI’s theory was “that American’s failure to investigate and take appropriate defensive actions drove up the settlement value of the case, exposed the insured to additional liability, and left RSUI with no choice but to reach a settlement . . . that was excess to the primary policy limit.” American States moved for summary judgment, which the district court granted, reasoning that the absence of an adjudicated excess judgment as to damages was dispositive and barred RSUI’s claim. On appeal by RSUI, the Fifth Circuit considered the purely legal question of “whether, in the absence of an adjudicated excess judgment . . . subrogated bad faith claim against the primary insurer to recover monies it paid in settlement of claims against the insured above the primary policy limit.” The Fifth Circuit recognized such a claim.

In particular, relying on Great Southwest Fire Ins. Co. v. CAN Ins. Co., 557 So2d 966 (La. 1990), the Fifth Circuit recognized that a primary carrier can be responsible for damages beyond its coverage layer that arise “as a direct consequence of bad faith failure to perform.” The Fifth Circuit also emphasized that under Louisiana law, an insurer’s duty to defend is separate and broader than an insurer’s duty to settle, and that under either requirement the insurer is obligated to “act in good faith and to protect its insured from excess liability.”

As such, the Fifth Circuit rejected the district court’s finding that there can be no claim for bad faith failure to settle unless damages have been determined in an adjudicated excess judgment against the insured and found that the cases relied on by the district court were distinguishable “insofar as they lack a nexus between the primary insurers’ alleged bad faith of their duty to the insured and resulting exposure to excess liability. Instead, the Fifth Circuit held “it is clear that an excess insurer may, through subrogation, assert claims against a primary insurer ‘to recover from the primary insurer for acts which make the excess insurer’s contract and liability more burdensome.’” Applying this standard, the Fifth Circuit reversed the district court and remanded for a determination of RSUI’s bad faith claim on the merits.

This decision is significant because it recognizes a primary insurer’s duty to excess carriers to effectively manage the defense of their common insured to avoid excess liability and confirms the Fifth Circuit’s adherence to what it described as “the general principles of insurance law” that “[a]n insurer whose bad faith causes an excess judgment or necessitates an excess settlement is primarily liable to the insured on that account, and the excess insurer is entitled upon discharging the insured’s obligations, to assert the insured’s rights against the primary insurer.”