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Insurer’s Duties When Policy Limits Demands Involve Multiple Claimants

Insurer’s Duties When Policy Limits Demands Involve Multiple ClaimantsEggshell Eddie was driving his Volvo with his two children, Robin and Wren. As he proceeds through an intersection on a green light, defendant Crackhead Craig runs a red light and strikes Eggshell’s vehicle causing serious injuries to Eggshell, Robin and Wren. After striking Eggshell’s car, Crackhead’s vehicle impacts vehicle number two that was stopped at the intersection waiting to turn left. Vehicle two was operated by Professor Timmy Tyler. Eggshell Eddie, Robin and Wren all suffered serious injuries. Professor Tyler suffered soft tissue injuries.

Crackhead Craig was insured by Saturn Insurance Company under a $50,000 per person/$100,000 per accident automobile insurance policy. Crackhead had no assets.

You are immediately retained to represent Eggshell Eddie, Robin and Wren. Each of their claims have a value in excess of $75,000. You submit a policy limits demand with ample evidence and provide Saturn Insurance Company with 30 days to accept the demand.

On the 25th day, Saturn Insurance Company notifies you that it cannot accept your policy limits demand. Has Saturn breached the implied covenant of good faith and fair dealing owed to Crackhead Craig so as to open its policy limits?

If you think the answer is yes, you may be wrong. If you think the answer is no, you still may be wrong. The devil is always in those pesky details.

The Insurer’s Duty to Settle

Liability insurance policies typically state that the insurer may “at our discretion ... settle any claim or suit.” However, each insurance policy contains the implied covenant of good faith and fair dealing that obligates an insurer to accept reasonable settlement demands within policy limits to avoid exposing its insured to personal liability in excess of those limits. Communale v. Traders & Gen. Ins. Co. (1958) 50 Cal.2d 654, 659. “If the insurer breaches the implied covenant by refusing to settle the third party suit, the insured may sue the insurer in tort to recover damages proximately caused by the insurer’s breach.” PPG Industries, Inc. v. Transamerica Ins. Co. (1999) 20 Cal.4th 310, 312.

When an insurance carrier receives an offer to settle a claim that has a value exceeding the policy limits, it is required to weigh its own interests on the scales along with those of its insured in order to make a good faith determination whether to accept or reject the offer. In other words, it must attempt to evaluate the merits of a settlement offer within policy limits both from its own point of view and that of its insured. Merritt v. Reserve Ins. Co. (1973) 34 Cal.App.3d 858, 874. Since an insurance company has the right to control settlement and defense, and has a motive to effect settlements for less than policy limits, an insurance carrier must exercise good faith in evaluating settlement demands to avoid exposing the insured to a substantial risk of excess liability. Merritt v. Reserve Ins. Co., supra, 34 Cal.App.3d at 870.

The California Supreme Court has described the test of “reasonableness” of a settlement demand as follows: “[w]hether, in light of the victim’s injuries and the probable liability of the insured, the ultimate judgment is likely to exceed the settlement offer. Johansen v. California State Auto Ass’n Inter-Ins. Bureau (1975) 15 Cal.3d 9, 16. CACI Jury Instruction 2334 describes the test for a reasonable settlement demand as follows:

A settlement demand is reasonable if (insurer) knew or should have known at the time the settlement demand was rejected that the potential judgment was likely to exceed the amount of the demand based on (claimant’s) injuries or loss and (insured’s) probable liability.

Johansen and the CACI Jury Instruction 2334 focus solely on the reasonableness of the claimant’s settlement demand itself, and do not include any consideration of the reasonableness of the insurer’s conduct in evaluating and responding to the demand.

There are many other factors that can come into play in determining whether or not a carrier acted unreasonably in rejecting a settlement demand. However, those factors involve a totally different issue and will have to wait for another day.

No Duty to Accept All Policy Limits Demands

An action for bad faith may be based on an insurer’s failure to accept a reasonable settlement demand from a third party. The reasonable settlement demand, however, must meet the following conditions: (1) the settlement demand terms must be clear in order to create an enforceable contract, if accepted; (2) all third party claimants must join in the demand; (3) it must provide for a release of all insureds; (4) the amount demanded must be within the policy limits and must be for a reasonable amount; and (5) the time provided for acceptance of the demand must afford the insurer adequate opportunity for investigation of the conduct of the insured and the claimant, the injuries claimed, and the likely damages. Rutter Group, Insurance Litigation, §12:294. If a settlement demand is unclear, an insurance carrier is required to act in good faith and must seek clarification of any ambiguity or uncertainty in the offer. Betts v. Allstate Ins. Co. (1984) 154 Cal.App.3d 688, 708, fn. 7. An insurance company that rejects a settlement offer outright without seeking clarification of its terms cannot avoid the consequences of a bad faith claim by claiming that the settlement offer was uncertain. Id. Likewise, an insurance company may not simply ignore a defective settlement demand. Allen v. Allstate Ins. Co. (9th Circuit (1981) 656 F.2d 487, 490 – evidence supported conclusion that insurance company ignored the offer, “as a calculated gamble in which only its insured could lose” and thus was bad faith failure to settle.

The implied covenant of good faith and fair dealing does not require a liability insurer to accept a settlement demand that requires performance beyond that due under its policy. Heredia v. Farmers Ins. Exch. (1991) 228 Cal.App.3d 1345, 1357. In Heredia, the plaintiff had offered to settle for policy limits if the insureds would participate at the trial and the insurance company would pay their cost of defense. Plaintiff wanted to avoid the empty chair situation. Farmers Insurance rejected the demand. It was held that no bad faith action could be maintained against Farmers for failure to settle within its policy limits because the demand for policy limits plus the continuing cost of defense was not a demand within the policy limits. Heredia v. Farmers Ins. Exch., supra, 228 Cal.App.3d at 1357.

While an insurance company is not required to accept settlement demands that exceed its policy limits, it has a duty to keep the insured informed about the status of settlement negotiations. When the insurer knows there is a risk that the injured party may obtain a verdict against its insured for more than the policy limits, it must keep the insured informed of the settlement demands from the third party.

The company having the right to select counsel to defend the insured, had the duty to communicate to (the insured) the results of any investigation indicating any liability in excess of policy limits, and any offers of settlement which were made so he may take proper steps to protect his own interest.

Martin v. Hartford Acc. & Indem. Co. (1964) 228 Cal.App.2d 178, 184. A conflict of interest exists when there is an offer to settle a claim that has a value in excess of the policy limits and the settlement demand is within the policy limits (or when the offer exceeds the policy limits and the insured is able and willing to contribute the excess). Anguiano v. Allstate Ins. Co. (9th Cir. 2000; 209 F.3d 1167, 1169. Therefore, “if a settlement offer is made in excess of policy limits ... the first step is for the carrier ... to communicate the offer to the assured.” Merit v. Reserve Ins. Co., supra, 34 Cal. App.3d at 875.

An insurance carrier that refuses to settle unless a lien holder’s claim has also been resolved has been deemed a proper refusal of a policy limits demand. In Coe v. State Farm Mut. Auto. Ins. Co. (1977) 66 Cal. App.3d 981, 984, State Farm rejected the injured party’s policy limits demand because no provision was made for payment of a lien asserted by the workers compensation carrier against plaintiff’s action. The Court of Appeal held that State Farm’s response that the settlement demand was “premature” for a number of reasons, including the lack of a release from the workers compensation carrier, was proper and State Farm was not liable for bad faith failure to settle. Consequently, its conduct did not amount to the rejection of a “reasonable” settlement offer. Id. Furthermore, an insurance company cannot simply pay its policy without obtaining a release for its insured. Without obtaining a release of the claims against its insured, the payment of the liability policy limits would simply “bank roll” the injured party’s continuing litigation against the insured, constituting “bad faith” toward the insured. State Farm Mut. Auto. Ins. Co. v. Crane (1990) 217 Cal.App.3d 1127, 1136. Likewise, the release must include all co-insureds under the policy. Strauss v. Farmers Ins. Exch. (1994) 26 Cal.App.4th 1017, 1021, in which the court held Farmers properly rejected a policy limits settlement offer that did not include a complete release of all of its insureds.

All Claimants must Join in Policy Limits Demand

An insurance carrier that faces multiple claimants is required to give due regard to the interests of its insured and provide the insured the best protection against all of these claimants. Kinder v. Western Pioneer Ins. Co. (1965) 231 Cal.App.2d 834, 902; Heredia v. Farmers Ins. Exch. (1991) 228 Cal.App.3d 1345, 1357.

An insurance company that enters into piecemeal settlements with individual claimants and leaves the insured exposed to personal liability on the unsettled claims, breaches the insurer’s implied covenant of good faith and fair dealing with the insured. Kinder v. Western Pioneer Ins. Co., supra, 231 Cal.App.2d 834, 902. Once the policy limits are exhausted, the earlier settlements are likely to be attacked as “unreasonable” by the insured (or by the remaining claimants as the insured’s assignees). Kinder v. Western Pioneer Ins. Co., supra, 231 Cal.App.2d at 901. An insurance company is required to pay its policy limits to known claimants. It cannot be held liable for breach of the implied covenant of good faith and fair dealing for failing to discover the existence of others who could have made claims but did not. Spearman v. State Farm Fire & Cas. Co. (1986) 185 Cal.App.3d 1105, 1111. The rationale for this principle is that the insurance company’s duty is
to investigate a claim and to make reasonable settlement offers and that duty is owed only to its insured, not to third party claimants. Id.

In the example stated above involving the claims of Eggshell Eddie, Robin and Wren against Crackhead Craig, Saturn Insurance Company would be obligated to resolve all of the claims against its insured. If it was aware of Professor Tyler’s injuries, it would be incumbent upon it to try and resolve Professor Tyler’s injury claim along with Eggshell Eddie’s and those of his children. If it was unaware of Professor Tyler or his injuries, it has no duty to investigate his claims.

If Saturn were simply to interplead the money with the court pursuant to Code of Civil Procedure §386.6 and walk away from the case, such conduct would probably amount to bad faith since a release was not obtained for Crackhead Craig. Furthermore, Crackhead Craig could lose his defense under Saturn’s policy if the policy clearly stated that Saturn’s duty to provide a defense terminates upon payment of its policy limits. What is Saturn to do if it is aware that Professor Tyler was also injured by Crackhead Craig?

There are multiple practical solutions to this dilemma. First, the attorney for Eggshell Eddie and his children can contact Professor Tyler and find out if he intends to pursue a claim. If he is not pursuing a claim, you can have him sign the release in exchange for payment of nominal consideration of $1.00. If he is intends to pursue a claim, you can attempt to negotiate with the Professor the apportionment of his claims versus the claims of Eggshell Eddie and his children. If an agreement can be reached, a settlement agreement can be executed with the agreed upon apportionment since all claims are being resolved when the policy is exhausted.

Sometimes unrepresented potential plaintiffs are suspicious of attorneys who are attempting to convince them to take a specified sum. Consequently, you might recommend that Professor Tyler retain competent counsel. Claimants routinely retain attorneys who do not understand the duties of an insurance carrier to obtain a release of all claimants before it is permitted to pay its policy limits. In those circumstances, you need to educate Professor Tyler’s attorney on the duties imposed upon an insurance carrier to obtain a full and complete release of all claimants when the total policy limits are being exhausted. Without all claimants joining in the policy limits demand, the policy limits would remain at $50,000 per person and $100,000 per accident.

If litigation was prosecuted through a judgment, the carrier could never be held to be in bad faith because a reasonable policy limits demand was never made by all claimants. The parties would ultimately end up with judgments in excess of the liability limits and they would end up accepting the policy limits in a proportionate amount relative to their respective judgments. However, they would have incurred unnecessary expenses through the trial that may not be recoverable against Crackhead or Saturn Insurance.

In situations in which an agreement on how the policy limits should be apportioned between all of the claimants cannot be reached, the parties should work together to agree to accept the policy limits, provide a full release to Crackhead Craig, and then proceed to either a mediation, settlement conference, or an interpleader situation to ultimately determine how the policy limits should be distributed to all of the claimants.

Would Saturn’s conduct be considered bad faith if it was unaware of the injuries suffered by Professor Tyler and paid its policy limits to Eggshell Eddie, Robin and Wren? An insurer has a duty to investigate the claims. However, if Professor Tyler did not come forward to notify anyone of his injuries or moved out of the area and Saturn was unaware of his injuries, it is possible that its conduct in failing to obtain a release from all claimants would not amount to the bad faith breach of the implied covenant of good faith and fair dealing owed to Crackhead Craig. In addition, if Saturn was aware that Professor Tyler was injured but he never submitted a claim or indicated he did not intend to pursue a claim, Saturn could still exhaust its policy if it notified Crackhead of the settlement demands of Eggshell Eddie and his family and Crackhead Craig agreed to that settlement.


Should you find yourself in the position of representing a claimant in a multiple claimant situation against a single policy that is insufficient to satisfy the claims of all of the claimants, you should keep in mind that individual piecemeal settlements are unlikely. Insurance carriers are aware that they cannot dissipate their insurance proceeds with piecemeal settlement when there is a risk that the remaining unsettled claims could exceed the balance of the liability policy limits. You should work with the attorney for the other claimants to reach an agreement to accept the policy limits and thereafter try and resolve the individual claims by negotiation, mediation, or some fact finding proceeding through an interpleader action or arbitration. However, the attorney for Eggshell Eddie and his two children will need a waiver of the conflict of interests or need to retain separate attorneys for the each of the two children to resolve the apportionment of the insufficient insurance proceeds.

If there are claimants that are unrepresented and have little or no injuries, it may be worthwhile for Eggshell’s attorney to contact them and explain the situation and request them to accept a token settlement amount ($1 or some other nominal figure) in order to effectuate the global settlement of the claims arising from accident so that your clients can be compensated. When claimants with nominal injuries are presented facts indicating that someone else in the accident suffered serious injuries, claimants will frequently withdraw their claims or accept a nominal amount in order to see themselves as taking the moral high road to assist you in obtaining compensation for your clients. In this case, Professor Tyler accepted a nominal amount so that Eggshell Eddie, Robin and Wren could be compensated to the extent possible given the insufficient insurance proceeds available through Crackhead Craig’s insurance policy with Saturn Insurance Company. Once again, you have proven yourself to be a super lawyer and your clients will be singing praises of your name throughout Southern California.

This article was also published in the Trial Bar News. The APA citation for the Trial Bar News article is as follows:

Copley, R. K. (2012). Insurer’s duties when policy limits demands involve multiple claimants. Trial Bar News, 35(5), 15-16, 30-32.

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