What Is a Buyout Settlement Clause?

The term buyout settlement clause refers to a contractual provision commonly found in liability insurance contracts. This clause provides the policyholder with the right to reject a settlement offer made by the insurer. If the insured party exercises this right, the insurance company buys out the policy. The policyholder can use this amount of money to settle the claim on their own, without the support of their insurance provider.

Key Takeaways

  • A buyout settlement clause in a contractual provision found in many insurance contracts.
  • This clause allows the policyholder to reject a settlement offer made by their insurer.
  • If they exercise the buyout settlement clause, the policyholder receives the settlement amount as a buyout payment, releasing the insurance company from any future liabilities associated with the claim.
  • Policyholders may use the payout to settle for a lower amount with the claimant or to pay for any legal costs incurred.

How Buyout Settlement Clauses Work

Buyout settlement clauses are generally part of the liability insurance industry. They exist to protect policyholders against the risk of insurance companies offering a settlement to another party without the insured individual's approval. Details of these clauses are normally outlined in insurance policy contracts.

Let's consider the case of a business owner who purchases business liability insurance to demonstrate how the clause works. A customer who falls and is injured while on the company's property may sue the business, claiming the incident happened because the business failed to properly maintain its facilities. In that situation, the business’s insurance company may wish to settle the lawsuit quickly to avoid incurring legal fees and spending a significant amount of time in court.

To avoid these costs, the insurance company may offer to settle the customer’s claim out of court. However, some policyholders may disagree with this decision, either because they believe the lawsuit is frivolous or because they expect they can settle for a lesser amount at a later date. In this case, the policyholder can elect to handle the lawsuit on their own instead of allowing their insurance company to settle on their behalf. To achieve this, the policyholder can exercise the buyout settlement clause in their insurance contract. Once the policyholder exercises this clause, their insurance company pays them the amount that they had previously planned to pay as a settlement. The insurance company effectively buys out the policyholder through this payment, releasing the insurance company from any further liability resulting from this claim.

The policyholder, meanwhile, is free to use this settlement amount either to settle the lawsuit themselves or to help fund the cost of fighting the lawsuit in court. There is no guarantee that any efforts to fight the lawsuit will be successful, and it is possible that the policyholder will end up having to pay more than the settlement offer initially proposed by their insurance company. This means any additional costs and risks must, therefore, be assumed by the policyholder.

Policyholders who settle lawsuits for less than the insurance company's settlement offer are free to keep the difference, while those who end up incurring more costs must pay the difference out of pocket.

Example of a Buyout Settlement Clause

Michael is the owner of a small retail store. To help protect his customers, he takes all reasonable precautions to ensure that his storefront is clean, well-lit, and free of any potential tripping hazards or other potential risks. As an added precaution, he also purchases commercial general liability (CGL) insurance to protect himself from any lawsuits that might nonetheless arise.

One day, Michael receives notice of a lawsuit from one of his customers, who alleges that they sustained a serious and costly injury after tripping on misplaced merchandise while visiting his store. The customer’s lawsuit includes a description of his store as having been cluttered and poorly lit, with many tripping hazards. Upon seeing the lawsuit, Michael immediately realizes that the claims are untrue and that the conditions described bear no relation to the actual state of his store.

Despite these discrepancies, Michael’s insurer recommends that they settle the lawsuit in order to avoid potentially costly legal expenses. After all, defending against the claim in court would consume valuable time, making it simpler to pay a settlement to the customer. Although Michael understands that settling the claim could turn out to be the most practical option, he feels offended by the customer’s dishonest lawsuit and decides to fight the claim in court. He reasons that, because the customer’s description of his store is so at odds with its actual condition, he should be able to fight the case by relying on sources such as his own store’s camera footage and the testimonials of other customers. 

For this reason, Michael decides to exercise the buyout settlement clause in his insurance contract. Going forward, he will receive the settlement amount from his insurance company as a buyout payment, releasing the insurer from any further liability resulting from this claim. Michael is then free to pursue the case on his own and is able to use the funds from the settlement to pay for the costs. He may use part of it to settle with the claimant and keep the remaining funds for himself. If the claimant wins, he can use the payout toward the actual court settlement but must front any additional costs out of his own pocket.