96-506




                                                                                 No. 96-506
                                                                                 No. 96-507
                                                                                 No. 96-508

                                                  IN THE SUPREME COURT OF THE STATE OF MONTANA


                                                                                 1997

                                  ______________________________________________________

                                                                     TRACY AUGUSTINE,

                                                                       Plaintiff and Appellant,

                                                                                         v.

                                    SUSAN SIMONSON, and FARMERS INSURANCE EXCHANGE,

                                                                    Defendants and Respondents.

                __________________________________________________________________
                      JAY AUGUSTINE as GUARDIAN AD LITEM for CHASE AUGUSTINE,

                                                                       Plaintiff and Appellant,

                                                                                         v.

                                    SUSAN SIMONSON, and FARMERS INSURANCE EXCHANGE,

                                                                    Defendants and Respondents.

                __________________________________________________________________

                                                                         TRAVIS GRAY,

                                                                       Plaintiff and Appellant,

                                                                                         v.

                                    SUSAN SIMONSON, and FARMERS INSURANCE EXCHANGE,

                                                                    Defendants and Respondents.

                                  ______________________________________________________

                     APPEAL FROM:                   District Court of the Eighth Judicial District,
                                                           In and for the County of Cascade,
                                                      The Honorable John Warner, Judge presiding.




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                                                                    COUNSEL OF RECORD:

                                                                                 For Appellants:

                                                Channing J. Hartelius (argued); Hartelius, Ferguson,
                                                         Baker & Kazda; Great Falls, Montana

                                                                                For Respondents:

                                              William J. Gregoire (argued) and Robert J. Vermillion;
                                               Smith, Walsh, Clarke & Gregoire; Great Falls, Montana




                                                                                Submitted: April 1, 1997

                                                                                Decided: June 24, 1997
                                                                                Filed:


                                                          __________________________________________
                                                                      Clerk

                             Justice Jim Regnier delivered the opinion of the Court.

     Tracy Augustine, Jay Augustine, as guardian ad litem for Chase Augustine, and
Travis Gray (collectively referred to herein as "the Augustines") filed three
complaints
against Susan Simonson and Farmers Insurance Exchange in the Eighth Judicial District
Court. The complaints, arising out of an automobile accident, alleged that Simonson
was
liable for their personal injuries and that Farmers was liable for the damages in
excess
of the insurance proceeds available from Simonson pursuant to their underinsured
motorist (UIM) coverage. On December 20, 1995, at a court-ordered mediation
conference, the Augustines settled with Simonson. As a result, each claimant signed
a
release reserving their underinsured motorist claim against Farmers. The claims
against
Simonson were dismissed. Farmers filed a Rule 12(b)(6), M.R.Civ.P., motion to
dismiss
on January 25, 1996, based on the exhaustion clause contained in its UIM policy. The
District Court issued an order granting the motion to dismiss on June 24, 1996. The
Augustines appeal from this order. We reverse.
     The issue on appeal is whether the District Court erred in holding that the
exhaustion clause in Farmers' underinsurance policy was a valid contractual
provision and
thereby granting Farmers' motion to dismiss.
FACTUAL BACKGROUND
     On July 28, 1992, a vehicle driven by Susan Simonson rear ended a vehicle driven
by Travis Gray. Tracy Augustine, Chase Augustine, and Cole Davison were passengers

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in Gray's vehicle. Claims against Simonson and Farmers were made by Travis Gray,
Tracy Augustine, and Jay Augustine on behalf of Chase Augustine. Cole Davison was
a minor, age nine, at the time of the collision. No claim has been made on Cole's
behalf
as of this date.
      Simonson was insured by an American States insurance policy with an aggregate
combined single limit of $100,000. On December 20, 1995, the Augustines settled with
Simonson, reserving their claims against Farmers. Travis Gray's claim was settled
for
$20,000. Tracy Augustine's claim was settled for $16,875, and Chase Augustine's
claim
was settled for $16,875. Approximately $1,100 was paid for property damage.
Therefore, with one potential claim still outstanding, approximately $54,600 has been
paid out on the American States policy, leaving approximately $45,400 remaining on
the
policy limits.
      After the settlement, Farmers filed a motion to dismiss pursuant to Rule 12(b)
(6),
M.R.Civ.P., for failure to state a claim upon which relief could be granted. Farmers
asserted that the Augustines failed to comply with the exhaustion clause in their
underinsurance policy by entering into settlements which were less than the tort-
feasor's
policy limits of liability. The District Court heard argument on the motion and
ordered
supplemental briefing by the parties. On June 20, 1996, the District Court issued an
order in which the court recognized public policy reasons for invalidating exhaustion
clauses, but declined to hold the clause invalid, reasoning that "it would be unwise
to
encroach on the legislative function in this area." The Augustines appeal.
                            DISCUSSION
      Did the District Court err in holding that the exhaustion clause in Farmers'
underinsurance policy was a valid contractual provision and thereby granting Farmers'
motion to dismiss?
      The District Court's order on the motion to dismiss was based in part upon facts
outside of the pleadings. If a court considers matters outside of the pleadings on a
Rule 12(b)(6), M.R.Civ.P., motion to dismiss, that motion is constructively converted
into a motion for summary judgment regardless of how the order was phrased. See Rule
12(b), M.R.Civ.P.; American Medical Oxygen Co. v. Montana Deaconess Medical Ctr.
(1988), 232 Mont. 165, 168, 755 P.2d 37, 39. This Court reviews a district court's
grant of summary judgment de novo applying the same evaluation as the district court
based on Rule 56, M.R.Civ.P. Motarie v. Northern Montana Joint Refuse Disposal Dist.
(1995), 274 Mont. 239, 242, 907 P.2d 154, 156; Bruner v. Yellowstone County (1995),
272 Mont. 261, 264, 900 P.2d 901, 903. Summary judgment is proper when there is no
genuine issue as to any material fact and the moving party is entitled to a judgment
as a
matter of law. Rule 56(c), M.R.Civ.P.
      The interpretation of an insurance contract in Montana is a question of law.
Wellcome v. Home Ins. Co. (1993), 257 Mont. 354, 356, 849 P.2d 190, 192. This Court
reviews questions of law to determine whether the lower court's application or
interpretation of the law is correct. Hollister v. Forsythe (1995), 270 Mont. 91,
93, 889
P.2d 1205, 1206; McGregor v. Madsen (1992), 253 Mont. 210, 212, 832 P.2d 779, 780.

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      The Augustines argue on appeal that the District Court erred when it determined
that they must exhaust the tort-feasor's insurance policy limits in order to make a
claim
for UIM coverage. They further assert that the term "exhaust" is ambiguous and
therefore
unenforceable. Farmers argues that the term "exhaust" is not ambiguous and that this
Court should not rewrite the insurance policy by declaring the exhaustion clause
invalid
as violative of public policy.
      We have previously held that if a contract's terms are clear and unambiguous,
the
contract language will be enforced. Youngblood v. American States Ins. Co. (1993),
262
Mont. 391, 395, 866 P.2d 203, 205; Keller v. Dooling (1991), 248 Mont. 535, 539, 813
P.2d 437, 440;    28-3-401, MCA. This Court has further held that the only exception
to enforcing an unambiguous contract term is if that term violates public policy or
is
against good morals. Youngblood, 866 P.2d at 205; Amsterdam Lumber, Inc. v.
Dyksterhouse (1978), 179 Mont. 133, 140, 586 P.2d 705, 709;    28-2-701, MCA.
      The Farmers policy at issue contains a standard exhaustion clause which
provides:
"We will pay under this coverage only after the limits of liability under any
applicable
bodily injury liability bonds or policies have been exhausted by payment of judgments
or settlements." We do not find the Augustines' argument persuasive that the term
"exhaust" in this clause is ambiguous. We conclude that there is only one reasonable
interpretation of the clause in light of its purpose. Leibrand v. National Farmers
Union
Prop. and Cas. Co. (1995), 272 Mont. 1, 6, 898 P.2d 1220, 1223. The term requires
that the insured entirely exhaust the limits of all existing bodily injury liability
bonds or
policies before he or she is entitled to proceed against the underinsured motorist
carrier.
We shall, therefore, examine the validity of the clause in light of public policy
considerations.
      Neither the Montana Legislature nor this Court have specifically addressed the
issue of whether an exhaustion clause in an underinsurance policy is enforceable
under
public policy. This Court has, however, spoken generally as to the purpose of
underinsurance. In Sorenson v. Farmers Ins. Exch. (Mont. 1996), 927 P.2d 1002, 53
St.
Rep. 1155, we adopted a "no prejudice" rule as a matter of public policy and stated
that
"[t]he purpose of underinsured motorist insurance is to provide a source of
indemnification for accident victims when the tortfeasor does not provide adequate
indemnification." Sorenson, 927 P.2d at 1005 (citing State Farm Mut. Auto. Ins. Co.
v.
Estate of Braun (1990), 243 Mont. 125, 130, 793 P.2d 253, 256). In Sorenson, the
plaintiff settled with the tort-feasor and provided a release without obtaining the
consent
of her own underinsurance carrier. The insurer argued that when she settled and
provided

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a release without the insurer's consent, she was precluded from receiving her
underinsured motorist coverage. In reversing the district court, we held that there
was
no prejudice to the insurer where the tort-feasor was judgment proof and,
consequently,
the insured's actions would not compromise the insurer's ability to subrogate. We
explained the meaning of this no prejudice rule as "absent some showing of material
prejudice to the underinsurance carrier, a claim for underinsured motorist coverage
may
not be precluded on a technicality." Sorenson, 927 P.2d at 1004.
      In its order on the motion to dismiss, the District Court devoted considerable
attention to specific public policy reasons for not requiring adherence to exhaustion
clauses. The court noted that not requiring the insured to fully exhaust the tort-
feasor's
insurance serves a dual purpose of discouraging prolonged litigation and promoting
early
settlements, thereby providing the injured party with the relief when it is most
needed.
Numerous jurisdictions have agreed that these are important public policy reasons and
that exhaustion clauses violate public policy. For instance, Justice Holmes of the
Ohio
Supreme Court observed:
There are of course a number of considerations which militate in favor of
settlement between the underinsured tortfeasor's insurer and the injured
party. Obviously, settlement avoids litigation with its attendant expenses
and resultant burden upon the legal system. Where the amount of
settlement is less than the policy limits, the unpaid amount may well
represent the savings in litigation costs for both sides. More importantly,
settlement hastens the payment to the injured party who obviously needs
compensation soon after the injuries when the medical expenses begin to
amass and when the anxiety level is probably quite high. Additionally,
there are many situations where litigation would not be a preferred course
of action because, while the injuries are certain, there may remain other
problems of proof. Thus, the public policy considerations, apart from the
contract of the parties, generally favor settlements.

Bogan v. Progressive Cas. Ins. Co. (Ohio 1988), 521 N.E.2d 447, 451, modified in part
on other grounds, McDonald v. Republic-Franklin Ins. Co. (Ohio 1989), 543 N.E.2d
456.
     The Supreme Court of Nevada also determined that exhaustion clauses violate
public policy because
they unnecessarily promote litigation costs, increase the number of trials,
and unreasonably delay the recovery of underinsured motorist benefits.
Specifically, these cases point out that an insured may have valid reasons
for accepting less than the tortfeasor's policy limit, that an "underinsured
motorist carrier" can compute its payments to the insured as if the insured
had exhausted the tortfeasor's policy limit, and that if an "exhaustion
clause" is in effect, the tortfeasor's carrier can force the plaintiff to go to
trial by offering less than the tortfeasor's policy limit, thereby greatly
increasing litigation costs and expenses and promoting delay. See
Mulholland v. State Farm Mutual Auto Ins. Co., 171 Ill.App.3d 600, 122
Ill.Dec. 657, 527 N.E.2d 29 (1988); Schmidt v. Clothier, 338 N.W.2d 256

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(Minn.1983) (superseded by statute); Longworth v. Van Houten, 223
N.J.Super. 174, 538 A.2d 414 (App.Div.1988); Hamilton v. Farmers Ins.
Co. of Washington, 107 Wash.2d 721, 733 P.2d 213 (1987).

Mann v. Farmers Ins. Exch. (Nev. 1992), 836 P.2d 620, 621.
      In sum, the policy reasons for not enforcing exhaustion clauses include the
following rationales. Exhaustion clauses promote litigation expenses which lessen
the
insured's net recovery. The time involved in litigation serves to delay payment of
UIM
benefits to the insured. Furthermore, such clauses fail to recognize that the
insured may
have a legitimate and valid reason for accepting less than the tort-feasor's policy
limits,
i.e., the cost and risk of litigation and issues of proof. They fail to consider
that the
underinsured carrier can compute its payments to the insured as if the insured had
exhausted the tort-feasor's policy, thereby not prejudicing the UIM carrier.
Finally,
under an exhaustion clause the tort-feasor's carrier can force the injured party to
go to
trial by offering less than the policy limits, thereby increasing costs, litigation,
and delay.
      We conclude that this reasoning is consistent with the public policy of this
State.
It is also consistent with the purpose of underinsurance, to provide indemnification
for
accident victims when the tort-feasor does not provide adequate indemnification.
Sorenson, 927 P.2d 1002. Furthermore, it is consistent with the declared public
policy
of this State to encourage settlement and avoid unnecessary litigation. Holmberg v.
Strong
(1995), 272 Mont. 101, 106, 899 P.2d 1097, 1100. Therefore, we conclude that the
provision requiring that the tort-feasor's liability insurance be entirely exhausted
as a
prerequisite to securing indemnification from the underinsured motorist coverage is
contrary to the public policy of the State of Montana and is unenforceable to the
extent
that it violates public policy.
      Jurisdictions which have held exhaustion clauses to be unenforceable as against
public policy have resolved the exhaustion requirement using different methods. Some
jurisdictions have held that exhaustion clauses can be fulfilled when the claimant
settles
with the tort-feasor's insurance company and leaves only a reasonable amount on the
table
which could be said to represent a savings for both parties as costs of avoided
litigation.
See, e.g., Bogan, 521 N.E.2d 447; Leuchtenmacher v. Farm Bureau Mut. Ins. Co. (Iowa
1990), 461 N.W.2d 291. This determination often requires an evidentiary hearing to
determine if the amount left on the table does represent a savings for both parties
as
avoided costs of litigation. It also requires representative counsel to provide

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depositions
or testify as to potential litigation costs. This process then requires the lower
court to
apply a subjective test to determine what comprises a reasonable amount left on the
table.
This determination becomes even more complex when the factual situation involves
multiple claimants, some of whom might have outstanding claims at the time one
settlement is reached.
      Requiring additional litigation to determine whether an exhaustion clause has
been
substantially fulfilled would only further frustrate our previously stated public
policy of
encouraging settlement, and not delaying the payment of claims and increasing the
costs
and burdens borne by the insured in obtaining compensation. A more prudent
approach,
and the one we hereby adopt today, does not prejudice the underinsurance carrier, nor
does it place additional burdens of time and litigation costs on insureds seeking to
recover
on their underinsurance policies.
      To prevent unnecessary litigation and yet fulfill the contract made between the
insurer and its insured, the insured may proceed to bring his or her claim against
their
UIM carrier whether or not they have fully exhausted the tort-feasor's insurance
policy
limits. A claim must first be made with the tort-feasor's insurance company. This
claim,
however, does not have to be finally disposed of before proceeding against the
underinsurer. In the case of an individual claimant, the underinsurance coverage
liability
then commences only when the insured's damages exceed the stated limit of the tort-
feasor's liability insurance, thus making the insured responsible for any gap
between the
amount of settlement and the tort-feasor's liability limits. The underinsurer shall
receive
credit, however, for the full amount of the tort-feasor's policy limits.
      In a situation where multiple claimants seek to recover the proceeds of a single
policy, such as we have here, there are additional considerations. In most
instances, the
nature and extent of the injuries suffered by the individual claimants will
differ. As a
workable solution, we adopt the following procedure. The limits of the tort-feasor's
policy shall be divided among the claimants, in an equal pro rata share, for the
purpose
of considering exhaustion. This share, or the amount of the tort-feasor's insurance
actually received by the claimant, whichever is greater, shall then be credited to
their
individual underinsurers as being the "limits" of the tort-feasor's policy.
      We can foresee some instances where the claimant may nevertheless want to
proceed to exhaust the policy. In a multiple claim-single limit situation, a
claimant may
receive a minimal settlement because the other claimants may have comparatively more

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serious injuries. The amount received may be significantly less than the value of
the
claim, but considerably under the pro rata set off. There is nothing to prevent
such a
claimant from fully "exhausting" the policy under traditional methods and then
proceeding
against the underinsurer.
       In sum, the underinsurer is not prejudiced by allowing a claim for
underinsurance
to proceed regardless of whether the tort-feasor's policy limits have not been fully
exhausted because the underinsurer receives a credit for the policy limits. This
procedure
still provides protection to an insurance company against a demand by its insured to
fill
the gap after a weak claim has been settled for an unreasonably small amount, yet it
provides prompt payment to the insured and does not lessen the insured's recovery by
requiring him or her to pay additional litigation costs and delay the payment of
claims.
Furthermore, this method bypasses the necessity of litigating the determination of
whether
a policy has been exhausted by a settlement leaving only a reasonable amount on the
table
reflecting saved costs of avoided litigation.
      Although we agree with the District Court's statement of public policy, we
reverse
the District Court's decision and remand for further proceedings consistent with this
opinion.

                                                                       /S/       JIM REGNIER


We Concur:

/S/       J. A. TURNAGE
/S/       KARLA M. GRAY
/S/       W. WILLIAM LEAPHART
/S/       JAMES C. NELSON
/S/       WILLIAM E. HUNT, SR.
/S/       TERRY N. TRIEWEILER




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