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SHALLOW POCKETS

--Multiple Claimants on an Underinsured Defendant.

The situation arises all too often. An individual with insufficient insurance is involved in a loss that results in more than one claimant. At least one of the claimants refuses to settle for a share within the policy limits. This essay reviews the duty of the insurance carrier and suggests several possible resolutions to the problem.

The Context

The most common example of "shallow pockets" involves a so-called "judgment proof" individual (one who has no assets that can be seized to satisfy a judgment), insured by a small automobile liability policy, and involved in an accident with many gravely injured persons. Similar situations can arise in college flying clubs when an overloaded aircraft crashes or in cases where most of the insurance has been paid out and subsequent claimants emerge.

Limits of Insurance Coverage

After substantial litigation in many states, there is no longer any question that a policy's limit of liability "per person" includes both the claim of the person directly injured and all related and derivative claims. E.g. see McGovern v. Williams, 741 S.W.2d 373 (Tex. 1987). There is just one claim limit per person directly in the accident.

Thus, when a person with the usual family connections is injured, all of those claiming under that person are limited by the "per person" liability limits, regardless of the separate mental anguish, injury to family relations or other harms. E.g. see Cradoct v. Employers Casualty Ins. Co., 733 S.W.2d 301, 302 (Tex.App. -- El Paso 1987, writ ref'd n.r.e.) and Tumison v. St. Paul Ins. Co., 780 S.W.2d 406, 408 (Tex.App. -- Houston [1st Dist.] 1990, writ denied). This limit helps to pare down the number of claimants and to separate claims on the policy limits to claims on the (usually) smaller "per person" limits.

In addition, there is generally no breach of duty when an insurer refuses to pay the full amount of its "per occurrence" limit where there are two claims, one of which may result in an excess judgment and the other which is far below the "per person" limit.

For more on that sub-point, see Clark v. Hartford Accident and Indemnity Co., 61 Tenn.Ap. 596; 457 S.W.2d 35 (1970); Roberie v. Southern Farm Bureau Casualty Ins. Co., 185 So.2d 619 (La.App.1966) aff'd in part, rev'd in part, 250 La. 105; 194 So.2d 713 (1967); Standard Acc. Ins. Co. of Detroit, Mich. v. Winget, 197 F.2d 97 (9th Cir. 1952).

Basic Rules of Settlement With Multiple Claimants

The law is skimpy on what must be done when there are multiple claimants, each of whom has suffered damages too large to fit them all within the policy limits. Three cases are good for general discussion and represent the only trend.

The lead case is Farmers Ins. Exchange v. Shropp, 222 Kan. 612; 561 P.2d 789, 795 (1973). This case suggests that the insurer meets its obligations by attempting "to settle claims within the policy limits as they [are] presented."

More recently Holteclaw v. Falco, Inc., 355 So.2d 1279, 1286-87 (La. 1980) suggests that the insurer must only attempt to manage the insurance proceeds in a manner reasonably calculated to protect the insured by minimizing total liability.

Finally, there is Rosell v. Farmers Texas County Mut. Ins. Co., 642 S.W.2d 278, 279-280 (Tex.App. -- Texarkana 1982, no writ). The court of appeals in that case affirmed a summary judgment ruling, that stated among other things that an insurance company could not be compelled to make or accept "package deal" "settlements from multiple claimants."

The general rule thus arises that settlement need not be a package deal disposing of all claimants, but must only reasonably attempt to settle claims within the limits as those claims are presented. The insurer must only use reasonable efforts to protect the insured by minimizing total liability.

The rationale of good faith suggests a similar result. The traditional definitions of good faith have included the observance of reasonable commercial standards (cf U.C.C. 2-103) and honesty in fact (see U.C.C. 1-201). It is the general faithfulness to duty or obligation, acting with honesty of purpose that has come to define good faith. Efron v. Kalmonovitz, 249 Cal.App.187, 57 Cal.Reptr. 248, 251.

Honest general faithfulness to the insured under those terms seems to include following the general practices in the industry and reasonable efforts to faithfully discharge the duty of insuring or protecting against liability. The very existence of coverage limits dictates that there are limits to the duty to protect. The tort nature of the duty of good faith and fair dealing implies that reasonable efforts (the so-called ordinary care required to avoid general negligence tort liability) will discharge the duty.

Settlement Approaches to Attempt

The following are methods that apply to situations where the insured is basically judgment proof and the policy coverage is not sufficient for the reasonable damages claimed. When an insured has substantial assets and insufficient insurance, the insured's private attorney should be presented with the various methods and the insured's input should be sought.

1. Settle claimants as they present claims within the policy limits. This is the approach of Farmers Ins. Exchange v. Shropp, which suggests that claims need only be paid as they are presented until the policy limits are expended. Paying claims as they are presented allows an insurer to faithfully pay each claim, as presented, until the policy is expended. It is a straightforward reduction of the insured's liability by the amount of the policy contract.

While this method is exactly what the parties contracted, and has been approved in Kansas, it is probably the better practice in a seriously underinsured matter to attempt to locate all significant claimants and to seek to reduce overall liability by settling with the major claimants rather than just paying out the policy on a first come, first serve basis.

To further the better course, an auditor for an insurer should propose standardized guidelines for adjusters to follow. Such guidelines would provide or define what constitutes a reasonable effort to locate significant claimants so that the policy is not expended on the lesser claims but rather serves to reduce overall liability in a reasonable fashion.

Practice shows that major claimants are more likely to agree to reasonable divisions of insurance policies than are minor claimants when the insured has minimal assets. When the insured has significant assets it is time to call in the insured's personal attorney. Even then, major claimants are often more likely to compromise than minor claimants.

The reason is simple. Pro rata compromises, the most common sort of compromises, leave minor claimants with minimal payments. For example, with a $100,000 aviation policy, two fatalities and three property loss claimants, a pro rata distribution could well leave less than $10,000 to cover $90,000 or more of property loss spread between three claimants.

If the estates will settle for a pro rata distribution, it is quite possible to discharge the significant portion liability by paying them, even if the property loss claimants are unwilling to settle.

This modified approach is often the best approach for settling underinsured automobile liability problems. Generally, the attorneys for the major claimants will be satisfied with taking the lion's share of the proceeds and exiting the fray. With a judgment proof insured and little leverage, the smaller claimants are then forced to consider balancing the cost and expense of going forward with seeing reason.

2. Negotiate ratio agreements. If claimants are approached early in the settlement process, they will often commit to pro rata or ratio agreements. Early disclosure of the limited policy coverage and a request that they agree to settle for whatever ratio of the policy that their damages are as a ratio to all damages, these early moves often result in a commitment to settle.

Many settlement problems arise as the claimants discover (a) that there is not "enough" insurance and (b) that dividing the coverage fairly (i.e. pro rata) will result in "too little" to the claimant. The pattern again arises of the common problem of the major claimants being agreeable and the minor claimants causing trouble.

An early ratio agreement can often forestall this problem by preparing the claimant for the bad news or disappointment before it is experienced and by locking the claimant into a mechanical procedure already defined as fair. In addition, even if the ratio agreement "turns sour" by one or more parties breaking out of it, the attempt to set up a ratio agreement demonstrates good faith by the adjuster or attorney negotiating the matter.

The important facet to using ratio agreements is to negotiate them before the claimants can determine who will receive the lion's share under the agreement. As losers are generally the ones who will balk, it is important to establish a ratio agreement before the claimants can determine who will win and who will lose.

3. Settle the significant claimants after giving notice of limits of liability. This method is the one to follow after a ratio agreement is impossible to reach or after such an agreement breaks down. It often works best if unrepresented claimants are encouraged to seek the advice of an attorney.

First, the insurer gives notice of the policy limits to the claimants. This step is required by law in some states and virtually forbidden in others. The purpose of giving notice of the limits is to make clear the size of the asset pool from which claims can be paid. The insurer should clearly notify the claimants of the fact that the insured is virtually without assets and is judgment proof (or will be after bankruptcy) and that the policy represents the practical limit of recovery.

Next, notify the parties of an intent to distribute the policy to those who are willing to be reasonable and settle in a pro rata settlement. Also state that the money that would otherwise go to a claimant under the pro rata will be distributed only to the settling claimants. If a party refuses to join in settlement and release, make certain that they know this will result in no recovery from the insurance company.

The purpose of this strategy is two-fold. First, the insurer wants to reduce the liability of the insured by settling with the largest claimants and thus discharging the largest liability claims. If an impasse is reached, common sense calls for doing one's best to get rid of those claims even if minor claims remain.

Second, by a threatened depletion of insurance fund, those parties refusing to settle are faced with a changed situation. Without depletion, the party gets the money and whatever they can force out of the insured. When an insurer does not expend all of the coverage it invites the plaintiff's attorney to take the risk and to litigate a minor claim. After all, the insured may not be totally judgment proof and if the insured really is judgment proof, then there is still the insurance money. All that is risked is some time.

Depleting the fund raises the risk for the parties who refuse to settle. They now face a guarantee of no recovery if they refuse to settle. This increases the pressure on the claimant to accept a settlement.

4. File an Interpleader. In an interpleader the party with the money gives it to the Court and states that they have given up all claim to the fund and that the only issue is how the fund is to be distributed. Important benefits to interpleader include the fact that the jury is put on notice as to the insurance limits (you are telling the finder of fact up front that "here is the insurance money and this is all that there is") and that the legal expenses of the party placing the money into interpleader are paid first out of the fund.

By filing an interpleader the insurer is reducing legal expenses and putting the claimants on notice that their efforts in litigating the matter will result only in a reduced recovery for all.

Some times an interpleader will make the only sense. A drunk driver with minimal policy limits who crashes into a college dormitory may very well face a number of angry and unreasonable claimants who refuse to settle. The claim clearly exceeds the policy. Giving up any claim to the policy gives up nothing.

At the same time that the interpleader gives up nothing it gains a great deal. All of the possible plaintiffs are forced into one law suit, in one proceeding, in the same court and can be handled out of the same file. In addition, the cost of defending the matter can be taken out of the policy rather than being an additional expense. Finally, when a fact finder is looking at the policy limits and determining damages, any speculation about insurance coverage is resolved and the total judgment against the insured will probably be much lower.

5. Try a Summary Trial, Arbitration, or Mediation, with or without a Bankruptcy. It is very possible that the insured will be judgment proof only by going through bankruptcy. If the claims are substantial, bankruptcy may be a preferable method of litigating the matter compared with interpleader.

The insurer, after discussing the matter with the insured, files a bankruptcy. Listed as the only substantial asset are the insurance funds, interplead into the bankruptcy court. Often a bankruptcy court will authorize or require a summary proceeding to distribute the assets. Summary trials, arbitration and mediation are all summary proceedings that can be authorized.

The combination of bankruptcy and a summary proceeding both aggressively limits the insured's liability and reduces the costs of defense. Many insured parties will balance the benefits and liability of bankruptcy and find that after all is considered that they prefer the protection that bankruptcy provides.

In addition, sometimes a summary trial, arbitration or mediation will provide the claimant with the emotional relief and the assurance by an exterior party necessary to bring about a settlement. Often a mediator or arbitrator's presence will reaffirm the basic fairness of pro rata or ratio settlements and aid a claimant in finding a willingness to accept one.

Finally, some claimants do not object so much to the pro rata settlement as they do to the method by which damages are calculated. Sometimes the easiest and least expensive method of dealing with a claimant or claimants who are unreasonable because of their inability to acknowledge that anyone else's loss is as great as their own is to have an impartial finder of fact determine the damages.

When all else fails, some parties will agree to a ratio settlement -- but one where the damages and/or comparative negligence are not determined by a formula but instead by an informal jury panel or arbitrator sitting as a finder of fact in a summary trial. The summary trial also allows the claimant to discharge the emotional force that may be preventing them from acting rationally and settling.

The decision not to accept a fair settlement position in a case of insufficient coverage is usually not the product of balanced rational thinking. While such a decision is may be the result of a party who is attempting to extort more than their fair share, it is usually the result of emotional, non-logical thinking.

Mediation and arbitration both are very successful in allowing parties to discharge their emotions and to then reach rational conclusions. My own experience has been that mediation is especially useful in moving individuals whose problems in reaching settlement are emotional and irrational.

In any case, regardless of the reason for using summary proceedings, they are often less prone to wide variances from the normal range of reasonable outcomes, less expensive to pursue, and a good choice when attempting to resolve multiple parties. Whether used to facilate bankruptcy, to set the amounts for a ratio settlement, to ease emotional bottlenecks or to save costs in the defense of claim clearly over the policy limits, summary proceedings are often less expensive and carry a lesser degree of risk than the traditional judicial trial.

6. Partial Settlement with Mary Carter Agreements of "Significant Party" Prepared With the Jury in Mind. The final approach, if all else fails, is to settle with those parties who will settle and to litigate with the rest. Pursuant to any litigation, it is important to obtain "Mary Carter" settlement documents, in the name of the insured, expressly laying out the amount paid to the settling claimants.

Most jurisdictions follow Federal Rule of Evidence Rule 607 which allows allow a party to impeach their own witnesses. Settlement contracts, with or without a paid testimony provision, are fair game for impeachment of the witnesses. They are also a method by which the amount that other parties received for their injuries may be presented to the jury.

If the worst injured party settles for $20,000.00 (the typical per person limit in a typical minimum coverage policy), a person with lesser injuries is judged by that standard. When a party is seeking more than an appropriate ratio compared with that obtained by other claimants, there is a definite influence on the jury. Partial settlements as impeachment documents are useful tactical tools in setting the stage for the jury's consideration of what amount of money is appropriately awarded in a claim for damages.

Even an underinsured with substantial assets benefits from settling out only some of the parties. The settling parties, whether their claims are great or small, provide a yard stick for the jury to observe when setting damages.

Bottom Line

The bottom line is that an insurance company can only do what it can do. There are good reasons for policy holders to obtain more coverage than the bare statutory or bank required minimums. When a policyholder has miscalculated risk and benefits, there is no magic solution that will protect the insured from liability in excess of the policy limits.

All that can reasonably be expected is for the insurer to act in good faith and to make a reasonable attempt to protect the insured from liability. Following rational established guidelines, in consultation with the insured, and making good use of the various settlement tools described in this article seems to be one way to fairly deal in good faith with the problem of multiple claimants on an underinsured defendant.


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Copyright 1998, 2000 Stephen R. Marsh

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