Four passengers in a car that Yan Fang Du was driving were injured in a June 2005 collision on a California highway. Du and his passengers sued Joon Hak Kim, the driver of the other vehicle, whom they claimed was at fault. Because Du and Kim were from different states, the case proceeded to trial in federal court.

A jury returned a verdict of more than $4.1 million for Du against Kim. Kim's insurance policy with Allstate Insurance Co. and its subsidiary Deerbrook Insurance had a $300,000 per-incident limit, leaving Kim on the hook for the massive excess judgment. Kim assigned his right to sue his insurer to cover the excess amount to Du in exchange for an agreement that Du would not execute the judgment against him.

Du then sued Allstate and Deerbrook, claiming that they should pay the whole $4.1 million judgment because they had an opportunity to settle the case for the policy limit, but failed to do so in bad faith.

Excess liability litigation is not uncommon in personal injury cases, but what happened with Du's case was unexpected. A San Francisco jury found that the insurers had not breached their duty of good faith, and therefore their liability was capped at the policy limit. Du appealed. The 9th Circuit affirmed, but not without handing down an unwelcome surprise to insurers. The court stated in dicta that an insurer could be liable for an excess verdict if it did not settle for the policy limit even in the absence of a settlement demand from the injured person.

The decision greatly increased insurance companies' potential liability for excess verdicts. Prior to Du v. Allstate, California courts had held that insurers could only be liable for failure to settle in bad faith if they unreasonably failed to respond to a demand for the policy limit from the plaintiff in a timely manner.

“We got a great verdict, and then we won the appeal in a disastrous way,” says Peter Klee, a partner at McKenna, Long & Aldridge. Klee represented Allstate in Du. “The decision was going to foment unnecessary litigation in every big damages case.”

In an unusual move, the 9th Circuit amended its decision in response to Allstate's motion for rehearing, saving insurers from a host of new liabilities.

Deciding Duty

Prior to the original 9th Circuit decision in Du, California law was clear that insurers did not have an affirmative duty to initiate settlement discussions in the absence of a settlement demand and would not be exposed to bad-faith liability for not doing so. The 9th Circuit reversed course.

“The rule (announced in Du) was problematic because in many instances the insurance company doesn't have sufficient information to make a settlement offer. The claimant is the person with all of the information about his injuries and damages,” says Larry Golub, a partner at Barger & Wolen. “Du put the cart before the horse.”

Litigants worried that the decision would create an incentive for any plaintiff with serious injuries to simply avoid initiating settlement discussions in the hope that he could then make the insurance company pay a large verdict in excess of the policy. Although the 9th Circuit decision seemed aimed at protecting injured people, the result could have been the opposite.

“From a policy standpoint, the rule was absolutely contrary to the best interests of policyholders and consumers,” Klee says. “Under the old rule, there was an incentive on both sides to reach early settlement. By eliminating the requirement of a demand, the court created a situation where any time a lawyer had a big damages case, he wouldn't make a demand and then say that the insurer should have offered the policy limit sooner.”

Switching Course

Counsel for Allstate took the unusual step of asking the 9th Circuit to rehear the case, despite the fact that it had won the appeal. In its petition for rehearing, Allstate argued that the court had made two errors—one was issuing a ruling contrary to existing California law governing the case, and the other was reaching an issue that it didn't need to broach to resolve the dispute between the parties.

Without granting Allstate's petition, the court issued an amended opinion, removing the language regarding an insurer's duty to approach settlement in the absence of a demand from the plaintiff. After six tense months waiting for the deluge of bad-faith claims, defense attorneys were relieved.

“It's helpful to not have a published opinion that can be cited by plaintiffs trying to make this the law in California or other states,” says Arthur Schwartz, a partner at Gordon & Rees.

Counsel for Du did not immediately return requests for comment.