Seventh Circuit: No Bad Faith Failure to Settle Where Insurer Did Not Believe Adverse Judgment Was Reasonably Probable Despite Recognizing Possibility of Exposure to Damages Beyond Policy Limits

The United States Court of Appeals for the Seventh Circuit, inSurgery Ctr. at 900 N. Michigan Ave., LLC v. Am. Physicians Assurance Corp., Inc., No. 18-2622, 2019 WL 1855397 (7th Cir. Apr. 25, 2019), affirmed a lower court decision holding that American Physician Assurance Corporation, Inc. ("APA") did not act in bad faith by failing to settle a medical malpractice claim within its insured’s policy limit because APA’s belief that an adverse verdict was merelypossible, as opposed toreasonably probable, did not trigger its duty to settle.

An outside physician with privileges at Surgery Center at 900 North Michigan Avenue, LLC ("Surgery Center") provided care to a patient but failed to give proper discharge instructions, leading to complications that rendered the previously healthy thirty-four-year-old patient a quadriplegic. The patient sued the physician and Surgery Center for malpractice in Illinois state court; APA hired an outside law firm to defend Surgery Center in accordance with its defense guidelines. The plaintiff offered to settle with Surgery Center for the full amount of its policy with APA: $1 million. APA, believing the case was defensible but that itcouldresult in exposure beyond Surgery Center’s policy limit, rejected the settlement offer. Surgery Center got the case dismissed on summary judgment, but the dismissal was reversed on appeal. APA subsequently increased its reserves from $560,000 to $1 million. In anticipation of trial, the plaintiff again offered—and APA again rejected—to settle for $1 million. The jury returned a verdict for the plaintiff for $5.17 million of which APA paid only $1 million.

Surgery Center brought a number of claims against APA in federal court, including a claim for bad faith failure to settle. The Seventh Circuit relied uponHaddick ex rel. Griffith v. Valor Insurance, 198 Ill. 2d 409 (2001), in which the Illinois Supreme Court announced that the duty to settle arises when a third party demands settlement within policy limits and there is areasonable probabilityof a finding of liability against the insured and of recovery in excess of the limits. While theHaddickcourt did not articulate a definition of the reasonable probability standard, a subsequent intermediate appellate court decision explained that "reasonable probability" requires that liability be more likely than not but not completely certain. APA argued that the reasonable probability standard applying to the duty to settle in Illinois is a more-likely-than-not standard; Surgery Center argued it is more like a preponderance standard. The Seventh Circuit did not need to decide the issue because it found that Surgery Center failed to put on evidence that APA thought Surgery Center’s liability was reasonably probable, so the duty to settle did not arise.

The evidence and testimony showed that APA and Surgery Center’s counsel all believed that an adverse judgment would likely result in an award outside Surgery Center’s policy limit, but that the case was defensible. Surgery Center argued that APA’s increase of the reserves for an adverse judgment was evidence of bad faith because it showed APA recognized an increased risk of liability, protected itself by raising its reserves, but did not warn Surgery Center to do the same. The Seventh Circuit found that APA’s act of increasing its reserve fundsdid not take into account its evaluation of the likelihood of success; instead, it focused on potential damages, which everyone knew could greatly exceed the policy.In conclusion, the court held that the evidence showed APA believed there was only a mere possibility Surgery Center would be found liable when it declined to settle within policy limits, and mere possibility is insufficient to meet the reasonable probability standard.