Insurance Law: Covenant Judgments.

In California, when an insurer provides a defense to its insured, the insured has no right to interfere with the insurer's control of the defense (even if the insurer has reserved rights) and a stipulated judgment between the insured and the injured claimant, without the consent of the insurer, is ineffective to impose liability upon the insurer. See Safeco Ins. Co. of Am. v. Superior Court, 71 Cal.App. 4th 782, 84 Cal.Rptr. 2d 43 (1999); Jamestown Builders v. General Star Indem.Co., 77 Cal.App.4th 341, 91 Cal.Rptr.2d 514 (1999). Insurers, in this regard, are typically protected by 'no-action' or 'no-voluntary payments' clause(s) in the insurance policy, as well as a predominating judicial notion or concern that such settlements would foster collusion and fraud between the settling parties and work to the unfair advantage of the insurer. If the insurer mounts a deficient defense or fails to accept a reasonable settlement offer, however; it may be held liable for any judgment in excess of the insured's coverage, but such damages arise only after the entry of an adverse judgment against the insured. Safeco Ins. Co. of Am. v. Superior Court, 71 Cal.App. 4th 782, 788-89, 84 Cal.Rptr. 2d 43 (1999). A mere dissatisfaction over the quality of the insurer's management of the case or a theoretical exposure of an insured's personal assets would not entitle the insured to settle the action on its own and without the insurer's consent. In fact, in California it appears to be a bright-line rule that the insurer must have completely abdicated its duty to defend before it will be held liable for a stipulated settlement.

In other states including Washington, however, the law has taken a decidedly more favorable bent toward exposing insurance when a claimant enters into a stiplulated or covenant judgment with a defendant-insured. Recently, the Washington Supreme Court decided Mutual of Enumclaw Ins. Co. v. T & G Construction, Inc., et.al., concerning an underlying condominium construction defect suit and related coverage litigation. The Court was asked "to balance the interests of an insured defendant in reaching a reasonable settlement with a claimant against the insurer's (Mutual of Enumclaw Insurance Company or "MOE") interest in fully litigating its insured's legal obligation to that claimant.

In the underlying construction defect litigation in Snohomish County Superior Court, the Association, with MOE's knowledge but without its consent or participation, entered into a settlement with T & G, a subcontractor-defendant who MOE insured and who installed board and batten siding on the condominiums. T & G stipulated to a judgment of $3.3 million (for alleged costs to repair defects in the siding) with the Association promising not to execute the judgment against T & G. T & G, in turn, assigned its rights under the insurance policy to the Association so that the Association could try to make MOE satisfy the judgment. The trial court blessed the parties' settlement (in an adjusted amount of $3 million) as 'reasonable' and over the objections of MOE who appeared and participated in a reasonableness hearing.

Meanwhile, MOE initiated a declaratory judgment action in King County Superior Court arguing that its insured, T & G, was not liable for the underlying covenant judgment on the grounds that a statute of limitations had run on the underlying action against T & G, that the insured's damages were outside the coverage provisions of the policy issued to T & G, that T & G had breached its obligation to cooperate, and that several policy exceptions applied. The King County Superior Court by Judge Julie Spector granted summary judgment against MOE on all of these issues.

The Washington Supreme Court got the case upon the Association's appeal from the Washington Court of Appeal's decision that absent any determination of bad faith, that MOE should have been allowed to litigate to finality whether a statute of limitations defense had run on the underlying defect claims against its insured (T & G) and, if the trial court concluded that the statute of limitations had not run, whether Mutual of Enumclaw had been prejudiced by its insured's failure to cooperate at the end of the liability case. See Mut. of Encumclaw Ins. Co. v. T & G Constr., Inc., 143 Wn.App. 6667 (2007). Simultaneously, the Court of Appeals upheld the settlement and reasonableness determination in the liability suit. See Villas at Harbour Pointe Owners Ass'n v. Mutual of Enumclaw Ins. Co. v. T & G Constr., Inc., 137 Wn.App. 751 rev.den. 163 Wn.2d 1020 (2008).

The Washington Supreme Court in T & G accepted review of only the coverage dispute and reversed the Court of Appeal's rulings. The Court held that when the insurer has an opportunity to be involved in a settlement fixing its insured's liability, and that settlement is judged reasonable by a judge, then it is appropriate to use the fact of the settlement to establish liability and the amount of the settlement as the presumptive damage award for purposes of coverage. In so holding, the Court stated that it would be inequitable to allow an insurer to relitigate questions that were resolved in the underlying liability action and held that an insurer is not entitled to litigate factual questions that were resolved in the liability case by judgment or arm's length settlement. In reaching these holdings the Court noted that courts in other states have made similar determinations citing United Servs. Auto Ass'n v. Morris, 741 P.2d 246 (Az. 1987) (rejecting claim that insurer could raise a liability defense in a coverage case); Patrons Oxford Ins. Co. v. Harris, 905 A.2d 819 (Me. 2006); and Miller v. Shugart, 316 N.W.2d 729 (Mn. 1982). See also, Weber v. Indem. Ins. Co. of N. Am. 345 F. Supp. 2d 1139 (Dist. of Hawaii 2004).

The Court in T & G hastened to add, however, that the "presumptive damages" are not necessarily the "covered damages" under the subject policy and remanded several issues of coverage to the trial court. Notably, "property damage" issues under the "impaired property" and "your work" exclusions in the policy were at issue. The Court stated that the cost of removal and reinstallation of the siding was within the scope of 'property damage' stating that 'property damage' is a term of art that does not necessarily mean tangible damage to tangible property and can include consequential damages stemming from the repair process. See Dewitt Constr., Inc. v. Charter Oak Fire Ins. Co., 307 F.3d 1127 (9th Cir. 2002); Yakima Cement Prods. Co. v. Great Am. Ins. Co., 93 Wn.2d 210 (1980); Gen.Ins. Co. of Am. v. Gauger, 13 Wn.App. 928 (1975). But, the Court found that it could not tell from the record what facts or underlying determinations the coverage court had employed, if any, on its own determinations concerning these policy exclusions and consequently remanded for further proceedings on the issues concerning any applicability of the exclusions.

The Washington Supreme Court's decision in the T & G case caps a string of cases that have empowered insureds and their assignees by holding that convenent judgment(s) are enforceable against insurers in a variety of ways so long as they are determined reasonable. See Besel v. Viking Ins. Co., 146 Wn.2d 730 (2002) (the amount of a covenant judgment is the presumptive measure of an insured's harm caused by an insurer's tortious bad faith if the covenant judgment is reasonable under the Chaussee criteria) and Chaussee v. Maryland Casualty Co., 60 Wn.App. 504 (1991) (insurer that defended under reservation of rights but misrepresented policy limits may be liable for stipulated judgment in excess of limits, but claimant bears burden of showing reasonableness of the settlement). See also Glover v. Tacoma Gen. Hosp., 98 Wn.2d 708 (1983); Werlinger v. Warner, 126 Wn.App. 342 (2005); Truck Ins. Exch. v. Vanport Homes, 147 Wn.2d 751 (2002). The court, in this situation, essentially functions as both judge and jury on critical issues of liability and damages in determining reasonableness and this determination, in turn, can greatly impact the potential availability of insurance to satisfy the covenant judgment.