Commercial Union Ins. Co. v. Medical Protective Co.

• Decision Date: 17 September 1986
• Docket Number: Docket No. 74912
• Citation: 426 Mich. 109,393 N.W.2d 479
• Parties: COMMERCIAL UNION INSURANCE COMPANY, Plaintiff-Appellee, v. MEDICAL PROTECTIVE COMPANY, Defendant-Appellant.
• Court: Michigan Supreme Court

Page 479

393 N.W.2d 479

426 Mich. 109

COMMERCIAL UNION INSURANCE COMPANY, Plaintiff-Appellee, v. MEDICAL PROTECTIVE COMPANY, Defendant-Appellant.

Docket No. 74912.

Supreme Court of Michigan.

Argued Jan. 15, 1986.

Decided Sept. 17, 1986.

MacArthur, Cheatham, Acker & Smith, P.C. by Brian J. Doren, James G. Gross, Detroit, for plaintiff-appellee.

Moll, Desenberg, Bayer & Behrendt by Jon P. Desenberg, David J. Franks, Detroit, for defendant-appellant.

WILLIAMS, Chief Justice.

The issue in this case is whether an excess insurer has a cause of action against a primary insurer for the latter's failure to defend or settle a liability claim in good faith. Courts have recognized such a cause of action under at least two theories: 1) the primary insurer owes a duty to act in good faith toward its insured, and the excess insurer is equitably subrogated to the position of the insured, and 2) the primary insurer owes a duty to act with due care and in good faith directly toward the excess insurer. We join many other jurisdictions by adopting the first theory and holding that an excess insurer may sue a primary insurer as the equitable subrogee of the insured. We would decline to hold at this time that a primary insurer owes a tort duty to act in good faith and with due care directly to the excess insurer.

I. FACTS

In 1974, Elaine Smith and her husband sued Merle Berman, M.D., and Cottage Hospital for damages which allegedly resulted from Dr. Berman's negligent administration of spinal anesthetic. Mrs. Smith alleged that Dr. Berman's negligence caused a right foot drop, constant right leg pain, psychiatric problems, and a neurogenic bladder requiring regular self-catheterization.

The Medical Protective Company (MP) insured Dr. Berman with primary professional liability insurance up to $200,000, and the Commercial Union Insurance Company (CU) insured him with excess professional liability insurance up to $1,000,000. Under the terms of the primary policy, MP controlled Dr. Berman's defense in the malpractice action. MP hired attorney Lee Wulfmeier to represent Dr. Berman.

In September, 1975, the Smiths sent interrogatories to Wulfmeier, who forwarded them to Berman. Berman apparently refused to answer after Wulfmeier urged him twice by letter to respond. Berman's failure to comply with a court order compelling answers to the interrogatories resulted in a default judgment being entered against him on May 25, 1978.

Soon thereafter, Wulfmeier informed MP that the default judgment had entered and that Berman had retained private counsel, who had supplied Wulfmeier with answers to the interrogatories. The remainder of the letter states:

"I have spoken with [the Smiths' attorney] who has indicated he would not set aside the default, voluntarily, but would not necessarily oppose it if indeed we tried to set it aside. We are in that tender position of having the matter defaulted although our defense to same is lack of cooperation and therefore I believe we would not have to forward monies to the stp [sic] if indeed they went forward with collection. This is again a complicated situation and one that nessitates [sic] your thinking and attention, almost immediately. I would be more than happy to discuss this matter with you and also have a conference call with Dr. Berman's personal attorney if you deem that necessary." (Appellee's Appendix, pp. 1b-2b.) (Emphasis added.)

Another letter from Wulfmeier to MP, dated July 12, 1978, enclosed a draft "reservation of rights" letter to be forwarded to Berman. This letter indicated MP's intent to refuse to pay damages on any award entered in the case because of Berman's failure to cooperate in the defense. The draft letter also notified Berman that he must have his own counsel seek to set aside the default judgment. In a third letter to MP, sent one week before the parties were to go to trial on the question of damages, Wulfmeier assessed the case as follows:

"I believe this is a very bad case, and presents us with very little defense in light of Dr. Gibbs' testimony. He is absolutely convinced that this injection was given into the conus and that is the reason for all of the problems that this lady has, which obviously are well-documented in the records. The hospital has indicated that they would pay $25,000.00 of a total $200,000.00 settlement and unfortunately we did not jump on this some time ago when we could probably have paid only $100,000.00. I would appreciate your thoughts as to whether or not you wish to spend $175,000.00 to resolve this potentially horrendous case." (Appellee's Appendix, p. 7b.) (Emphasis added.)

Two other important events occurred in the late months of 1978, just prior to the trial date in January, 1979. In October, 1978, Berman died. On December 21, 1978, CU wrote to MP protesting MP's failure to attempt to have the default judgment set aside. CU apparently suspected MP of deliberately allowing the default judgment to stand in order to avoid paying any judgment on the grounds of noncooperation. (Appellee's Appendix, pp. 49b, 53b, 55b.) In its letter to MP, CU stated:

"With Dr. Berman in default, in my opinion the trial of the case will be limited to the issue of damages. In my further opinion it is very likely that damages will greatly exceed the sum of $200,000, your policy limit.

"It is the position of [CU] that if this case proceeds to trial on the issue of damages and if those damages are in a sum in excess of $200,000 and if [CU] is called upon to pay any sum in excess of $200,000, that it will look to the Medical Protective Company and its agents for the recovery of such sums. It is [CU's] opinion that your actions in this case have clearly prejudiced it." (Appellant's Appendix, pp. 12a-13a.)

On the first day of trial, Wulfmeier unsuccessfully attempted to have the default judgment set aside. Settlement negotiations ensued between MP, CU, and Wulfmeier. The attorney representing CU stated that

"it is the position of the ... excess carrier that Medical Protective, by not offering its primary limits, is engaging in negotiations in bad faith, at least as far as we are concerned, and the circumstances of this litigation should be tendering its limits of Two Hundred Thousand Dollars toward any potential settlement.... It is the position of the excess carrier this case has a value of at least Two Hundred Thousand Dollars, no less than Two Hundred Thousand Dollars and under those circumstances, the limits of Medical Protective ought to be tendered to the excess carrier." (Appellee's Appendix, p. 9b.)

The attorney representing the Smiths stated that "[t]he plaintiffs never have been offered a nickel in this case." (Appellee's Appendix, p. 10b.)

The parties eventually entered into a settlement for $350,000. MP contributed $190,000, and Dr. Berman's estate contributed $10,000, toward MP's policy limit of $200,000. Cottage Hospital contributed $25,000, and CU contributed the remaining $125,000. (Appellee's Appendix, p. 39b.) The malpractice action was dismissed with prejudice on May 24, 1979.

CU filed the present action in March, 1980, alleging that "notwithstanding its duties and obligations ... [MP] was guilty of negligence and bad faith...." ¹ The trial court granted MP's motion for summary judgment on two grounds: 1) CU had no direct cause of action against MP, and 2) CU was estopped from maintaining its claim as the subrogee of its insured because of its participation in the settlement of the claim.

The Court of Appeals reversed, holding that 1) MP had a duty to act in good faith toward CU, and CU could claim breach of this duty directly or as the equitable subrogee of the insured; and 2) summary judgment was improperly granted, because factual questions were raised regarding whether MP had acted in good faith, whether Berman's action amounted to noncooperation, and whether MP reasonably relied on CU's participation in the settlement. Commercial Union Ins. Co. v. Medical Protective Co., 136 Mich.App. 412, 356 N.W.2d 648 (1984). In an order entered June 26, 1985, we granted leave to appeal. 422 Mich. 939.

II. EQUITABLE SUBROGATION

This Court held long ago that an insurer is liable to its insured for a judgment exceeding policy limits when the insurer, who has exclusive control of defending and settling the suit, refuses to settle within policy limits in "bad faith." City of Wakefield v. Globe Indemnity Co., 246 Mich. 645, 648, 225 N.W. 643 (1929). This cause of action originates in the implied covenant of good faith and fair dealing which arises from the contract between the insurer and the insured. Id., 650, 225 N.W. 643. Because no contract exists between a primary insurer and an excess insurer, courts have struggled to determine whether any sound theoretical basis exists for recognizing an excess insurer's cause of action against a primary insurer for failing to defend or settling in bad faith. A majority of courts recognize such a cause of action on the basis of equitable subrogation.

Equitable subrogation is a legal fiction through which a person who pays a debt for which another is primarily responsible is substituted or subrogated to all the rights and remedies of the other. It is well-established that the subrogee acquires no greater rights than those possessed by the subrogor, and that the subrogee may not be a "mere volunteer." Smith v. Sprague, 244 Mich. 577, 579-580, 222 N.W. 207 (1928); Foremost Life Ins. Co. v. Waters, 88 Mich.App. 599, 603, 278 N.W.2d 688 (1979), rev'd. on other grounds, 415 Mich. 303, 329 N.W.2d 688 (1982).

Where an insured does not carry excess insurance, the insured can become liable for any judgment exceeding primary coverage limits. Sutterfield, Relationships between excess & primary insurors [sic]: The excess judgment problem, 52 Ins Counsel J 638, 639 (1985). In such a situation, the insured has every incentive to enforce the primary insurer's contractual duty to defend or to attempt to...