Liability Insurance and Contractual Aspects of Settlement

Abstract

Most civil litigation settles. Certainly, most tort litigation settles. The settlements in many cases are paid by liability insurers. Indeed, standard liability insurance policies grant the insurance company the right to settle a lawsuit against an insured as the insurer deems expedient.

Of course, settlements are achieved by agreement between the parties. Settlement agreements are contracts. Their interpretation and enforcement are therefore governed by contract law principles.

The essential elements of a contract are offer, acceptance, and consideration. In the liability insurance context as elsewhere in litigation, contract disputes connected to settlements typically center on either offer or acceptance. For instance, to be valid, a settlement offer must be capable of acceptance. Thus, a settlement offer that requires the insurer to produce copies of the declarations pages of every insurance policy that covers the insured for the subject accident—including policies issued by other insurance companies—is not valid because the insurer has no ability, authority, or right to produce other insurance companies’ records. Alternatively, consider a case that involves a progressive occurrence, such as the plaintiff’s exposure to asbestos or toxic chemicals over a period of years, such that multiple insurers may be obligated to indemnify the insured. An offer by the plaintiff to one of them to settle for the limits of all applicable insurance policies is not capable of acceptance by the single insurer to which the offer is made because that insurer does not have the authority to bind the other insurers; it can only offer its own policy limits in settlement.

When it comes to accepting a settlement offer, the “mirror image” rule applies in this context as it does in other contract formation scenarios. So, for example, an insurer that sends a claimant a settlement check accompanied by a proposed release that is materially broader than the release the claimant said she would agree to may in some jurisdictions convert the attempted acceptance of the claimant’s settlement offer into a counteroffer. If the claimant declines the counteroffer, there is no settlement. This turn of events can be enormously consequential if the insured’s potential liability exceeds its policy limits and litigation ensues.

The importance of achieving enforceable settlement agreements—which, again, are contracts—is difficult to overstate. The law and public policy strongly favor the settlement of disputes, and courts would be overwhelmed if most cases went to trial. This Article examines contractual aspects of settlement in the liability insurance context, concentrating on the elements of offer and acceptance. It also addresses insurers’ ability to reject settlement offers that are intended to facilitate later bad faith litigation without incurring extracontractual liability.

Keywords: insurance, contracts, litigation, torts