U.S. Fire Ins. Co. v. Royal Ins. Co.

• Decision Date: 13 May 1985
• Docket Number: No. 84-1379,84-1379
• Citation: 759 F.2d 306
• Parties: UNITED STATES FIRE INSURANCE COMPANY v. ROYAL INSURANCE COMPANY, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 306

759 F.2d 306

UNITED STATES FIRE INSURANCE COMPANY v. ROYAL INSURANCE COMPANY, Appellant.

No. 84-1379.

United States Court of Appeals Third Circuit.

Argued Feb. 7, 1985.

Decided April 16, 1985.

Rehearing Denied May 13, 1985.

Stephen A. Cozen (Argued), Jeanne P. Wrobleski, Cozen, Begier & O'Connor, Philadelphia, Pa., for appellant.

Joseph P. Selfridge (Argued), James J. McEldrew, McEldrew, Hanamirian, Quinn & Scace, Philadelphia, Pa., for appellee.

Before GARTH, BECKER and ROSENN, Circuit Judges.

OPINION OF THE COURT

ROSENN, Circuit Judge.

This is a case of considerable importance because of the questions it poses with respect to the operations of the liability insurance industry of this country. It explores for the first time by this court the question of the duty owed by a primary insurance carrier under Pennsylvania law to an excess carrier. It also raises the question of whether the primary carrier acted in bad faith by refusing to tender its policy limits in an attempt to achieve a settlement when a "high-low" settlement approved by both was reached; where both the primary and excess carriers agreed that there was a substantial chance of winning the underlying litigation; and where neither the plaintiff nor the insured itself demanded that the primary carrier settle within the policy limits.

United States Fire Insurance Co. (Fire), the excess carrier, won a verdict in the United States District Court for the Eastern District of Pennsylvania against Royal Insurance Company (Royal), in which a jury found that Royal acted in bad faith in refusing to tender its policy limits during the defense of a prior products liability action. The court had denied Royal's prior motions for a directed verdict and entered judgment on the verdict. Royal appeals and we reverse.

I.

On December 31, 1977, a fire damaged a food plant in Philadelphia owned by Ready Food Products, Inc. (Ready Foods). Ready Foods, one of its employees, and the Ex-Cell-O Corporation brought a products liability suit for damages resulting from the fire against the Nordson Corporation (Nordson), the manufacturer of a solvent which allegedly caused the fire. Nordson carried liability insurance with two separate carriers: Royal, the primary carrier, insured Nordson in the amount of $250,000 and Fire, as Nordson's excess carrier, provided insurance in the amount of $5,000,000.

When the claims against Nordson arose in 1978, Royal retained David Steck as counsel. Fire's claims supervisors became involved in the case in January 1980 and Fire's attorney, Paul Bechtel, entered the case the following December. Royal's counsel conducted the pre-trial preparation and trial proceedings in collaboration with Bechtel, and it is undisputed that Steck performed in a competent and satisfactory manner.

Trial in the Nordson litigation began on May 4, 1981. On that day, the plaintiffs offered to settle the case for $1,200,000. Both carriers agreed that the offer should be rejected out of hand. Royal rejected the offer and made a counter-offer of $75,000-$80,000, which the plaintiffs in turn refused.

The trial judge next advised Steck and Bechtel that $800,000 would settle the case, the attorneys for the plaintiffs in the Nordson case, having been authorized to accept $800,000. Again, both carriers concluded that this offer should also be rejected and neither Royal nor Fire responded to it. By the time the plaintiff's case was concluded, it seemed to both Bechtel and Steck that the defense was going very well. Bechtel advised his client, Fire, that in his estimation the defendants had an eighty percent chance of winning the case. Based on their estimation of the weakness of plaintiff's case, Steck and Bechtel decided not to call any witnesses for the defense.

On May 11, after the close of the evidence, the trial judge informed counsel for Royal and Fire that he had the "impression" that $400,000 would settle the case. Bechtel later testified in these proceedings that he too suspected that $400,000 would have settled the case, but he could not recall the source of his belief. In any event, he communicated his "suspicion" to Fire's home office. Fire's claims supervisor in turn informed his superior that plaintiffs had made a demand for $400,000. Fire thereupon sent a letter to Royal demanding that Royal tender its policy limits of $250,000 to settle the case for $400,000 and advising Royal that if it failed to do so, Fire would consider such failure to be in bad faith. Plaintiff's attorneys, however, testified that in fact they never offered to settle for $400,000, and that they would not have settled for that amount.

As an alternative, the district court recommended to the parties a "high-low" settlement arrangement under which plaintiffs would receive $65,000 if they lost the suit, and no more than $750,000 if they won. Royal expressed approval of this arrangement. Plaintiffs were unwilling to accept these figures, but suggested $100,000 if they lost and $1,000,000 if they won.

Royal accepted the "high-low" settlement plan because in Steck's opinion the defense had a substantial chance of winning the case. There is substantial evidence that Nordson, the insured, also believed the case should be tried to a conclusion. Ultimately, Royal accepted the "high-low" $1,000,000/$100,000 counter-offer arrangement proposed by the plaintiffs. Fire concurred in this arrangement. Thus, Fire's potential liability became reduced by several strokes of a pen from $5,000,000 to $1,000,000, and if the defense were successful, it would not be required to pay anything. However, Royal obligated itself to pay $100,000 even if the plaintiff lost. Nonetheless, Fire refused to withdraw its bad faith letter to Royal.

The Nordson litigation went to trial, and the jury returned a verdict in favor of plaintiffs. Judgment was entered on the verdict against Nordson in the amount of $1,000,000, with Royal required to bear $250,000 and Fire to pay $750,000. Fire thereupon sued Royal for $600,000, the difference between the $150,000 it would have paid had the case been settled for $400,000 and the $750,000 it actually paid. The suit rested on two theories of liability, alleging (1) direct liability to it on the basis of negligence in the settlement negotiations, and (2) that Royal breached a legal duty to Nordson to exercise good faith in the settlement negotiations with the plaintiffs in the underlying action. The jury found in favor of Fire and Royal appeals.

II.

The primary question raised by Royal on appeal is whether a primary carrier is obligated to tender its full policy limits to settle a case based upon a demand only made by the excess carrier in litigation in which both carriers believe there is a substantial probability that their insured will obtain a favorable verdict, and where the plaintiff has made no demand for settlement within primary limits. ¹ It is well settled under Pennsylvania law that although there is no absolute duty on the insurer to settle a claim when the judgment against the insured may exceed the amount of the insurance coverage, an insurer is required to "consider in good faith the interest of the insured as a factor in coming to a decision as to whether to settle or litigate a claim against the insured." Cowden v. Aetna Casualty and Surety Co., 389 Pa. 459, 470, 134 A.2d 223, 228 (1957). ²

Many courts have applied this requirement to the relationship between a primary carrier and an excess carrier through the doctrine of equitable subrogation. ³ See, e.g., Valentine v. Aetna Insurance Co., 564 F.2d 292, 296-97 (9th Cir.1977). No Pennsylvania state court, however, has so extended this duty. Therefore, we must consider, first, whether the Pennsylvania Supreme Court would apply the doctrine of equitable subrogation in the instant case.

The basic idea of subrogation is that of substituting the insurance carrier for the insured in the insured's action against a third party. Anderson v. Borough of Greenville, 442 Pa. 11, 16, 273 A.2d 512, 514 (1971), citing Home Owner's Loan Corp. v. Crouse, 151 Pa.Super. 259, 30 A.2d 330 (1943). "Subrogation is an equitable doctrine and is applicable whenever a debt or obligation is paid from the funds of one person although primarily payable from the funds of another." Anderson, 442 Pa. at 16, 273 A.2d at 514.

This doctrine is readily applicable to the situation presented by the instant case in which the insured "purchase[d] excess coverage, [effectively substituting] an excess insurer for himself. It follows that the excess insurer should assume the rights as well as the obligations of the insured in that position." Centennial Insurance Co. v. Liberty Mutual Insurance Co., 62 Ohio St.2d 221, 223, 404 N.E.2d 759, 761 (1980), quoting Continental Casualty Co. v. Reserve Insurance Co., 307 Minn. 5, 8-9, 238 N.W.2d 862, 864 (1976). We are convinced and therefore hold that Pennsylvania courts would rule that an excess insurer who has discharged an insured's liability stands in the shoes of the insured and as subrogee may maintain an action for breach of the primary carrier's duty to act in good faith. See Puritan Insurance Co. v. Canadian Universal Insurance Co., 586 F.Supp. 84, 87 (E.D.Pa.1984).

Having concluded that Fire may maintain the present action, we must next determine whether Royal breached its duty of good faith. Under Pennsylvania law, the insured must prove bad faith on the part of the primary by "clear and convincing evidence." Cowden, 389 Pa. at 472, 134 A.2d at 229; LaRocca v. State Farm Mutual Automobile Insurance Co., 329 F.Supp. 163, 169 (W.D.Pa.1971), aff'd 474 F.2d 1338 (3d Cir.1973). Clear and convincing evidence has been defined as follows:

"[The witnesses'] testimony [must be] so clear, direct, weighty and convincing as to enable the jury to come to a clear conviction, without hesitancy, of the truth of the precise facts in issue...."

In re Estate of Fickert, 461 Pa. 653, 658, 337 A.2d...