AMERICAN PHYSICIANS ASSURANCE CORPORATION, ETC., V. STEVEN SCHMIDT, ET AL
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2004-SC-0171-DG
AMERICAN PHYSICIANS ASSURANCE
CORPORATION, SUCCESSOR TO
KENTUCKY MEDICAL INSURANCE
CORPORATION
V
ON REVIEW FROM COURT OF APPEALS
2002-CA-1179 AND 2002-CA-1292
JEFFERSON CIRCUIT COURT NO. 96-CI-1974
STEVEN SCHMIDT; STEVEN L.
SCHMIDT ; ADMINISTRATOR OF THE
ESTATE OF TERRY ANN SCHMIDT,
DECEASED ; STEVEN SCHMIDT,
ASSIGNEE OF J . BOSWELL TABLER,
M .D . ; AND TABLER & ASSOCIATES,
N/K/A TABLER CLINICAL SERVICES
APPELLEES
OPINION OF THE COURT BY JUSTICE COOPER
REVERSING
On July 8, 1991, Dr. J . Boswell Tabler, M.D., a psychiatrist, began treating Terry
Ann Schmidt, wife of Appellee, Steven L. Schmidt, for a mental illness. Dr. Tabler
prescribed two psychotropic medications, Lithium and Stelazine, as part of the
treatment . Mrs . Schmidt had a history of blood abnormalities and subsequently
developed aplastic anemia, a blood disease that is often fatal . She died on June 30,
1993 . Steven Schmidt, individually and as administrator of his deceased wife's estate,
brought a medical malpractice action against Dr. Tabler, alleging that ingestion of
Lithium and/or Stelazine caused Mrs . Schmidt to develop aplastic anemia which
resulted in her death . Dr. Tabler was covered by a medical malpractice liability
insurance policy issued by Kentucky Medical Insurance Corporation ("KMIC"), the
predecessor corporation of Appellant, American Physicians Assurance Corporation . Dr.
Tabler's KMIC policy had liability limits of one million dollars per occurrence . At the
conclusion of a Jefferson Circuit Court jury trial held in October 1995, the jury returned a
verdict in favor of Schmidt in the sum of . $1,807,295 .36, i.e . , $807,295.36 more than the
liability coverage limits of Tabler's KMIC policy. It is undisputed that Schmidt offered to
settle his claim for one million dollars prior to trial and that KMIC neither accepted this
offer nor made a counteroffer . Like many professional liability insurance policies,
Tabler's KMIC policy contained a "consent to settle" clause providing that: "The
Company shall not compromise any claim hereunder without the consent of the named
Insured." KMIC maintains that it did not enter into negotiations with Schmidt because
Dr. Tabler did not consent to a settlement of Schmidt's claims against him .
After judgment was entered pursuant to the verdict, Dr . Tabler retained personal
counsel who negotiated a settlement offer from Schmidt in the amount of 1 .2 million
dollars, or $200,000.00 more than KMIC's policy limits, and demanded that KMIC pay
that amount to settle the judgment. Instead, KMIC paid Schmidt its policy limits of one
million dollars, plus interest, in partial satisfaction of the judgment against Tabler.
Tabler then executed a written assignment to Schmidt of any "bad faith" claim Tabler
might have against KMIC for its failure to settle Schmidt's claim and/or judgment ; and, in
exchange, Schmidt released Tabler from any liability for the excess judgment. Schmidt
then filed this derivative action against KMIC for the unpaid balance of his judgment
against Tabler. See -generally Manchester Ins. & Indem . Co. v. Grundv, 531 S .W .2d
493 (Ky . 1975) ; Terrell v. W. Cas. & Sur . Co. , 427 S .W.2d 825 (Ky. 1968) ; Grundy v.
Manchester Ins . & Indem . Co. , 425 S .W.2d 735 (Ky. 1968) . The "bad faith" case was
tried before a Jefferson Circuit Court jury in April 2002 . Dr. Tabler testified on direct
examination as a witness for Schmidt, inter alia, that he "did not recall" being warned by
his attorneys of his potential exposure to liability in excess of his policy limits and that he
"did not understand" that he could be personally, as well as corporately, liable for an
excess judgment. He also denied withholding his consent to a settlement of Schmidt's
claim. However, when confronted on cross-examination with sworn statements he had
previously made during a discovery deposition, he admitted :
"
That he had reviewed the "settlement brochure" prepared by
Schmidt's attorney claiming over $900,000 .00 in medical bills,
demanding five million dollars in settlement, and advising that he
(Tabler) would be personally liable for any excess judgment over
his policy limits;
"
That he received and read KMIC's "excess letter" advising him that
any damages over the one million dollar policy limits were his
responsibility and that he could obtain personal counsel;
"
That he wanted "his day in court" to tell his story to a jury of twelve
people" and "to be exonerated of any wrongdoing" "because he did
nothing wrong ;"
"
That he had no complaints about his lawyers ; that they were
prepared to try the case, he trusted them and they were honest with
him; that they did not mislead him or tell him not to settle the case;
that they provided him with medical literature which supported his
position and met with him frequently ; and that the expert witness
they retained was more believable and intellectually honest than
the expert retained by Schmidt;
"
That he knew that his insurance limits were one million dollars, but
regardless of whether his limits were $100,000 .00 or five million
dollars, he wanted to take the case to verdict and he did not want to
settle ;
"
That he knew there were no guarantees in litigation and that he
was told by his lawyers that if the jury believed Schmidt's expert
and disbelieved him and his expert, he would lose the case ;
That he had conversations with his lawyers regarding the potential
for a verdict in excess of his policy limits and the fact that the
exposure would be both personal and corporate ;
"
That if KMIC had settled the "Schmidt v. Tabler" case without his
consent, he would have sought legal counsel, and that he was
concerned about any settlements being reported to the National
Practitioners Data Bank;'
"
That, prior to trial, he consulted with his corporate/personal attorney
regarding what would happen to his residence, which was titled in
his wife's name, and to assets he had placed in trust in the event a
verdict was rendered against him in excess of his policy limits .
The attorneys who had represented Tabler in the malpractice action also testified that
they had advised Tabler of the risks of going to trial but that he was convinced that he
had done nothing wrong and that he would be exonerated by the jury. At the
conclusion of the evidence in the "bad faith" trial, the jury returned a verdict answering
"Yes" to the following interrogatory :
Do you believe, from the evidence presented in this case, that Dr.
Tabler, during the litigation of the claim against him by the plaintiffs, did
not give his consent to a settlement of the case after KMIC had conducted
reasonable investigation based upon all available information and after
being fully informed of the results of that investigation and the risks of not
settling?
' See , e.g_, Brion v. Vigilant Ins. Co . , 651 S.W.2d 183,184-85 (Mo . Ct. App. 1983)
(holding that insured psychiatrist could maintain cause of action against insurer for
settlement of patient's malpractice claim without psychiatrist's consent, seeking
damages for loss of malicious prosecution claim; embarrassment, humiliation, and
disgrace individually and professionally ; loss of reputation and standing in the
community as a psychiatrist ; mental anguish ; and loss of time and earnings and
attorneys' fees incurred in unsuccessful prosecution of claim for malicious prosecution) ;
Lieberman v. Employers Ins. of Wausau, 419 A .2d 417, 423-25 (N .J. 1980) (holding that
insured neurosurgeon could maintain cause of action against both insurer and attorney
for settlement of patient's malpractice claim without neurosurgeon's consent, seeking
damages for injury to reputation and malpractice liability insurance premium
surcharges) .
Tabler had corresponded with the drug manufacturer, who told him that there was
only one reported case worldwide involving Lithium and aplastic anemia and no
reported cases involving Stelazine . He had also spoken with Mrs. Schmidt's
subsequent treating physician who told him that Mrs . Schmidt's aplastic anemia was
idiopathic (of unknown cause) .
Having answered "Yes" to that interrogatory, the jury, pursuant to the trial court's
instructions, did not reach the instructions on whether KMIC's refusal to settle
constituted "bad faith" but simply returned a verdict in favor of KMIC, awarding Schmidt
nothing .
The Court of Appeals reversed and remanded for a new trial, citing Dr. Tabler's
testimony on direct examination and disregarding his testimony on cross-examination .
It also held that the jury should have been permitted to consider whether KMIC's failure
to pay the post-verdict settlement offer of 1 .2 million dollars constituted "bad faith," citing
avowal testimony by Tabler's personal attorney that KMIC could have paid the
additional $200,000.00 out of "unused defense costs" saved by the fact that Tabler
chose not to appeal the judgment.3 We granted discretionary review and now reverse
the Court of Appeals and reinstate the judgment of the trial court. There was ample
evidence to support the jury's finding that, after being "fully informed" of the risks, Dr.
Tabler did not consent to a compromise settlement prior to the return of the excess
liability verdict . The Court of Appeals erred in usurping the fact-finding authority of the
jury on this issue .
An insurer acts in "bad faith" with respect to a potential excess judgment against
its insured only if it is afforded the opportunity to settle within the policy limits . Davis v.
Home Indem. Co . , 659 S .W.2d 185, 189 (Ky. 1983) ("[T]he first premise is that the
insurance carrier has been presented with an opportunity to settle within the policy
limits .") . In Davis , the insured demanded that its insurer settle within the policy limits,
but the plaintiff never offered to settle for that amount. Rejecting an argument that the
3 Although KMIC's policy covered costs and fees incurred during an appeal, it only
covered the cost of an appeal bond to the extent of its policy limits and only its pro rata
share of interest payable on the judgment. Thus, the policy required Tabler to
supersede the excess portion of the judgment and to pay any interest thereon.
-5-
insurer is required to offer its policy limits in the absence of a demand therefor, we held
that, without such a demand, there could be no "bad faith" refusal to settle that would
give rise to liability for an excess judgment. Id . Here, the plaintiff was willing to settle
for the policy limits, but the insured exercised his right under the policy to withhold
consent to any such settlement, thus denying the insured the opportunity to settle within
the policy limits .
Compare this scenario with the usual case in which the policy gives the insurer
absolute control over settlement . Esc ., Terrell , 427 S .W.2d at 828 ("The insurer has
control of the defense and settlement of the claim.") ; Grundv, 425 S.W .2d at 737
("Under the terms of the policy, the insurer alone had the right and power to settle .");
Am . Sur . Co. of N.Y. v. J.F. Schneider & Son , 307 S .W.2d 192,195 (Ky. 1957) ("As
insurer, appellant was authorized to effect any compromise or settlement of the claims it
considered just and advantageous provided it acted in good faith in so doing ."),
overruled on other grounds by Manchester Ins . & Indem . Co. v. Grundv, 531 S.W.2d
493 (Ky. 1975) . Where the insured retains the right to consent to settlement and
withholds that consent, the insurer's failure to settle cannot be deemed "bad faith" that
would give rise to liability for an excess judgment. Carlile v. Farmers Ins. Exch. , 219
Cal . Rptr. 773, 777 (Cal. Ct. App. 1985) (where insurance policy contained "consent to
settle" clause and insured hospital withheld consent, insurer's failure to negotiate with
plaintiff did not violate California's Unfair Practices Act, Cal . Ins. Code ยง 790 .03). That
is particularly true where, as here, the plaintiff's "bad faith" claim is derivative of the
insured's right to make such a claim. Cf . Eklund v. Safeco Ins. Co. of Am . , 579 P.2d
1185, 1187 (Colo . Ct. App . 1978) (holding insurer entitled to summary judgment in
action by insured's bankruptcy trustee seeking to hold insurer liable for excess judgment
when insured had adamantly opposed settlement) .
The trial court correctly declined to submit to the jury the issue of KMIC's failure
to pay a post-verdict settlement offer in excess of its policy limits. An insurer is liable for
a judgment against its insured in excess of the policy limits only if it refused in "bad
faith" to pay a settlement demand within its policy limits. Harvin v. U .S . Fid. & Guar.
Co. , 428 S.W .2d 213, 215 (Ky. 1968) . An insurer does not act in "bad faith" by failing to
pay a settlement demand that exceeds its policy limits. Motorists Mut. Ins. Co . v. Glass ,
996 S.W.2d 437, 453 (Ky. 1997) ; Cooper v. Auto. Club Ins. Co. , 638 S.W.2d 280, 282
(Ky. App . 1981) ; Schlauch v. Hartford Accident & Indem. Co. , 194 Cal. Rptr. 658, 664
(Cal. Ct. App. 1983) ("While Hartford had a duty to protect its insured from an excess
judgment, it had no duty to either its insured or third party claimants to settle for any
amount in excess of the policy limits. Its settlement duty to the insureds and claimants
alike was limited to the policy limits .") . While some insurance policies have provisions
that deduct the cost of defense from the liability limits, see, e .q_, Aetna Cas . & Sur. Co .
v. Commonwealth, Natural Res . & Envtl. Prot. Cabinet, 179 S.W .3d 830, 840-41 (Ky.
2005), neither Schmidt nor the Court of Appeals has cited any authority, and we have
found none, holding that "unused defense costs" increase the liability coverage limits of
an insurance policy. Paragraphs B, C, and E of Tabler's KMIC policy clarify that the
cost of defense is a separate and distinct obligation from its maximum obligation to pay
damages, i .e . , its liability coverage limits, viz:
B.
Upon receipt of notice the Company shall immediately assume its
responsibility for the defense of any such claim and shall retain
legal counsel, who shall defend in conjunction with the claims
department of the Company. Such defense shall be maintained
until final judgment in favor of the Insured shall have been obtained
or until all remedies by appeal, writ of error or other legal
proceedings deemed reasonable and appropriate by this Company
shall have been exhausted at the Company's cost and without limit
as to the amount expended. However, the Company shall not be
obligated to incur any further defense cost nor provide any further
defense of any kind on any pending or further claims or suits after
the "annual aggregate" limit of this policy has been exhausted by
the payment of judgments or settlements .
C.
The Company shall furnish a bond not to exceed the limit of liability
for each medical incident herein, required to appeal a judgment
hereunder, but shall not be liable for more than a pro rata share of
interest payments on appealed judgments .
D.
Except for the cost of defense provided under Section B and the
premium on any bond furnished under Section C, the Company's
liability . . . shall not exceed the stated maximum amount for any
one occurrence (each medical incident) and, subject to the same
limit for each occurrence, the Company's total liability during any
one policy year shall not exceed the stated maximum amount
(annual aggregate).
The policy limits under Tabler's KMIC policy were one million dollars per occurrence and
three million dollars annual aggregate .
Our cases clearly distinguish between an insurer's duty to defend and its duty to
indemnify . Cincinnati Ins . Co. v. Vance , 730 S.W .2d 521, 522-23 (Ky. 1987) ; Wilcox v.
Bd . of Educ. , 779 S .W.2d 221, 223 (Ky. App. 1989) . KMIC's duty to defend Tabler
might have required it to prosecute an appeal, even after paying its liability limits, if
Tabler had so demanded and if there were reasonable grounds for appeal. Ursprung v.
Safeco Ins . Co. of Am . , 497 S.W.2d 726, 730-31 (Ky. 1973) . However, Tabler did not
demand an appeal and Schmidt does not assert that there were reasonable grounds
therefor . Regardless, the failure to appeal did not metamorphose any "unused defense
costs" that might otherwise have been incurred during such an appeal into increased
liability coverage .
To summarize, since the excess judgment against Tabler was not the result of
any "bad faith" on its part, KMIC was not required to pay any portion of the judgment
that exceeded the liability limits of its policy - and, ipso facto , its refusal to pay any
portion of the judgment that exceeded the liability limits of its policy could not be the
basis for a separate claim of bad faith.
Accordingly, we reverse the Court of Appeals and reinstate the judgment of the
Jefferson Circuit Court .
All concur .
COUNSEL FOR APPELLANT :
Mark G . Arnzen
Beverly R. Storm
Arnzen, Wentz, Molloy, Laber & Storm, PSC
600 Greenup Street
P .O . Box 472
Covington, KY 41012-0472
COUNSEL FOR APPELLEES :
Bixler W. Howland
Bixler W. Howland, PSC
414 Kentucky Home Life Building
239 South Fifth Street
Louisville, KY 40202
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