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Colorado Supreme Court Rules that a Stipulated Excess Judgment Coupled with a Covenant Not to Execute Constitutes Actual Damages Sufficient to State A Claim for Bad Faith

Blogs, Insurance Coverage

Over a forceful dissent the Colorado Supreme Court recently held that an insured driver suffered actual damages, sufficient to state a claim for bad faith, when he entered into a stipulated judgment in excess of the policy limits and a covenant not to execute with the injured passenger. Nunn v. Mid-Century Insurance Company, 244 P.3d 116 (2010). The stipulated judgment was required for the passenger, as the insured’s assignee, to pursue a bad faith claim against the insurer for its purported refusal to settle within the policy limits. At the time the insured entered into the stipulated judgment, the insurer was providing a complete defense. 

In reaching its decision, the Court first noted that traditional tort principles govern claims for bad faith breach of an insurance contract and therefore, proof of actual damages is required. It then went on to note that there are two approaches to the question of whether an excess judgment alone is sufficient to establish actual damages for a claim of bad faith breach of the duty to settle; the judgment rule and the prepayment rule. The Court explained that the majority judgment rule states that entry of judgment in excess alone is sufficient damage to sustain a recovery from an insurer for its breach of the duty to act in good faith. The minority prepayment rule, on the other hand, dictates that if an insured did not and cannot pay out any money in satisfaction of an excess judgment, the insured was not harmed and there can be bad faith liability. 

The Court ultimately rejected the prepayment rule on that basis that, in its view, regardless of whether the insured can or will pay the judgment, entry of a judgment in excess of the policy limits harms the insured because it may result in damage to the insured’s credit, its ability to successfully apply for loans and / or its reputation and it may also cause the insured to suffer fear, anxiety or other emotional distress. The Court dismissed the risk of fraud and collusion that this rule posed on the basis that the insurer would have the opportunity to assert fraud or collusion as an affirmative defense, as well as challenge the reasonableness of the stipulated judgment.