It is one of the most challenging issues that insurers face.  Its insured is confronted with a demand to settle within limits.  And, based on liability and damages at issue, the insurer should accept it under the applicable state standard that dictates that obligation.  But the insurer has a coverage defense – and perhaps a strong one.  So, if the insurer accepts the settlement demand, because the standard says it should, then its coverage defense has gone up in smoke.  But if the insurer declines to accept the settlement demand, because it does not believe it has an obligation to settle an uncovered claim, and there is an excess verdict, and coverage is determined to be owed, is the insurer liable for the amount of the verdict over the limit?  In other words, was the insurer entitled to rely on its coverage defense as part of the equation whether it was obligated to accept a limits demand, that should have been accepted if only liability and damage considerations were in play?

Despite the frequency in which this scenario arises, there is, surprisingly, relatively little case law addressing it.  The recent decision in Liberty Mutual Fire Ins. Co. v. ACI International, Inc. (C.D. Cal. May 21, 2025) demonstrates how California addresses the situation -- and an insurer that used it to its advantage. 

The approach is hardly perfect and the insurer prevailed on only 60% of the claim – which was still a lot.  But at least the Golden State has a solution for insurers for this vexing situation.

At issue was coverage for ACI International for intellectual claims brought against it.  The specifics are not important here.  The issues are ones that often arise in “personal and advertising injury” claims, such as trademark, trade dress, advertisement, prior publication exclusion and so on.

Liberty, ACI’s commercial general liability insurer, paid $3,000,000 toward a settlement of the litigation and expressly reserved its rights to recoup the settlement amount as well as the nearly $2 million paid in defense costs. 

Liberty had such right under California’s Blue Ridge rule, discussed below.

In the recoupment litigation, the court held that Liberty had a duty to defend and was not entitled to reimbursement of defense – with one possible exception not important to this discussion.  Not to say that Liberty did not have strong defenses; but the duty to defend is broad and sometimes the high standard to deny a defense simply cannot be satisfied.  And that’s what happened here. 

But it was a much different story on the issue of Liberty’s recoupment of its $3,000,000 settlement payment.  Here, with the test being actual coverage, and not simply the potential for coverage for the duty to defend, the court, examining the issues under this different standard, held that no coverage was owed.  Thus, Liberty was entitled to recovery of its $3,000,000 settlement payment.

Here’s the rub: Under California law, an insurer confronted with a settlement demand within limits cannot consider its coverage defenses when making the decision whether to accept the demand.  But the California Supreme Court, in Blue Ridge Ins. Co. v. Jacobsen (2001), set out a method to address this, explaining as follows:

“In light of Johansen [an insurer confronted with a settlement demand within limits cannot consider its coverage defenses when making the decision whether to accept the demand], were we to conclude insureds could, as in this case, refuse to assume their own defense, insisting an insurer settle a lawsuit or risk a bad faith action, but at the same time refuse to agree the insurer could seek reimbursement should the claim not be covered, the resulting Catch-22 would force insurers to indemnify noncovered claims. If an insurer could not unilaterally reserve its right to later assert noncoverage of any settled claim, it would have no practical avenue of recourse other than to settle and forgo reimbursement. An insured’s mere objection to a reservation of right would create coverage contrary to the parties’ agreement in the insurance policy and violate basic notions of fairness.”
    
No rule is perfect. And often-times in coverage things are easier said than done.  And surely not every insured has the financial means to reimburse a settlement of a later-determined non-covered claim   But at least California has a mechanism for insurers dealing with the difficult issue of addressing a limits demand that should be accepted while holding a coverage defense.