During the pendency of the action the depositions of the Collinses were taken by one of the other defendants, although Allstate's representative was present at the time of the taking of the depositions. Depositions were also taken of Kaudern at which time Allstate's representative was present.
In February of 1962 a settlement conference was held before Judge Long of the Morris County Superior Court. This settlement conference occurred after Allstate had received a statement of the damages, medical reports, answers to interrogatories, and transcripts of the depositions. At the conference George Brown, Esq., an employee of Allstate, stated that Allstate would not contribute any amount to the settlement. Judge Long scheduled another settlement conference for March 2, 1962, but it was cancelled at the request of the attorney for the Collinses, when he was advised by Allstate that it still would not contribute anything to a settlement. Kaudern was never informed of the existence of these conferences.
On March 5, 1962, when it appeared that the case might soon reach trial, counsel for Collinses, Frank A. O'Brien, Esq., sent a registered letter to Marley, Winkelried & Hillis, the attorneys of record for Kaudern, offering to settle for $10,000,
which was, incidentally, Allstate's liability limit under its policy with Kaudern. No response was made by either Marley, Winkelried & Hillis or Allstate to this letter, nor did Marley, Winkelried & Hillis or Allstate communicate with Kaudern with respect to the receipt or contents of the letter.
Thereafter, the suits by the Collinses against Kaudern and the other defendants were consolidated for trial and scheduled for June 2, 1962. Just prior to trial the Collinses were offered $5,500 by Allstate, which was rejected. The case actually went to trial on June 14, 1962. Upon submission of the case to the jury, a verdict was rendered in favor of Mrs. Collins against Kaudern and co-defendant Pedro Melendez in the sum of $75,000, and a verdict was rendered in favor of Mr. Collins against Kaudern and Melendez in the sum of $100,000. Judgment was thereafter entered on each verdict. Melendez was and is without funds and his liability on the aforesaid judgment is not covered by any insurance.
Allstate's counsel appealed from the adverse decision against Kaudern to the Superior Court, Appellate Division, and that court unanimously affirmed the verdict. Subsequent to this affirmation, Allstate, on or about November 29, 1963, made a payment of $24,575 on the judgment against the plaintiff Kaudern, but declined to make any further payments thereon, despite demands by Kaudern. The payments consisted of $10,000 on the judgment, plus all interest that had accrued through the date when Kaudern's appeal was denied. As a result of Allstate's refusal to pay more than its $10,000 policy liability plus interest, the present action was commenced.
Jurisdiction of this court is based upon diversity of citizenship and an amount in controversy in excess of $10,000, pursuant to 28 U.S.C. § 1332. The cause of action presently before the court arose in the State of New Jersey and as such we must apply the law of that state under the mandate of Erie R.R. Co. v. Tompkins, 304 U.S. 64, 58 S. Ct. 817, 82 L. Ed. 1188 (1937).
In substance, plaintiff's complaint asserts that Allstate exercised bad faith in the preparation, investigation, and settlement negotiations surrounding the case of Collins against Kaudern, which resulted in a judgment against Kaudern greatly in excess of the limits of his policy with the insurer. Such an allegation states a justiciable controversy. See Atlantic City v. American Cas. Ins. Co., 254 F. Supp. 396 (D.N.J.1966); and Gaskill v. Preferred Risk Mut. Ins. Co., 251 F. Supp. 66 (D.Md.1966), aff'd. 371 F.2d 792 (4th Cir. 1967).
The area of the law involving insurers' liability for verdicts in excess of policy limit has been fraught with uncertainty from its inception. Two competing schools of liability have arisen, both recognizing the amenability of the insurer to suit, but disagreeing as to the standard of conduct chargeable to the company. These theories have been denominated the negligence theory and the good faith theory.
In Radio Taxi Serv. Inc. v. Lincoln Mut. Ins. Co., 31 N.J. 299, 157 A.2d 319 (1960), the New Jersey Supreme Court determined that the state, as a matter of policy, should adopt the good faith theory. In so holding the Court stressed the following elements of that theory, 31 N.J. at 304, 157 A.2d at 322:
[We] hold that the obligation assumed by the insurer with respect to settlement is to exercise good faith in dealing with offers of compromise, having both its own and the insured's interests in mind. And it may be said also that a reasonable diligent effort must be made to ascertain the facts upon which a good faith judgment as to settlement can be formulated.
The problems in this area arise from the standard clause in a liability insurance policy, present here, which provides that the insurer will defend in the name of and on behalf of the insured any claims for injuries to persons by reason of the operation of the motor vehicle owned by the insured. This clause naturally encompasses the negotiation of any settlement prior to trial.
The insurance company's obligation to defend in the name of the insured creates a conflict of interest on its part. On one hand, its interest lies in minimizing the amount of its payout; on the other, the insured's interest, which it is also supposedly defending, lies in keeping the plaintiff's award - however high - within the policy limits, so that he will not suffer any personal financial loss. The problem becomes most acute where there is a settlement offer which approximates the policy limits. The insured's desire to be free from uncertainty, regardless of the merits of the claimed injury, so long as the settlement offer is within the policy limits, would compel him, were he to be in charge of settlement negotiations, to accept the offer. The insurance company's interest, on the other hand, is prompted by its evaluation of the liability aspects of the litigation and a desire not to expose itself to payments which do not adequately reflect the dangers which might be involved in pursuing the case to trial. When a settlement offer is made which approaches the policy limits, it may be tempting for the insurance company - pursuing its own interest exclusively - to gamble on the outcome of a trial, their exposure not being considerably affected by a verdict substantially in excess of the coverage.
The New Jersey Supreme Court took cognizance of these competing interests in the Radio Taxi case, noting that during the process of settlement negotiations and assessments by the insurer, the company must have "both its own and the insured's interest in mind." 31 N.J. at 304, 157 A.2d at 322. Recognizing specifically the situation where the settlement offer approaches the policy limits the court went on to say that:
[In] interpreting the policy, the courts cannot allow the insurer to frustrate that purpose [the protection of the insured] by a selfish decision as to settlement which exposes the insured to and results in a judgment beyond the specific monetary protection which his premium has purchased.
Other jurisdictions having adopted the good faith rule have elucidated the manner in which the insurer must approach settlement questions which might arise. Pennsylvania has adopted a position very similar to that of New Jersey. In Bell v. Commercial Ins. Co., 280 F.2d 514, 515-516 (3rd Cir. 1960), the Court of Appeals for the Third Circuit, considering Pennsylania law, stated:
The view taken is that the insurer must accord the interest of its insured the same faithful consideration it gives its own interest: since the interest of one or the other may be imperiled at the instant of decision, the fairest method of balancing the interest is for the insurer to treat the claim as if it were alone liable for the entire amount. The insurer is not bound to submerge its own interest, but the decision to expose the insured to personal pecuniary loss must be based upon a bona fide belief by the insurer, predicated upon all of the circumstances of the case, that it has a good possibility of winning the law suit. The insurer does not have an absolute right to risk the insured's financial well-being; the insurer's obligation of good faith requires that the chance of finding non-liability be real and substantial and that the decision to litigate be honestly made.