In Truck Insurance Exchange v. VanPort Homes, Inc., __ Wn.2d __, 58 P.2d 276 (2002), the Washington Supreme Court held that an insurer's extreme delay in responding to the insured estopped the insurer, not only from asserting its coverage defenses or its policy limits, but also from challenging the reasonableness of the insured's settlement with the claimants.
VanPort Homes provided construction consultation and project manager services to persons building their own homes. Several customers sued VanPort regarding defective work done by contractors on their homes. VanPort tendered to its commercial general liability ("CGL") carrier, Truck Insurance Exchange ("Truck").
One year after tender, Truck declined coverage. By letter, it informed the insured that, after a "thorough investigation," it had concluded that all claims were excluded from coverage. The company file indicated that Truck had done little investigation before reaching its determination. VanPort requested an explanation from Truck about the reasons for its coverage denial, and Truck did not respond. Approximately two years later, and almost four years after the tender, Truck commenced a declaratory judgment action to absolve itself of a duty to defend or indemnify VanPort. While that action was pending, VanPort settled with its customers for approximately $700,000.
In a 5-4 decision, the Washington Supreme Court held that Truck was responsible for the entire amount of the settlement, unless it could prove that VanPort's settlement was collusive or fraudulent.
First, the majority held that Truck had acted in bad faith when it declined to defend. According to the majority, there was a question of fact as to whether the exclusions relied upon by Truck applied, and the insurer was not allowed to resolve those questions of fact in its favor. "Put simply," the court said, "an insurer may not rely on facts extrinsic to the complaint in order to deny its duty to defend where, as here, the complaint can be interpreted as triggering the duty to defend." Instead, the court admonished that, when an insurer is unsure of its obligation to defend, it should defend under a reservation of rights while seeking a declaratory judgment on the question of whether it has that duty.
The four dissenting justices disagreed. They would have held that, because Truck had a reasonable basis to deny coverage, it could not be found in bad faith for doing so.
Having determined that Truck was in bad faith, the majority held that the insured's remedy was "coverage by estoppel," meaning that Truck "voluntarily forfeited" its coverage defenses by its bad faith. Thus, the court did not need to address the issue as to whether, in fact, coverage was excluded.
Regarding the measure of the insured's damages for Truck's bad faith, the court forged a new trail beyond what it had only recently blazed in Besel v. Viking Ins. Co., 146 Wn.2d 730 (2002). Citing Besel, the court in VanPort held that the amount of the settlement between VanPort and its customers was presumptively reasonable. The court said, "We hold that where an insurer acts in bad faith in refusing to defend, the settlements entered into by insureds with third parties and approved by a court as reasonable will be presumed to be reasonable" (emphasis added), but in fact there was never any determination of reasonableness by any court in the VanPort case. Neither the court in the liability action nor the court in the declaratory judgment action decided the question, and certainly Truck was never heard on the issue. The supreme court held that the presumption of reasonableness could be overcome "upon a showing that the settlements were the product of fraud or collusion," but the court did not indicate what might constitute fraud or collusion. Moreover, the court expressly held (which it had not done in any earlier decisions) that the remedy of "coverage by estoppel" is not restricted to the policy limits: "To limit an insurer's liability to its indemnity limits would only reward the insurer for failing to act in good faith . . . ."
The majority justifies its reasonableness presumption on the ground, among others, that requiring the policyholder to prove reasonableness would "discourage settlement." The flaw in the court's analysis is that there is no basis for concluding that the amount of the settlement between the claimants and the insured is reasonable. In VanPort, the claimants provided the insured with a covenant not to execute on the amount of the settlement, meaning that the amount of the settlement had no consequences for the insured. Under such circumstances, claimants may choose a number commensurate with their desires, rather than with just compensation for their harm. There is no reason to believe, expect, or presume that a settlement not negotiated at arms length between parties of opposing interests will be reasonable.
Moreover, the presumption is not fully rebuttable. The court's ruling does not merely shift the burden to the insurer on the question of reasonableness—the settlement amount will be presumed reasonable unless the insurer can prove it was the product of "fraud or collusion." The court does not explain what actions between the insured and the claimants would constitute fraud or collusion, but presumably it is something more than entering into an unreasonable settlement.
Thus, the Washington Supreme Court in
VanPort has succeeded in providing a disincentive for insurers to act in bad faith, its express goal. But it has also imposed a measure of damages that is not necessarily related to the harm caused by the insurer's bad faith, has precluded the insurer from being heard on that issue, and has thereby increased the risk, and so the cost, of handling claims.