Washington Court of Appeals, Division II, Will Consider the Propriety of a Settlement With a Covenant Not to Execute
Water’s Edge Homeowners Association v. Water’s Edge Associates, et al., Superior Court of the State of Washington for Clark County, Case No. 05-2-03446-1 (2008) is a good example of how, when allowed adequate discovery, an insurer was able to reveal to the court the true collusive nature of a covenant judgment between the insured and the injured party. The case is on appeal to the Washington Court of Appeals, Division II, Case No. 374153.
In Water’s Edge, a construction defect case, plaintiff Homeowners Association entered into a settlement agreement with the defendants, wherein defendants stipulated to entry of judgment in the amount of $8,750,000, which included a cash payment by defendants of $215,000. Plaintiff covenanted not to execute the judgment against defendants and defendants assigned to plaintiff the defendants’ rights under a bad faith suit against defendants’ insurers, and defendants’ rights under a malpractice suit against defense counsel. Defendants also retained the right to recoup from their insurers the $215,000 payment. The settling parties then sought a ruling on the reasonableness of the settlement in order to establish the presumptive damages in the bad faith suit against defendants’ insurers.
The insurers intervened to challenge the reasonableness of the settlement. Unlike some other cases in Washington where this has been done, however, the trial court allowed adequate discovery so the insurers could investigate the potentially collusive covenant judgment.
The Judge was clearly displeased by what he found to be a collusive arrangement that erodes the integrity of the adversarial system – and was in this instance orchestrated to the benefit of the settling parties in derogation of an insurer’s rights:
[T]he court has no confidence in the integrity of this settlement, and the court has grave concern that, as evidenced by the facts of this case, the use of such settlements with covenants not to execute has the potential to become a ‘cottage industry’ within the practice of law, undermining the respect owed to the honorable profession.
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When, in the context of an adversary proceeding, the parties, heretofore at odds, unite for the purpose of mutual benefit, and for the purpose of shifting the risk of loss to a third party, the truth’s protections inherent in a truly adversary proceeding are lost, and that confidence is eroded.
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Our Supreme Court has held that a statute which limits general damages in tort cases deprives a litigant of the right of a jury trial, in violation of the state constitution. It is not clear to me why the same could not be said of a judicial process which establishes presumptive damages in anticipation of bad faith litigation.
In the end, the Court concluded that $400,000, not $8,750,000, would be a reasonable settlement.
Briefing has yet to be filed, so a decision from the appellate court is likely more than a year away; but this is a case to watch.
