2.4 Duty to Give Equal Consideration to Settlement Proposals

• Jurisdiction: Arizona

Standard automobile liability insurance policies contain a usual provision requiring the carrier to defend any suit against the insured and giving the carrier the right "to make such investigation and settlement of any claim or suit as it deems expedient."^[458] A significant amount of litigation has occurred focusing on the carrier's obligations to the insured when exercising its right to decide whether a claim under the policy will be settled within the carrier's policy limits in those cases where there is a possibility of the claim exceeding such limits.^[459] Co-extensive with the carrier's right to decide when to settle a claim is the carrier's implied contractual duty to settle claims within policy limits in appropriate cases, even though such a duty might not be specifically expressed under the terms of the policy.^[460] This duty has been characterized as an implied duty of good faith and fair dealing and is a part of every insurance policy:

It is manifest that a common legal principle underlies all of the foregoing decisions; namely, that in every insurance contract there is an implied covenant of good faith and fair dealing. The duty to so act is imminent in the contract whether the company is attending to the claims of third persons against the insured or the claims of the insured itself. Accordingly, when the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort.^[461]

The Arizona courts have refused to characterize this implied duty as rising to the level of a fiduciary duty.^[462]

Determining the extent of this implied contractual duty has been a troublesome problem for the courts.^[463]

The principal difficulty experienced by the courts has been in fixing a test for the degree of consideration the insurer must give the insured's interests in order to have met its legal obligation in this respect. Different standards have been adopted. There is authority to the effect that the insurer may give paramount consideration to its interests. [Citations omitted.] Other jurisdictions have said paramount consideration must be given to protect the insured. [Citation omitted.] A third position is that the insurer must give equal thought to the end that both the insured and the insurer shall be protected.^[464]

The Arizona courts have adopted what has generally been referred to as the "equality of consideration" test to determine whether a carrier has fulfilled its implied contractual obligation of good faith and fair dealing.^[465] The "equality of consideration" test was first adopted by the supreme court in Farmers Insurance Exchange v. Henderson:^[466]

It occurs to us that when the insurer is defending litigation against the insured, employs attorneys to represent the interests of both and has sole power and opportunity to make a settlement which would result in the protection of the insured against excess liability, common honesty demands that it not be moved by partiality to itself nor be required to give the interests of the insured preferential consideration. A violator of this rule of equality of consideration cannot be said to have acted in good faith. [Citation omitted.] The enunciation of the rule is not difficult but its application is troublesome. It is a matter of consideration of comparative hazards.^[467]

A carrier must not be motivated by partiality to itself. If the carrier fails to give equal consideration to the interests of the insured, it will have acted in bad faith.^[468] "In the event good faith obliges the [carrier] to terminate the litigation by settlement, its failure to do so renders it liable as between the insured and [carrier] for the full amount of the judgment."^[469]

In discussing the application of the "equality of consideration" test, the courts generally speak in terms of the "good faith" or "bad faith" of the carrier.^[470] However, "no dishonest or fraudulent motive on the part of the [carrier] is required in order to find that the [carrier] has failed to give the required equality of consideration to the interests of the insured."^[471]

In State Farm Automobile Insurance Co. v. Civil Service Employers Insurance Co.,^[472] the court held that the carrier's initial good faith denial of coverage did not excuse its bad faith failure to enter into a settlement agreement disposing of the claim made against its insured. Where the carrier erroneously denies coverage and consequently refuses to give consideration to a settlement offer, it will be liable to its insured, if coverage exists, "for any judgment subsequently entered against the insured in excess of policy limits, unless the [carrier] shows that an application of the equality of consideration test would not have required acceptance of the settlement offer."^[473] The court further observed:

In the normal case where the insurer admits coverage and is actively engaged in the litigation it makes sense to consider whether the insurer gave equal consideration to the interests of the insured or was guilty of "bad faith" in rejecting a settlement offer. However, is the same test equally applicable when the insurer, entertaining "an honest though erroneous belief" that there was no coverage under the policy, refuses to give any consideration to the proposed settlement? In answering this question, it must be kept in mind that the insurer's obligation to settle, as well as the obligation to defend, arises out of the contract between the parties. The mere fact that an insurer has erroneously concluded that there is no coverage and therefore in good faith refuses to defend, cannot excuse subsequent breaches by the insurer of other provisions of the contract, including the implied obligations pertaining to settlement. To hold otherwise would result in penalizing the more prudent insurer who initially correctly recognizes the duty to defend, but subsequently wrongfully refuses a settlement offer.^[474]

The court recognized that a heavy burden is placed upon carriers by the above principles;^[475] nonetheless, the court also recognized that when a carrier breaches its contract and erroneously refuses to defend, it does so at its own peril.^[476] The court stated:

It is the insurer's initial breach which gives rise to the consequent inattention to the interests of the insured and thus the insurer should not be allowed to escape the consequences of such inattention, absent a showing by the insurer that due attention to, and consideration of, the interests of both the insurer and the insured would not have required acceptance of the settlement offer. Therefore we reject State Farm's contention that its initial good faith denial of coverage has any direct bearing on the question of its liability for the alleged breach of its settlement obligations.^[477]

The court in General Accident Fire & Life Assurance Corp. v. Little,^[478] asked the following rhetorical question: "What constitutes a breach of duty to exercise good faith?"^[479] The court answered this question by adopting an objective standard:

[I]t should be clear that the evaluation of a case should not be determined by looking to the policy limits. When an insurance company evaluates a claim without looking to the policy limits and as though it alone would be responsible for the payment of any judgment rendered on that claim it views the claim objectively, and in doing so renders "equal consideration" to the interests of itself and the insured.^[480]

The court rejected a hindsight standard because in hindsight both the carrier and the insured would agree that in light of the excess judgment it would have been better for the carrier to have accepted the settlement offer.^[481] In rejecting a hindsight standard, the court in Little cited with approval the analysis of the Iowa court in Ferris v. Employers Mutual Casualty Co.:^[482]

* * * Again there is the implication that we should judge the fairness of the decision not to settle by the result. We suggest that if we are to venture into the area of what counsel "should have known" in advance of the trial of a lawsuit as shown by the final outcome, by a jury's decision, we are requiring of him the gift of foretelling the future not often given to mankind. We know of no mortal who has been vouchsafed this power since the days of the Bible prophets; and as we understand it, these ancient seers had access to some inside information not presently available to counsel in damage cases. The court placed an unfair burden on the defendant here * * *

* * *

* * * We may not measure the reasonableness of the offer by the ultimate result of the litigation; it must be considered in the light of the case as it fairly appeared to the insurer and its authorized agents and attorneys at the time the offer was made. Whether Mr. Mitchell was mistaken in his judgment that he could successfully defend may be argued; but a mere mistake in judgment is not enough to show bad faith * * *^[483]

Where the carrier acts honestly and in good faith upon adequate information, it will not be held to have breached its duty of good faith and fair dealing because it fails to prophesy the result.^[484] A mistake in judgment on the part of the carrier in rejecting the offer is not enough to show bad faith.^[485] If the carrier in good faith believes that it can successfully defend the claim, it is not required to relieve the insured of all possible harm that might come from the insured's election to purchase the limits of coverage that were selected.^[486]

There are several factors the courts will consider in assessing whether the...