Puritan Ins. Co. v. Canadian Universal Ins. Co., Ltd.

• Decision Date: 15 October 1985
• Docket Number: No. 85-1002,85-1002
• Citation: Puritan Ins. Co. v. Canadian Universal Ins. Co., Ltd., 775 F.2d 76 (3rd Cir. 1985)
• Parties: PURITAN INSURANCE COMPANY, Appellee, v. CANADIAN UNIVERSAL INSURANCE COMPANY, LTD., d/b/a Canadian Universal Insurance Company, Inc., Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 76

775 F.2d 76

PURITAN INSURANCE COMPANY, Appellee, v. CANADIAN UNIVERSAL INSURANCE COMPANY, LTD., d/b/a Canadian Universal Insurance Company, Inc., Appellant.

No. 85-1002.

United States Court of Appeals, Third Circuit.

Argued Aug. 13, 1985.

Decided Oct. 15, 1985.

Steve A. Cozen (argued), Miles A. Jellinek, Richard C. Bennett, Cozen, Begier & O'Connor, Philadelphia, Pa., for appellant.

Lawrence M. Silverman (argued), Joel D. Rosen, Astor, Weiss & Newman, Philadelphia, Pa., for appellee.

Before ADAMS, GIBBONS, and WEIS, Circuit Judges.

OPINION OF THE COURT

WEIS, Circuit Judge.

An insurance company which had issued an excess policy received a judgment against the primary carrier because of its failure to settle a claim that had resulted in an unfavorable verdict against their common insured. On this appeal we hold that under applicable Pennsylvania law an excess insurer's rights against a primary carrier are based on equitable subrogation to those of the insured. When the decision to try, rather than settle, a personal injury suit is approved by the insured, neither it nor the excess insurer may recover from the primary carrier when the verdict exceeds the primary policy limits. Since the record demonstrates that to be the situation here, we will reverse the district court's judgment.

After a nonjury trial, the district court found that by failing to settle a claim against its insured, defendant primary carrier had acted in bad faith. Plaintiff, as excess insurer, was therefore entitled to a judgment for the sums it had paid over and above primary coverage. Defendant has appealed.

This case had its genesis in a products liability suit brought by Ricky Donahue against the Northwest Engineering Company. Donahue was seriously injured when the boom of a crane manufactured by Northwest fell on him. The case was tried in early 1981 and resulted in a verdict against Northwest in the amount of $1,413,152.35, which was later settled for $1,375,000.

At the time of the accident, defendant Canadian Universal Insurance Company insured Northwest under a primary liability policy with upper limits of $500,000 but subject to a $100,000 deductible. Plaintiff Puritan Insurance Company had issued a separate policy to Northwest with limits of $5,000,000 but excess to that of the primary carrier.

The Donahue trial was bifurcated. Before trial, Canadian refused to offer the $500,000 policy limit but did make such a tender after the jury had found Northwest liable. After settling the case, Puritan sued Canadian for the $850,000 expended above the primary limit and sought punitive damages as well.

In the Donahue litigation, the plaintiff's theory was that the operator of the crane, while turning in his seat to operate a control located behind him, inadvertently hit a pedal which released the boom causing it to fall. Donahue's claim was based on an allegation of design defect attributable to the failure of the manufacturer to provide a guard that would prevent accidental contact with the boom release pedal. The operator of the crane, however, insisted that he had not touched the pedal and disclaimed any responsibility for the accident. No other mishaps had occurred before or after the accident, and the crane was put back in service without any repairs or modifications.

At the Donahue pretrial conference, the trial judge ¹ suggested a settlement in the amount of $600,000. Neither of the parties had submitted any figures to each other before that point.

Canadian convened a claims committee consisting of a state judge, two vice presidents, the claims manager, assistant claims manager, claim superintendent, and the claims examiner in charge of the case. ² The case summary submitted to the committee contained a verdict range of approximately $1,000,000, a demand of $600,000, and a settlement range of $300,000 to $400,000. The committee decided that the case was one of "no liability," i.e., no offer should be made and the case should be tried. Although he never communicated his decision to Canadian, its counsel, or the trial judge, Donahue's lawyer had concluded that if an offer of $400,000 were made, he would recommend that figure to his client.

About six months before the trial, Puritan's counsel wrote to Canadian, pointing out the dangers of the case, and urged negotiations with Donahue's lawyer. On receiving this letter, Canadian reconvened its claims committee, which held to its previous decision. After that recommendation, the trial lawyer Canadian had retained to defend the Donahue case sent a letter to Northwest's private counsel, advising him of the possibility of an excess verdict. Documentary evidence in the record establishes that Northwest persisted in its belief that the case should be tried and so advised Canadian.

Donahue's lawyer had been informed that Canadian considered the case one of no liability and, based on this statement, submitted no demand for settlement.

In making its findings in the litigation at hand, the district court concluded that the Donahue case had been thoroughly investigated, and at the time of trial the relevant facts were known. The parties realized that the issue would be submitted to the jury and that the injuries were serious. According to the district court, "there were virtually no defenses available" and "there was no alternative theory" to be presented by Northwest. In those circumstances, the district court held that Canadian had an affirmative duty to explore settlement possibilities and that a demand from Donahue was not a prerequisite to liability for bad faith.

The court further concluded that after the Donahue pretrial conference, the rigid stance of "no liability" was "evidence of a demonstration of bad faith," which had been established by "a clear preponderance of the evidence and by evidence that was also clear and convincing."

Puritan, as excess insurer, was found by the court to be "equitably subrogated as to any rights Northwest has against Canadian." In addition the court held that Canadian "as the primary insurer owes a direct duty to the plaintiff Puritan." The court entered judgment for the amount Puritan had expended but denied punitive damages and counsel fees.

On appeal, defendant contends that the district judge erred in applying an improper standard to determine the duty of the primary carrier and in failing to interpret properly the doctrine of equitable subrogation. Plaintiff argues that a primary carrier has an affirmative duty to initiate settlement discussions and that it owes a direct duty to an excess carrier.

The relationship between the primary and excess carrier is an unusual one; each has a separate contract with the insured, but they have none with each other. Conflicts of interest invariably arise when the underlying tort injury is of such severity that a recovery over the limits of the primary policy is possible. In that circumstance, the excess carrier wishes the primary insurer to dispose of the case within its limits and is not unduly impressed with the primary insurer's desire to save some or all of its policy limits by a favorable verdict at trial. Conversely, the primary carrier is unlikely to have such paternalistic feelings as will induce it to concede its limits when there is some chance of obtaining a favorable verdict. In each instance, one carrier is to some extent gambling with the other's money. See generally, Lanzone and Ringel, Duties of a Primary Insurer to an Excess Insurer, 61 Neb.L.Rev. 259 (1982).

The obligations of the carriers to the insured are somewhat different. Because it has a duty to defend the insured and on average most claims are within its limits, the primary carrier charges a larger premium for an equivalent amount of coverage. In addition, the primary's policy generally gives it the right to decide when a claim shall be settled or tried.

Because of its less frequent exposure, the excess carrier generally charges lower premiums. Its obligation does not arise until primary limits are exhausted, and to some extent the excess carrier is at a disadvantage in dealing with a tight-fisted and overly optimistic primary carrier, which has greater control over settlement. To gain increased leverage, excess insurers frequently resort to use of the "bad faith letter"--an epistle sent to the primary carrier demanding settlement within primary limits and warning that failure to do so will be interpreted as evidence of bad faith.

The insurance industry has long recognized the unsatisfactory nature of the relationship between primary and excess carriers. Attempting to ease some of these tensions, in 1974 the Claim Executive Council of the American Insurance Association, the American Mutual Insurance Alliance, and some unaffiliated insurers proposed and adopted a set of guiding principles to govern relationships between primary and excess carriers. However, very few companies ultimately subscribed to these principles. See Magarick, Excess Liability, Sec. 14.09 (2d ed. 1982).

As we have pointed out in other cases, the insurance industry has available to it a system of inter-company arbitration where disputes such as the one at hand can be resolved by arbitrators thoroughly experienced in the complexities of insurance policies and practice. See Insurance Co. of North American v. Continental Casualty Co., 575 F.2d 1070 (3d Cir.1978). Despite these alternatives, the industry has been unable to resolve its internal disputes and instead submits them to the vagaries of state law. To no one's surprise, the results have been less than uniform.

The parties concede that the law of Pennsylvania applies but the state appellate courts have not yet faced the legal issue presented here. We must therefore grope our way through the flickering Erie light in an effort to predict what Pennsylvania would decide in a case such as this. There are some guideposts.

After the district court entered judgment in this case, we decide...