What happens when one of several defendants has insurance and the others don’t, there is joint liability, and the insured defendant settles the case on behalf of all parties before resolving the coverage issues?  As we all learned back in law school, the answer to this question, like so many answers in the law, is “it depends”.

Interstate Fire & Cas. Co. v. Catholic Diocese, 2014 U.S. Dist. LEXIS 37437 (W.D. Tex. Mar. 19, 2014) provides a good example of how a court may reach an answer by applying the “Larger Settlement Rule”.  There, the victims of sexual abuse sued three parties: the Catholic Diocese, the Brothers of the Christian Schools (the “Brothers”), and Brother Martinez, a member of that order. The victims’ claims against the Diocese and the Brothers were for variations of negligent supervision. Their claims against Brother Martinez were for sexual molestation. Neither the Brothers nor Brother Martinez had insurance coverage. And neither was a named insured under the Diocese’s policy. All of the claims in the underlying litigation were eventually settled and released. The issue in the coverage litigation was whether the entire settlement paid by the Diocese was covered liability, given that the settlement released the claims against uninsured parties, the Brothers and Brother Martinez.

The insurer, Interstate Fire and Casualty, did not participate in the settlement negotiations or decisions because it was an excess carrier that had no such obligations. Both the Diocese and the Brothers participated. The Brothers, however, was not present when the Diocese negotiated a settlement for $1.2 million. But immediately thereafter, the Brothers asked the Diocese to negotiate its release as well. Without receiving additional amounts in settlement, the plaintiffs agreed to do so and, in the final settlement documents, released the Brothers and Brother Martinez from all claims.

After the settlement was finalized, the Diocese made a claim for coverage. In so doing, it informed Interstate that it was not apportioning any part of the settlement to the release of the claims against the Brothers and Brother Martinez. Interstate objected and filed a declaratory judgment action in which it argued that a substantial part of the settlement amount, if not all, should be apportioned to the claims against uncovered parties: “Interstate contends that the Diocese is not entitled to reimbursement because the settlement agreement included claims against Brother Martinez and [the Brothers], [and] the Diocese alleges that notwithstanding this fact, the settlement amount only covers those claims asserted against the Diocese.”

Where an insured settles a loss that also gave rise to claims against uninsured co-defendants, courts generally put the burden on the insured to justify its apportionment of the settlement between itself and any uninsured co-defendants. See, e.g.¸Twin City Fire Ins. Co. v. Amerisure Ins. Co., No. 03-0264, 2008 U.S. Dist. LEXIS 50867, 2008 WL 2678434, at *5 n.8 (S.D. Ala. July 2, 2008); Raychem Corp. v. Federal Ins. Co., 853 F. Supp. 1170, 1176 (N.D. Cal. 1994). In such matters, courts follow one of two rules to apportion settlement costs: the Relative Exposure rule or the Larger Settlement rule.

Using the “larger settlement rule,” a court treats part of the cost of settlement as uninsured if the “settlement is larger because of the activities of uninsured persons,” whether those persons were sued or not. Caterpillar, Inc. v. Great Am. Ins. Co., 62 F.3d 955, 960 (7th Cir. 1995). This rule “requires that the insurer pay the settlement up to the extent that the potential liability from the non-covered claim increased the settlement amount.” Clackamas County v. Midwest Emplrs. Cas. Co., 2009 U.S. Dist. LEXIS 118195, 28-29 (D. Or. Oct. 8, 2009).

The larger settlement rule looks to avoid unfairness to both the insured and the insurer. Courts recognize, for example, that the presence of activities of uninsured persons should “not impose a marginal cost on the insurer.” Owens Corning v. Nat'l Union Fire Ins. Co., 257 F.3d 484, 493 (6th Cir. 2001). They also recognize that such activities should not decrease the coverage of an insured unless, in some way, it imposes additional settlement costs.

In contrast, using the “relative exposure rule,” a court allocates part of the settlement amount to the covered person and part to the uncovered persons by comparing the potential exposure of the uninsured and insured persons at the time of the settlement. This relative exposure rule requires a more involved “inquiry into what happened in a settlement and who really paid for what relief.” Owens Corning, 257 F.3d at 493; see also Caterpillar, 62 F.3d at 961 (explaining that this rule requires “a somewhat elaborate inquiry”). Indeed, one well-regarded authority offers a list of eleven issues that should be considered by a court making a “relative exposure” apportionment. W. Knepper & D. Bailey, Liab. of Corp. Officers & Directors § 17.06, Supp. at 248-249 (4th ed. 1988 & Supp. 1992).

The result can be quite different under the two rules. Applying the relative exposure rule, for example, a court might apportion a larger part of a settlement to an uninsured co-defendant either because it has a deeper pocket or because it was primarily at fault. In contrast, the larger settlement rule would make no such allocation unless it could be shown that the settlement was larger because it released the claims against that uninsured co-defendant.

The larger settlement rule has a more focused analysis and, perhaps, a more predictable outcome. It is, therefore, less likely to lead to litigation over allocation of the costs of settlement. Consequently, courts generally use the larger settlement rule unless the insurance policy clearly states that the settlement should be allocated according to the kind of criteria considered by the relative exposure rule.

In Clifford Chance Ltd. Liab. P'ship v. Indian Harbor Ins. Co., for example, the language in the insurance policy showed intention to use the relative exposure rule by stating: “the Insured and the Insurer agree that in determining a fair and appropriate allocation of Loss, the parties will take into account the relative legal and financial exposures of, and relative benefits obtained, in connection with the defense and/or settlement of the Claim by the Insured and others.” 14 Misc. 3d 1209[A], *13, 836 N.Y.S.2d 484 (N.Y. Sup. Ct. 2006), affirmed on appeal, 41 A.D.3d 214, 838 N.Y.S.2d 62 (2007) (emphasis added).

 In contrast, the court in Owens Corning, held that policy language must be “clear and exact” if it is to have the effect of invoking the relative exposure rule. 257 F.3d at 493. Consequently, a policy provision that merely required “a fair and proper allocation” of the costs of settlement between covered and uncovered claims was too vague to be the basis to use the relative exposure rule. 257 F.3d at 492-3.

In the Diocese/Interstate matter that began our discussion, the United States District Court for the Western District of Texas ruled in favor of the Diocese, holding that the entire settlement amount should be allocated to the claims against the Diocese. Interstate Fire & Cas. Co. v. Catholic Diocese, 2014 U.S. Dist. LEXIS 37437 (W.D. Tex. Mar. 19, 2014). Applying the larger settlement rule, the court found that there was no evidence that the amount of the settlement was larger on account of the release of claims against the Brothers and Martinez. Id. at *29. The mere fact that the plaintiffs settled claims against the uninsured co-defendants in the same instrument did not establish that additional funds were paid—that the settlement was larger—to settle those claims:

[T]he parties do not present any evidence nor can the Court find any evidence that the claims asserted against [the Brothers] and Brother Martinez were released because a sum of money was paid to plaintiffs on their behalf. As such, the Court finds that settlement of the underlying suit does not necessarily indicate that a monetary value is attached to each individual claim.

Id.at *29 (emphasis added, internal quotation marks omitted).

The Court agreed with Interstate that the “plain terms” of the settlement agreement shows that the claims against the Brothers and Martinez were “settled.” Id. at *36. But, the court explained, that fact did not resolve the issue of apportionment because “it is not presumed that a monetary value is attributed to each individually settled claim.” Id. What mattered was intent, and there was no evidence that the parties intended that a portion of the settlement was paid on account of releasing the claims against the Brothers and Brother Martinez. Id.at *35-36.

To the contrary, the evidence showed “the Diocese was willing to pay $1.2 million for its claims regardless as to whether the plaintiffs would release the other co-defendants.” Id. at *39. The amount of the settlement, therefore, was determined before there was any discussion about releasing the uninsured co-defendants. The settlement thus was no larger on account of settling the claims against the Brothers and Brother Martinez. Id. at *42. Consequently, there was no apportionment under the larger settlement rule. Id.

The outcome of this analysis hinged on the fact that the plaintiffs and the Diocese reached an agreement on the amount to be paid to settle the Diocese’s exposure before there was any discussion of releasing the uninsured co-defendants’ claims. Had the uninsured co-defendants participated in the settlement discussions or had the first iteration of the settlement agreement recited the release of their claims, the outcome might have been very different.

There are many lessons to be learned. Counsel representing a settling insured in a multi-defendant litigation should be very careful to negotiate the settlement in a manner that shows its client is not paying a larger settlement on account of settling the claims of uninsured co-defendants. And, as always, parties should strive to allocate any foreseeable risk in advance to mitigation the uncertainty of litigation.

 

Leon Silver is co-managing partner of the Phoenix Office of Gordon & Rees LLP. Mr. Silver is a Fellow of the Litigation Counsel of America. Gary Lento is a member of the Commercial Litigation and Insurance practice groups in Gordon & Rees’ Phoenix office.