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'Hand' Down

A third-party judgment creditor cannot sue for the part of the judgment in excess of policy limits

 

Los Angeles Daily Journal
Monday, August 14, 2000

By Michael M. Pollak

There is no third-party bad faith in California. The California Supreme Court in Moradi-Shalal v. Fireman's Fund Ins Co., 46 Cal.3d 287 (1988) overruled Royal Globe v. Superior Court, 23 Cal.3d 880 (1979) which had allowed third-party bad faith. Also this year the voters rejected the "FAIR" legislation, which would have reinstated third-party bad faith.

However, in Hand v. Farmers Ins. Exch., 23 Cal.App.4th 1847 (1994), the Court of Appeal, for the first time, announced that a third-party judgment creditor could sue the defendant's insurance carrier for bad faith. Based on Hand, some plaintiffs' attorneys have argued that a third-party judgment creditor can sue for the portion of the judgment in excess of policy limits.

California has long had a "direct action" statute. Insurance Code Section 11580(b)(2). It allows a judgment creditor to bring an action against the defendant's insurance carrier to recover on the judgment, up to the amount of the liability-insurance policy limits. Based on that statute and public policy, the carrier and the insured cannot alter coverage after the accident to affect a third party's rights. Shapiro v. Republic Indemnity Co. of America, 52 CaI.2d 437 (1959).

The first significant modern-era case to discuss third-party beneficiary rights was Murphy v. Allstate Ins. Co., 17 Cal.3d 937 (1976). In Murphy, the insurance carrier rejected settlement demands within the policy limits. At trial, the plaintiff obtained a judgment in excess of the policy limits. The plaintiff did not thereafter secure any assignment of the insured's rights against the insurance carrier. The insurance carrier paid the plaintiff judgment creditor only the amount of the policy limits and refused to pay the excess. The plaintiff then attempted to enforce the judgment against the insured.

Even though she obtained no assignment from the insured, the plaintiff in Murphy brought a lawsuit against the defendant's insurance carrier in order to recover the portion of the judgment in excess of the policy limits. In a unanimous opinion, the California Supreme Court held that, without an assignment, the plaintiff could not recover the excess portion of the judgment or any other damages.

The court reasoned that the liability-insurance carrier's duty to settle within policy limits when there is a substantial likelihood of recovery in excess of those limits is a duty owed only to the insured, to protect the insured from exposure to liability in excess of the policy limits. When an insurance carrier breaches its duty to settle, the insured — but not the third-party claimant — can recover the portion of the judgment in excess of the policy limits. The court stated that an insured may assign his or her cause of action for breach of the duty to settle but cannot assign damages for emotional distress or punitive damages.

The court also held that the third party's rights under Insurance Code Section 11580(b)(2) extend only to amounts owed under the liability-insurance policy. The third-party claimant, a third-party beneficiary of the contract, can only enforce covenants made for his or her benefit, not covenants made for the benefit of others. Because the duty to settle is intended to benefit the insured and not the claimant, third-party beneficiary doctrine does not provide a basis for the third-party claimant to recover the portion of the judgment in excess of policy limits.

In Coleman v. Gulf Ins. Group, 41 Cal.3d 782 (1986), the California Supreme Court held that a third-party judgment creditor could not bring an action against the defendant's insurance carrier for appealing the judgment, allegedly to achieve delay and force a settle­ment.

It was against this backdrop that, in 1994, the Court of Appeal decided Hand. The court considered the "novel issue" of whether a judgment creditor could bring an action for breach of the implied covenant of good faith and fair dealing (bad faith) against the defendant's insurance carrier. The court held that a judgment creditor who has become a third-party beneficiary of the insurance policy by operation of Insurance Code Section 11580 could sue for bad faith based on the insurance carrier's unreasonable refusal to pay the judgment.

In Hand, because of the status of the vehicle driver, there was a dispute as to whether the policy provided $15,000 or $500,000 coverage. The jury verdict was about $235,000. After the judgment was entered, the insurance carrier did not appeal and did not pay it. The carrier took the position that the claimant was entitled to only $15,000. The third-party claimant then sued the insurance carrier. In addition to a cause of action for recovery under Section 11580, the plaintiff asserted a cause of action for insurance bad faith.

The Court of Appeal held that the policy limits were $500,000. It recognized the general rule that third-party claimants may not bring an action for breach of the implied covenant but stated that there are exceptions with respect to third-party beneficiaries of insurance contracts in whose favor the implied covenant and its duties have been held to run.

Hand relied heavily on Murphy. The Hand court reaffirmed that a third-party judgment creditor may enforce the implied covenant of good faith and fair dealing only to the extent that those covenants or their duties run in favor of the judgment creditor. Hand stated that the Murphy court left unresolved whether an unreasonable, bad-faith refusal to pay a judgment creditor the entire amount of the judgment after it becomes final implicates some recognizable duty of good faith by the insurance carrier under its policy, which was intended to benefit the third-party beneficiary.

The Hand court held that the implied covenant of good faith and fair dealing imposes a duty not to withhold in bad faith the payment of damages that the insured has become obligated by judgment to pay. According to the court, because the cause of action for bad-faith nonpayment of a finally adjudicated claim sounds in tort as well as in contract, the plaintiff was permitted to seek tort damages and punitive damages.

Hand was an unusual case in that the amount of the policy limits was in dispute. In most cases, there is no such dispute. Ordinarily, where the amount of the judgment is within policy limits, the insurance carrier will pay that amount to the third-party claimant. Where the judgment is in excess of policy limits and the third-party claimant obtains an assignment from the insured, the carrier will owe the excess portion of the judgment if it unreasonably failed to accept a settlement demand within policy limits. Walbrook Ins. Co. v. Liberty Mutual Ins. Co., 5 Cal.App.4th 1445 (1992).

After Hand, some plaintiffs' attorneys used Hand as a basis to argue that a judgment creditor could sue the defendant's insurance carrier for bad faith for failure to pay the excess portion of the judgment. Hand does not say that. Hand relied heavily on Murphy, which held that an insurance carrier owes no duty to the third-party claimant as to amounts in excess of the policy limits. Also, because Hand is a court of appeal case, but Murphy and Coleman are California Supreme Court cases, Hand cannot be read to have changed Murphy or Coleman.

The decisions after Hand gave it less than a resounding ovation. (It was more like the sound of one hand clapping.) In Hughes v. Mid-Century Ins. Co. , 38 Cal.App.4th 1176 (1995), the plaintiff judgment creditor sued the defendant's insurance carrier for bad faith before the judgment against the insured was final. The court held that the plaintiff could not proceed on a bad-faith action against the insurance carrier because the judgment was not final when the bad-faith action was filed. Accordingly, the judgment creditor's suit was barred altogether, even though the suit was merely premature.

The Hughes court intimated that Hand was incorrectly decided: "Although the analysis in Hand might be viewed as improperly extending the law of tortious bad faith particularly by finding a 'special relationship' exists between an insurer and its insured's judgment creditor … , we need not determine whether Hand accurately states the law. Even if we were to deem such cause of action for bad faith to exist, on this record Hughes would be precluded from asserting such a claim."

In Maxwell v. Fire Ins. Exch., 60 Cal.App.4th 1446 (1998), the plaintiff obtained a judgment against two defendants, each of which had a different liability-insurance carrier. After the judgment, each carrier paid a portion of it. The carriers did not pay the entire judgment, which they acknowledged they owed, because of a dispute between themselves over liability for costs and the effect of a pretrial settlement payment from a dismissed defendant.

Less than two months after the judgment was final, the plaintiff filed a complaint against both insurance carriers for breach of contract and bad faith. A few weeks later, 81 days after payment became due, the two insurance companies paid the remainder of the judgment, including accrued interest. The plaintiff proceeded with the case to seek emotional-distress damages based on the loss of use of money during the 81-day delay.

The Court of Appeal affirmed the carriers' summary judgments, holding that, as a matter of law, the loss of use of money did not meet the threshold financial-loss requirement to allow emotional-distress damages for bad faith. With respect to Hand, the Maxwell court stated, 'To the extent that Hand v. Farmers Ins. Exchange ... could be deemed inconsistent with the principles we have enunciated we decline to follow it."

Hand was wrongly decided. The tort of bad faith is predicated on the existence of a contract between the insured and the insurer. In the absence of a contract, there is no basis for a duty to act in good faith. Egan v. Mutual of Omaha Ins. Co., 24 Cal.3d 809 (1979).

The covenant of good faith and fair dealing was developed in the contract arena and is aimed at making effective the agreement's promises. Foley v. Interactive Data Corp., 47 Cal.3d 654 (1988). A cause of action in tort for breach of the implied covenant of good faith and fair dealing is allowed only when there is a contract between the parties and only in the insurance area (Foley) because of the "special relationship" between an insurance carrier and its insured (Egan).

That relationship is "special" because an insured paid a premium to seek protection against calamity. Egan. A judgment creditor has no special relationship with the defendant's insurance carrier, the judgment creditor is not even a party to the contract that gives rise to the implied covenant.

The California Supreme Court has yet to comment on Hand. If and when it does, it is expected to overrule the case. Until then, based on the other cases discussing judgment creditors' rights, Hand does not permit a judgment creditor to sue for the excess portion of a judgment or to prevent a carrier from appealing a judgment. Hand is limited to those instances when a carrier does not pay the portion of a judgment final for all purposes that is within policy limits.

Michael M. Pollak is a partner at Pollak, Vida & Barer in Los Angeles

 

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