Posted on: 6/15/2012
Paul W. Johnson, Fox Galvin
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Given that the majority of the readers of this fine newsletter are professionals working tirelessly in their respective fields, it may make sense to take a breather and once again dust off your professional liability policy to examine the small but important details contained in it. This article will start with the premises that your policy provides for an adequate dollar amount coverage in the unfortunate event you or your firm winds up on the wrong side of the "v." It also presumes that your deductible or Self-Insured Retention (SIR) is within the dollar range such that you or your firm can comfortably defend the claim before your policy limits begin to cover the claim.
While we are at it, are defense costs included in your limits of coverage? Does your policy provide you with the right to choose your own defense counsel so that your firm has the ultimate choice of who will defend your firm's reputation and best interests? Does your policy provide you with the ever important right to reasonably reject a proposed settlement demand even if the insurer deems the settlement fair?
The purpose of this article is not to harp on the above critical parts of your policy, but to get you primed to start taking a conscious look at how your firm will be protected in the event suit papers cross your desk. As with anything in life, the devil is in the details. Glossing over your policy or blindly accepting the limitation language contained in the policy does your firm no justice and will only lead to heartache, sleepless nights and trouble down the road. With that said, let's take a closer look at the settlement portion of your policy to determine the rights your policy provides when it comes time to either settle or try the case.
Ordinarily, most comprehensive general liability policies contain limitation language stating that the insurer has an unfettered right to settle claims without the approval of the insured. This type of language is deemed necessary for insurers due to the size of the awards that can result from these types of liability suits. In these cases, many insurers will do what they are supposed to do -- analyze the risk and try to settle the case taking into account the insured's anticipated liability for the asserted claim. To the insurer, it is simply a matter of risk and money.
The language contained in professional liability policies such as E&O and D&O polices differ somewhat significantly, mainly because the insured's reputation is being questioned, and consequently, at stake. Because of this, insureds may not wish to yield to the insurer's desire to settle a claim based upon pure numbers alone. As readers of this newsletter are keenly aware, a settlement or adverse judgment can often be viewed as a sign of a firm's incompetence or an admission of wrongdoing, regardless of the denial of wrongdoing. Firms doing business with the insured and catching wind of the settlement or adverse judgment may lose confidence in the insured, which could subsequently have an adverse impact on the insured's bottom line or on the viability of the firm itself. Also, the insured's competitors will no doubt see an opportunity to capitalize on the meaning of the settlement or adverse judgment. Rest assured that these considerations are not at the top of the insurer's list when it comes to resolving the claim.
Many professional insureds comprehend these risks and demand that their policies mandate that the insured has the ultimate choice of whether to settle a case or vindicate its reputation by going to trial or by appealing adverse judgment despite the associated costs. Insurers, eager to maintain the ever-competitive business from professionals, are forced to capitulate to these demands, but not without additional limiting language.
Enter the Hammer Clause
It has often been said that the most important words in any document, particularly insurance documents, are the words following "however" or "except." The Hammer Clause, hidden deep in many policies, normally follows the consent to settle discussed above, except for the limiting language following the consent to settle. A typical full Hammer Clause reads something like this:
The Insurer shall not settle any Claim without the consent of the Insured. However, if the insured refuses to consent to a settlement or compromise recommended by the Insurer and elects to contest or continue to contest a Claim, the Insurer's liability shall not exceed the amount for which the Insured would have been liable for Loss if the Claim had been so settled when and as recommended, and the Insurer shall have the right to withdraw from the further defense of the Claim by tendering control of the defense thereof to the Named Insured. The operation of this subsection shall be subject to the Limits of Liability and Retention provisions of this Policy.
A version of the Hammer Clause cited above is part of nearly every professional liability policy. You will be hard-pressed to find a specific "Hammer Clause" provision; instead you will find softer and more euphemistic language such as a "cooperation clause." Regardless of the insurance jargon used in your policy, the end result is the same. The clause, obviously, was designed to protect the insurance company from extended liability in the event the insured declines to settle for what the insurance company deems reasonable. If you did not negotiate this provision when you bought your policy, then your policy contains some version of the above quoted language. If you have not found it yet, it is only because you may not know where to look. Keep digging.
The Hammer Clause provision cited above contains rather draconian language and is considered in the insurance industry to be a "Full Hammer Clause." More on that later. Sophisticated, informed, and business savvy professionals realize the competitive nature of professional liability insurers. As such, they know full well that the provision can be negotiated with the insurer before the purchase of the policy or certainly before suit has been brought. While it is doubtful that the provision can be negotiated out entirely, modifications to it are absolutely proper and worthwhile of a firm's time and probably increased premium. Uninformed professionals accept the language given to them and suffer the consequences later. Hopefully this article will get you and your firm to at least have an understanding of what you are paying for in your policy.
Now that you are conscious of the presence of the Hammer Clause, let's take a look at the differing clauses and how each will effect settlement discussions, the appeal of adverse judgments and ultimately your firm's choices during litigation. Hypothetically, let's assume that an insured, as a professional, has been sued and that the insured has a $2 million policy limit with an SIR of $100,000. Let's also assume that plaintiff has offered to settle the claim for $400,000.
The insurer whole-heartedly supports settling the claim for that amount and recommends that the insured take plaintiff's offer, resulting in a $300,000 charge to the insurer and a $100,000 charge to the insured. The insured decides that settling will not be appropriate because doing so would lower the aggregate limit on future claims and because it will send the signal to future plaintiffs that the insured is an easy mark for suit and ultimately easy settlement. Maybe the insured also realizes that its current insurer may also non-renew the insured, leaving the insured in the unenviable position of replacing coverage with a negative loss experience. The insured politely declines to settle, litigates the case and ultimately ends up on the sour end of an $800,000 verdict.
In a Full-Hammer Clause situation, the insured's cost will equal 100 percent of any defense costs exceeding the first proposed settlement. In other words, the invocation of the Hammer Clause means that the insured will have to pay out of pocket any litigations costs, attorney fees and judgment in excess of the proposed settlement amount. In the hypothetical, the poor insured would be required to pay $500,000 of the $800,000 verdict, plus attorney fees. By invoking the Hammer Clause, the insurance company has essentially turned a $2 million policy into a $300,000 policy.
A modified Hammer Clause, as its name suggests, punishes the insured less severely than the Full Hammer Clause. Some policies dictate that if the insured does not agree to settle a claim for an amount that the insurer deems reasonable, the insurer's liability exposure is limited to the amount of the proposed settlement plus 50 percent of the costs exceeding the proposed settlement. Thus, while the insurer is still limiting its exposure, the insured will not be exposed to the full amount above the proposed settlement. In the hypothetical, the insured would be required to pay $350,000, with the insurer picking up the rest of the tab. By invoking the modified Hammer Clause, the insurance company turned its $2 million policy into a $450,000 policy.
The good news here is that the Hammer Clause has traditionally been used sparingly by insurance providers. Case law on the subject is rather dearth, giving the impression that if insurers utilized the Hammer Clause more often, then there would certainly be more case law on the subject. The use of the clause in settlement talks or mediation may never be known, however. Commentary on the subject shows that there are several prerequisites to the application of the Hammer Clause. First, there is an obvious need for a reasonable settlement demand that must be recommended by the insurer. Second, the demand must fully and finally resolve all claims. Third, the insured's refusal to consent cannot be the result of counsel's poor advice or representation. Finally, the insurer's right to invoke the Hammer Clause may be limited by the obligation of good faith and fair dealing. Thus, while not explicit in the Hammer Clause, the insurer must still give some consideration to protecting the insured's business and reputation. Kenneth S. Meyers, Alschuler Grossman Stein &Hahan LLP, Professional Liability Insurance: Beware of the Hammer Clause, ASS'N OF BUSINESS TRIAL LAWYERS REP., Vol. XXI, No. 2 (February 1999).
Aside from these considerations, an insurer with a reputation for disregarding the best interests of its insureds (customers) stands little chance of surviving in this business climate. After all, the insurer is also a business. The type of insurance a professional firm purchases should depend on the firm's needs and appetite for risk. To be clear, the Hammer clause should not be seen as an evil contrivance of the insurance industry. Remember that insurance companies work on the basis of pooling. Insurance premiums fill up the pool while insurance claims drain the pool. When an insurer is forced to pay $800,000 on a claim it could have settled for $300,000, that amount may initially come out of the insurer's profits, but someone has to fill the pool, and that someone are other insureds, whose premiums are increased. See Berges v. Infinity Ins. Co. 896 So.2d 695 (Fla. 2004) (dissent analyzing the effect bad faith claims have on insureds).
I hope that after reading this article you take a hard look at your policy so that you can make conscious and business driven decisions.
Paul W. Johnson
Fox Galvin, LLC
St. Louis, Missouri