The California Court of Appeals held that a carrier who breaches the duty to defend may be liable for consequential damages above policy limits. Carlson v. Century Surety Co., 2012 U.S. Dist. LEXIS 23119 (N.D. Cal. Feb. 23, 2012).
The underlying plaintiffs listed their home for sale with Prudential California Realty. Plaintiffs entered into a sales agreement for $1,262,000. When the sale fell through, the purchaser released the $1,000 deposit to plaintiffs. The plaintiffs, however, demanded $5,000. It became clear that Prudential never deposited the $1,000 in escrow.
The plaintiffs sued Prudential, demanding over $65,000 in damages. Prudential tendered to its errors and omissions carrier, Century Surety Co., who denied coverage. The policy only provided coverage for a claim first made during the policy period if the insured had no basis to believe that any act or omission might reasonably be expected to be the basis of a claim. The policy period was from February 1, 2008 to February 1, 2009.
Prudential's file contained a letter from plaintiffs dated August 20, 2007, before the policy period, demanding that Prudential attend a mediation prior to the suit being filed. Prudential claimed it never received the August 20, 2007 letter regarding mediation.
Prudential agreed to allow a default judgment be entered for $3,334,834.61. Plaintiffs agreed to not execute on the judgment against Prudential in return for an assignment of rights under Prudential's policy with Century.
Acting under the assignment, plaintiffs sued Century for failing to defend and for breach of the covenant of good faith and fair dealing. In a prior decision, the court ruled Century had breached its duty to defend, but found questions remained regarding whether the settlement agreement and default judgment were reasonable and free from fraud or collusion.
Century now argued even though it incorrectly denied the claim, its action was not unreasonable. Century relied on the presumption that a letter correctly addressed and properly mailed was presumed to have been received in the ordinary course of mail. The court agreed that Century's denial of coverage was not unreasonable, so Century's motion for summary judgment on plaintiffs' allegations of breach of the implied covenant of good faith and fair dealing was granted.
Century's motion for summary judgment on whether plaintiffs' damages could exceed the policy limits, however, was denied. A plaintiff could recover consequential damages and an excess judgment by proving breach of the express terms of a policy. A judgment in excess of the policy limits was a foreseeable outcome of the breach of the duty to defend.
But to recover an agreed to default judgment against the insurer, the plaintiffs had to show the judgment was not unreasonable and was free from fraud or collusion. Here, theevidence showed that plaintiffs had colluded with Prudential. Both parties knew that the plaintiffs had first made their claim prior to the inception of the policy. Yet, the settlement agreement was conditioned on sworn declarations by Prudential and provided to plaintiffs stating that the insured was unaware of plaintiffs' claim prior the policy period.
Because the settlement agreement was collusive, plaintiffs were not entitled to any recovery from Century.
