Buyout Settlement Clause

Buyout Settlement Clause

Investopedia / NoNo Flores

What Is a Buyout Settlement Clause?

A buyout settlement clause is a contractual provision often 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 money to settle the claim on their own, without the support of their insurance provider.

Key Takeaways

  • A buyout settlement clause is a contractual provision found in many insurance contracts.
  • The 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 insurer from any future liabilities associated with the claim.
  • Policyholders may use the payout to settle for a lower amount with the claimant or 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's approval. Details of these clauses are normally outlined in insurance policy contracts.

To demonstrate how the clause works, let's consider the case of a business owner who purchases business liability insurance. A customer who falls and is injured while on company property may sue the business, claiming the incident happened because the business failed to properly maintain its facilities. In this case, the company's insurer 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 insurer 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 believe 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 insurer 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 insurer pays the amount it had previously planned to offer as a settlement. The insurer effectively buys out the policyholder through this payment, releasing it from any further liability resulting from this claim.

The policyholder, meanwhile, is free to use this settlement amount to either settle the lawsuit or fund the cost of fighting the lawsuit in court. There is no guarantee that any efforts to fight the lawsuit will succeed, and it is possible the policyholder will end up paying more than the initial settlement offer. Any additional costs and risks are assumed by the policyholder.

Policyholders who settle lawsuits for less than the insurer'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 owns a small retail store. He takes all reasonable precautions to ensure 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 arise.

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

Despite these discrepancies, Michael's insurer recommends settling in order to avoid potentially costly legal expenses. After all, defending against the claim in court would consume valuable time; it would be simpler to pay a settlement to the customer. Although Michael understands this could 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. He will receive the settlement amount from his insurer 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 cover any additional costs out of pocket.