The United States District Court for the District of South Dakota, applying South Dakota law, has held that an insured healthcare system was barred from settling without its healthcare liability insurer’s consent where the insurer had not breached its duty to defend because the insured had not yet exhausted the policy retention and thus had not yet triggered the insurer’s duty to defend. Sacred Heart Health Servs. v. MMIC Ins., Inc., 2021 WL 5882990 (D.S.D. Dec. 13, 2021). The court also held that, even if the insurer had no duty to defend, it had a duty to settle in good faith because it controlled the settlement through its right to consent to settlement.
Thirty-six lawsuits were filed against the insureds, a healthcare system and a hospital, in connection with a surgeon who provided medical services through both insureds. The lawsuits alleged that the surgeon performed unnecessary spinal surgeries and that the healthcare system and hospital were negligent in their credentialing, retention, and supervision of the surgeon.
The insureds tendered the lawsuits to their insurer under their respective liability policies. The insurer had issued to the healthcare system a primary policy with a self-insured retention (SIR), as well as an umbrella policy. The primary policy provided that the insurer did not have a duty to defend the healthcare system, while the umbrella policy provided that “if no underlying insurance is available due to exhaustion of its Policy limits by payment of losses . . . [the insurer] shall have the right and duty to defend any suit against the insured[.]” With respect to the hospital, the insurer similarly had issued a primary policy, under which it had a duty to defend, and an umbrella policy.
The policies contained: (i) a “cooperation” clause, which required that the insured cooperate with the insurer in making settlements and conducting suits; (ii) a “no voluntary payments” clause, which provided that “[t]he insured shall not, except at the insured’s own cost, voluntarily make any payment, assume any obligation or incur any expense”; and (iii) a “no action” clause, which provided that “[n]o action shall lie against [the insurer] unless, as a condition precedent thereto, there shall have been full compliance with all of the terms of [the policy].”
After five years of litigation, the insurer participated in a mediation with its insureds and the underlying plaintiffs. The insurer agreed to contribute $2 million to an initial offer, conditioned only on a global settlement of all claims. During the mediation, however, the insurer informed the insureds that it was conditioning its contribution upon an agreement to waive any and all bad faith and other claims against the insurer. When the insureds declined to waive their potential bad faith claims, the insurer withdrew its contribution and left the mediation. The insureds and the underlying plaintiffs reached a $10 million global settlement, which was within the insureds’ policy limits and which exhausted the healthcare system’s SIR. The insureds requested that the insurer pay the $2 million it previously agreed to pay. The insurer conditioned doing so on the waiver of all claims against it, including any potential bad faith claims.
In the ensuing coverage litigation, the insurer filed a motion to dismiss, arguing that the insureds breached their policies when they unilaterally settled without the insurer’s consent. The insureds argued that the insurer waived its right to enforce the “cooperation,” “no voluntary payments,” and “no action” provisions because it breached its duty to defend; breached its duty to settle in good faith; and defended subject to a reservation of rights.
The court concluded that the three provisions barred the healthcare system from settling without the insurer’s consent because the insurer had not breached its duty to defend. The court determined that the insurer did not have a duty to defend the healthcare system until the healthcare system had exhausted its SIR, and, as a result, the insurer did not have a duty to defend the healthcare system prior to its settlement of the underlying lawsuits. However, the court concluded that, based on the underlying facts, including the insurer’s withdrawal from settlement negotiations, a reasonable inference could be made that the insurer abandoned its defense of the hospital. The court held that a factual question existed as to whether the insurer breached its duty to defend the hospital prior to the settlement.
The court also held that the complaint stated a claim for the insurer’s breach of the duty to settle in good faith. First, the court predicted that the South Dakota Supreme Court would conclude that an insurer has waived its rights under the “cooperation,” “no voluntary payments,” and “no action” provisions if an insured proves that the insurer breached its duty to settle in good faith, and that a judgment in excess of policy limits would not be required to prove a bad faith claim. Based on the insureds’ allegations that the insurer failed to negotiate and enter into a settlement in good faith within policy limits, failed to defend and indemnify the insureds, and conditioned its settlement payment on the insureds’ waiver of bad faith claims, the court concluded that the complaint set forth a claim for the insurer’s bad faith.
Second, the court held that the insurer owed the healthcare system a duty to exercise good faith in making settlement decisions even though it did not have a duty to defend. The court determined that, even though the insurer did not control the healthcare system’s defense, the insurer retained control over the settlement because the terms of the policies provided for the insurer’s consent to settle. The court predicted that the South Dakota Supreme Court would adopt the rule that failure by an excess insurer to exercise good faith in settlement would expose an excess insurer to tort liability because of the “fiduciary-like relationship” between an excess insurer and its insured. The court further concluded that, based on this special relationship, the insurer had a duty to disclose prior to mediation that its settlement contribution was contingent on a waiver of bad faith claims.
The court concluded that an insured may not settle solely because the insurer defends subject to a reservation of rights. The court opined that a defense under a reservation of rights was an accepted practice; however, the reservation of rights must be a mutual agreement between the insurer and the insured, and not a unilateral decision by the insurer.
