Try this little catastrophe on for size:
You’re in the mediation of a legal malpractice case. The case appears to have a settlement value of $700,000 to $800,000. The defendant has $1,000,000 of insurance coverage. Everything copacetic?
Not quite.
The zealous advocates defending the case have incurred fees and costs of $325,000. And, as we often see in professional liability cases, the insurance is an “eroding limits,” “burning limits,” defense within limits” policy. That is, the amount of available insurance is reduced by the amount spent on the defense. The arithmetic is clear: $1,000,000 - $325,000 = $675,000. There’s not enough insurance left to settle this case on the merits.
The parties’ choices are not good. The plaintiff can settle for less than the case is worth. The defendant can dip into personal assets to make up the shortfall.
For many defendants, this could mean mortgaging, or even selling, their home. Once we leave the realm of BigLaw and multimillion-dollar cases, many legal malpractice claims arise in family law and probate; areas where lawyers often practice solo or in small firms, and where much of their net worth is tied up in their principal residence.
These lawyers often have malpractice policies with $500,000 or $1,000,000 limits. Defense costs can rack into the hundreds of thousands. When policy limits erode in this way, it’s easy to see these little catastrophes grow large for the people involved.
What can you do if you find yourself in this situation? Well, when you’re up to your hips in alligators, it’s too late to remember you meant to drain the swamp. So, think about preventive measures.
On the defense side:
On the plaintiff’s side:
This will often result in an early policy-limits demand. For both plaintiffs and defendants, the early policy-limits demand has pluses and minuses.
For plaintiffs, a policy-limits demand may seem to involve a discount from the fair value of the claim. As litigation proceeds and the policy erodes, though, the amount of insurer money available for settlement can only go down. And tapping into a defendant lawyer’s personal funds in a settlement isn’t easy.
For defendants, even if there appears to be enough insurance at the outset, litigation costs may erode the policy limits below the fair value of the claim, and expose the attorney defendant’s personal assets. This may incentivize the attorney defendant to exhort the insurer to pay what may seem to be a premium above the claim’s fair value.
There are a lot of wild cards here! To avoid catastrophes in professional liability cases with eroding limits insurance, the goal should be to prepare cases quickly, mediate them early, confront the issues on their merits, and get good deals done while there’s still money there to make good deals.
Eroding limits is a coverage issue that can influence negotiations. The information is better managed when the mediator knows that there are eroding limits that may affect negotiation strategy or litigation strategy. Often, people are reluctant to provide this information to the mediator, particularly when the fact of eroding limits has not been shared with the other side. The coverage type may cause the mediator to assume that limits are eroding, but when the coverage type is general liability or auto the mediator cannot know absent being told. An experienced, coverage savvy mediator might guess that defense is inside if there is a GL tower the size of which would likely be structured as defense inside.
If the defense group doesn’t discuss eroding limits with the mediator, then the mediator does not know whether the information has been shared with the other side, and unless the mediator is told that the limits are eroding and to keep that information secret, the mediator may speculate about the potential of it to the other side. In other words, it is better to be up front with the mediator about the fact of eroding limits.
The other side may see eroding limits as a pressure point or they may see it as a reason that they have to compromise sooner. This viewpoint can be impacted by how the subject is discussed by the mediator with them. The obvious follow-up from the mediator when learning of limits erosion is to ask, “By how much are the limits eroded? What is the anticipated erosion rate going forward?” The answers to those questions then need to be clearly denoted as secret or shareable (and, if shareable, when).
If the other side does not know that the demand is exceeding available limits, they may negotiate in a seeming irrational fashion. The defense side indicating only that it does not view the case settlement value the same as the other side only goes so far. Sometimes sharing that the limits are eroding reinforces to the other side (which could include co-defendants) that a contribution from a particular defendant will be so much today and a lesser amount tomorrow. On the other hand, sharing the information with the other side could cause them to hold out for everything that remains and leverage a carrier’s obligation to get a policyholder out of harm's way.
In the lattermost instance where the other side is trying to use the fact of eroding limits to get the defense to pay more than the defense assesses to be a rational settlement amount. Mediators can work with the parties to elicit information from the defense regarding why even with risk of an ultimate judgment exceeding the limit the defense is not going to pay everything that remains.
Trust the mediator, work with the mediator, inform the mediator of the eroding limits early and strategize on how to work with the information.
