The Hammer Clause: Not the Solid Coverage Defense You Thought

By on November 21, 2016

Most professional liability policies contain the following or a similar provision addressing settlement by an insurer and an insured’s consent to the settlement.

[Insurer] shall…not settle any CLAIM without the written consent of the NAMED INSURED which consent shall not be unreasonably withheld. If however, the NAMED INSURED refuses to consent to a settlement recommended by [Insurer] and elects to contest the CLAIM or continue legal proceedings in connection with such CLAIM, [Insurer’s] liability for the CLAIM shall not exceed the amount for which the CLAIM could have been settled, including CLAIMS EXPENSES up to the date of such refusal, or the applicable limits of liability, whichever is less. Freedman v. United Nat’l Ins. Co., 2011 U.S. Dist. LEXIS 25490, *2; 2011 WL 781919 (C.D. Cal. Mar. 1, 2011) (emphasis added).

Under the first sentence, an insurer can negotiate settlement directly with a claimant. However, any resulting settlement is subject to the consent of the insured. If the insured refuses to consent, that refusal must not be unreasonable. The second sentence also gives the appearance that an insurer can negotiate with a claimant to achieve a settlement. Under this scenario, if the insured does not consent and the litigation continues against the insured, the insurer is not prejudiced because its exposure for loss ceases on the date of the insured’s refusal to consent. This provision often is referred to as the “hammer clause” because of the power it gives an insurer to enforce a settlement. Essentially, insurers believe they have some control over a recalcitrant insured.

That belief is misplaced. A further review of these two sentences elicits a suspicion that there is some ambiguity between the two. The first sentence expressly provides that the insured’s written consent is necessary to any settlement. The first sentence also clearly sets forth that the insured’s consent cannot be unreasonably withheld. In contrast, the second sentence does not address whether the insured’s consent must be reasonable.

The harmonious interpretation of these two sentences was at issue in Freedman v. United Nat’l Ins. Co., cited above. In Freedman, an attorney tendered a legal malpractice action to his professional liability carrier. The claimant offered to settle within the policy limits, but the defendant attorney refused because he believed the action lacked merit. After the insurer invoked the hammer clause, the attorney still declined to settle and filed an action against the insurer claiming the carrier acted in bad faith by settling the underlying suit, which had no merit, over his objection and without his consent. The insured attorney advanced the following interpretation of the above provision: (1) an insurer cannot settle without the insured’s consent, but the insured cannot unreasonably refuse to consent to settle; and (2) if the insured unreasonably refuses to consent to settle, then the insurer’s liability is limited to the amount for which the insurer would have settled plus the cost of the defense up to the date of the insured’s refusal. Essentially, the insured argued that the insurer could rely on the hammer clause only if the insured’s refusal to consent was unreasonable. Conversely, the insurer in Freedman argued that the two sentences actually are separate clauses. The parties’ disagreement arose over whether the second sentence, standing alone, allows an insurer to limits its liability when an insured refuses to consent to a settlement, regardless if that refusal is reasonable. The court sided with the insured and held the policy was not ambiguous and the hammer clause may be invoked only if the insured unreasonably refuses to consent to a settlement.

The Freedman court based its ruling on a decision from the Court of Appeals for the First Circuit in Clauson v. New England Ins. Co., 254 F.3d 331, 337-38 (1st Cir. 2001). In Clauson, the insured attorney refused multiple offers to settle a malpractice action filed against him. The underlying action involved the attorney’s failure to attend a hearing in which a martial asset his client used for business was sold. After the client filed a malpractice suit against the insured, the client made several offers to settle during the pendency of the action which the insured rejected. The insurer twice informed the attorney that his refusal to settle was unreasonable and invoked a clause similar to that in Freedman which limited the insurer’s exposure to the amount of the rejected settlement. After judgment was entered against the insured in excess of the offers, the client filed a declaratory action against the insurer to recover the amount of the judgment in excess of the settlement offer the insurer previously had agreed to pay. The trial court held that the insured was reasonable when he refused to consent to settle, and thus, the provision limiting the insurer’s exposure did not apply. The Court of Appeals affirmed the trial court’s ruling that the hammer clause did not apply, and thus, the insurer was liable for the total judgment against its insured.

Pragmatically, the hammer clause is a provision which is intended to limit an insurer’s liability when an insured refuses to consent to a settlement. However, recent case law has eroded that veneer and revealed that the coverage defense actually rests on the conduct of the insured; specifically, whether the insured’s refusal to settle is unreasonable. Based upon the case law, the merits of the case and a legitimate settlement value alone may not determine if an insured acts unreasonably in refusing consent.

Filed under Consent to Settle, Professional Liability

Oregon Supreme Court Bars Plaintiff From Executing on Covenant Judgment Against the Defendant’s Insurer

By on October 26, 2015
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The Oregon Supreme Court recently answered a question certified to it by the Ninth Circuit Court of Appeals, which asked whether a settlement agreement that released an insured from liability could be amended to revive the liability of the insured so that the plaintiff could seek recovery from the insurer. The Oregon Supreme Court concluded that, based upon the theory presented by the plaintiff, the settlement agreement could not be amended. A&T Siding v. Capitol Specialty Insurance Corp., ___ Or. ___ (Oct. 8, 2015)

The case arose out of a lawsuit by the Brownstone Homes Condominium Association related to construction defects in the condominium complex, which Brownstone alleged were caused in part by A&T Siding. Capitol Specialty and Zurich insured A&T for the relevant time period. Capitol initially defended A&T, but withdrew its defense when it concluded that the damage alleged by Brownstone was not covered.

Brownstone later settled with A&T via a “covenant judgment.” Under the agreement, judgment would be entered against A&T for $2 million and Zurich would pay $900,000 of that judgment. A&T agreed to assign its rights against Capitol to Brownstone, and Brownstone covenanted not to execute the judgment against A&T or its assets. Instead they agreed that Brownstone would be entitled to seek recovery of the unexecuted portion of the judgment from Capitol. The parties also agreed to release each other from “all past, present and future claims” arising out of the dispute.

Brownstone then began garnishment proceedings against Capitol for the unpaid portion of the judgment. Capitol moved for summary judgment, arguing that because the settlement agreement released A&T from all liability, Capitol was likewise released from liability. The trial court agreed and entered judgment in Capitol’s favor. The court relied in part upon its decision in Stubblefield v. St. Paul Fire & Marine, 517 P.2d 262 (1973), which also involved a covenant judgment. The settlement agreement in Stubblefield excused the insured from any obligation to pay the judgment, and the insurance policy limited the insured’s coverage to sums the insured was “legally obligated” to pay. The court therefore held the underlying plaintiff had acquired no enforceable claims or rights against the insurer under the assignment.

Following the entry of judgment, Brownstone and A&T executed an “addendum” to their settlement agreement. Among other things, the addendum eliminated the original assignment to Brownstone of A&T’s claims and required A&T to pursue those claims itself under Brownstone’s direction and at Brownstone’s expense. The addendum also replaced the original unconditional release of all parties with a release only of Zurich.

A&T then sued Capitol and the case eventually found its way to the Ninth Circuit, which certified the following question to the Oregon Supreme Court:

The parties’ original settlement agreement, under which [Brownstone] released A&T from liability and signed a covenant not to execute the stipulated judgment against A&T, was construed pursuant to Stubblefield * * * to also release A&T’s insurer, [Capitol] from liability. The parties to the agreement assert that such a construction is contrary to the parties’ intent. Under Oregon law, may the parties amend their settlement agreement to reflect their original intent, and thereby restore the insurer’s duty to provide coverage for A&T’s resulting liability to the extent its policy provides coverage for the loss alleged by Brownstone?

The Oregon Supreme Court accepted the certified question. Capitol argued that Brownstone originally released A&T from any liability and that the addendum they created could not undo that release in the absence of the trial court rescinding or reforming the settlement agreement. A&T argued that it and Brownstone did not intend for the language in the original settlement agreement to have the legal effect the trial court gave it. It further argued that the parties reformed the original settlement agreement when they created the addendum, even though they did not call on the equitable authority of a court to reform the agreement. A&T therefore argued that the addendum should relate back to the original settlement agreement.

The Oregon Supreme Court rejected A&T’s argument. It did not reach the question of whether A&T and Brownstone could privately reform the contract without court approval. Instead it concluded among other things that A&T and Brownstone were not entitled to the equitable remedy of reformation based on A&T’s “mistake of law” argument that the language in the original agreement had unintended consequences. Accordingly, the insured and plaintiff could not reform the original settlement agreement.

The court left open the possibility that other legal or equitable theories not argued by the parties might justify treating the addendum as relating back to the original settlement agreement, though it did not explain what those theories might be. It is clear, however, that Stubblefield remains the law in Oregon. Insurers faced with a settlement agreement and covenant judgment in Oregon should always examine the settlement documents carefully to determine whether the agreement releases the insured from all liability. In such a case the insurer may have a strong argument that it is not obligated to fund the settlement.

Filed under Commercial General Liability, Consent to Settle, Covenant Judgments, Garnishment Proceeding, Reformation