(Article from Insurance Law Alert, March 2025)
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Holding
Reversing a California federal district court decision, the Ninth Circuit ruled that there was an “arguable basis” that the amount in controversy for diversity jurisdiction in a declaratory judgment action was satisfied by potential liability in excess of policy limits. Farmers Direct Prop. & Cas. Ins. Co. v. Perez, 2025 U.S. App. LEXIS 5245 (9th Cir. Mar. 6, 2025).
Background
The dispute arose out of an automobile accident between the insured, Perez, and a third party, Montez. When Montez sued Perez, Farmers Direct agreed to defend Perez pursuant to a policy issued to Perez’s sister. Perez was uncooperative with counsel throughout discovery, and the court allowed Farmers Direct to intervene on behalf of Perez. Ultimately, the court entered a default judgment against Perez, who had essentially refused to comply with deposition and discovery orders or otherwise participate in his own defense.
Thereafter, Farmers Direct filed a declaratory judgment action in California federal district court, seeking a ruling that Perez breached the policy’s cooperation clause and therefore that it no longer had a duty to defend or indemnify Perez in the underlying tort action. The court entered judgment in Farmers Direct’s favor, declaring that it had no continuing duty to defend and owed no indemnity to Perez in connection with the underlying suit.
However, notwithstanding the declaratory judgment, Farmers Direct continued to defend the underlying suit, which ultimately resulted in a jury verdict awarding compensatory damages to Montez and a judgment against Perez in an amount exceeding the $25,000 policy limit. Farmers Direct paid the $25,000 policy limit.
Montez then filed a motion to intervene in Farmer Direct’s declaratory judgment action and to vacate the judgment based on several grounds, including a lack of diversity jurisdiction. The district court granted the motion, finding a lack of jurisdiction based on an insufficient amount in controversy. In particular, the district court reasoned that the $75,000 statutory minimum was not met because the policy limit was $25,000. The Ninth Circuit reversed.
Decision
The Ninth Circuit ruled that the district court erred in holding that the value of the underlying tort action was limited to the policy’s limit. The court reasoned that Farmers Direct could ultimately be held liable for an amount in excess of that limit, particularly given Montez’s allegations in the underlying complaint that he was entitled to “hundreds of millions of dollars in damages” and his pursuit of a bad faith claim against Farmers Direct. In rejecting an insurance policy limit as the benchmark for the amount-in-controversy requirement for federal diversity jurisdiction, the court endorsed the following rule from the Fifth Circuit:
We hold that where the claim under the policy exceeds the value of the policy limit, courts considering declaratory judgments should ask whether there is a legal possibility that the insurer could be subject to liability in excess of the policy limit. The party seeing diversity jurisdiction should establish this possibility by a preponderance of evidence.
Applying this standard, the court ruled that there was at least an “arguable basis” that the amount-in-controversy requirement was satisfied and therefore reversed the district court’s ruling vacating the judgment.
The Ninth Circuit also ruled that the district court erred by failing to consider Farmers Direct’s defense costs in its amount-in-controversy analysis. Farmers Direct had submitted evidence that it had already incurred hundreds of thousands of dollars in attorneys’ fees—evidence that provided an independent basis for satisfaction of the amount in controversy.
Comments
Notably, the Ninth Circuit clarified the scope of its earlier ruling in Budget Rent-A-Car, Inc. v. Higashiguchi, 109 F.3d 1471 (9th Cir. 1997). Contrary to Montez’s assertion, that decision did not hold that a policy limit sets a cap on the value of an underlying tort action for purposes of establishing federal subject-matter jurisdiction. Rather, Budget held that an insurer’s policy limit is “relevant” to determining the amount in controversy (but not necessarily controlling), and that “the amount in controversy is the value of the underlying potential tort action.”