When The Insurer Won’t Settle A Third Party Claim, Consider A Covenant Judgment

Andrew M. McKenzie, Edmonds Lawyer

Sometimes a defendant in a lawsuit has insurance to cover some or all of the potential damages alleged.  Most of the time in those circumstances after the insurer agrees to defend on the insured’s behalf, the insurer hires counsel to represent the insured.  While this may provide some assurance to the insured, the insured can face potential liability which exceeds the amount of coverage under the policy.  The insurer owes a duty to the insured to act in good faith and treat the insured’s assets as being just as much at risk as the insurer’s assets.  Despite the insurer’s duty of good faith, insurers are naturally incentivized to minimize what they pay on covered claims, as this directly affects their bottom line.  The insured can be dragged through litigation and exposed to a judgment in excess of policy limits when it might have been possible to settle within policy limits.  Faced with this possibility, the insured may be forced to expend resources out of pocket to help defend against the claim and prepare for trial even though the insurer should bear the burden of providing the defense.

Under the right circumstances, when an insurer drags its feet in settling a claim with a third party plaintiff, the insured may be able to eliminate or minimize its liability by settling with the plaintiff under an arrangement known as a “covenant judgment.”  Under a covenant judgment, the insured defendant enters into a settlement agreement for a monetary judgment against the insured.  However, the plaintiff covenants not to execute the judgment against the insured defendant, and instead to pursue the insurer through an assignment of the insured’s rights under the policy.  This allows the aggrieved plaintiff to seek direct recovery against the insurer for insurance bad faith, standing in the shoes of the insured.  As one might imagine, such an arrangement is susceptible to abuse and collusion, as the insured may feel no particular motivation to keep the judgment amount as low as possible.  To guard against that potential injustice to the insurer, Washington law allows the insurer to contest the terms of the covenant judgment via a “reasonableness hearing.”  The court must make a determination that the terms of the settlement were reasonable.  If the court determines the terms are reasonable, then the monetary figure of the judgment becomes the presumptive amount which the plaintiff may recover against the insurer for bad faith.  In determining reasonableness, the court considers various factors, including the following: (1) the plaintiff’s damages; (2) the merits of the plaintiff’s liability theory; (3) the merits of the defense theory(ies); (4) the defendant’s relevant fault; (5) the risks and expenses of continued litigation; (6) the defendant’s ability to pay; (7) any evidence of bad faith, collusion, or fraud between the settling parties; (8) the extent of the plaintiff’s investigation and preparation of the case; and (9) the interests of parties not being released.

The determination by a trial court regarding reasonableness is reviewed on appeal under an “abuse of discretion” standard, meaning that it is very difficult to overturn on appeal.  In a recent Washington State Supreme Court case, Wood v. Milionis Construction, Inc., et al., the Supreme Court upheld a covenant judgment for $1.7M in a construction defect case.  The insurer claimed the settlement was unreasonable because a defense expert believed the plaintiff’s damages were far less.  But because plaintiff’s experts offered contrary opinions with potential damages exceeding $2M, the court found the settlement reasonable.  Notably, the Supreme Court also upheld a decision by the trial court denying the insurer a postponement of the reasonableness hearing, even though the insurer only received a copy of the covenant judgment settlement agreement about a week before the hearing.  Covenant judgments can be enforceable against the insurer even where they were negotiated without any input by the insurer, so long as the terms are reasonable.

The lawyers at Beresford Booth have experience representing insured defendants both in underlying litigation and in disputes with their insurers.  We would be happy to assist you with your litigation needs or in resolving your insurance dispute.

To learn more about covenant judgments, please contact Beresford Booth at info@beresfordlaw.com or by phone at (425) 776-4100.

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