Legal Definitions - follow-the-settlements doctrine

The follow-the-settlements doctrine is a legal principle, primarily found in insurance and indemnity agreements, stating that a party providing financial protection (the "indemnitor" or "reinsurer") must generally accept the reasonable and good-faith decisions made by the party they are protecting (the "indemnitee" or "reinsured") when that party adjusts, negotiates, and settles claims. In essence, the protector agrees to "follow" the primary party's lead in resolving covered losses, as long as those resolutions are not fraudulent or made in bad faith.

This doctrine ensures that the party responsible for handling the initial claim has the authority to make settlement decisions without constant second-guessing from the party providing the financial backstop, promoting efficiency and trust in these contractual relationships.

• Example 1: Reinsurance Agreement

  Imagine "Coastal Coverage Inc.," a regional insurance company, insures homes along the coast. To manage its risk from major storms, Coastal Coverage Inc. buys reinsurance from a larger global reinsurer, "Global Reassurance Corp." A severe hurricane hits, and Coastal Coverage Inc. receives thousands of claims. After thorough investigation and negotiation, Coastal Coverage Inc. pays out a $5 million claim to a policyholder whose home was completely destroyed.

  How it illustrates the doctrine: Under the follow-the-settlements doctrine, Global Reassurance Corp. (the reinsurer) is generally obligated to accept Coastal Coverage Inc.'s (the reinsured's) decision to pay the $5 million claim. Global Reassurance Corp. must then reimburse Coastal Coverage Inc. for its agreed-upon share of that loss, assuming Coastal Coverage Inc. handled the claim reasonably and in good faith. Global Reassurance Corp. cannot typically challenge the settlement amount itself unless there's evidence of fraud or bad faith in Coastal Coverage Inc.'s claim handling process.

• Example 2: Construction Surety Bond

  "BuildRight Construction" is contracted to build a new community center. As part of the agreement, BuildRight obtains a performance bond from "Surety Solutions LLC," which guarantees that BuildRight will complete the project according to the contract. During construction, a dispute arises with the city over unexpected delays and additional costs. To avoid a lengthy and expensive lawsuit, BuildRight negotiates a settlement with the city, agreeing to pay an additional $200,000 to cover the city's losses due to the delays.

  How it illustrates the doctrine: In this scenario, Surety Solutions LLC (the indemnitor, backing the bond) would typically be bound by the follow-the-settlements doctrine to accept BuildRight Construction's (the indemnitee's) decision to settle with the city for $200,000. If BuildRight later seeks reimbursement from Surety Solutions LLC for costs related to the bond, Surety Solutions LLC generally cannot challenge the reasonableness of the settlement itself, provided BuildRight acted in good faith when negotiating with the city.

• Example 3: Corporate Indemnity Agreement

  "Tech Innovations Inc." develops software and uses a third-party cloud service provider, "DataHost Corp.," for its data storage. Their contract includes an indemnity clause where DataHost Corp. agrees to indemnify Tech Innovations Inc. for any legal claims arising from data breaches caused by DataHost's negligence. A data breach occurs due to a vulnerability in DataHost's system, leading to a class-action lawsuit against Tech Innovations Inc. Tech Innovations Inc. investigates, consults with legal counsel, and decides to settle the lawsuit for $1 million to avoid prolonged litigation and reputational damage.

  How it illustrates the doctrine: The follow-the-settlements doctrine would apply here, obligating DataHost Corp. (the indemnitor) to accept Tech Innovations Inc.'s (the indemnitee's) decision to settle the class-action lawsuit for $1 million. As long as Tech Innovations Inc. acted reasonably and in good faith in assessing the claim and negotiating the settlement, DataHost Corp. generally cannot refuse to cover the settlement amount by arguing that a different, potentially lower, settlement could have been reached.