The “Hammer Clause”
The “Hammer Clause”05.01.2017
Many professional liability policies contain a policy condition known as the “hammer” or “consent to settle” clause. This provision generally provides both the insurer and insured with certain protections such as requiring an insurance company to obtain the insured’s approval before settling a claim. This clause, however, also is designed to protect the insurer in the event the insured does not “consent” to a settlement demand that the insurer would like to accept.
In the event of the latter, the “consent to settle” clause typically places a cap on the amount of money an insurer will be responsible to pay, usually holding an insured responsible in the event of an adverse judgment greater than a settlement demand for (i) the difference between the adverse judgment and the amount for which the claim could have been settled; and, (ii) the legal fees incurred to continue with the defense from the time the insured refuses to provide consent. Such a provision can have a significant impact on an insured’s decision to accept or reject a settlement demand with potentially significant financial repercussions leading to the term “hammer clause” if invoked by the insurer.
Over the last several years, courts have been watering down what is perceived by insureds to be the harsh results of invoking the “hammer clause”, especially when the provision uses the “reasonableness” standard to evaluate an insured’s conduct. For example, in Freedman v. United National Insurance Company, the U.S. District Court, Central District of California held that an insurer could invoke the “hammer clause” only if the insured unreasonably refuses to consent to a settlement. I have recently heard from professionals who have been given advice on the potential impact of a “consent to settle clause” that does not have the teeth it once had based on the Freedman decision and others like it.
I have always been reluctant to make such a broad-brush conclusion, and a Federal Appeals Court decision from earlier this year lends support that a professional insured should not put his/her head in the sand with respect to potential impact of a “hammer clause”. In Security National Insurance Company v. City of Montebello, the municipality refused to settle and rejected Security National’s contribution to a $1.5 million settlement of a discrimination lawsuit. Under the “hammer clause” at issue, even if the settlement demand is not acceptable to an insured, Security National (an excess insurer) could offer the City of Montebello an amount equal to the insured’s retained limit, less defense costs, and be discharged from liability. In the decision, the 9th Circuit For The United States Court of Appeals reversed a lower Court decision, finding that the settlement demand was made in good faith and would have resulted in a final disposition. As a result, the Appeals Court concluded that Security National had the contractual right to invoke the clause as to “hold otherwise would impermissibly rewrite the hammer clause to the policyholder’s benefit”.
When shopping for a professional liability policy, a prudent professional insured will not only look at premium and deducible costs in evaluating overall insurance costs, but also explore whether an insurer offers a “soft hammer clause” or other “consent to settle” options. This provision provides that, for an additional premium (an amount that is typically a relatively small percentage of the premium), the insurer is responsible for a greater percentage of the litigation and/or judgment costs even if an insured rejects a settlement recommendation. There are different variations of the “soft hammer clause” option depending on the insurer, if offered, and can range from a percentage (i.e., 50% or 75%) of the costs exceeding the settlement amount rejected to be the insurer’s responsibility to an insured retaining the “underage” if the litigation settles or there is a judgment for less than the settlement demand that was rejected.
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