If an insurance company refuses to settle a lawsuit, then it may be on the hook for the entire judgment, even if that’s more than the policy limits. The Tennessee Supreme Court’s decision in Johnson v. Tennessee Farmers Mutual Insurance Company is the paradigm case for establishing an insurance company’s bad faith in refusing to settle:

“It is well established that an insurer having exclusive control over the investigation and settlement of a claim may be held liable to its insured for an amount in excess of its policy limits if as a result of bad faith it fails to effect a settlement within the policy limits.” Bad faith refusal to settle is defined, in part, as an insurer’s disregard or demonstrable indifference toward the interests of its insured. This indifference may be proved circumstantially. Bad faith on the part of the insurer can be proved by facts that tend to show “a willingness on the part of the insurer to gamble with the insured’s money in an attempt to save its own money or any intentional disregard of the financial interests of the plaintiff in the hope of escaping full liability imposed upon it by its policy.” If the claim exceeds the policy limits, then the insurer’s conduct is subject to close scrutiny because there is a potential conflict of interest between the insurer and the insured.

To discharge its duty to act in good faith, an insurer must exercise ordinary care and diligence in investigating the claim and the extent of damage for which the insured may be held liable. The manner in which the insurer investigates the case “has an important bearing upon the question of bad faith in refusing or failing to settle the claim.” Ordinary care and diligence in investigation require the insurer to investigate the claim to such an extent that it can exercise an honest judgment regarding whether the claim should be settled. Courts must review the facts that were known to the insurer and its agents and that should have been considered in deciding whether to settle.

Mere negligence is not sufficient to impose liability for failure to settle. Moreover, an insurer’s mistaken judgment is not bad faith if it was made honestly and followed an investigation performed with ordinary care and diligence. However, negligence may be considered along with other circumstantial evidence to suggest an indifference toward an insured’s interest. The question of an insurance company’s bad faith is for the jury if from all of the evidence it appears that there is a reasonable basis for disagreement among reasonable minds as to the bad faith of the insurance company in the handling of the claim.

Johnson, 205 S.W.3d at 370–71 (citations omitted). In Johnson, Christopher Moore was injured in a car accident involving Robert Johnson and both had insurance policies with Tennessee Farmers. Id. at 369. Moore sued Johnson as well as a John Doe claiming negligence. Id. Tennessee Farmers paid Moore $25,000 based on his own UM coverage. Id. Moore offered to settle his claim against Johnson for Johnson’s policy limits of $25,000. Id. Tennessee Farmers refused given the disputed liability. Id. At the trial of the underlying claim, Moore obtained a verdict for $387,500, and Johnson was found 50% at fault and liable for $193,750. Id. Johnson unsuccessfully appealed. Id. Johnson then sued Tennessee Farmers for bad faith for its refusal to settle with Moore for $25,000. Id. At the bad faith trial, evidence showed Johnson could have avoided hitting Moore; Johnson’s deposition in the underlying case indicated he may have been speeding; the claim representative did not read in detail the summaries of Johnson’s deposition in the underlying case; and the insurer knew Moore’s medicals were $66,412.35 at the time of the underlying case’s depositions. Id. at 371. The trial court denied Tennessee Farmers’ motion for a directed verdict. Id. at 369-70. The jury found Tennessee Farmers had committed bad faith and awarded Moore $279,430.92 ($193,700 – $25,000 + post-judgment interest). Id. at 370. On appeal, the Tennessee Supreme Court affirmed and held the directed motion was properly denied where the insurer had failed to settle a case for $25,000 that ultimately resulted in a verdict of $193,700 against its insured.

Additionally, it does not matter if the insured has enough money to pay the full judgment because Tennessee follows the “judgment rule” (in contrast to the “payment rule”). In S. Fire & Cas. Co. v. Norris, the insurance company argued the insured “failed to prove any damage to himself as a result of bad faith on the part of defendant since he admitted in his testimony that he has no property out of which Davis can obtain satisfaction of the judgment.” 250 S.W.2d 785, 791 (Tenn. App. 1952). In rejecting that argument and adopting the “judgment rule,” the Tennessee Court of Appeals explained: “[W]hile logical in the abstract, [the insurance company’s argument] only serves as a windfall to an insurer fortunate enough to have insured an insolvent. The insurer in such a case stands in the position of having been derelict in the performance of its duty under a policy for which it accepted a premium paid by the insured in good faith. The liability, though ex delicto, as we have seen, arises out of the contract. If the insured had not felt the need of the protection offered by the policy and the services of the Company in handling claims against him it is to be assumed he would not have taken the policy. The claim is now an adjudged liability which he can escape only by a discharge in bankruptcy or by payment. If he chooses the former course his credit is impaired. If he does not the outstanding judgment against him is likely to prove an insurmountable barrier to payment. If prepayment is required in cases of this kind the insurer is likely to be less responsive to its trust duties in cases where the insured is insolvent than in cases where the insured is able to discharge any judgment in excess of the policy limit which may be rendered against him.” Id.