Can an insurer avoid bad faith by first settling, then suing?
The 10th Circuit U.S. Court of Appeals recently affirmed the ruling of the lower court, in a win for insurers.
The 10th Circuit U.S. Court of Appeals recently affirmed the ruling of the lower court and held that an insurer can recover an underlying settlement that it made on behalf of its insured as fraud damages, effectively avoiding a bad faith claim.
Aminokit Laboratories Inc., (Aminokit Labs) a Colorado corporation, owned and operated an addiction-treatment center in the same state. In October 2014 Aminokit Labs obtained an insurance policy that covered “outpatient drug/alcohol rehab services” from Evanston Insurance Company (Evanston) for the treatment center. In securing the policy Aminokit Labs made several material misrepresentations to Evanston.
In 2015, a patient of the addiction-treatment sued, alleging consumer protection and racketeering claims against Aminokit Labs relating to inpatient treatment that was administered at the facility. Evanston denied coverage and the underlying plaintiff amended his claim to include negligence and vicarious liability claims against the treatment center and a doctor employed by the center, which potentially brought the claim into the scope of coverage provided by the policy.
After that amendment, Evanston agreed to defend Aminokit Labs in the suit, subject to a reservation of rights. After Evanston defended Aminokit Labs for six months, a mediation was held that involved all three parties. Evanston initially declined to pay the full settlement, contending that several claims were not covered by the policy, and filed a declaratory judgment action seeking a declaration of that there was no duty to defend or indemnify. Aminokit Lab’s attorney threatened to bring a bad faith claim, and Evanston agreed to pay the full settlement, making clear that it would seek reimbursement for the whole cost of defense and indemnity if it settled the case, effectively reserving its right to seek full reimbursement.
After funding the settlement Evanston amended its prior complaint to include counts for unjust enrichment, and fraudulent misrepresentation and fraudulent concealment, both related to the misrepresentations made in the policy application. Evanston sought damages for fraud, including the settlement damages and costs associated with the provided defense.
On appeal, Aminokit Labs argued that Evanston failed to state a claim for fraud when it failed to show damages; when the alleged fraud did not impact the decision to settle the case; and due to the fact that Evanston knew of the fraud at the time, it agreed to settle the case.
The 10th Circuit disagreed with Aminokit Labs, holding that it would have been economically unreasonable for Evanston to refuse to pay the settlement because it would put the insurer at risk to be sued for bad-faith. The court then emphasized a state public policy against insurance fraud, noting that allowing the insureds to retain the benefit of insurance coverage that was fraudulently obtained would foster a climate of fraud. The court ruled in favor of Evanston.
The case is Evanston Ins. Co. v. Aminokit Labs., Inc. No. 19-1065, 2020 U.S. Ap. LEXIS 8571 (10th Cir. Mar. 18, 2020)
Editors Note: This case provides a potential workaround to avoid bad faith lawsuits, but like all insurance coverage cases, an outcome like this requires a certain set of facts. In a case like this, not only do you need a fraudulent insured, you also need a solvent one. If the insured was insolvent, the insurer would ultimately lose out more than just the settlement costs by paying the settlement and then suing the insured for fraud.
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