Insurance Taking Center Stage

Published in The Recorder's Fall 2010 issue of "Arbitration and Mediation"

Defendants, plaintiffs, mediators and insurers are increasingly sophisticated and attuned to the need of addressing insurance coverage disputes in mediation. The financial downturn has also placed greater pressure on companies to maximize insurance contributions to resolve lawsuits. The insurance implications of insolvency and bankruptcy add a new layer of complexity to the task. Careful and early attention to insurance coverage disputes is necessary to a successful mediation outcome.

The Role of Insurance in Mediation

Insurance money often drives settlements. Even when other assets exist, both plaintiff and defendant may assume that the case will be settled, if at all, within the policy's limits.

If insurance is critical to settlement, and the carrier is objecting to funding, coverage counsel for the insurer and the insured may take center stage in the mediation to broker a deal. Indeed, one major trend in mediations is simply the growing sophistication of mediators in the role of insurance. Many mediators, if insurance is involved, will educate themselves about the insurance disputes even before turning to the underlying liability issues. One of the first questions to parties arranging a mediation will be: Is insurance involved? Do you have coverage counsel? Will the carrier be attending with its coverage counsel?

Another trend in mediation is that plaintiffs' counsel are paying closer attention to defendants' insurance and any coverage disputes, even when non-insurance assets may be sufficient. Plaintiffs' attorneys are increasingly hiring coverage counsel to advise them. The interests of plaintiff and defendant may be largely aligned when it comes to insurance issues. Still, the plaintiff needs to understand, for example, whether coverage disputes are genuine or merely being used to drive down the settlement value of the case. Also, regardless of the company's other assets, more insurance money increases the possibility of a greater settlement.

Plaintiff may also need to consider whether it wants to agree to a settlement in which it takes an assignment of the defendant's rights against the insurer. The ability to agree to such a settlement, where the insurer has denied coverage, can be an important tool in negotiations. Even the realistic threat of a settlement with a covenant not to execute and assignment of rights can help move an intransigent insurer to contribute meaningfully to a final settlement.

Issues and Trends of the Recession

Companies tight on cash and faced with coverage objections are less able to enter a mediation with the option of funding a settlement and resolving the dispute with the carrier later. Insureds must find a way to address and resolve those disputes before, or in connection with, mediation.

Insureds may increasingly face the real threat of insolvency or bankruptcy if the case goes to judgment. This increases the need to maximize the carrier's contributions to settlement. On the other hand, the risks for the carrier of failing to contribute similarly increase. The possibility that the carrier's refusal to settle will be found to have caused the insured's bankruptcy exposes the insurer to large compensatory and punitive damage awards. That prospect, in turn, will often cause carriers to tread far more carefully in taking coverage positions.

Companies already in bankruptcy raise additional complications for pursuit of insurance proceeds, particularly under directors and officers liability policies. The company's inability to indemnify its officers creates fights over a limited pot of money. In addition, a trustee pursuing claims for malfeasance against former directors and officers may object to insurance monies being paid to the individuals' attorneys on the grounds that the policy is part of the bankruptcy estate. Most courts have concluded that, even if the policy itself is part of the estate, the proceeds owed to individuals are not. Carriers nonetheless have hidden behind the trustee's objections and insisted on a "comfort order" from the bankruptcy court before paying out. This leaves the individual insureds in a predicament, particularly if the court is unwilling to issue such an order.

A fallout from the recent rounds of financial litigation, arising out of stock option backdating practices and the mortgage industry meltdown, is the increasing importance of "Side A Only" D&O coverage. "Side A Only" coverage is a separate D&O insurance that covers individual directors and officers in the event that the company can't indemnify them. Side A coverage is included in standard D&O policies (in addition to "Side B," which covers the company's obligation to indemnify its directors and officers). In the last decade, however, Side A Only coverage became popular as an additional stand-alone policy. In connection with a recent mediated settlement of the Broadcom stock option backdating derivative litigation, Broadcom's "Side A Only" carriers contributed $40 million. This was apparently the first case in which a "Side A Only" tower made a significant contribution to the settlement of a derivative case where the company was not insolvent.

Preparing to Address Insurance in Mediation

Preparing for mediation requires close and early coordination among defense counsel, coverage counsel and the insured. Both coverage and defense counsel need to understand how the liability and damages theories and facts dovetail with the policy. The insurance issues, moreover, may require coverage counsel to view the underlying case from a perspective defense counsel has not considered. For example, it may not matter to defense counsel whether damages are characterized as compensatory or restitutionary. This may matter for purposes of coverage, however, and coverage counsel may have to view the underlying law in a way that defense counsel does not.

Insureds and defense counsel are often reluctant to provide information to carriers. This is particularly true when the carrier has denied coverage or reserved significant rights. Nonetheless, unless the carrier has outright denied coverage, the insured owes a duty to cooperate. Moreover, even in the face of a denial, a mediation of the underlying case will often present the opportunity to obtain a contribution from the carrier. As a practical matter, a carrier cannot make a decision about settlement unless it has information. It is therefore important to start providing information early in the case and address any and all objections to coverage the insurer may have.

One tricky issue insureds confront in attempting to cooperate with a carrier is how to respond to carrier requests for otherwise privileged communications (e.g., defense counsel case evaluations). Contrary to popular belief, case law generally does not recognize an attorney-client privilege encompassing the carrier in this circumstance. Civil Code §2860 provides some protection as to third parties, but permits insureds to withhold from the carrier privileged information relevant to coverage disputes. It therefore becomes important for defense and coverage counsel to work closely to provide information to the carrier without waiving the privilege as to coverage issues.

The statutory prohibition on disclosing mediation communications raises an additional hurdle in preparing for a mediation. One way an insured can pressure a carrier to contribute to a settlement is to create an admissible record showing that the carrier had an opportunity to settle the case reasonably within policy limits. The mediation privilege prevents that record from being made if the offer and the carrier's response were made at the mediation. The insured must therefore take steps to create the record of a demand, within policy limits, and defense counsel's recommendation that the settlement is reasonable outside of - and preferably before - mediation.

Mediators, as well as defendants, plaintiffs and their counsel, are increasingly attuned to the role of insurance in settling cases through mediation. Insureds and even plaintiffs must start addressing the coverage issues at the outset of litigation to maximize insurance contributions at mediation.

Careful and early attention to coverage disputes is increasingly necessary to a successful mediation outcome

Dennis Cusack is a partner at Farella Braun & Martel and chair of the firm's insurance practice group, representing policyholders in coverage disputes.

Reprinted with permission from the October 11, 2010 issue of The Recorder. © 2010 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.