Kransco v. AMERICAN EMPIRE SURPLUS LINES

• Decision Date: 22 June 2000
• Docket Number: No. S062139.,S062139.
• Court: California Supreme Court
• Parties: KRANSCO, Plaintiff and Appellant; International Insurance Company et al., Plaintiffs and Respondents, v. AMERICAN EMPIRE SURPLUS LINES INSURANCE COMPANY, Defendant and Appellant.

97 Cal.Rptr.2d 151

23 Cal.4th 390

2 P.3d 1

KRANSCO, Plaintiff and Appellant;

International Insurance Company et al., Plaintiffs and Respondents, v. AMERICAN EMPIRE SURPLUS LINES INSURANCE COMPANY, Defendant and Appellant.

No. S062139.

Supreme Court of California.

June 22, 2000.

As Modified July 26, 2000.

Thacher, Albrecht & Ratcliff, James F. Thacher, Arthur R. Albrecht, San Francisco, Frank E. Solomon; Quarles & Brady, W. Stuart Parsons, Milwaukee, WI, Kevin P. Crooks, Katherine H. Grebe; Irell & Manella and Thomas W. Johnson, Jr., Newport Beach, for Plaintiff and Appellant.

Anderson Kill & Olick, Jordan S. Stanzler, Deborah M. Mongan, San Francisco, and John A. MacDonald, Philadelphia, PA, for United Policyholders as Amicus Curiae on behalf of Plaintiff and Appellant.

James T. Linford, San Francisco, as Amicus Curiae on behalf of Plaintiff and Appellant.

Latham & Watkins, David L. Mulliken, Kristine L. Wilkes, Dorn G. Bishop and Julia E. Parry, San Diego, for Montrose Chemical Corporation of California as Amicus Curiae on behalf of Plaintiff and Appellant.

Carroll, Burdick & McDonough, Bertrand LeBlanc II, Donald T. Ramsey, David M. Rice, Rosemary Springer, San Francisco; Kravit Gass & Weber, J. Ric Gass, Janice A. Rhodes, Milwaukee, WI, Karen B. Goldberg, Santa Monica; Newman & Company and Thomas R. Newman for Defendant and Appellant.

Hancock Rothert & Bunshoft, Richard L. Seabolt, Eve F. Lynch and Robert M. Fineman, San Francisco, for London Market Insurers as Amicus Curiae on behalf of Defendant and Appellant.

Horvitz & Levy, Lisa Perrochet, Encino, and Stephanie Rae Williams for Truck Insurance Exchange and Allstate Insurance Company as Amici Curiae on behalf of Defendant and Appellant.

Engstrom, Lipscomb & Lack, Bolson, Nishimura & Saunders, Hahn Bolson & Mendelson, Jeffrey T. Bolson and Karen-Denise Lee, Los Angeles, for Plaintiffs and Respondents International Insurance Company and Transco Syndicate No. 1, Ltd.

Gibbons, Lees & Conley, Gibbons & Conley and Dolores M. Donohoe, Walnut Creek, for Plaintiff and Respondent Agricultural Excess and Surplus Insurance Company.

BAXTER, J.

Can a liability insurer assert the insured's "comparative bad faith" as an affirmative defense in a bad faith action brought against it for breach of the covenant of good faith and fair dealing? In this case a liability insurer breached its duty of good faith and fair dealing owed its insured manufacturer by unreasonably failing to settle an injured third party's action against the insured within policy limits, thereby exposing the insured to a verdict awarding the injured party compensatory and punitive damages far in excess of policy limits. On appeal the insurer did not contest the jury's finding of bad faith, but argued the insured's comparative bad faith and comparative negligence as a litigant in the underlying third party action was a contributing legal cause of the verdict and should reduce its liability for tort damages in the bad faith action.

The trial court initially accepted this argument, instructing the jury to determine if the insured itself breached its reciprocal duty of good faith and fair dealing toward the insurer or acted negligently in failing to exercise ordinary care as a litigant in the underlying third party action. The jury found the insured's conduct did contribute to the amount of the verdict in excess of policy limits and set the insured's comparative fault at 90 percent. The trial court thereafter decided it had erred in instructing the jury on comparative bad faith and comparative negligence and entered judgment notwithstanding the verdict in favor of the insured for the full amount of the insured's damages, without reduction for the insured's comparative fault as allocated by the jury. (Code Civ. Proc., § 629.)

Both the insurer and insured appealed on a number of grounds. As relevant here, the insurer sought reinstatement of the jury's verdict allocating fault and liability for damages. The Court of Appeal affirmed the judgment in its entirety. For reasons to be explained, we conclude a liability insurer cannot assert the comparative bad faith of its insured in the underlying third party litigation as an affirmative defense in a bad faith action brought against it.

I. FACTS

A. The Wisconsin Products Liability Litigation

In June 1987, 35-year-old Michael Hubert jumped headfirst onto his Wisconsin neighbor's backyard water slide toy known as a Slip `N Slide and broke his neck, rendering him a partial quadriplegic.<sup>1</sup> Hubert brought a personal injury action in Wisconsin against Kransco, the California corporation that manufactured the Slip `N Slide toy (the Hubert action).

Kransco tendered defense of the action to its Ohio-based primary liability carrier, American Empire Surplus Lines Insurance Company (AES), which had agreed to defend Kransco against personal injury actions in any state and indemnify it for all sums it became legally obligated to pay as damages up to $1 million, less Kransco's $100,000 self-insured retention. Kransco also had three layers of excess insurance above its AES primary insurance coverage: International Insurance Company (International) provided $2 million in excess of the $1 million primary coverage, Agricultural Excess and Surplus Insurance Company (Agricultural) provided the next layer of $1 million in excess of the $3 million, and Transco Syndicate No. 1 Ltd. (Transco) provided the last layer of excess insurance: $1 million in excess of the $4 million. In all, Kransco had $5 million in available liability coverage over and above its $100,000 self-insured retention.

During the discovery phase of the Hubert action, in response to an interrogatory by Hubert, Kransco denied knowledge of prior Slip `N Slide accidents that had resulted in cervical injuries to adults. Kransco later amended its response to admit knowledge of two such accidents. One accident had resulted in the user's death, the other had left the user a quadriplegic and resulted in a $1.5 million settlement against the corporation from which Kransco had purchased the rights to manufacture the Slip `N Slide. Kransco's amended response itself contained inaccurate information about the date of one of these accidents.

Hubert's action against Kransco was tried to a Wisconsin jury in April 1991. During the trial, Hubert offered to settle the action for $750,000, almost a million dollars less than his pretrial demand. Kransco approved settlement at that amount and tendered its $100,000 self-insured retention. Primary insurer AES, however, would contribute only $250,000 toward a settlement. AES rejected Hubert's $750,000 settlement offer and, given Kransco's willingness to contribute $100,000, and excess insurer International's willingness to contribute another $100,000, made a counteroffer of $450,000, which Hubert rejected. The jury ultimately returned verdicts awarding Hubert roughly $2.3 million in compensatory damages and $10 million in punitive damages.

In June 1991, while postverdict motions were pending in the Wisconsin trial court to reduce the unprecedented punitive damages award,² Kransco settled with Hubert. Kransco and its insurers paid Hubert $7.5 million. Of this amount, AES contributed its policy limits of $900,000 while objecting to the settlement as unreasonable because it thought the verdict likely would have been judicially reduced or set aside. Excess insurers International and Agricultural contributed their policy limits of $2 million and $1 million, respectively, and excess insurer Transco contributed $500,000, half its policy limit.³ Kransco paid the remaining $3.1 million from its own funds. At Hubert's insistence, Kransco stipulated to entry of judgment against it in the full amount of the jury verdict plus interest (approximately $12.5 million) but Hubert agreed not to execute on the judgment. Additionally, under the terms of the settlement Kransco agreed to prosecute a bad faith action against AES and to split equally with Hubert any net proceeds from the litigation (after deduction of litigation expenses and reimbursement of the subrogated excess insurers' cash settlement payments).

B. The California Bad Faith Litigation

Kransco initiated this bad faith action against AES in January 1992, alleging AES had breached the implied covenant of good faith and fair dealing by rejecting Hubert's offer to settle his lawsuit against Kransco for a sum within the AES policy limits despite a substantial risk of a verdict greatly in excess of those limits. Among other claims, Kransco sought recovery of $11.6 million, the amount by which the Hubert judgment exceeded the AES policy limits and Kransco's self-insured retention.⁴ AES answered with a general denial and the assertion of various affirmative defenses. As one affirmative defense, AES alleged that Kransco had "failed to exercise ordinary care for its own safety" and that "such failure on its part proximately contributed to and was the sole proximate cause of all the loss and damage complained of by [Kransco], if any there were." AES further alleged that "any recovery by [Kransco] is barred or limited by the unreasonable conduct and comparative bad faith actions of [Kransco] and/or its duly authorized agents and representatives with respect to the matters alleged in its First Amended Complaint herein."

At the trial of the bad faith action, AES argued that Kransco was itself largely at fault for the excess verdict (i.e., the large Hubert compensatory and punitive damages award) as a consequence of its having given false interrogatory answers during pretrial discovery in the Wisconsin products liability action. The Court of Appeal characterized the claim and relevant supporting facts as follows:

"Kransco submitted an incorrect interrogatory answer in the underlying Hubert action and AES contends that this act constituted breach of the covenant of good faith and fair dealing or negligence in handling the Hubert action. ...