THE HAMMER CLAUSE AND THE RIGHT TO CONSENT

(Are You The Hammer Or The Nail?)

Negotiating an insurance contract can be done fast, cheap, or right.  Even if you have the proper coverage, your premiums will skyrocket if the insurer simply decides to settle cases despite your desire to contest the case.  Even a slam-dunk defense verdict can be settled – unless you (through your agent) negotiate the requirement that you consent to any settlement.

The “right to consent” by an insured is almost never included in a general policy, and must be added by endorsement after negotiation.  It is easier to obtain such a clause in an SIR than a deductible; and is easier still with a higher SIR.  But regardless of whether you have a deductible, low SIR or high SIR, a right to consent may be negotiated.  If it is not requested, it will not be included in your policy.

What Is a Right to Consent

A right to consent clause is, simply, a provision that states that the insured has the right to consent (or not) to a proposed settlement.  Not surprisingly, the most common use of consent clauses is in legal and medical professional liability policies.  Lawyers (and doctors) do not want insurers to settle a case without their consent.  And lawyers make sure that they have the right to consent before an insurer settles a malpractice case.  It is, after all, their reputation at stake.

For the manufacturer, or even in the service industry, the same factors are at play.  The insurer assigns an over-worked, under-qualified adjuster who does not know your product or business who, absent a consent clause, views your claim as an obstacle that can be overcome by settlement.  But, like the lawyer, it is your reputation, and your product’s reputation at stake.

The Hammer Clause

If the insurer agrees to provide a consent clause, it will almost never come without consequences.  The insurer views the right to settle as its right to get out of a case at a fixed cost (the amount of settlement).

If you were to consent, then the insurer’s cost would be fixed, there would be no additional defense costs, and the file would be closed.  If you are unreasonable in your refusal to consent, the result can be tens of thousands of dollars in additional defense costs – and a verdict even worse than the settlement offered.

The insurer will try to protect itself from these results with a Hammer Clause.  A Hammer clause, in essence, caps the insurer’s liability on a case to the amount offered.  However, not all hammers are created equal.

The Sledge Hammer

When the insurer agrees to provide you with the right to consent, it will also provide the proposed language, including the hammer clause.  The hammer clause it will first propose is what RRS calls the “sledge” hammer.  It is so big, so heavy, that it effectively destroys the right to consent.

The Sledge Hammer clause provides that, from the moment the insurer would have settled the case (but for the lack of consent), the insurer’s liability for indemnity payments is capped at the settlement amount, and the insured becomes responsible for all future defense and related costs.  If the case was within the SIR, no additional defense costs are applied against the SIR.

The effect of the Sledge Hammer can be seen in a simple illustration:  Assume that the SIR is exhausted.  The insurer wants to settle the case for $1,000,000.  The client believes that it will win the case, and therefore refuses to consent. The defendant spends an additional $30,000 to get the case through trial and, as expected, gets a defense verdict.

Using the Sledge Hammer, the insurer will NOT pay the $30,000 trial cost.

The insurer will pay no costs whatsoever.  Instead, the client has to pay the additional $30,000, and the insurer gets the entire benefit of the defense verdict.

Indeed, in our example, the insured basically takes on the cost of defense, AND the risk of an excess verdict, even though the SIR has been satisfied.

A Sledge Hammer clause essentially makes illusory the right to not consent.  There is no direct benefit to the right, because savings in future premiums may even be offset by the defense costs.

You can instead negotiate a fair hammer clause.  The fair hammer clause caps the insurer’s total liability to the amount of the settlement it could have settled for, but the insurer continues to pay defense costs up to the capped settlement amount.  After all, had you settled the case, the insurer would have had to pay the entire settlement amount, but would have saved the defense costs of getting to verdict.

The Fair Hammer Clause

Essentially, a fair hammer clause provides that the insurer’s obligations are capped at the settlement amount. A couple of examples will help.

Using the previous example, the insurer could settle for $1,000,000.  You refuse to consent.  The insurer’s total liability is capped at $1,000,000.

It costs $30,000 to get the case to trial.  The insurer continues to pay defense costs. The effective cap on the insurer has been reduced by ongoing defense costs.  As long as the verdict is less than $970,000, the insurer is on the hook for the entire amount.

Thus, with a defense verdict, the insurer pays all defense costs, but reaps the benefit (with you) of the defense verdict.

Similarly, if the verdict is adverse, but less than (in our example) $970,000, the insurer pays the entire verdict.

Further, at any point, you have the right to negotiate a settlement at no cost to you, provided that it is for less than the previously offered amount (plus ongoing defense costs).

So, if you settle the case for $950,000, and defense costs are less than $50,000 (in our example), you pay no additional money.

The hammer, remains significant:  if you lose the case, and the verdict plus ongoing defense costs exceed the offered settlement amount, you are on the hook for the excess.  This is because the insurer has capped its liability at the amount it could have settled the case for.

The Take Away

To protect your risk, the mere right to refuse to settle provides substantial motivation on the insurer to work with you on a unified plan.  But the insurer will know what a good consent (and hammer) clause consists of, and the ones that really give you no rights at all.

It is up to you and your agent to make sure that the consent clause (and hammer clause) is effectively negotiated to protect your interests.

One final benefit – the insurer, knowing you have a hammer clause, is much more likely to work with you and not work to try to settle a case without your consent.  If it tries to work a settlement unacceptable to you, it cannot use your lawyer (this would create a conflict of interest for the lawyer, who is appointed to represent you).  It is also much more difficult for the insurer to try to negotiate when it does not have the authority to close the deal.  Thus, you have far more control over the litigation and the settlement than you would without the hammer clause.