AN OPINION ON THE WATERS EDGE OF INSURANCE LAW
Division II Upholds Finding of Collusion and Unreasonableness
Waters Edge Homeowners Association v. Waters Edge Associates, ___ Wn. App. ___, 216 P.3d 1110 (2009) (Div. II)
by Pamela A. Okano, Reed McClure
November 2009

Facts:

The insured developer converted an apartment complex into a condominium. The insured property manager, at the developer’s behest, arranged for substantial repairs and replacement of siding, roofs, and exterior stairways, but did not repair or replace all of them.

The unit owners discovered pervasive rot, deterioration and damage to the siding stairways and roofs. The homeowners association (HOA) sued the insured developer and insured property manager for breach of warranties under the Washington Condominium Act, misrepresentation, violation of the duty to provide documentations to the HOA, breach of the implied warranty of habitability, breach of the duty to repair common areas, violation of the Consumer Protection Act, violation of board of directors requirements, failure to maintain financial records and conduct independent audits, and improper use of HOA funds.

The Washington Condominium Act claims were dismissed as barred by the statute of limitations. The HOA agreed to dismiss its implied warranty of habitability claim.

Mediation was scheduled for January 2007, a month before trial. In late August 2006, the HOA’s counsel contacted the insured developer’s corporate attorney and provided him with a ghost letter designed to spur retained defense counsel to better prepare the case. The HOA’s counsel suggested that the insureds retain Rick Beal and Greg Harper due to their experience as coverage counsel in construction defect cases. The HOA attorney told the insured’s attorney that Beal and Harper had “substantial success squeezing every possible nickel out of insurance companies on behalf of their clients.”

In the meantime, the insureds’ liability carrier sent the insureds a reservation of rights letter, but confirmed continued representation of both insureds by the defense attorney selected by the insurer.

The insured hired Beal and Harper as coverage counsel. In November 2006, the insured filed a bad faith suit against the insurer, claiming that the insurer had failed to retain separate counsel for each insured and had failed to adequately prepare the case for trial.

Retained defense counsel said that his relationship with his clients, the insured, began to deteriorate in November 2006 and that he was unaware until January 2007 that Beal and Harper had been retained as his clients’ coverage counsel. When the insured property manager complained that defense counsel had a conflict of interest and Beal and Harper claimed he had committed malpractice and various ethical violations, defense counsel withdrew.

The insurance company assigned a second defense attorney to represent the insured developer and a third defense attorney to represent the insured property manager. Beal instructed the third defense attorney not to enter a formal notice of appearance or substitution and withdrawal of counsel. The first defense attorney later claimed that this was an attempt to manufacture a malpractice claim against him.

Beal and the HOA’s attorney communicated when the former became concerned that the second defense attorney’s actions “completely undermine[d] any legal malpractice claim against” the first defense attorney.

At the mediation, the HOA sought $17.65 million. The HOA claimed that the two defense attorneys had only $175,000 in authority.

The HOA attorney and Beal began discussing the possibility of a stipulated settlement several days before the mediation. Ultimately the parties agreed that the insured would contribute $215,000 in cash, that there would be a stipulated judgment of $8.75 million, that the settlement would not be contingent upon a subsequent finding of whether the settlement was reasonable, that the insureds agreed to assign their bad faith claims to the HOA, and that Beal would testify that the $8.75 million was reasonable. The HOA signed a covenant not to execute.

The settlement had taken several days to negotiate. The HOA had originally demanded a $500,000 cash contribution from the insureds and a $14 million stipulated judgment.

The insureds and the HOA then sought a reasonableness hearing in the trial court. The trial court allowed the insurer to intervene and conduct limited discovery. After hearing testimony, reviewing documents and briefs, and hearing argument, the trial court took the case under advisement for 5 months. The trial court then found the stipulated settlement of $8.75 unreasonable and that a $400,000 would have been reasonable, based on the first defense counsel’s estimates.

The HOA and the insureds filed a joint motion for entry of judgment for the $8.75 million. The trial court denied the motion and instead entered a final order dismissing the HOA’s claims.

Holding:

A unanimous Division II affirmed. The court rejected the HOA’s claim that the standard of review was de novo. The court said that it would review the trial court’s ruling that the settlement was not reasonable for abuse of discretion.

The nine Chaussee factors are used to review reasonableness. That the trial court did not specifically refer to the HOA’s evidence about its damages in ruling on the settlement’s reasonableness is immaterial. A reasonableness determine can be valid even when the trial court fails to list any of the Chaussee factors, but instead simply says that the parties addressed the factors in their briefs and that the trial court considered the briefs. There is no authority to require the trial court to specifically list, cite or comment on the evidence relied upon.

The trial court did consider the HOA’s three repair estimates, but did not find them persuasive. All three estimates were based on the theory that the cost of repair was the correct measure of damages. But the trial court found credible the first and second defense attorneys’ arguments that the dismissal of the warranty claims had effectively “gutted” the HOA’s case. Thus, the cost of repair damages that would have normally been recoverable was unavailable. And even if the HOA had been entitled to damages under the warranty claims, it would have been entitled to only the lesser of the cost to repair or diminution in value. The record indicated that the HOA could not prove diminution in value because every unit owner who sold made a profit.

Furthermore, the first defense counsel felt that he could have obtained summary dismissal of many of the remaining claim. He believed that there was a less than 20% chance that the jury would award more than $1 million and that damages would more likely be in the $300,000 range. He told the insureds that the case had a verdict range of $200,000-$500,000 and told the insurer that the likely settlement value was between $250,000 and $350,000.

The court of appeals also rejected the HOA’s argument that the trial court improperly considered the merits of the liability and defense theories by focusing on the economic loss rule. The HOA claimed that that defense had not been properly raised. However, the record showed that the first defense counsel raised the economic loss rule as an affirmative defense in March 2006 and that the second defense counsel had also raised the defense and had planned to file a motion in limine based on that defense. Had the motion not been granted, the second defense attorney planned to present evidence that the contractor the HOA had used to come up with a repair estimate had a history of preparing inflated repair estimates for HOAs and then renegotiating the actual cost after settlement.

The trial court also did not abuse its discretion in determining that the Chaussee factor for the released party’s relative fault was not applicable. The factor generally applies when a trial court is determining the reasonableness of a plaintiff’s settlement between one or more codefendants. Although the insured developer was separate from the insured property manager, the parties settled without a condition that the trial court find the settlement reasonable.

The HOA also claimed that the trial court erred with respect to the Chaussee factor on the interests of third parties not being released. Specifically, the HOA claimed that the trial court had erred in concluding that the insurer, not being fully involved in the case, was at a disadvantage. The trial court felt that the insurer was at a disadvantage from the start because the reasonableness determination creates a presumed measure of damages in separate litigation. The trial court apparently believed that once Beal and Harper became involved, the parties began to align in hopes of reaching a stipulated settlement. The insureds did not involve the insurer in their preparation for mediation, nor in the settlement negotiations for the stipulated judgment.

With respect to the Chaussee factor of the releasing party’s investigation and preparation, the trial court’s failure to discuss it is not an abuse of discretion.

Although the trial court dedicated several pages of its reasonableness ruling to collusion, it concluded that at covenant judgment settlement is a necessary evil, especially when an insurer defends under reservation of rights. The trial court specifically stated that its decision was not based solely on the collusion factor, but on all the considerations required by law. The court of appeals rejected the argument that the trial court’s personal distaste for covenant judgment settlements affected its ruling.

The court of appeals rejected the argument that the insurer had to prove fraud or collusion. Once a trial court finds a covenant judgment reasonable, the burden shifts to the insurer to show it was the product of fraud or collusion. But the burden here was on the HOA to show that its settlement was reasonable and whether there is evidence of bad faith, collusion or fraud is merely one of the Chaussee factors in determining reasonableness.

The trial court noted the following evidence in finding collusion: (1) the way the case shifted abruptly from litigation to collaboration; (2) the structure of the settlement that was a joint effort to create, in a nonadversarial atmosphere, a resolution beneficial to both the HOA and the insureds, but highly prejudicial to the insurer; (3) the HOA’s counsel’s contacts with the insureds, supposedly adverse parties, including his authoring a ghost letter critical of defense counsel for the insureds to send to the insurer and his recommendation that the insureds contact Beal and Harper; (4) coverage counsel’s undermining the first defense counsel’s efforts to reduce the insureds’ exposure; (5) the parties’ stipulating that the insureds could recover their $215,000 contribution if the HOA prevailed in its malpractice and bad faith case; (6) the joint venture type relationship between the parties, whereby the HOA agreed to kick back some of the proceeds of any recovery from the insurer or the first defense attorney; (7) Beal’s insistence that the settlement be binding regardless of the trial court’s reasonableness determination; (8) neither insured had any reason to care about the amount of the settlement agreement, so long as they could persuade the trial court it was reasonable. Although the insureds had not assigned their legal malpractice claims, the parties had agreed that the HOA would hold the insureds harmless from the legal expenses of litigating those claims and that the proceeds of any judgment in the legal malpractice case could be used to satisfy any unpaid balance on the stipulated judgment.

For a stipulated judgment to serve as the presumptive measure of harm in a bad faith case against the insurer, the HOA, which owns the rights to the bad faith claim as part of the settlement, had to convince the trial court that the settlement was reasonable. Absent a presumptive value, the HOA would have to start from scratch to establish bad faith damages. As part of the settlement, Beal agreed to testify as to the reasonableness of the amount, even though he had never tried a construction defect case. The HOA expected the trial court to believe Beal, but it did not. The trial court did not err in finding collusion.

That the trial court relied heavily on the first defense attorney’s assessment of the case rather than on Beal’s was not evidence that the trial court surrendered its independent judgment. The trial court knew the first defense counsel to be a very experienced and capable attorney. Beal had never tried a construction defect case. The trial court noted that because of coverage counsel, it never had the opportunity to rule on the first defense counsel’s planned summary judgment motion on the economic loss rule, but that the second defense attorney believed that such an argument would have been successful.

The panel also rejected the HOA’s argument that the first defense attorney was unprepared for trial, feared possible exposure in a future malpractice case, and therefore had the incentive to undervalue the case. If counsel had truly feared he was not prepared for trial and wanted to reduce his malpractice exposure, he would have had the incentive to overvalue the case so that the parties would be more willing to settle. In any event, the trial court found that the first defense counsel had been skillfully litigating the matter to his clients’ benefit. The trial court did not abuse its discretion.

The court of appeals refused to review the partial summary judgment dismissing the warranty claims under the Washington Condominium Act. The HOA has fully settled with the insureds and has released them from liability. Review of the dismissal would be a purely advisory decision.

Further, there is no aggrieved party as required by RAP 3.1. The HOA and the insureds have settled. The settlement agreement provides no contingencies to the settlement. The insureds are not parties to the appeal and have no potential liability from any determination of the court of appeals. The insurer, which is a party to the appeal, did not bring the partial summary judgment motion and was not even a party to the suit at the time it was brought.

Finally, the trial court did not err in dismissing the case rather than entering judgment on the $8,750,000 settlement amount. First, the proposed judgment presented to the trial court said that the trial court had found that amount reasonable, which it had not.

In any event, RCW 4.22.060(1) requires the trial court to determine reasonableness and that if a settlement is found to be unreasonable, the trial court is to determine a reasonable amount. Under RCW 4.22.060(3), a trial court determination of unreasonableness does not affect the validity of the settlement agreement and the trial court cannot adjust the amount paid under that agreement. Although the parties can agree to have the trial court enter a judgment in the amount the trial court has found reasonable, here the HOA did not agree to stipulate to the $400,000 amount the trial court found reasonable. Indeed, the HOA had already appealed the trial court’s ruling that the initial settlement amount was unreasonable.

Besel v. Viking Insurance Co., 146 Wn.2d 730, 49 P.3d 887 (2002), does not apply. That case was a subsequent bad faith case against the insurer. The supreme court ruled that the amount of the covenant judgment was the presumptive measure of an insured’s harm caused by the bad faith so long as the judgment was reasonable under the Chaussee factors.

Neither CR 54 nor CR 58 required the trial court to sign an inaccurate or incomplete judgment. If the HOA wanted the trial court to establish the amount of presumptive damages for its bad faith suit against the insurer, it should have agreed to the $400,000 the trial court found reasonable. To this day it has not done so.

The HOA has filed a petition for review to the Washington Supreme Court.