In a recent opinion, Carpenter v. Lovell’s Lounge and Grill, LLC, et al., --- N.E.3d ---, No.33A01-1602-CT-265, 2016 WL 4701673 (Ind. Ct. App., Sept. 8, 2016), the Indiana Court of Appeals addressed — for the first time under Indiana law — what constitutes bad faith or collusion in the context of a policyholder’s procurement of a consent judgment with a claimant. The court ruled that, where an insurer shows by clear and convincing evidence that a consent judgment is the product of bad faith or collusion, the insurer is not bound by the consent judgment’s determinations of liability and damages.

The Setup

In May 2012, upon entering Lovell’s Lounge and Grill, the plaintiff, Thomas Carpenter, sustained serious bodily injuries from Jerry Johnson, another lounge patron. Following a trial where Carpenter, himself, gave testimony of Johnson’s intentional hitting and kicking him, Johnson was convicted for the class C felony of battery resulting in serious bodily injury. By all accounts, Johnson’s actions were intentional.

In August 2013, Carpenter filed a complaint against the lounge, alleging that Johnson “brutally attacked” him. Carpenter also alleged that Johnson was “an employee of and/or performed services” for the lounge. At best, however, evidence suggested that Johnson occasionally made repairs at the lounge for free beer. Carpenter’s initial complaint included a claim for civil assault and battery (based on intentional conduct); negligence; and violations of the Dram Shop Act (i.e., the lounge furnished Johnson with alcohol — though Johnson was visibly intoxicated — and Johnson’s intoxication was a proximate cause of Carpenter’s injuries).

In October 2013, the lounge’s CGL insurer, Cincinnati Specialty Underwriters (CSU), denied coverage to the lounge on several grounds, including the policy’s assault and battery exclusion. In July 2014, Carpenter filed an amended complaint, which was identical to the initial complaint, but with the additional allegations that Johnson “negligently” breached the duty of care he owed to Carpenter by coming into physical contact with Carpenter “at which time Johnson accidentally caused bodily injury to Carpenter.” The amended complaint also alleged that Carpenter’s injuries were the proximate result of Johnson’s negligence; and that the lounge owed Carpenter a duty to protect him from foreseeable negligent harm.

Regardless, CSU stood by its coverage denial based on the policy’s assault and battery exclusion.

The Consent Judgment and Post-Judgment Agreement Not to Execute

On February 25, 2015, Carpenter and the lounge submitted a consent judgment to the trial court, which the court approved and entered. The consent judgment stipulated that:

• Johnson negligently came into physical contact with Carpenter, accidentally causing him serious bodily injury. The harm was neither intended not expected from the standpoint of Johnson or the lounge.
• The lounge had a duty to warn Carpenter of foreseeable negligent conduct that could cause harm.
• Johnson’s negligent conduct was foreseeable to the lounge, but it was neither intended nor expected from the standpoint of the lounge, or its employees, including Carpenter.
• Johnson performed services and was an agent of the lounge, and he was within the scope of his agency at the time of the negligent conduct that caused harm to Carpenter.

The lounge agreed that Carpenter incurred injuries and damages, including pain and suffering, totaling $1,125,000. The lounge’s owner, Jeremy Lovell, signed the consent judgment on behalf of the lounge, pro se;¹ and Carpenter’s legal counsel signed on behalf of Carpenter. Though Johnson was not a party to the consent judgment, on March 17, 2015, Johnson was dismissed from the case. In consideration for the consent judgment, Carpenter agreed: not to execute or enforce the consent judgment against the lounge; to indemnify and defend the lounge from any action by CSU against the lounge for its execution of the consent judgment; and to pay the lounge’s agent, Lovell, the first $7,000 of any recovery by Carpenter against CSU.²

In this instant context of tort and insurance law, where such a consent judgment (or, covenant judgment, as it is sometimes called) is effective and binding against the insurer, it eliminates all defenses to the claimant plaintiff’s tort claim. Though the consent judgment may lack evidentiary support and likely was entered into without a trial, the tort claim initially asserted against the policyholder evolves into one against the insurer (potentially giving the claimant both a breach of contract and a tort claim against the insurer).

Through the consent judgment, Carpenter became a judgment creditor and, as a judgment creditor, filed a motion requesting that the court order CSU to appear to answer to its obligation under the policy. Carpenter asserted that the policy provided coverage for the consent judgment. Carpenter’s counsel filed an appearance on behalf of the lounge, even though he still represented Carpenter. For all intents and purposes, the claimant Carpenter and the policyholder Lovell, in effect, became one party with one adversary — Lovell’s insurer, CSU.

The Insurer Points to Policyholder Bad Faith

In addition to filing its answer in the underlying case to which it had been added, the lounge’s insurer, CSU, also filed a separate action, seeking a declaratory judgment that it had no obligation under the policy with respect to the consent judgment, based on the policy’s assault and battery exclusion, and that the consent judgment was obtained by fraud, bad faith, or collusion. The trial court ultimately concluded that CSU had no obligation under the consent judgment or for the incident between Johnson and Carpenter. The trial court found that the lounge, Carpenter, and Lovell did not enter the proceeding with clean hands and operated with “furtive design” in trying to construct a consent judgment that would fall within CSU’s coverage, allowing the defendants to jointly profit.

Does Collateral Estoppel Bar an Insurer’s Challenge to a Consent Judgment Where the Insurer Did Not Defend the Underlying Action?

On appeal, the lounge, Lovell, and Carpenter (the appellants) argued that, under Indiana law, collateral estoppel applied to bar CSU from re-litigating the facts and issues determined by the consent judgment due to CSU’s coverage denial, and its failure to defend the lounge under a reservation of rights in the underlying action.³ The Indiana Court of Appeals, however, found the Metzler and Frankenmuth II line of cases — upon which appellants relied — distinguishable and ultimately inapplicable, as the cases did not involve the issue of “whether collateral estoppel operates to bind the insurer to a consent judgment where the consent judgment was procured by bad faith and/or collusion.”

The court, however, determined that a federal district court’s prediction of Indiana law, in Midwestern Indem. Co. v. Laikin, 119 F. Supp.2d 831, 843 (S.D.Ind. 2000), provided guidance:

Indiana courts would adopt an approach … in which a consent judgment with a covenant not to execute would bind the insurer on issues of its insured’s liability and the extent of the injured parties’ damages, so long as (1) coverage is eventually shown, and so long as the judgment (2) is not the product of bad faith or collusion and (3) falls somewhere within a broad range of reasonable resolutions of the underlying dispute.

Carpenter, at *8 (quoting Laikin, 119 F. Supp.2d at 842).

The Laikin policyholder, however, filed its declaratory judgment before the trial court approved the consent judgment there. Because CSU filed its declaratory judgment after the trial court approved the consent judgment, the lounge, Lovell, and Carpenter argued that Laikin’s principles did not apply, The Indiana Court of Appeals disagreed, citing the injustice of requiring an insurer to pay a consent judgment procured by bad faith solely because it did not defend the policyholder under a reservation of rights or file a declaratory judgment action prior to the court’s approval of a consent judgment. The court agreed with CSU that such an analysis would encourage policyholders to obtain consent orders through bad faith and collusion, thus requiring insurers always to file preemptive declaratory judgment actions to address the risk of policyholder-claimant collusion.

What Constitutes Policyholder Bad Faith or Collusion in the Context of Obtaining a Consent Judgment?

The Indiana Court of Appeals then addressed for the first time what constitutes bad faith or collusion in a policyholder’s procurement of a consent judgment. The appellate court determined that CSU — as an insurer that did not file its declaratory judgment action before the consent judgment was approved — had the burden to prove by clear and convincing evidence that the consent judgment was procured by bad faith or collusion. In doing so, the court cited a Tenth Circuit Court of Appeals decision, Continental Casualty Co. v. Hempel, as guidance for its own analysis. 4 F. App’x 703, 717 (10th Cir. 2001) (other internal citations omitted). The Hempel case explained that a consent judgment becomes:

collusive when the purpose is to injure the interests of an absent or nonparticipating party, such as an insurer or non-settling defendant. Among the indicators of bad faith and collusion are unreasonableness, … attempts to affect the insurance coverage, profit to the insured, and attempts to harm the interest of the insurer. They have in common unfairness to the insurer, which is probably the bottom line in cases in which collusion is found.

Id. (emphasis added).

The Carpenter court had no difficulty in concluding that such clear and convincing evidence of bad faith and collusion existed here because, among other factors:

• The consent order’s stipulation that Johnson’s conduct was negligent made the order “patently unreasonable” in light of the available evidence of the brutal intentional attack through the allegations in the verified amended complaint as well as Carpenter’s own testimony at trial;
• Though the consent order stipulated that Johnson was an agent for the lounge, and acting in the scope of such agency at the time of the incident, there is insufficient evidence to support an agency relationship between the two, including the fact that the amended verified complaint did not include any allegations regarding such a relationship between the two;
• Evidence shows that the lounge and Carpenter did not engage in serious settlement negotiations, as the parties did not begin negotiations until after CSU’s second denial of coverage;
• There was an email from the attorney originally representing the lounge to Carpenter’s attorney, stating that he, as the lounge’s legal counsel, could not uphold his ethical obligation to the court by agreeing to stipulate that Johnson was an agent of the lounge, acting within that scope at the time of the assault (immediately after which the lounge’s attorney withdrew as counsel for the lounge, and Lovell began representing the lounge, pro se);
• Lovell, who is not licensed to practice law in Indiana, signed the consent judgment on behalf of the lounge, and, less than a month later, Carpenter’s attorney filed an appearance on behalf of the lounge.

The court, therefore, concluded that CSU met its burden to show by clear and convincing evidence that the lounge and Carpenter “did not seriously negotiate with each other, but, instead, they were trying to affect coverage by purposely remaking the incident so that it would not fall under the policy’s assault and battery exclusion.” Carpenter, at *11. The consent judgment, therefore, was a product of bad faith and collusion. Collateral estoppel did not apply to the consent order, and CSU was not bound by the consent judgment.

Conclusion

In light of the documented bold actions by the policyholder, the claimant, and claimant’s counsel, the Carpenter case is a textbook example of the insurer setup. A set of circumstances with such glaring evidence of collusion, however, tends to be the exception rather than the rule. More often than not, there are no written emails between counsel denouncing the terms of a claimant’s proposed consent judgment based on the policyholder’s defense counsel’s ethical obligations, as in Carpenter. It is also a less likely circumstance that the consent judgment would include express covenants for the claimant to give the policyholder a portion of the recovery from the insurer, as in Carpenter. In most cases, indicators of collusion typically arise through a “totality of the circumstances” analysis, i.e., the global timeline of all events potentially related to the underlying incident, including: when the claimant filed suit against the policyholder; date of the demand package and deadline(s) to respond; the insurer’s coverage determination(s), and the date on which the policyholder and claimant learned of coverage determinations and possible coverage defenses; date of amended pleadings and whether they are the result of certain coverage defenses; date of a plaintiff moving to enter a default judgment against the policyholder defendant, if any; and the possible filing of a bankruptcy petition by the policyholder, compared to the date of when a settlement or consent judgment is agreed upon by the parties.

Where an insurer or its counsel identifies certain facts that raise concerns of potential collusion or policyholder bad faith with respect to a settlement, assignment or consent judgment in an underlying case, a thorough investigation and detailed analysis of the facts under applicable state and federal law is critical. The determination of the procedural and substantive avenues available for an insurer to protect its rights and, where warranted, address such issues, includes assessing jurisdiction-specific factors including whether the jurisdiction may:

• examine “reasonableness” of the settlement as an indicator of potential collusion, based on the claimant’s chances of success against the policyholder and likely range of damages;
• consider evidence of secretive activity between claimant and policyholder to create insurance coverage for the incident;
• hold, as a matter of law, that a consent judgment with a covenant not to execute is unenforceable against the insurer, as it is not a true legal obligation of a policyholder to which coverage terms of an insurance policy would apply;
• find that a consent judgment is not a “judgment in excess of policy limits” sufficient to provide a basis for a bad faith or other extracontractual claim against an insurer; and
• present certain procedural advantages (or disadvantages) associated with an insurer making the first move and filing a declaratory judgment action against the policyholder and the assignee, positioning itself as the plaintiff; whether to file in state or federal court, and the jurisdiction’s pleading requirements for collusion, fraud and policyholder bad faith, if any.

In conclusion, any negotiated settlement involves cooperation, and cooperation is not collusion. One of the most commonly recognized indicators of when a claimant and policyholder have moved beyond cooperation and into the area of potential collusion when settling a tort matter is that there is evidence of an overarching and common purpose to create coverage and negatively impact the insurer for the joint benefit of the settling parties in the underlying action.