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Court rules in insurer's favor based on hammer clause

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A federal appellate court has overturned a lower court decision and ruled in favor of an insurer in litigation over a city’s refusal to settle a discrimination lawsuit, based on its policy’s “hammer clause,” which allows it to accept a good-faith settlement even if is not acceptable to the insured.

New York-based Security National Insurance Co., the excess insurer for Montebello, California, tendered $550,00 to the city, which was “an amount seemingly sufficient” with its self-insured contribution to settle a lawsuit claiming racial discrimination brought by a city employee, according to Tuesday’s ruling by the 9th U.S. Circuit Court of Appeals in San Francisco in Security National Insurance Group, a Texas Corporation v. City of Montebello, a California municipal entity.

Montebello refused to settle and rejected the sum, arguing the employee’s $1.5 million settlement demand, which provided for the worker’s continuing employment, was made in bad faith in light of his threats to sue for continuing discrimination and retaliation, according to the ruling.

Security National then filed suit in U.S. District Court in Pasadena, California, and Montebello filed a counterclaim, with both parties seeking summary judgment.

At issue was the hammer clause in Security National’s insurance policy, which allows the insurer to accept a good-faith settlement where the payment would result in the lawsuit’s final disposition.

Under the clause, even if the settlement demand is not acceptable to the insured, the insurer can offer to the insured an amount equal to the difference of the insured’s retained limit, less defense costs, and the plaintiff’s settlement demand and be discharged from liability, according to the ruling.

The District Court ruled in Montebello’s favor, stating it was not “realistically reasonable” that an employer would pay $1.5 million to settle a lawsuit “but give in to a demand of continuing employment with threats of additional litigation arising from that employment.”

The court held Security National, therefore, could not invoke the hammer clause to terminate its liability as the city’s excess insurer.

A three-judge panel of the 9th Circuit unanimously overturned that ruling.

“The employee’s $1.5 million settlement demand was made in good faith.  It was substantially less than previous offers, and it was made honestly, without intent to defraud, and according to reasonable standards of fair dealing,” said the ruling.

“The settlement offer also would have resulted in a full and final disposition of the employee’s claims against Montebello,” said the ruling. 

“The employee, notwithstanding continuing employment, would not have been able to sue for infringements of the same right, concerning substantially the same evidence, and arising from the same nucleus of facts.”

Although Montebello argued it had acted reasonably in refusing a settlement offer conditioned on the employee’s continued employment, the hammer clause does not limit an insurer’s right to invoke the clause in cases where the insured unreasonably rejected an offer, said the ruling. 

“To hold otherwise would impermissibly rewrite the hammer clause to the policyholder’s benefit,” said the court, in remanding the case.

 An earlier version of this story mistakenly identified Security National as a Zurich Insurance Group unit that has a similar name.