Insurer Must Show Due Diligence Before Court May Vacate Default Judgment Against Insured

Insurers frequently are presented with questions as to whether their insured has been validly served and at what point in time counsel must be retained to defend the insured.

The case of Lee R. Stafford v. Toan Mach (Allstate Insurance Company, Intervenor and Respondent), 98 Daily Journal D.A.R. 6569 (6/16/98), is a classic example of what might happen when an insurer operates under a mistaken belief that service on an insured was invalid and does not proceed with reasonable diligence to retain counsel to defend the insured or intervene to move to set aside a default judgment.

In Stafford, Allstate's insured, Toan Mach ("Mach"), was involved in a two-vehicle accident with Lee R. Stafford ("plaintiff"). When settlement negotiations broke down between Allstate and the plaintiff attorney, suit was filed. After several unsuccessful attempts, substituted service on Mach was accomplished by leaving the suit papers at Mach's residence at the feet of a resident (who the process server thought might be Mach), and thereafter mailing copies of the suit papers to Mach. Mach referred the suit papers to Allstate and was asked if he had been "personally served." Mach told the claim representative he had not, but that he had received the papers in the mail. The Allstate claim representative, apparently not knowing about the substituted service procedure and believing service was not valid, believed there was no obligation to do anything and did not retain defense counsel. Plaintiff's counsel thereafter obtained a default from the San Francisco Superior Court, and less than two months later obtained a default judgment against the insured in the amount of $440,000. While the evidence was disputed as to whether Allstate had ever received the first request to enter default, it was undisputed that Allstate became aware of the actual default judgment four and one-half months before the six-month limitation to move to set aside the default judgment expired under Code of Civil Procedure section 473.

Allstate did not respond to plaintiff attorney's demands to pay the default judgment, apparently on the mistaken belief that the judgment was void and could be set aside at any time. Plaintiff attorney attempted to enforce the judgment against Mach by recording an abstract of judgment against Mach's residence, which eventually resulted in an agreement whereby Mach assigned his bad faith cause of action against Allstate in exchange for an agreement not to execute on the default judgment against him.

On the day before the six-month limitation expired, Allstate filed motions to intervene in the underlying tort case and to set aside the default and default judgment pursuant to the provisions of Code of Civil Procedure section 473.

The trial court granted Allstate's motion to intervene and vacated the default and default judgment. The plaintiff appealed.

On appeal, the court ruled that the trial court had abused its discretion in vacating the default and default judgment. While Allstate had sought to intervene and set aside the default and judgment before the six months expired, the court did not have the discretion to grant the motion unless Allstate supplied the court with evidence justifying its delay, or rule that a mistaken belief that service was invalid was not a sufficient excuse. The court, in holding that Allstate had not proceeded in a diligent fashion, noted:

Allstate's conduct was far from diligent and raises questions as to whether it met its obligations to its insured. Allstate undertook no investigation regarding the propriety of service. Instead, it relied upon representations from an insured who its adjuster knew had difficulty with the English language. Moreover, Allstate did not promptly appoint counsel or move to quash service. As a result, default and default judgment were entered against its insured. Even after receiving notice of the judgment, Allstate did not move to quash service, and waited over four and one-half months, until its insured's home was threatened and he had entered into a "Mary Carter" settlement agreement, before it took any action. In context, Allstate's excuse is suspect and insufficient to justify the lengthy delay in filing its section 473 application.

The moral learned from this story is that insurers should never assume a purported service was invalid, even when the insured is disputing the validity of the service. In order to avoid any prejudice to the insured or insurer, defense counsel should be retained at the earliest hint of service. At that point, counsel can be effective in advising the insurer on the validity of service and the options available, including waiver agreements from the insured, an agreement from the plaintiff attorney that service is not valid, as well as motions to quash service.

In instances where a default or default judgment has been entered, the matter should be immediately referred to defense counsel to move to set aside the default or default judgment. In instances where the insured has possibly breached the notice and cooperation clauses of the policy, or cannot be located, an insurer may wish to consider intervening in the underlying tort action for the limited purpose of moving to set aside the default and default judgment. See Jade Kay v. Viguri (1989) 210 Cal.App.3d 1459, 1468; Nasongkhla v. Gonzales (1994) 29 Cal.App.4th Supp. 1, 4. In fact, an insurer may not be able to establish prejudice sufficient to successfully prevail on a late notice or lack of cooperation defense unless it attempts to intervene to set aside the default judgment. See Nasongkhla, supra, p. 4.

Prompt action and retention of counsel can go a long way in protecting both the insured and the insurer. Since liability insurers are in the litigation business, courts generally hold them to a higher standard of care than other litigants. A mistake of law made by a claims handler no doubt can be costly. To avoid such circumstances, insurers need to remind their claims handlers to never assume that no action needs to be taken simply because service to them appears to be invalid.

Mr. Brugge is a Principal in the firm's Insurance Coverage and Appellate Departments.
Email: rdb@kpclegal.com

Copied to clipboard