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March 2017

Ninth Circuit Applies Diamond Heights Framework to Excess Insurer’s Duty to Settle Under California Law

In Teleflex Medical Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2017 U.S.App.LEXIS 4996 (9th Cir.  March 21, 2017), the Ninth Circuit Court of Appeals ratified a district court’s application of the California appellate court’s decision in Diamond Heights Homeowners Ass’n v. Nat’l Am. Ins. Co. (1991) 227 Cal.App.3d 563 (“Diamond Heights”), agreeing that an excess insurer presented with a proposed settlement for covered claims that has been approved by the insured and primary insurer but invades its excess limits has three options: approve the settlement; reject the settlement and assume the defense of the insured; or reject the settlement, decline the defense and face a potential lawsuit by the insured seeking contribution. 

The underlying claims in Teleflex involved two rival medical device manufacturers. LMA filed suit seeking recovery of damages for patent infringement and the competitor filed counterclaims for trade disparagement and false advertising. After several years of litigation, the parties attended a two day mediation where a settlement was reached, subject to LMA obtaining consent and funding from its primary and excess insurers.  As part of the conditional settlement, LMA agreed to pay $4.75 million for the disparagement claims and LMA’s competitor agreed to pay $8.75 million for the patent claims. 

LMA maintained a primary liability policy issued by CNA and an excess policy issued by National Union.  The National Union policy included a “no voluntary payments” clause which provided that “no insured will except, at their own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without [National Union’s] consent.”  The National Union policy also contained a “no action” clause that stated that “[t]here will be no right of action against us under this insurance unless … [t]he amount you owe has been determined with our consent or by actual trial and final judgment.” 

CNA defended LMA and agreed to contribute its full $1 million limit of liability towards the settlement.  National Union was provided daily updates during the mediation and over the following months, several reports regarding the claims and excess exposure faced by LMA.  Ultimately, LMA demanded a response from National Union, advising that its options were to: (1) accept the settlement; (2) reject the settlement and take over the defense; or (3) reject the settlement and refuse to undertake the defense, leaving LMA the option of pursuing contribution.  After, National Union declined to approve the settlement, LMA went forward with the settlement.  Three days after the settlement was executed, National Union agreed to fund LMA’s defense if it could un-do the settlement agreement.  LMA stated the settlement could not be un-done and alleged National Union had acted in bad faith.

LMA then brought suit against National Union for breach of contract and breach of the implied covenant of good faith and fair dealing.  National Union filed a motion for summary judgment arguing that the no voluntary payments and no action clauses gave National Union an absolute right to reject the settlement.  The district court denied the motion based upon the Diamond Heights decision.  The case proceeded to trial and the jury awarded LMA damages for breach of contract and bad faith. 

On appeal, National Union argued that Diamond Heights was effectively overruled by Waller v. Truck Ins. Exch. (1995) 11 Cal.4th 1, where the California Supreme Court held that an insurer can only waive a policy defense through an intentional relinquishment of a known right.  National Union argued that application of the Diamond Heights rule was inconsistent with Waller, because it had not intentionally waived the “no voluntary payments” and “no action” clauses.  Rejecting this argument, the Ninth Circuit noted that the Waller decision did not mention Diamond Heights and only reiterated California’s general waiver principles that existed prior to Diamond Heights.  The Court further noted that consistent with this interpretation, two post-Waller decisions by the California Court of Appeal had applied Diamond Heights.    

The Court also concluded that Diamond Heights and Waller were reconcilable because the rule in Diamond Heights addressed an insurer’s breach of a contractual or implied obligation; and thus, did not offend the court’s ruling in Waller, which addressed the expansion of a policy beyond the parties’ intent and reasonable expectations.

With respect to the appropriate burden of proof, the court held the insured is required to demonstrate, by a preponderance of the evidence, that: (1) the insurer wrongfully failed or refused to provide coverage or a defense; (2) the insured entered into a settlement that was reasonable in the sense that it reflected an informed and good faith effort to resolve the claim; and (3) the insurer was afforded a reasonable opportunity to undertake the defense in order to avoid settlement.  The burden then shifts to the excess insurer to show, by a preponderance of the evidence, that it was not provided with a reasonable opportunity to evaluate the settlement and undertake the defense or that the settlement was a product of fraud or collusion. 

The Ninth Circuit further held that the trial court was correct in declining to provide a jury instruction on the genuine dispute doctrine, stating that it was skeptical about its applicability to third party claims and reasoning that the doctrine was subsumed within the standard jury instruction for breach of good faith and fair dealing set forth in CACI  2331.  The Court also rejected the notion that, as a matter of law, National Union acted reasonably because of a genuine dispute over the applicability of Diamond Heights, because those arguments had been made to and rejected by the jury.

Finally, the court held that an insured’s entitlement to recover fees under Brandt v. Superior Ct. (1985) 37 Cal.3d 813, did not extend to fees attributable solely to bad faith and related punitive damages claims.

Click here for the opinion.

This opinion is not final.  It may be withdrawn from publication, modified on rehearing, or review may be granted.  These events may render the opinion unavailable for use as legal authority in California state courts.