Absent a Pre-Litigation Settlement Demand Within Policy Limits, Liability Insurer Cannot Be Held Liable for Bad Faith Failure to Enter into Pre-Litigation Settlement Discussions

MEDICAL MALPRACTICE COVERAGE – BAD FAITH – FAILURE TO ENGAGE IN PRE-LITIGATION SETTLEMENT NEGOTIATIONS
CBLPath, Inc. v. Lexington Ins. Co.
(2nd Dept., decided 5/11/2010)

When the insured's liability is not in doubt and the nature of injuries it caused are such that a recovery will likely exceed the policy limit, is it actionable bad faith for a liability insurer to refuse or fail to enter into pre-litigation settlement discussions and negotiations?  In the opinion of the Second Department, Appellate Division, no, not if there's been no pre-litigation settlement demand within policy limits, it isn't. 

Lexington insured CBLPath, a medical diagnostic laboratory, under a $1,000,000 per medical incident medical malpractice liability policy. In March 2006, CBL negligently switched Darrie Eason's biopsy specimen with a biopsy specimen from another individual, which resulted in Eason being erroneously diagnosed with breast cancer, and subsequently undergoing an unnecessary double mastectomy.

From February 2007 through September 2007, Eason's counsel made several attempts to open settlement discussions, but Lexington, which in February 2007 had exercised its right as the sole authority to handle the Eason claim, never made a substantive response to those inquiries. Eason commenced a personal injury action against CBL in October 2007, and her counsel made her first settlement demand of $5,000,000 in December 2007.  That action was settled several months later for the sum of $2,500,000, with Lexington paying the policy limit in the sum of $1,000,000 and CBL paying the balance.

CBL thereafter commenced this action against Lexington, asserting a single cause of action for breach of the covenant of good faith and fair dealing implied in the insurance contract. The gravamen of CBL's complaint was that Lexington, which had asserted sole control over the Eason claim, acted in bad faith by refusing to enter into pre-litigation settlement discussions with Eason's counsel. CBL sought actual and consequential damages, including, inter alia, injury to its business reputation, lost sales, increased sale expenses, lost profits, and lost business opportunities caused by the negative publicity that resulted from the commencement of the underlying action. After answering, Lexington moved for summary judgment dismissing the complaint, and CBL cross-moved to dismiss Lexington's affirmative defenses. The Supreme Court granted Lexington's motion and denied CBL's cross motion. CBL appealed, and the Second Department unanimously affirmed:

An insurer "may be held liable for the breach of its duty of good faith' in defending and settling claims over which it exercises exclusive control on behalf of its insured" (Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d 445, 452). The root of this doctrine is that, typically, an insurer exercises "complete control over the settlement and defense of claims against their insureds, and, thus, under established agency principles may fairly be required to act in the insured's best interests" (id.). However, since courts are understandably reluctant to expose insurers to liability exceeding the policy limits, the bad faith must be for conduct that is clearly more than ordinary negligence, i.e., more than merely poor judgment (id. at 453).

"Naturally, proof that a demand for settlement was made is a prerequisite to a bad-faith action for failure to settle. [Additionally,] the plaintiff in a bad-faith action must show that the insured lost an actual opportunity to settle the . . . claim at a time when all serious doubts about the insured's liability were removed.

"Bad faith is established only where the liability is clear and the potential recovery far exceeds the insurance coverage" (id. at 454 [internal quotations marks and citations omitted]; see also Smith v General Acc. Ins. Co., 91 NY2d 648, 653; Soto v State Farm Ins. Co., 83 NY2d 718, 723; Vecchione v Amica Mut. Ins. Co., 274 AD2d 576, 578; cf. United States Fid. & Guar. Co. v Copfer, 48 NY2d 871, 873).

Here, Lexington met its prima facie burden of establishing its entitlement to judgment as a matter of law (see Alvarez v Prospect Hosp., 68 NY2d 320, 324; Zuckerman v City of New York, 49 NY2d 557, 562) by submitting, inter alia, an affirmation of an AIGDC attorney who had handled the Eason claim. In that affirmation, the attorney stated that Eason's counsel did not issue the first settlement demand until after commencement of the underlying action, and that once such demand was made, negotiations ensued, and a settlement was reached, with Lexington paying the policy limit in the sum of $1,000,000, and CBL responsible for the balance in the sum of $1,500,000. Thus, Lexington established that CBL's bad faith claim could not stand, as there was no pre-litigation settlement demand made within the policy limits (see Smith v General Acc. Ins. Co., 91 NY2d at 653; Soto v State Farm Ins. Co., 83 NY2d at 723; Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d at 454).

In opposition, CBL failed to raise a triable issue of fact. CBL submitted, inter alia, an affidavit of its vice president and corporate controller, who indicated that after AIGDC asserted exclusive control over the Eason claim in February 2007, it thereafter refused to contact Eason's counsel to settle her claim and avoid negative publicity to CBL. Notably, however, CBL's opposition did not raise a triable issue of fact as to whether Eason's counsel had made a pre-litigation settlement demand within the policy limits. As such, while it may arguably be some evidence of bad faith that AIGDC failed to enter into pre-litigation settlement discussions with Eason's counsel at a time when CBL's liability was not in doubt and the nature of Eason's injuries indicated that her recovery would exceed the policy limit, we are constrained to find that Lexington was entitled to summary judgment because CBL failed to raise a triable issue of fact as to whether Eason made a pre-litigation settlement demand within the policy limit (see Pavia v State Farm Mut. Auto. Ins. Co., 82 NY2d at 453; see also Smith v General Acc. Ins. Co., 91 NY2d at 653; Soto v State Farm Ins. Co., 83 NY2d at 723; Vecchione v Amica Mut. Ins. Co., 274 AD2d at 578). Under the circumstances, CBL cannot show that, because of AIGDC's conduct, it lost an actual opportunity to settle and, thus, any damages it asserts are based on mere speculation (see United States Fid. & Guar. Co. v Copfer, 48 NY2d at 873).

What is sometimes called "third-party" insurer bad faith depends on there having been an opportunity to settle within policy limits after the insured's liability becomes clear and the value of the plaintiff's injuries or damages will likely far exceed the policy limit.  In cases where there is no pre-litigation settlement demand within policy limits, the liability insurer cannot be held liable under a bad faith theory for having failed or refused to enter into pre-litigation settlement discussions.