For affirmance -- Chief Justice Hughes, Justices Sullivan and Pashman and Judge Kolovsky. For reversal -- Justices Mountain and Clifford and Judge Conford. The opinion of the court was delivered by Kolovsky, P.J.A.D., Temporarily Assigned. Clifford, J. (dissenting). Justice Mountain and Judge Conford join in this opinion.
The malpractice liability insurance policy issued by defendant insurance company includes the following provisions with respect to malpractice claims asserted or suits instituted against its insured:
"* * * the company may make such investigation and, with the written consent of the insured, such settlement of any claim or suit as it deems expedient.
The insured shall cooperate with the company and, upon the company's request, assist in making settlements, in the conduct of suits, * * *. The insured shall not, except at his own cost, voluntarily make any payment, assume any obligation or incur any expense.
No action shall lie against the company unless, as a condition precedent thereto, the insured shall have fully complied with all the terms of this policy, nor until the amount of the insured's obligation to pay shall have been finally determined either by judgment against the insured after actual trial or by written agreement of the insured, the claimant and the company, * * *."
The principal question presented on this appeal is the effect, in any, to be given to those provisions in a situation in which it appears that: (a) the potential award against the insured is far in excess of the policy limits; (b) the plaintiffs in the malpractice action have offered to settle for an amount greater than the policy limits but much less than the amount of their potential recovery; and (c) the insured reasonably concluded that the settlement offer should be accepted and that the insurance company, in refusing to
contribute its policy limits to the settlement, is acting in bad faith -- a fact established in the later action instituted on the insured's behalf against the insurance company.
Both the trial court and the Appellate Division rule, in unreported opinions, that in such circumstances the insured may proceed to effectuate a reasonable good faith settlement for an amount in excess of the policy limits and, upon proof of the insurer's bad faith, may recover from it the amount of its policy limits even though no judgment had been entered in the malpractice actions against the insured. That ruling is challenged by defendant in its appeal to this court upon certification granted. 68 N.J. 143 (1975). On plaintiff's appeal, upon certification also granted, 68 N.J. 278 (1975), it seeks a reversal of the Appellate Division's affirmance of the trial court's refusal to award it punitive damages.
The instant litigation stems from two malpractice actions which had been instituted against a firm of attorneys who had represented a limited partnership and a corporation. The plaintiff in one of the actions was the receiver of the limited partnership. The plaintiffs in the second action were the directors of the corporation who had been named as defendants in an action in the Chancery Division instituted by the receiver.
It is conceded that primary insurance coverage to the extent of $50,000 was afforded to the law firm (the insureds) with respect to those malpractice claims under a lawyer's professional liability policy issued by New Amsterdam Casualty Company, a predecessor of defendant Security Insurance Company of Hartford (Security). A similar policy issued by plaintiff Fireman's Fund Insurance Company (Fireman's) afforded excess coverage to the law firm to the extent of $250,000. Both insurance companies designated one attorney to defend the malpractice actions on behalf of their insured.
Shortly before those actions were to come to trial, the plaintiffs therein expressed a willingness to settle for
$147,000. Defendant refused to settle or to contribute the $50,000 limit of its policy toward the required settlement amount -- this despite the request of its insured and the recommendation of the trial attorney and of Fireman's that it do so.
The insured, with the financial cooperation of Fireman's, then settled the malpractice actions for $135,000. This action to recover $50,000 plus interest and punitive damages was instituted by Fireman's, as assignee of the insured.*fn1 The trial court found, as Fireman's and the insureds had alleged, that Security had acted in bad faith in refusing to settle and that the $135,000 settlement was reasonable and made in good faith. The court awarded Fireman's compensatory damages of $50,000 plus interest in the amount of $11,161.60, but denied its prayer for punitive damages. On appeals taken by both defendant and plaintiff, the Appellate Division affirmed.
Security offers no serious challenge to the finding that it had acted in bad faith in refusing to contribute its policy limits towards the proposed settlement. Indeed, no basis for such a challenge appears in the proofs, which are summarized in the lower court opinions.
Security, whose policy limit was $50,000, knew that if there were an adverse verdict in the malpractice actions the damages awarded would exceed $400,000 and might go as high as $542,000. Nevertheless, in disregard of its acknowledged fiduciary duty to its insured, Rova Farms Resort v. Investors Ins. Co., 65 N.J. 474, 496 (1974), and its obligation to treat the settlement offer of $147,500 "as if it had full coverage for whatever verdict might be recovered, regardless of policy limits, and makes its decision to settle or go to trial on that basis," Bowers v. Camden Fire Ins. Assoc., 51 N.J. 62, 71-72 (1968), it gave only
perfunctory, if any, consideration to the recommendations for settlement of those most familiar with the litigation and best in a position to evaluate the likelihood of a successful defense of the action -- the attorney it had designated to defend the malpractice actions, the expert he had retained to testify at the trial, the insured law firm, Security's local claim manager and Fireman's.
Security chose to ignore its obligation to make an honest, intelligent and good faith evaluation of the case for settlement purposes and to weigh the probabilities in a fair manner. Cf. Radio Taxi Service, Inc. v. Lincoln Mutual Insurance Co., 31 N.J. 299, 305 (1960); Knobloch v. Royal Globe Ins. Co., 38 N.Y. 2d 471, 381 N.Y.S. 2d 433, 344 N.E. 2d 364 (Ct. App. 1976). It adopted that course even though it knew that if the favorable settlement offered by the plaintiffs in the malpractice actions was ever to be accomplished, it had to be accomplished promptly and in conjunction with a proposed settlement of an action which had been instituted by the receiver against the corporate directors in the Chancery Division, in which the trial was imminent. The "package" settlement offered by the receiver, and approved by the Chancery Division judge who appointed him, required the corporate directors to agree not only that all the moneys to be paid in settlement of the two malpractice actions should belong to the receiver, but also that the directors should pay the receiver additional sums out of their own funds.
Security's conduct amounted to a repudiation of the obligation it owed its insured under the policy.
Nevertheless, Security contends that there may be no recovery against it based on the settlement made by the insureds because no judgment had been entered against its insureds in the malpractice actions and the settlement ultimately made -- whose reasonableness is no longer disputed -- had not been authorized by it. It contends that, despite its bad faith, it is entitled to rely on the rights reserved to it by
the "settlement" and "no action" provisions of the policy quoted at the outset of this opinion.
In support of its contentions, Security argues:
"An insurer should not be deprived of its right to settlement because it is guilty of bad faith in refusing to participate in settlement prior to trial. A continuing test of its abuse of the right to settle must be made up until judgment is entered. The insured suffers no detriment except the inconvenience of trial while he awaits the outcome. His right to recover against the insurer is preserved and, of course, under Rova Farms, supra, he need not prove a case of bad faith against the carrier. If the judgment is in excess of his limits where there is a failure to settle within its limits, the carrier is 'automatically' liable to the insured for the over-the-limit judgment. We respectfully submit that the adoption of a rule allowing an insured to settle a pending case, prior to entry of judgment and then sue his carrier in bad faith would be a step backward from the landmark holding in Rova Farms, supra. Bad faith would have to be proved by the insured in a subsequent trial and the insured might be guilty of estoppel where he fails to take over settlement upon an insurer's refusal to participate in settlement. Under Rova Farms, supra, bad faith need not be proved after judgment and the insured need not participate in settlement negotiations prior to trial."
Were the holding in Rova Farms, supra, what Security says it was, then indeed there would have been no reason for the insured to be concerned with a settlement of the malpractice actions or the potential award if those actions were tried, since Security's failure to settle would make it liable for the full amount of any judgment ultimately recovered even if it had acted in good faith in rejecting the settlement offer.
However, Security's argument is bottomed on an erroneous interpretation of our opinion in Rova Farms, supra. Contrary to what Security contends, Rova did not eliminate "bad faith" as one of the factors to be proven where an action is instituted by an insured against his insurer based on its refusal to settle. Nor did we in Rova adopt a rule making the insurer "automatically liable to the insured for the over the limit judgment." While the opinion in Rova did suggest that it might be desirable "one day" to adopt such a rule, it concluded that "it is unnecessary in the instant
case to embrace such an extended rule" (65 N.J. at 502), and such a rule has never been adopted.
There being no substance in the argument thus presented in unwarranted reliance on Rova, we turn next to a consideration of Security's argument that in any event -- despite its bad faith and the fact that the potential recovery and the amount of the settlement were far in excess of its policy limits -- it is entitled to rely on the quoted policy provisions as a bar to this action. It contends that there is no warrant for depriving it of the rights reserved to it by the policy, conditioning recovery in any action against it on either a prior recovery of a judgment against its insureds or a settlement agreed to by both it and its insureds. We disagree.
While the right to control settlements reserved to insurers is an important and significant provision of the policy contract, Radio Taxi Service, Inc. v. Lincoln Mutual Insurance Co., supra 31 N.J. at 305; Condenser Service, etc., Co. v. American, etc., Ins. Co., 45 N.J. Super. 31, 41 (App. Div. 1957), it is a right which an insurer forfeits when it violates its own contractual obligation to the insured. As we said in Warren v. The Employers' Fire Insurance Co., 53 N.J. 308, 311-312 (1969):
"* * * Before an insurance company will be heard to allege the breach of a contractual provision by plaintiff, the insurance company must be able to assert its own lack of any breach."
So it is settled, as stated in N.J. Mfgrs. Ind. Ins. Co. v. U.S. Cas. Co., 91 N.J. Super. 404, 407-408 (App. Div. 1966):
"* * * Where an insurer wrongfully refuses coverage and a defense to its insured, so that the insured is obliged to defend himself in an action later held to be covered by the policy, the insurer is liable for the amount of the judgment obtained against the insured or of the settlement made by him. * * * The only qualifications to this rule are that the amount paid in settlement be reasonable, and that the payment be made in good faith."
See also Annotation, "Liability Insurer -- Refusal to Defend," 49 ...