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Oregon Supreme Court Overrules 40-Year Precedent on Covenant Judgments



Good news for policyholders today from the Oregon Supreme Court: the court overruled the 42-year-old Stubblefield decision, making it much easier for defendants in litigation to protect themselves if their insurance company fails to reach a reasonable settlement with the plaintiff. Today's decision in Brownstone Homes Condo Ass'n v. Brownstone Forest Heights LLC means that a policyholder may more easily reach an agreement with the plaintiff to resolve the litigation and allow the plaintiff to go after insurance assets. Oregon has now joined the majority of states that allow policyholders to enter into these "covenant judgment" agreements without jumping through a series of hoops that are fraught with peril.

To set the stage, imagine a car accident caused by a company's delivery truck. The truck driver is clearly at fault, and the injured person has substantial physical and psychological injuries. The lawsuit against the company is for $5 million in damages. The company has a $1 million auto liability policy. The company's insurance company agrees to defend the company, and hires a lawyer to defend, who evaluates the exposure as above policy limits. The plaintiff offers to settled for policy limits, but at mediation the insurance company refuses that offer. The insurer has committed bad faith. But the policyholder is faced with the possibility of going to trial and being hit with a verdict that exceeds policy limits, on top of the substantial disruptions and stresses that go along with proceeding to trial in a case that should have been settled. So the policyholder is looking for a way to end the litigation, to avoid the exposure beyond policy limits, while allowing the plaintiff to collect from the insurer. The obvious answer is to enter into an agreement that: 1) a judgment will be entered against the defendant for an amount in excess of policy limits; 2) provides that the plaintiff will only attempt to collect that judgment from the insurance company, and will not execute against the defendant's other assets; 3) assigns to the plaintiff the bad faith claim against the insurance company.

The issue in today's case is the second part of that agreement: the "covenant" not to execute on any assets other than the insurance policy rights of the defendant.

In Stubblefield the Oregon Supreme Court considered the language in a standard general liability policy providing that the insurance company will only pay “those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’ or ‘property damage.’" The court held that if the plaintiff gives the policyholder a broad and unconditional covenant not to execute, the policyholder is no longer "legally obligated to pay" anything, and that the insurance company's obligation to pay was therefore nullified by that agreement.

After Stubblefield the legislature passed a statute allowing a policyholder to assign its claim against its insurance company to a plaintiff and receive a covenant—but only after a judgment was entered. So, as a result, policyholders had to engage in a careful dance, timing each step of the process carefully so that a judgment was entered first and then, later, signatures done on a covenant and assignment.  The covenant would generally contain "carve-outs" requiring the policyholder to do certain things, to make sure the policyholder still had some "skin in the game." If the timing was done incorrectly or if the language was wrong the plaintiff could end up without anyone to pay the settlement. That process and its pitfalls was explained and ratified in the seminal case Portland School District v. Great American Insurance.

In today's decision the court went back to the drawing board on interpreting the "those sums that the insured becomes legally obligated to pay" language. The court observed that a covenant not to execute on certain assets is not the same as removing an insured's legal obligation to pay damages—it is a contractual agreement on a different topic. The court also suggested that the language was ambiguous, in an extended discussion of the holdings of the majority of courts across the country that a covenant arrangement does not extinguish the right to collect. The court further clarified that Oregon law does not recognize the risk of "collusion" between plaintiffs and policyholders as a basis for rejecting such agreements out of hand.

The court's decision today means that insurance companies will not be able to use technical arguments and traps to avoid paying a plaintiff who has entered into a covenant judgment settlement with a policyholder. It puts Oregon into the mainstream of states on another issue of critical importance to small business, who are most likely to use these procedures to protect themselves from abusive insurance company practices. A good day indeed.

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