LEGAL MALPRACTICE INSURANCE HAMMER CLAUSE

LEGAL MALPRACTICE INSURANCE HAMMER CLAUSE

Don’t Get Nailed By Your Legal Malpractice Insurer’s Hammer Clause

The legal malpractice insurance policy is a consent-to-settle policy, which means that the insurer agrees that it won’t settle any claim without the consent of the named insured, i.e., the attorney or law firm that purchased the policy.

Insurers express this agreement in the “defense and settlement of claims” section of the policy, a/k/a the “defense, indemnification and cooperation section”. Some insurers’ agreement is unconditional, others’ is conditional. Here’s an example of each:  

Unconditional: “The Company shall not settle a claim without the written consent of the Named Insured.” (CNA Insurance Company)

Conditional: “The Company will not settle any Claim without the consent of the Insured, which will not be unreasonably withheld.” (Arch Insurance Company)

The words in bold type are defined in the policy. “Unreasonably withheld” isn’t defined, so the dictionary definition of each word applies. Whether or not a given firm’s refusal to consent, rises to the level of being ‘unreasonably withheld’, would depend on the specifics of that situation. We’re unaware of any insurer ever invoking that clause.

It’s Hammer Time

Nonetheless, all legal malpractice insurers ‘put it in writing’, that they won’t settle a malpractice claim, without the insured attorney or law firm’s consent.

However, they also ‘put it in writing’, that they have a powerful tool to gain that consent, even if the insured doesn’t want to settle: a ‘threat to withdraw’ clause, a/k/a “the hammer clause”. It states that if the claimant makes a settlement demand, which the insurer recommends the insured firm agree to, but the firm refuses, then the insurer will reduce the firm’s policy limit to the amount of the settlement, and withdraw from the case, tendering the insured’s defense to the insured.

In that case, the firm will have to fund its own defense out-of-pocket, and pay any settlement or judgement awarded to the claimant.

The hammer clause immediately follows the consent-to-settle clause in the policy.

Types of Hammer Clauses:

I. Full Hammer Clause:

This is used by most insurers. Arch Insurance Company’s hammer clause language is typical:

“If, however, the Insured refuses to consent to any settlement recommended by the Company and acceptable to the claimant, then the Company’s Limit of Liability Each Claim under this policy will be reduced to the amount for which the Claim could have been settled plus all Claim Expenses incurred up to the time the Company made its recommendation… This amount will not exceed the remainder of the Limit of Liability Each Claim”.

So, if the claimant demands $100,000 to settle, the insurer is willing to pay it, and recommends that the insured law firm agree, but the firm won’t give its consent, then the insurer will reduce the firm’s per claim policy limit to $100,000 – the settlement amount – plus all claim expenses (defense costs, etc.) incurred up to the time the insurer recommended that the firm accept the settlement, i.e., any defense costs that have been incurred, but not yet billed, or billed, but not yet paid.

Arch’s hammer clause concludes:

“If the Insured refuses to settle, once the total Claim Expenses equal the amount for which the Claim could have been settled plus all Claim Expenses incurred up to the time the Company made its recommendation, the Company will have the right to withdraw from the further investigation and defense thereof, by tendering control of such investigation or defense to the Insured and the Insured agrees, as a condition of the issuance of this policy, to accept such tender.” (Emphasis added)

Using the example above, the insurer would withdraw from the matter, after paying another $100,000 – the amount of the settlement that the insured firm wouldn’t consent to – most likely in defense costs, but also in indemnity, if the insured firm changes its mind, and consents to settle.

2. .Soft Hammer Clause

To differentiate themselves, some insurers agree to pay 50% of any damages and defense costs in excess of the settlement the insured wouldn’t consent to, up to the policy limits.

AXA XL Insurance Company’s policy has typical ‘soft’ hammer clause language:

“If the Named Insured refuses to consent to a settlement demand acceptable to the claimant and recommended by the Insurer, and elects instead to contest the Claim, then the Insurer’s total liability for such Claim shall not exceed the combined total of:

-The amount of such proposed settlement offer;
-The amount of Claim Expenses incurred prior to the date the Named Insured refused to consent to the proposed settlement offer; and
-Fifty percent (50%) of the amount of Damages and Claim Expenses incurred in excess of the combined total of the amounts set forth in Items 1. and 2. of this Section above, provided that the Insurer will have no obligation to pay Damages or any Claim Expenses, or to defend or continue to defend any Claim, after the applicable Limit of Liability that applies to such Claim has been exhausted.”

In this case, the insurer will reduce the firm’s per claim limit by the amount of the settlement demand, and fund half of any defense costs and indemnity payment above the settlement amount that the firm refused to consent to, until the policy limit is exhausted. If that occurs, the firm must pay any further costs out-of-pocket.

Example: a firm has a $1,000,000 per claim limit. It refuses to consent to settle a claim for $200,000. Its insurer then invokes the soft hammer clause, which limits its payout to the $200,000 settlement offer + all defense costs incurred up to the time it recommended the settlement, plus 50% of any future defense costs and indemnity payments, up to the policy limit of $1,000,000.

In this case, the insurer doesn’t reduce the firm’s limit of liability, but the firm has to pay half any future costs, from that day forward.

3. No Hammer Clause

Finally, CNA is the rare insurer whose policy doesn’t have a hammer clause.

Effect of the Hammer Clause

Few firms have the risk tolerance to take on an open-ended exposure, or the financial wherewithal to fund it, which is what they’d have to do, if their insurer withdrew from defending them, and a trial loomed.

As a result, firms rarely withhold their consent to settle.

At the same time, insurers are sensitive to developing a reputation for coercing firms into consenting to a settlement, because it can damage their reputation in the market. As a result, most insurers will invoke the hammer clause, only if they feel that there’s no other option.

Conclusion

The wording of the policy’s ‘hammer cause’, should be part of your analysis in choosing an insurer, especially if your firm is larger, i.e., 20 or more attorneys, in which case it’s more likely to incur at least one malpractice claim each year.

 

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