By Stacy Broman and Danielle Dobry on April 11, 2018
Recently, the Colorado Court of Appeals in Preferred Professional Ins. Co. v. The Doctors Co., No. 17CA0405, 2018 WL 1633269 (Colo. Ct. App. Apr. 5, 2018) determined whether an excess insurer pursuing recovery under an equitable subrogation theory for a primary insurer’s failure to settle “steps into the shoes of the insured” and must plead the primary carrier’s bad faith. Preferred arose from an underlying medical malpractice suit. The court held that the derivative nature of equitable subrogation required the excess carrier to “step into the shoes of the insured” and plead a primary carrier’s bad faith refusal to settle. Because the excess insurer did not assert that the primary carrier acted in bad faith in refusing to settle underlying claims, the Colorado Court of Appeals reversed the lower court and remanded for entry of judgment of dismissal in the primary insurer’s favor.
In Preferred, the primary insurer defended the insured in the underlying suit. The primary policy provided a $1 million coverage limit and required the insured’s consent before accepting any settlement offers. However, the primary carrier had the discretion to accept or reject any settlement offer. The excess carrier covered any loss exceeding the primary policy’s limit up to an additional $1 million. The plaintiff in the underlying suit offered to settle the case with the insured for $1 million and the insured expressed his desire to settle. The primary insurer rejected the settlement. However, the excess insurer advised that the insured should accept the offer and paid its $1 million to settle the case. Thereafter, the excess insurer sued the primary insurer under an equitable subrogation theory to seek payment of the $1 million paid to settle the underlying suit.
The court first held that the excess carrier must proceed on a theory of equitable subrogation based on the rights of the insured in his contract with the primary carrier and therefore must “step into the insured’s shoes.” The court reasoned that equitable subrogation is derivative of the rights of the insured. The court further held that the excess insurer must plead the primary insurer’s bad faith refusal to settle. The court reasoned that the derivative nature of equitable subrogation held the excess carrier to the same requirements as the insured. The court further reasoned that under Colorado law the insured would be required to plead bad faith refusal to settle against its primary carrier and therefore, an excess insurer pursuing recovery under an equitable subrogation theory is held to the same standard.
While the Court of Appeals relied upon Colorado insurance law in its holdings, it also cited national case law in support of its position. The court recognized that other jurisdictions created an equitable subrogation remedy which required the excess carrier to be protected at least as much as the insured in its primary policy. See Twin City Fire Ins. Co. v. Country Mut. Ins. Co., 23 F.3d 1175, 1178 (7th Cir. 1994); Great Sw. Fire Ins. Co. v. CAN Ins. Co., 547 So.2d 1339, 1348 (La. Ct. App. 1989).
Further, the court cited to a national trend allowing an excess insurer to be equitably subrogated to the insured’s right to seek relief for a primary insurer’s alleged bad faith refusal to settle. See W. Am. Ins. Co. v. RLI Ins. Co., 698 F.3d 1069 (8th Cir. 2012); Nat’l Sur. Corp. v. Hartford Cas. Ins. Co., 493 F.3d 752 (6th Cir. 2007); Twin City Fire Ins., 23 F.3d at 1178; Hartford Accident & Indem. Co. v. Aetna Cas. & Sur. Co., 792 P.2d 749 (Ariz. 1990); Morrison Assurance Co., 600 So.2d at 1151; St. Paul Fire & Marine Ins. Co. v. Liberty Mutual Ins. Co., 353 P.3d 991 (Haw. 2015); Scottsdale Ins. Co. v. Addison Ins. Co., 448 S.W.3d 818 (Mo. 2014); Truck Ins. Exch. of Farmers Ins. Grp. v. Century Indem. Co., 887 P.2d 455 (Wash. Ct. App. 1995).
This national trend can be traced back to cases such as Northfield Ins. Co. v. St. Paul Surplus Lines Ins. Co., 545 N.W.2d 57, 60 (Minn. Ct. App. 1996) that recognized the excess insurer is subrogated to its insured’s rights against the primary insurer for breach of the good faith duty to settle. For instance, in St. Paul Fire & Marine Ins. Co. v. Liberty Mutual Ins. Co., the Hawaii Supreme Court held that an excess insurer can bring an action against a primary insurer under equitable subrogation because of the broad nature in which Hawaii state courts apply the doctrine “in line with the majority of jurisdictions.” St. Paul Fire & Marine Ins. Co. v. Liberty Mutual Ins. Co., 353 P.3d 991, 993 (Haw. 2015). Similarly, the court in Scottsdale Ins. Co. v. Addison Ins. Co. noted in its equitable subrogation holding the national case law trend permitting equitable subrogation claims by an excess carrier against a primary carrier. Scottsdale Ins. Co. v. Addison Ins. Co., 448 S.W.3d 818, 833 (Mo. 2014). Recent court decisions regarding equitable subrogation claims by an excess insurer against a primary insurer appear to rely at least in part on this body of case law.
Regarding the excess insurer’s requirement to plead and prove bad faith, the court in Preferred held that under Colorado law, “[t]he basis for tort liability is the insurer’s conduct in unreasonably refusing to pay a claim and failing to act in good faith, not the insured’s ultimate financial liability.” The court did not accept the primary insurer’s proposed bad faith test which would also require proof of the insured’s liability. See contra, Continental Cas. Co. v. Reserve Ins. Co., 238 N.W.2d 862 (Minn. 1976); Northfield Ins. Co., 545 N.W.2d 57. This holding highlights that while states may allow subrogation by a primary carrier against an excess carrier, bad faith claims are not well accepted.
The Preferred holding reinforces a checks and balances system between primary and excess carriers. Allowing an excess carrier to only show a reasonable, good faith belief it should make a payment to settle a claim would extinguish a primary carrier’s right to control the insured’s defense by surrendering all settlement power to the excess insurer. Further, it would encourage excess carriers to settle an insured’s claim within primary policy limits without consideration of damages or liability. While the Preferred holding reinforces the principle that primary insurers retain discretion to act reasonably in response to settlement offers, the excess insurer is prevented from using unrestrained discretion it does not have. Preferred appears to be in line with national case law.