Alert: Liability Insurance Policies Don’t Cover Settlements, Only Judgments, Court Rules

The California Supreme Court has denied review of a California Court of Appeal decision that creates a significant trap for the unwary under most standard general liability policies.  The opinion held that a standard form excess insurance policy, which obligated the carrier to indemnify for "damages," did not cover amounts the insured agreed to pay in a settlement. 

In Aerojet-General Corp. v. Commercial Union Ins. Co., 155 Cal.App.4^th 132 (September 13, 2007, review denied December 19, 2007), the Court of Appeal interpreted excess insurance policies that obligated carriers to indemnify Aerojet for "all sums which the Assured shall become legally obligated to pay, or by final judgment be adjudged to pay, to any person or persons as damages."  Relying on Certain Underwriters at Lloyd's of London v. Superior Court, 24 Cal.4^th 945 (2001) ("Powerine I"), the Court of Appeal held that "the term ‘damages' as interpreted in Powerine I and as used in a liability insurance policy means only money ordered by a court to be paid."  It thus does not include settlement amounts paid by the insured.  The California Supreme Court also declined to depublish the opinion.

The decision contains a significant trap for the unwary.  Previously, when a carrier denied coverage, insureds were free to settle the claim without the carrier's consent and pursue coverage later.  That course of action now could eliminate coverage.  Even when the carrier is defending under a reservation of rights, the Aerojet decision creates an additional impediment to settlement and has the potential to increase litigation costs.

Implications of Aerojet-General for Policyholders

Although Aerojet-General was decided in the context of coverage for environmental claims under excess policies, the decision turned on the "as damages" language in the insuring agreement.  This language is standard in primary general liability policies, and common in excess, umbrella and errors and omissions policies.  Insureds therefore should consider the following steps:

• Verify the wording in your policies, or ask your coverage counsel to do so. Some policies, especially umbrella and errors and omissions policies, cover "loss" or "ultimate net loss," terms often defined to include settlements.
• Do not settle potentially covered claims without first obtaining the carrier's consent and waiver of any Aerojet defense - even if the carrier has denied coverage.
• If the carrier is defending, seek an "Aerojet waiver" well in advance of beginning settlement negotiations.
• Address the issue prospectively, at least at the time of policy renewal, if not sooner. Insurers may be willing to add an Aerojet waiver to the policy by endorsement. Risk managers should consider requesting such a waiver when placing or renewing coverage to avoid this trap for the unwary.

If the carrier refuses to waive Aerojet-General and consent to a settlement, the insured must weigh its alternatives, which may include: (1) entering into a settlement that is documented as a court judgment, (2) reducing the claim to judgment by means of an uncontested trial or a stipulated judgment with a covenant not to execute, or (3) choosing not to settle, and permitting the case to proceed to judgment, thereby triggering the duty to indemnify if damages are proven.  Evaluating these alternatives requires consideration of a number of factors, including whether the carrier is defending, whether the carrier has asserted a reservation of rights, the precise terms and conditions of the policy, the strength of the coverage argument, and the risk of excess exposure.  No simple answer exists how to handle this situation, and a case-by-case evaluation is required. 

The California Supreme Court may clarify the issues raised in Aerojet-General in the relatively near future in a case now pending before it, Ameron Int'l Corp. v. Insurance Co. of the State of PA.  That case held that there is a duty to defend and indemnify an insured in administrative proceedings, including a duty to pay amounts paid in settlement, under similar but arguably broader policy language than that at issue in Powerine I and Aerojet-General.