Rethinking the cooperation clause in standard liability insurance contracts.

• Author: Giles, Nicholas J.

INTRODUCTION I. THE COOPERATION CLAUSE BY DESIGN II. THE COOPERATION CLAUSE IN PRACTICE: THREE CATEGORIES, ONE RESULT A. The Case of the Prototypical Noncooperative Policyholder B. The Fifth Amendment Case C. The Policyholder Settlement Case D. The Impact of the Heavy Settlement Environment on Cooperation Clause Cases III. THE COOPERATION CLAUSE IN COURT: MISGUIDED RESPONSES A. Obstacles to the Use of the Cooperation Clause B. Proscription of the Cooperation Clause as a Defense in Mandatory Liability Insurance Schemes IV. THE COOPERATION CLAUSE REIMAGINED A. A Contractual Response B. A Legislative Response C. A Tailored Fifth Amendment Response D. Observations on the Impact on Premiums CONCLUSION INTRODUCTION

In 2006, a Texas appellate court reprinted the transcript of a telephone message left by Carol Alvarado for her husband's automobile liability insurance provider following a car accident that he had caused:

Hello. This is Carol Alvarado calling, and I'm calling in response to a letter of March 17, 2003, that I just received that's postmarked April 16, 2003. I'm speaking on behalf of my husband because I'm his guardian. He's had more problems since this accident of April 17th and the reason I'm calling is, as far as we're concerned, you can just go ahead and deny coverage for that accident; that would be fine with us if you just deny coverage with regard to the lawsuit. Just inform the parties that you're denying coverage, send us a copy of the letter, and I mean that's fine. We have--we having nothing that they can--there's nothing that they can do to us by suing us because, well, you know, we're pretty well judgment proof anyway, and my husband is injured. I, myself, have cancer, so we just don't have the resources, the energy to be involved in this at all. I don't have a phone. I can't call you back, so just go ahead and deny coverage with regard to that accident of that day, April 17, 2001. I'm speaking on behalf of my husband as his guardian and that's fine with us. Thanks. (1) In response to this message, Mr. Alvarado's automobile liability insurance provider indeed denied coverage. It declined to defend him in the lawsuit the victim brought following the accident. In that suit, the victim won a default judgment, and subsequently sued the insurer for the proceeds. (2) Claiming that Mr. Alvarado had breached the policy's cooperation clause, the insurer asserted that the policy had been nullified and argued that it could not be forced to indemnify Mr. Alvarado against the liability stemming from the accident. (3) The Trevino court accepted this argument and denied the victims injured by Mr. Alvarado the right to collect their default judgment from the proceeds of his policy. (4) Neither the victims nor the court should have had any reason to doubt the truth behind Ms. Alvarado's statement that she and her husband were judgment-proof; in fact, most people are.s But neither should we underestimate the impact of her phone message. By refusing to cooperate with his insurer--indeed by refusing any involvement with the claims process--following an accident he caused, Mr. Alvarado substantially decreased the likelihood that the victims of his negligence (6) would receive any compensation for their injuries.

At the heart of this problem is the policyholder's duty to cooperate in the investigation and disposition of his claims, and the general acceptance of that duty as a condition precedent to coverage under a liability insurance policy. Where, as in Trevino, a court accepts the argument that the policyholder breached this duty, the victim's chances at a full recovery plummet, because recovery for tort damages is almost impossible if limited to the personal assets of the tortfeasor. (7) This Comment begins from the premise that, in a largely judgment-proof society, the cooperation clause in liability insurance policies creates perverse incentives for both policyholders and insurers. If breached, the cooperation clause enables the insurer to avoid indemnification duties, and the insurer benefits from the policyholder's noncooperation. Likewise, because all a judgment-proof policyholder stands to lose if found in breach is an unenforceable personal liability, he has no incentive to actively cooperate. When parties respond to these incentives, they impose the costs of accidents on their innocent victims.

Liability insurance literature has identified three central duties owed by the insurer to the policyholder that grow from the standard personal liability contract: the duty to defend covered claims against the policyholder, (8) the duty to indemnify the insured against liability within policy limits stemming from covered claims, (9) and the duty to settle those claims for a reasonable amount when feasible. (10) The duty to cooperate stands opposite these as the central duty owed by the policyholder to the insurer. But while scholars have extensively examined, analyzed, and critiqued the insurer's duties of defense, (11) indemnification, (12) and settlement, (13) the insured's duty to cooperate has not been adequately scrutinized. This Comment seeks to begin the scholarly discussion of the duty to cooperate by examining its impact on policyholder and insurer incentives, as well as on the resulting allocation of the costs of accidents. It goes on to propose several adjustments aimed at bringing the duty to cooperate back in line with its stated goals, as well as those of liability insurance in general.

Importantly, much of the harm this Comment seeks to eradicate arises when policyholders refuse to cooperate with their insurance companies when sued on a covered claim. While there are many breeds of noncooperation, (14) there is no indication--nor does this Comment suggest--that noncooperation is the prevalent policyholder reaction to being sued. Presumably, many policyholders comply with the requests of their insurers for reasons having little to do with their net worth: what the insurer requests may not present a burden, the policyholder may know the victim and affirmatively want to speed up the claims process, or the policyholder may simply believe that cooperating is the right thing to do. All of which prompts the question of whether this Comment ventures to fix that which, according to the old cautionary maxim, "ain't broke." But a system of liability insurance should not entrust its efficacy to the goodwill of its policyholders without an effective backstop of enforcement. (15) If, as Professor Kenneth Abraham suggests, insurers can be "understood as the intermediary through which individuals motivated by concern for themselves become part of an enterprise that transforms selfish concern into altruism," (16) a structural defect in the policy that allows (indeed encourages) both the insurer and the policyholder to subvert that goal should not be forced to hang its remedial hopes upon an economically irrational goodwill. To be sure, voluntary policyholder cooperation serves liability insurance in many ways: it speeds up what is often a drawn out process, (17) reduces costs to insurers who are not forced to track down the policyholder and coerce cooperation, (18) and promotes the truth about the circumstances surrounding accidents. (19) Relying on such voluntary cooperation, however, not merely to improve the delivery of insurance, but to hold the system together, is to beg divergent outcomes. This Comment proposes a duty to cooperate that instead relies on structural guarantees to serve the compensatory ends of the liability insurance system.

Part I examines the prevalent composition and interpretations of the cooperation clause and discusses in more detail the ways in which these interpretations create perverse incentives in practice. Part II details three categories of cases in which policyholders respond to such incentives. Part III identifies and evaluates two present judicial responses to this problem. Finally, Part IV offers a tentative solution to the problem, centered on altering the remedy for a breach of the cooperation clause to render it both a meaningful incentive for policyholder compliance and a meaningful guarantee of victim compensation.

1. THE COOPERATION CLAUSE BY DESIGN

   The policyholder's duty to cooperate is reflected in the virtual omnipresence of a cooperation clause in consumer liability insurance policies. (20) Though a cooperation clause of some variety is found in almost every liability policy, (21) this Comment focuses solely on such provisions and their effects in consumer automobile and consumer homeowner policies. The purpose of this limitation is three-fold. First, because such policies invariably deprive the policyholder of any bargaining power, (22) and the standard language of such policies always includes a cooperation clause, the duty to cooperate is an unavoidable and uniform element of insurance in this context. Examining the duty to cooperate against this backdrop thus provides a consumer class with largely identical protections and obligations, free of the variations and personalizations that characterize more complex commercial policies. (23) This limitation also obviates the need for any analysis of the policyholder's level of sophistication. Second, because this Comment centers its criticism of the duty to cooperate on the deprivation of compensation for injured third-party tort victims through unilateral policyholder action, it demands a landscape in which that action can be isolated and analyzed as an individual, rational decision. In the context of more complex policies and corporate policyholders, the decision not to cooperate is likely to implicate a more complicated set of considerations beyond the present scope. (24) Third, personal liability insurance premiums comprise the vast majority of annual insurance expenditures in the United States. (25) Because this massive expenditure is spread through an equally large class of consumers, these...