"Bad Faith" and insurer actionsArticle added by Christine Barlow on January 30, 2009
Christine G. Barlow, CPCU, is an Assiociate Editor of FC&S, a division of Summit Business Data. Christine has experience in claims, underwriting and training. Before joining FC&S, Christine worked as an Underwriting Supervisor for Maryland Auto Insurance Fund, and as Senior Underwriter/Underwrite... More
Good faith and fair dealing form the basis for any contract of insurance. These requirements can leave insurers exposed to extra-contractual damages, including punitive damages, for its breach. At heart, bad faith is the intentional failure by an insurer to perform the duty of good faith and fair dealing implied at law. Generally, an insurer may be acting in bad faith when it refuses to pay a claim and (1) has no reasonable basis for refusing to pay and has actual knowledge of that fact, or (2) has intentionally failed to determine whether it had a reasonable basis for so refusing.
This area of insurance law has been developed by case law and statutory and regulatory action in almost all jurisdictions. Additionally, many states have recognized a common law tort action (the tort of bad faith in insurance transactions) for the violation of the duty of good faith and fair dealing. Cases have arisen around the following claims: the insurer's failure to handle property insurance claims in good faith; the insurer's failure to reasonably settle liability claims within policy limits; the insurer's failure to tender a defense under the duty to defend.
This treatment examines the background and development of the bad faith doctrine and examples of cases arising under the common and statutory law of various jurisdictions. It attempts to illustrate what actions by an insurer constitute examples of good faith and bad faith in insurance transactions.
Bad faith defined
At law, all contracts have an implied covenant (or contractual promise) of good faith and fair dealing. All parties to contracts agree that they will do nothing to injure the right of other parties to receive the "fruits of the contract." Generally, however, damages for the breach of this requirement of good faith and fair dealing are only contractual in nature; that is, only the damages provided for by the contract are available for its breach. That is why lawyers drafting contracts pay particular attention to the damages provisions in case of breach. The law generally will not broaden the damages available for breach of contract beyond those contemplated by the parties.
In insurance transactions, the requirements of good faith and fair dealing are more stringent, with broader damages available to the aggrieved parties. This more stringent requirement arises out of the importance of insurance to society (the public policy interest), and the general insurance concept of "contracts of adhesion" where the bargaining power of the parties is substantially disparate. In a typical contractual claim, consequential and punitive damages are rarely, if ever, available to the aggrieved party. However, in a dispute on an insurance contract, these types of damages are often available to parties who can prove that the insurance company in some way acted in bad faith in dealing with an insurance claim.
The violation of the duty of good faith and fair dealing is acting "in bad faith." Bad faith, as a term of art in the legal community generally implies or involves "actual or constructive fraud, or a design to mislead or deceive another, or a neglect or refusal to fulfill some duty or some contractual obligation, not prompted by an honest mistake as to one's rights or duties, but by some interested or sinister motive. The term bad faith is not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will." (Black's Law Dictionary, 5th ed.) Insurance case law has softened the "ill will" or "conscious doing of wrong" into areas of more passive action, as is developed further in this article.
Courts have defined bad faith in differing language, often with synonymous meanings: "Bad faith is the intentional failure by an insurer to perform the duty of good faith and fair dealing implied at law" (Koch v. State Farm Fire & Casualty Co., 565 So. 2d 226 (Ala. 1990); and "An insurer's denial of coverage, without reasonable justification, constitutes bad faith (Whistman v. West Am, 686 P.2d 1086 (Wis. 1984).
The development of bad faith
The tort of bad faith, when applied to the breach of a duty of good faith, is a fairly recent (second half of the 20th century) tort. As seen below, extra-contractual damages have been available to aggrieved insureds since the 1940s, in the area of holding insurers responsible for excess judgments over policy limits in cases that the insurer refused to settle. In other words, the insurer could have reasonably settled within limits, but decided, at the insured's expense, to "try their luck" at trial. The development of bad faith principles in the handling of first party claims and the awarding of punitive damages are of more recent origin, having developed in most jurisdictions during the 1980s.
The first state to hold that there is an independent tort action for the bad faith handling of claims in a first party context (i.e., for wrongful denial of a property claim), was California. In Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (1973), the insured owner of a cocktail lounge became involved in an argument with a firefighter at the scene of a fire at the insured's premises. He was arrested and subsequently charged with arson and defrauding an insurer.
Thereafter, the insurance company demanded in writing that the insured submit to sworn examination. The insured's lawyer informed the insurer that no statements would be forthcoming until the resolution of the arson charge. The insurer refused to delay the sworn examination, and denied the loss for failure to comply with policy conditions. The court dismissed the charges against the insured for lack of probable cause, and the insured informed the insurer that he would now comply with the examination request. The company reaffirmed the denial of coverage, based on the insured's failure to appear.
The insured brought an action, stating that as a result of the outrageous conduct and bad faith of the insurer, he suffered economic damage, emotional distress, loss of earnings, and other damages. He sought compensatory and punitive damages.
The insured prevailed. The court held that Aetna's refusal (without proper cause) to pay the covered claim, gave rise to a tort cause of action for breach of an implied covenant of good faith and fair dealing. Although the facts differ, and various spins have been put on the area of bad faith, this remains the basic fact pattern and holding for this type of case.
Another significant case in the history of bad faith is Anderson v. Continental, 271 N.W.2d 368 Wis.,1978.; the insured came home to discover the walls, drapes, carpeting, furniture and clothing covered in oil and smoke residue, from a fire or explosion in the furnace. The dispute centers around $4,611.77 in costs incurred by the insured for additional cleaning needed after the insurer's contracted cleaners finished the job. The plaintiff's complaint stems from Continental's repeated refusal to accept a proof of loss and refusal to negotiate the amount due to the insured.
While the Wisconsin court followed California in recognizing tort causes of action for bad faith to first party-cases, the court defined more narrowly the cause of action than Gruenberg. Anderson stated that the plaintiff must show the absence of a reasonable basis for the denial of benefits and that the defendant knew of or had reckless disregard for the lack of a reasonable basis for denial. This makes bad faith an intentional act.
Evolution of the concept
Generally, the evolution of the doctrine in various jurisdictions has been a three-step process:
It is important to note here, however, that some jurisdictions have not recognized the tort of bad faith in insurance dealings; the chart below outlines how states handle bad faith concerning first-party cases.
One state's evolution in bad faith law
These cases from Ohio illustrate the evolution of the bad faith doctrine in that state. Yet, Ohio is not unique in its development of the bad faith insurance law area.
In 1949, the Ohio Supreme Court recognized that an insurer may be liable in tort "for the excess of the judgment over the policy limit where the insurer is guilty of fraud or bad faith" (Hart v. Republic Mutual Ins. Co., 87 N.E.2d 347 (1949). In this case, the court analogized bad faith to fraud and recognized a bad faith cause of action for a failure to reasonably settle in a third-party liability situation.
Thirteen years later, in Slater v. Motorists Mutual Ins. Co., 187 N.E.2d 45 (1962), the court overturned a lower court's ruling that the insurance company had acted in bad faith in another failure to settle case. The court took the opportunity to visit the findings of other jurisdictions and further defined bad faith. Among the court's holdings were:
In a 1988 case, Staff Builders, Inc. v. Armstrong, 525 N.E.2d 783 (1988), Ohio shifted from defining bad faith as analogous to fraud, and adopted a "reasonable justification" test. Bad faith became "refusal to pay the claim where such refusal is not founded on circumstances that furnish reasonable justification therefore." In contrast, punitive damages were available only where there is actual malice, fraud or insult on the part of the insurer. This further delineates the distinction between conduct found to be in bad faith and conduct found to warrant punitive damages. This "reasonable justification," or as it is referred to in many cases, the "reasonable basis" test is apparently the standard for most jurisdictions in assessing bad faith liability.
In 1992, the Ohio Supreme Court further defined bad faith in a fashion consistent with the development of this area of law in other jurisdictions. In Motorists Mutual Ins. Co. v. Said, 590 N.E.2d 1228 (1992), the court ruled that an insurer's failure to act in good faith can take one of two forms: (1) a failure to perform where it is known that there is no lawful basis for the failure; and (2) a failure to determine whether there is or is not a lawful basis for refusing to perform.
Zoppo v. Homestead Ins. Co. 71 Ohio St.3d 552, 644 N.E.2d 397 (Ohio,1994) revisited the Said and Slater decisions. Both decisions contained an element of intent in the action of bad faith, and the court overruled both with the opinion that intent is not part of the reasonable justification standard. By expressly overruling Said and Slater, the court felt it was correcting previous mistakes and reinstating the reasonable justification standard.
The law of many states followed much the same route to the tort of bad faith in insurance dealings as did Ohio. Bad faith evolved from as actual malice only (1949) to bad faith as failure to perform where there is a known duty to perform. This evolution opens insurance companies to bad faith legal challenges for a variety of actions falling short of malice or fraud. The failure to handle claims adequately might well be acting in bad faith. This failure on the insurer's part might thus expose the insurer to extra-contractual claims. Going one step further, malice, intent, or wrongful purpose in the settlement of claims might well leave the insurer open to bad faith damages and punitive damages.
The property cases --"Reasonable Basis"
In the first-party claim area, the laws of almost all jurisdictions recognize that an insurer can violate its duty of good faith and fair dealing by failing to pay a claim promptly when liability becomes reasonably clear. This recognition has come either through common law, developed case law, or statutory or regulatory enactment.
In greatly uniform language, courts have held that the cause of action against the insurer arises "where there is no reasonable basis for a denial of a claim or when the insurer fails to determine or delays in a determination of whether there is any reasonable basis for a denial of the claim... In order to sustain a claim for breach of good faith, the insured must establish (1) the absence of a reasonable basis for denying or delaying payment of the claim, and (2) that the insurer knew, or should have known, that there existed no reasonable basis for denying or delaying payment of the claim." (from Dixon v. State Farm Fire and Casualty Co., 799 F.Supp. 691 (S.D. Tex. 1992).
The legal basis is easily and simply stated; however, there is a great deal of litigation in this area, suggesting that the standards are not as easily recognized or practiced. The facts and outcomes of various cases provide some samples.
Following is one common fact pattern that has been litigated in several jurisdictions. An insured's building burns and the insured brings claim for loss. Upon investigating, the insurer suspects arson by the insured. Subsequently, the insured is charged by the authorities with arson. During the pending of the criminal action against the insured, the insurer denies or delays paying the claim. At either trial or pretrial hearing, the charges against the insured are dismissed or the insured is acquitted. Thereafter, the insured brings suit to recover on the insurance policy and includes a claim against the insurer for bad faith handling of the claim.
Under the same set of facts, cases have opposing outcomes, generally due to the variance in the manner in which the insurer handled the claim and investigation.
In Dixon, the court found for the insurer on the bad faith claim, while, of course, allowing recovery of policy proceeds. The court held that the insurer had demonstrated a reasonable basis for denying the claim. "State Farm demonstrated that it relied on the following to determine that there was a reasonable basis for denying the insurance claim: recorded statements of plaintiff and admissions made in a subsequent interview, laboratory findings demonstrating the existence of flammable liquids, a fire scene examination concluded that the fire was the result of an incendiary act with the burn pattern denoting deliberateness, and a committee report establishing motive and opportunity."
The insurer's deviation from the standards of the industry played a part in arriving at a judgment for the insured on his bad faith claim with similar facts in Brewer v. American and Foreign Ins. Co., 837 P.2d 236 (Colo. 1992). The insurer made the argument that there can be no bad faith claim if there is "any colorable evidence supporting the denial of an insurance claim." The court disagreed, holding that although the insured's case could not, as a matter of law, be decided by directed verdict on the underlying arson claim (i.e., there were issues that required the verdict of the jury regarding the arson and the insured could not move for a summary or directed verdict), the bad faith issue could still be decided in favor of the insured.
The difference between Dixon and Brewer is the claims handling and investigation by the insurer. "Here, evidence indicates that acceptable investigative procedure such as determination of the chronology of the fire, its origin, its cause, whether burn patterns were present, and if burn patterns were found, an interpretation of the patterns by an experienced arson investigator, were not followed by the insurance company.
"Additional testimony supported the conclusion that it was not customary in the insurance industry to rely exclusively on an inexperienced insurance adjuster/fire investigator to determine and interpret burn patterns. Nor was it customary in the industry for an insurance company's representatives to advise potential witnesses that the insured had committed arson and that it was conducting an arson investigation during the initiation of an interview. Because there was evidence that all or some of the industry standards were deviated from, there exists ample support in the record for the jury's conclusion that the insurance company acted unreasonably and had no reasonable basis for denying the insured's claim."
Further refining bad faith
Having dealt with the matter of what constitutes bad faith and its attendant principles, litigators and courts have turned to further refining the issues that might be raised in a bad faith claim.
Good faith error: An insurance company can make a good faith erroneous decision, or at least a decision that is later disagreed with by a fact finder, without subjecting itself to bad faith liability. An example of this line of cases is State Farm Lloyds, Inc. v. Polasek, 847 S.W.2d 279 (Tex. 1992). The insured's video rental business burned. The insurer denied coverage on the grounds that the fire was caused by arson and that the insureds had made material misrepresentations. The insureds were not charged with arson by the authorities.
The insureds filed suit and a jury found that the insureds had not caused the burning of their premises. The jury further found that the insurer had acted in bad faith because it did not have a reasonable basis for denying the claim. The jury awarded the insureds $40,000 for the property loss, $200,000 for mental anguish, and $500,000 in punitive damages. In overturning the mental anguish and punitive damages awards, the court held that "an arguable basis," existed to deny the claim, thus defeating a bad faith claim. In other jurisdictions, "arguable basis" is synonymous to reasonable basis.
The court stated that the insureds had argued that they had nothing to do with the fire and that the jury believed them. Absent appeal, that decided the issue of coverage and the insurer had to pay the claim. But the insureds did not demonstrate bad faith on the part of the insurer simply by proving that they did not commit arson. "It is not satisfied by proof that [the insurer] should have paid their claim, or that [the insurer] acted unreasonably in denying their claim." Instead, the insured must prove that no reasonable basis existed for denying or delaying payment of the claim or that the insurer failed to determine whether there was any reasonable basis for so denying or delaying.
It is important to note that, in effect, the court held the following in bad faith cases: the issue is not whether the fact finder (court or jury) believes the evidence used by the insurer to deny a claim, but whether such evidence existed, so as to give the insurer a reasonable basis.
In Polasek, the court found that the following facts gave the insurance company its reasonable basis for denying the claim:
The court took the opportunity to address the issue of bad faith in its decision. "Bad faith counts are now routinely pleaded in suits on insurance contracts. [Our] Supreme Court did not intend [this] result; it did not intend to convert first-party cases into tort cases. It simply gave a tort remedy for the exceptional case in which the insurer denies or delays payment even though no reasonable basis for that decision exists. Courts should be careful to ensure that the bad faith action is reserved for cases of flagrant denial or delay of payment where no reasonable basis existed, and not for mere unreasonable denial or delay."
A subsequent case, State Farm Fire & Cas. Co. v. Simmons, 857 S. W. 2d 126 (Tex.App.-Beaumont, 1993) disagreed with Polasek. This case involved a homeowner's fire claim that the carrier denied based on suspicions that the insured was responsible for the fire. The claim is made that the insurer did not make a through investigation of the claim. This court disagrees with Polasek in that the insured must prove that the carrier denied or delayed payment due to no reasonable basis in fact for such action. Simmons believes that this makes it possible for the carrier to pursue only one line of investigation and not look at all evidence in a case, which deteriorates the degree of care required of an insurer towards its insured. Simmons believes a better rule for dealing with bad faith is did the insurer fulfill its duty by performing a thorough, systematic, objective, fair and honest investigation of the claim?
Prolonged investigation without cause. The court held that an insurer might open itself to bad faith damages for prolonging an investigation beyond reasonable limits in Livingston v. Auto Owners Ins. Co., 582 So.2d 1038 (Ala. 1991). In this case, the court characterized the insurer's behavior in investigation of a fire loss as "a last ditch effort to find some evidence to support its suspicions that the [insureds] started the fire."
The residence in this case had burned on May 14, 1988. The insurer suspected the insured of arson. Auto Owners hired an independent fire investigator and adjuster, whose reports were done by July 15. The state Fire Marshall's report was also complete on July 15. The experts listed the cause of fire as incendiary, but reported no suspicions of involvement of the insureds. On August 16, the insured sued for coverage, including claims for bad faith. The insurer moved for summary judgment on the bad faith issue, but lost. In its denial, citing an earlier case, the court held that "where evidence of arson by the insured was slight, mere suspicion and speculation that new evidence will present itself at some future date is not reasonable grounds upon which to deny a claim." The court remanded the case to the court below for trial.
In Livingstone the insurer's four-month delay in paying the claim -- coupled with the fact that the insurer's actions appeared to the court to be foot-dragging -- was held to be unreasonable. In a similar case, a five month delay in which an interim advance was made by the insurer was held not to be in bad faith in Neal v. State Farm Fire and Cas. Co., 908 F.2d 923 (11th Cir. 1990). The court held the following in denying the insured's claim of bad faith by State Farm:
The court held that the insured's mailing of the ring was not prohibited nor excluded by the policy. Additionally, when the adjuster told the insured not to mail the ring, the court held that he was then adding an extra-contractual limitation on coverage after a loss. This action, thus, triggered the statutory bad-faith damage award.
Non-renewal or policy termination. The Alabama Supreme Court has held that the tort of bad faith does not apply to the insurer's alleged bad faith non-renewal of a policy; Alfa Mutual Ins. Co. v. Northington, 604 So.2d 758 (1992). In this case, the insurance company did not renew a policy of insurance because the insured and the insurance agent had become involved in an argument over the extent of coverage which had been represented. A company representative testified that the policy was not renewed, at least in part, due to the atmosphere of distrust that had arisen between the company and the insured.
The issue, as seen by the court, was whether an insured can sue for the tort of bad faith for a wrongful, bad faith cancellation, nonrenewal, termination, or other repudiation of an insurance policy. In answering no, the court stated that the law in the majority of jurisdictions is that the sole remedy for cancellation or nonrenewal of an insurance policy is under a contract action, and not in tort. Therefore, punitive damages would not be available in such situations.
Bad faith in third-party situations
Several issues arise that involve bad faith in the third-party liability area. They include:
An interesting development in this area is that there may be no duty to settle a case where the insurance company has competently assessed the potential of excess-over-limit damages as unlikely. Such was the result of Stevenson v. State Farm Fire and Cas. Co., 628 N.E.2d 810 (Ill. 1993). In this case, an insured was sued for negligently wounding another person in a shooting incident. The insurance company had a reasonable basis to believe that the policy might not provide coverage due to the intentional acts exclusion. Recognizing its duty to defend in questionable cases and its conflict in so providing a defense where the policy may not provide coverage, the insurer provided independent counsel for the insured. However, when faced with a settlement demand of $87,000, the company offered only $3,000. The policy had a liability limit of $100,000.
The insured then, on the advice of its independent counsel, settled with the injured party for the amount of $87,000. The insured then assigned his rights under the party to the claimant. In exchange the insured received a pledge from the injured party that he would not proceed personally against the insured. The injured party then sued the insurer and included a claim for bad faith in failing to reasonably settle.
The court held that the insurer had competently assessed the claim, and determined that there was little possibility of a verdict or judgment in excess of the policy limits, if indeed the claim was covered. Inasmuch as the insurance company had tendered an independent defense to the insured, because the claim was "fairly debatable" as to coverage, and because of the reasonable decision to try the case rather than settle (and the fact that any likely verdict would be in an amount under policy limits), the plaintiff's bad faith claim failed.
In another unreasonable failure to settle suit, it was held that there was no bad faith where the insurer settled a claim within policy limits without exposing the insured to above-the-limits liability, but where the insured claimed additional damages arising out of the settlement. In Shuster v. South Broward Hospital District Physicians' Professional Liability Ins. Trust, 570 So.2d 1362 (Fla. 1990), the insured was a doctor who claimed the insurer acted in bad faith in settling a malpractice claim within the policy limits because the settlement damaged his reputation and ability to generate income. The insurance policy specifically gave the insurer the right to investigate and settle claims.
The court concluded that "where an insurance policy gives the insurer the right to make such settlement of a claim as it deems expedient and the insurer settles the claim within the policy limits of insurance so that the insured is not exposed to liability, there is no cause of action for bad faith in effecting the settlement. The insurer obligates itself to indemnify the insured for liability on claims, not damage to the insured's reputation as a result of the claim. It is the insurer's funds which are to be used for that purpose. Thus, its insistence on having the broad discretionary right to settle as it deems expedient is not only understandable, but indeed is probably good business. An insurance company may not want to defend an insured's action based upon "principle," for instance, if it can use fewer dollars by settling. Furthermore, it is the public policy of this state to encourage settlement of litigation."
Section 627.4147(1) of Florida statutes was enacted after the Shuster decision (eff.10/1/03) and requires malpractice insurance policies to grant the insurer the sole authority to settle a claim where settlement is within policy limits. The statute also sets a standard for the insurer's exercise of its authority and requires that such a settlement be made in the best interests of the insured. This requires a larger duty on the insurer as Shuster permitted the insurer to settle a claim within the policy limits in its own self-interest, and did not require the insurer to consider the interests of the insured. Rogers v. Chicago Ins. Co.--- So.2d ----, 2007 WL 1427041 Fla.App. 4 Dist.(2007) discusses this further.
While on the subject of duty to settle, some specific advice from Wierck v. Grinnell Mutual Reinsurance Co., 456 N.W.2d 191 (Ia. 1990) is appropriate. "Authorities establish the following principles. We begin with the simple assumption that an insured buys an agreed amount of liability protection for a set premium. The insured, in the first instance, is at risk for the amounts in excess of the protection which has been purchased. The policy limits, however, set a boundary which the insurer cannot misuse to the detriment of the insured. It is bad faith for an insurance company to act irresponsibly in settlement negotiations with respect to the insured's risk in that part of the claim in excess of coverage. It is bad faith for the company to factor in its consideration of settlement offers the limited amount between an offer and the policy limit.
The best standard for good faith in a specific negotiation is to ignore the policy limits. If, but for the policy limits, the insurer would settle for an offered amount, it is obliged to do so (and pay toward settlement up to the policy limits). But the insurer is free to reject the offer if it would have rejected the same offer under policy limits covering the whole claim."
The failure to determine whether there is a duty to provide defense may also be considered bad faith. In Bracciale v. Nationwide Mutual Fire Ins. Co., 1993 U.S. Dist. LEXIS 11606, the complaint against the insured alleged negligence on the part of the insured; however, the insurance company read the complaint as consisting in actuality of a suit for damages due to (the excluded) intentional acts of the insured.
In this case, a police officer who stopped a driver was injured by the passenger in the car during the arrest. The police officer sued the passenger for wanton acts, but also pleaded negligence on the part of the person. The insurance company tendered no defense. After a judgment for more than $400,000 in favor of the officer (based, in part, upon the ground of negligent acts), the insured settled for the assignment of the insured's policy rights. The officer then brought suit against the insurer, including a claim for bad faith.
The court ruled, "An insurer who refuses to defend a claim potentially within the scope of the policy does so at its own peril. If an insurer has refused to provide a defense at trial, it may not later protest that it was deprived of an opportunity to litigate and establish that the underlying claims fell outside its policy coverage. Those insurers who did not contribute a defense are also precluded from arguing that the underlying claims fell outside their policies since they had the opportunity and declined to litigate the claims to conclusion."
The emphasized portion of the above paragraph is of extreme importance to insurers. The correct course of action in a disputed coverage case where a claim for defense is tendered, is to provide a defense under a reservation of rights and bring a declaratory judgment action on the coverage issue. It was specifically held in Zurich Ins. Co. v. Killer Music Inc., 998 F.2d 674 (9th Cir. 1993), that bringing such a declaratory action to determine coverage is not impermissible delay on the part of an insurer and does not, of itself, give the insured cause for a bad faith claim.
Finally, in two cases, it has been held that the inability of the insured to pay an excess judgment over the policy limit has no effect on the insurer's obligation for this amount in a bad faith claim. In Camp v. St. Paul Fire and Marine Ins. Co., 616 So.2d 12 (Fla. 1993), although the insured declared bankruptcy prior to a final judgment in a case against him, and therefore could not be personally liable for a judgment against him, the insurance company was still held liable for the excess amount of the judgment over policy limits. The same result occurred in Frankenmuth Mutual Ins Co. v. Keeley, 461 N.W.2d 666 (Mich. 1990).
Reverse bad faith
Insurers have recently begun to sue their customers for "reverse bad faith," which may be defined as the "tortious breach of the covenant of good faith and fair dealing by the insureds." In other words, insurers are holding their insureds to the same standards that insurers must meet. At least two states, California and Ohio, have declined to allow such actions.
For example, in Stephens v. Safeco Ins. Co., 852 P.2d 565 (Mt. 1993), both the insured and the insurer were held to have acted in bad faith in the settlement of a property claim. The jury had assessed the insured's mental distress damages under his bad faith claim as $38,000. However, the jury had allocated the insured's wrongful conduct at 53 percent, and the insurer's at 47 percent. The insurer argued that the insured could recover nothing on the bad faith claim, as the insured's wrongful conduct exceeded that of the insurer's.
The court disagreed. "Insurance companies have a duty to act in good faith with their insureds, and this duty exists independent of the insurance contract and independent of statute. If this duty is breached the cause of action against the insurer is in tort. However, if the situation is reversed, and the insured breaches the covenant of good faith, the result is not a tort, but a breach of contract." The court held that the tort of bad faith serves to discourage oppression in contracts which necessarily give one party a superior position and that the action is not available to the party in the superior position. Therefore, the insurer could not use the insured's bad faith to off-set its own bad faith conduct.
In citing Stephens, the California Supreme Court went even further to reject the idea of "comparative bad faith" (Kransco v. American Empire Surplus Lines Insurance Company, 54 Cal. App. 4th 1171, 1997). The court said, in part: "The doctrine of comparative bad faith is marked by inconsistencies and complexities... [and] is founded on the faulty premise that the obligations of insurer and insured -- and thus their bad faith -- are comparable. They are not." Even though both parties may have a "reciprocal obligation of good faith and fair dealing," the duties of the two differ because of "the differing performance due under the contract of insurance." Because the disparity between the parties "rests on contractual asymmetry," an insured and an insurer can not be considered to be on "equal footing."
In Agricultural Insurance Company v. The Superior Court of Los Angeles County (70 Cal. App. 4th 385), the California Court of Appeals held that the tort of reverse bad faith "finds no support in case law." It concluded that "an insured may be held liable in contract for breaching the covenant [of good faith dealing], but cannot be held liable in tort." In this case, the insurer contended that the insured (a health club damaged by an earthquake) had committed reverse bad faith when the club turned in questionable and possibly falsified loss notices.
In rejecting Agricultural's position, the Court stated that this argument failed on two grounds. The first, said the Court, was that no evidence existed to suggest that "the Legislature, in enacting [the insurance fraud statute] intended to expose all insureds to suits for 'reverse bad faith' whenever they make an insurance claim."
Secondly, Agricultural contended that the insurance fraud statute "created a new private right of action." The insurer said, in effect, that the concept of reverse bad faith was equivalent to that of fraud. In also rejecting this argument, the court held that "[t]he legislature did not attempt to criminalize 'bad faith' in [the insurance fraud statute] and probably could not do so constitutionally."
The Supreme Court of Ohio also struck down an attempt to create the tort of reverse bad faith, Tokles & Son, Inc., v. Midwestern Indemnity Company (605 N.E.2d 936), 1992. Here the court said that it had "never recognized such a tort and refuses to do so now." The justices went on to call the insurer "the holder of the purse strings" with "certain built-in protection from such evils" (e.g., an insured's attempt to defraud it). Because an insured "often finds himself in dire financial straits after [a] loss," he or she is entitled to the "equal footing" provided by the ability to sue an insurer for bad faith. The court concluded that "other avenues [exist] for an insurer to pursue" in the event of a fraudulent claim.
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This area of insurance law has been developed by case law and statutory and regulatory action in almost all jurisdictions. Additionally, many states have recognized a common law tort action (the tort of bad faith in insurance transactions) for the violation of the duty of good faith and fair dealing. Cases have arisen around the following claims: the insurer's failure to handle property insurance claims in good faith; the insurer's failure to reasonably settle liability claims within policy limits; the insurer's failure to tender a defense under the duty to defend.
This treatment examines the background and development of the bad faith doctrine and examples of cases arising under the common and statutory law of various jurisdictions. It attempts to illustrate what actions by an insurer constitute examples of good faith and bad faith in insurance transactions.
Bad faith defined
At law, all contracts have an implied covenant (or contractual promise) of good faith and fair dealing. All parties to contracts agree that they will do nothing to injure the right of other parties to receive the "fruits of the contract." Generally, however, damages for the breach of this requirement of good faith and fair dealing are only contractual in nature; that is, only the damages provided for by the contract are available for its breach. That is why lawyers drafting contracts pay particular attention to the damages provisions in case of breach. The law generally will not broaden the damages available for breach of contract beyond those contemplated by the parties.
In insurance transactions, the requirements of good faith and fair dealing are more stringent, with broader damages available to the aggrieved parties. This more stringent requirement arises out of the importance of insurance to society (the public policy interest), and the general insurance concept of "contracts of adhesion" where the bargaining power of the parties is substantially disparate. In a typical contractual claim, consequential and punitive damages are rarely, if ever, available to the aggrieved party. However, in a dispute on an insurance contract, these types of damages are often available to parties who can prove that the insurance company in some way acted in bad faith in dealing with an insurance claim.
The violation of the duty of good faith and fair dealing is acting "in bad faith." Bad faith, as a term of art in the legal community generally implies or involves "actual or constructive fraud, or a design to mislead or deceive another, or a neglect or refusal to fulfill some duty or some contractual obligation, not prompted by an honest mistake as to one's rights or duties, but by some interested or sinister motive. The term bad faith is not simply bad judgment or negligence, but rather it implies the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will." (Black's Law Dictionary, 5th ed.) Insurance case law has softened the "ill will" or "conscious doing of wrong" into areas of more passive action, as is developed further in this article.
Courts have defined bad faith in differing language, often with synonymous meanings: "Bad faith is the intentional failure by an insurer to perform the duty of good faith and fair dealing implied at law" (Koch v. State Farm Fire & Casualty Co., 565 So. 2d 226 (Ala. 1990); and "An insurer's denial of coverage, without reasonable justification, constitutes bad faith (Whistman v. West Am, 686 P.2d 1086 (Wis. 1984).
The development of bad faith
The tort of bad faith, when applied to the breach of a duty of good faith, is a fairly recent (second half of the 20th century) tort. As seen below, extra-contractual damages have been available to aggrieved insureds since the 1940s, in the area of holding insurers responsible for excess judgments over policy limits in cases that the insurer refused to settle. In other words, the insurer could have reasonably settled within limits, but decided, at the insured's expense, to "try their luck" at trial. The development of bad faith principles in the handling of first party claims and the awarding of punitive damages are of more recent origin, having developed in most jurisdictions during the 1980s.
The first state to hold that there is an independent tort action for the bad faith handling of claims in a first party context (i.e., for wrongful denial of a property claim), was California. In Gruenberg v. Aetna Ins. Co., 510 P.2d 1032 (1973), the insured owner of a cocktail lounge became involved in an argument with a firefighter at the scene of a fire at the insured's premises. He was arrested and subsequently charged with arson and defrauding an insurer.
Thereafter, the insurance company demanded in writing that the insured submit to sworn examination. The insured's lawyer informed the insurer that no statements would be forthcoming until the resolution of the arson charge. The insurer refused to delay the sworn examination, and denied the loss for failure to comply with policy conditions. The court dismissed the charges against the insured for lack of probable cause, and the insured informed the insurer that he would now comply with the examination request. The company reaffirmed the denial of coverage, based on the insured's failure to appear.
The insured brought an action, stating that as a result of the outrageous conduct and bad faith of the insurer, he suffered economic damage, emotional distress, loss of earnings, and other damages. He sought compensatory and punitive damages.
The insured prevailed. The court held that Aetna's refusal (without proper cause) to pay the covered claim, gave rise to a tort cause of action for breach of an implied covenant of good faith and fair dealing. Although the facts differ, and various spins have been put on the area of bad faith, this remains the basic fact pattern and holding for this type of case.
Another significant case in the history of bad faith is Anderson v. Continental, 271 N.W.2d 368 Wis.,1978.; the insured came home to discover the walls, drapes, carpeting, furniture and clothing covered in oil and smoke residue, from a fire or explosion in the furnace. The dispute centers around $4,611.77 in costs incurred by the insured for additional cleaning needed after the insurer's contracted cleaners finished the job. The plaintiff's complaint stems from Continental's repeated refusal to accept a proof of loss and refusal to negotiate the amount due to the insured.
While the Wisconsin court followed California in recognizing tort causes of action for bad faith to first party-cases, the court defined more narrowly the cause of action than Gruenberg. Anderson stated that the plaintiff must show the absence of a reasonable basis for the denial of benefits and that the defendant knew of or had reckless disregard for the lack of a reasonable basis for denial. This makes bad faith an intentional act.
Evolution of the concept
Generally, the evolution of the doctrine in various jurisdictions has been a three-step process:
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1. A recognition that insurance contracts contain a duty of good faith and fair dealing. If that duty is breached, the law recognizes extra-contractual damages. Such extra-contractual damages include:
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a. any amounts the insured has to pay in excess of policy limits when the insurer refuses to settle within the limits of liability;
b. attorney's fees; and
c. other consequential damages.
2. Policyholders have a tort action for bad faith dealing on the part of insurance companies which involves malice or fraud.
3. Extra-contractual damages, up to and including punitive awards in some jurisdictions, are available for actions not amounting to fraud or malice by the insurer (i.e., when an insurer knows that it does not have a reasonable basis to deny a claim, but denies it anyway).
It is important to note here, however, that some jurisdictions have not recognized the tort of bad faith in insurance dealings; the chart below outlines how states handle bad faith concerning first-party cases.
| Bad faith in first-party cases | Jurisdictions |
| Adopted bad faith tort as in Gruenberg v. Aetna | Alaska, Connecticut, Hawaii, Nevada, North Carolina, North Dakota, Ohio, Oklahoma, South Carolina, Texas, Washington |
| Adopted stricter formulation of Anderson v. Continental | Alabama, Arizona, Colorado, Delaware, Idaho, Indiana, Iowa, Kentucky, Nebraska, Puerto Rico, New Mexico, Rhode Island, South Dakota, Vermont, Wyoming |
| Refused to extend cause of action for bad faith to first party cases; instead expanded the damages available under breach of contract claim | New Hampshire, New Jersey, Utah, Virginia |
| Rejected common-law tort cause of action for bad faith in first-party cases | Florida, Georgia, Illinois, Kansas, Louisiana, Maine, Maryland, Michigan, Minnesota, Missouri, New York, Oregon, Pennsylvania, Tennessee |
| Required that insurer acted with morally reprehensible state of mind | Arkansas |
| Has not addressed whether bad faith extends to first-party cases | District of Columbia, Massachusetts, Virgin Islands |
| Created statutory cause of action for bad faith; recognized tort directly or allowed claims pursuant to unfair claim statutes, consumer protection, or unfair competition statutes. | Mississippi |
One state's evolution in bad faith law
These cases from Ohio illustrate the evolution of the bad faith doctrine in that state. Yet, Ohio is not unique in its development of the bad faith insurance law area.
In 1949, the Ohio Supreme Court recognized that an insurer may be liable in tort "for the excess of the judgment over the policy limit where the insurer is guilty of fraud or bad faith" (Hart v. Republic Mutual Ins. Co., 87 N.E.2d 347 (1949). In this case, the court analogized bad faith to fraud and recognized a bad faith cause of action for a failure to reasonably settle in a third-party liability situation.
Thirteen years later, in Slater v. Motorists Mutual Ins. Co., 187 N.E.2d 45 (1962), the court overturned a lower court's ruling that the insurance company had acted in bad faith in another failure to settle case. The court took the opportunity to visit the findings of other jurisdictions and further defined bad faith. Among the court's holdings were:
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1. Bad faith is an indefinite term with no constricted meaning.
2. Bad faith is not merely bad judgment or negligence.
3. Bad faith suggests a dishonest purpose and implies a conscious wrongdoing.
4. Bad faith involves breach of a known duty through some motive of interest or ill will.
5. Bad faith is in the nature of fraud.
6. Bad faith is an intentional tort of an active and affirmative nature.
7. Bad faith involves actual intent to mislead or deceive.
8. There is no bad faith absent the equivalent of actual or constructive fraud.
In a 1988 case, Staff Builders, Inc. v. Armstrong, 525 N.E.2d 783 (1988), Ohio shifted from defining bad faith as analogous to fraud, and adopted a "reasonable justification" test. Bad faith became "refusal to pay the claim where such refusal is not founded on circumstances that furnish reasonable justification therefore." In contrast, punitive damages were available only where there is actual malice, fraud or insult on the part of the insurer. This further delineates the distinction between conduct found to be in bad faith and conduct found to warrant punitive damages. This "reasonable justification," or as it is referred to in many cases, the "reasonable basis" test is apparently the standard for most jurisdictions in assessing bad faith liability.
In 1992, the Ohio Supreme Court further defined bad faith in a fashion consistent with the development of this area of law in other jurisdictions. In Motorists Mutual Ins. Co. v. Said, 590 N.E.2d 1228 (1992), the court ruled that an insurer's failure to act in good faith can take one of two forms: (1) a failure to perform where it is known that there is no lawful basis for the failure; and (2) a failure to determine whether there is or is not a lawful basis for refusing to perform.
Zoppo v. Homestead Ins. Co. 71 Ohio St.3d 552, 644 N.E.2d 397 (Ohio,1994) revisited the Said and Slater decisions. Both decisions contained an element of intent in the action of bad faith, and the court overruled both with the opinion that intent is not part of the reasonable justification standard. By expressly overruling Said and Slater, the court felt it was correcting previous mistakes and reinstating the reasonable justification standard.
The law of many states followed much the same route to the tort of bad faith in insurance dealings as did Ohio. Bad faith evolved from as actual malice only (1949) to bad faith as failure to perform where there is a known duty to perform. This evolution opens insurance companies to bad faith legal challenges for a variety of actions falling short of malice or fraud. The failure to handle claims adequately might well be acting in bad faith. This failure on the insurer's part might thus expose the insurer to extra-contractual claims. Going one step further, malice, intent, or wrongful purpose in the settlement of claims might well leave the insurer open to bad faith damages and punitive damages.
The property cases --"Reasonable Basis"
In the first-party claim area, the laws of almost all jurisdictions recognize that an insurer can violate its duty of good faith and fair dealing by failing to pay a claim promptly when liability becomes reasonably clear. This recognition has come either through common law, developed case law, or statutory or regulatory enactment.
In greatly uniform language, courts have held that the cause of action against the insurer arises "where there is no reasonable basis for a denial of a claim or when the insurer fails to determine or delays in a determination of whether there is any reasonable basis for a denial of the claim... In order to sustain a claim for breach of good faith, the insured must establish (1) the absence of a reasonable basis for denying or delaying payment of the claim, and (2) that the insurer knew, or should have known, that there existed no reasonable basis for denying or delaying payment of the claim." (from Dixon v. State Farm Fire and Casualty Co., 799 F.Supp. 691 (S.D. Tex. 1992).
The legal basis is easily and simply stated; however, there is a great deal of litigation in this area, suggesting that the standards are not as easily recognized or practiced. The facts and outcomes of various cases provide some samples.
Following is one common fact pattern that has been litigated in several jurisdictions. An insured's building burns and the insured brings claim for loss. Upon investigating, the insurer suspects arson by the insured. Subsequently, the insured is charged by the authorities with arson. During the pending of the criminal action against the insured, the insurer denies or delays paying the claim. At either trial or pretrial hearing, the charges against the insured are dismissed or the insured is acquitted. Thereafter, the insured brings suit to recover on the insurance policy and includes a claim against the insurer for bad faith handling of the claim.
Under the same set of facts, cases have opposing outcomes, generally due to the variance in the manner in which the insurer handled the claim and investigation.
In Dixon, the court found for the insurer on the bad faith claim, while, of course, allowing recovery of policy proceeds. The court held that the insurer had demonstrated a reasonable basis for denying the claim. "State Farm demonstrated that it relied on the following to determine that there was a reasonable basis for denying the insurance claim: recorded statements of plaintiff and admissions made in a subsequent interview, laboratory findings demonstrating the existence of flammable liquids, a fire scene examination concluded that the fire was the result of an incendiary act with the burn pattern denoting deliberateness, and a committee report establishing motive and opportunity."
The insurer's deviation from the standards of the industry played a part in arriving at a judgment for the insured on his bad faith claim with similar facts in Brewer v. American and Foreign Ins. Co., 837 P.2d 236 (Colo. 1992). The insurer made the argument that there can be no bad faith claim if there is "any colorable evidence supporting the denial of an insurance claim." The court disagreed, holding that although the insured's case could not, as a matter of law, be decided by directed verdict on the underlying arson claim (i.e., there were issues that required the verdict of the jury regarding the arson and the insured could not move for a summary or directed verdict), the bad faith issue could still be decided in favor of the insured.
The difference between Dixon and Brewer is the claims handling and investigation by the insurer. "Here, evidence indicates that acceptable investigative procedure such as determination of the chronology of the fire, its origin, its cause, whether burn patterns were present, and if burn patterns were found, an interpretation of the patterns by an experienced arson investigator, were not followed by the insurance company.
"Additional testimony supported the conclusion that it was not customary in the insurance industry to rely exclusively on an inexperienced insurance adjuster/fire investigator to determine and interpret burn patterns. Nor was it customary in the industry for an insurance company's representatives to advise potential witnesses that the insured had committed arson and that it was conducting an arson investigation during the initiation of an interview. Because there was evidence that all or some of the industry standards were deviated from, there exists ample support in the record for the jury's conclusion that the insurance company acted unreasonably and had no reasonable basis for denying the insured's claim."
Further refining bad faith
Having dealt with the matter of what constitutes bad faith and its attendant principles, litigators and courts have turned to further refining the issues that might be raised in a bad faith claim.
Good faith error: An insurance company can make a good faith erroneous decision, or at least a decision that is later disagreed with by a fact finder, without subjecting itself to bad faith liability. An example of this line of cases is State Farm Lloyds, Inc. v. Polasek, 847 S.W.2d 279 (Tex. 1992). The insured's video rental business burned. The insurer denied coverage on the grounds that the fire was caused by arson and that the insureds had made material misrepresentations. The insureds were not charged with arson by the authorities.
The insureds filed suit and a jury found that the insureds had not caused the burning of their premises. The jury further found that the insurer had acted in bad faith because it did not have a reasonable basis for denying the claim. The jury awarded the insureds $40,000 for the property loss, $200,000 for mental anguish, and $500,000 in punitive damages. In overturning the mental anguish and punitive damages awards, the court held that "an arguable basis," existed to deny the claim, thus defeating a bad faith claim. In other jurisdictions, "arguable basis" is synonymous to reasonable basis.
The court stated that the insureds had argued that they had nothing to do with the fire and that the jury believed them. Absent appeal, that decided the issue of coverage and the insurer had to pay the claim. But the insureds did not demonstrate bad faith on the part of the insurer simply by proving that they did not commit arson. "It is not satisfied by proof that [the insurer] should have paid their claim, or that [the insurer] acted unreasonably in denying their claim." Instead, the insured must prove that no reasonable basis existed for denying or delaying payment of the claim or that the insurer failed to determine whether there was any reasonable basis for so denying or delaying.
It is important to note that, in effect, the court held the following in bad faith cases: the issue is not whether the fact finder (court or jury) believes the evidence used by the insurer to deny a claim, but whether such evidence existed, so as to give the insurer a reasonable basis.
In Polasek, the court found that the following facts gave the insurance company its reasonable basis for denying the claim:
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1. The store was marginally profitable, at best;
2. The insureds had a note for $6,500 due five days after the fire;
3. The insureds had only $365 in the company bank accounts;
4. The insureds had borrowed money and paid operating accounts from personal funds and not cash flow;
5. Rent payments had been late; and
6. An uninsured air compressor was removed by the insured on the day of the fire
The court took the opportunity to address the issue of bad faith in its decision. "Bad faith counts are now routinely pleaded in suits on insurance contracts. [Our] Supreme Court did not intend [this] result; it did not intend to convert first-party cases into tort cases. It simply gave a tort remedy for the exceptional case in which the insurer denies or delays payment even though no reasonable basis for that decision exists. Courts should be careful to ensure that the bad faith action is reserved for cases of flagrant denial or delay of payment where no reasonable basis existed, and not for mere unreasonable denial or delay."
A subsequent case, State Farm Fire & Cas. Co. v. Simmons, 857 S. W. 2d 126 (Tex.App.-Beaumont, 1993) disagreed with Polasek. This case involved a homeowner's fire claim that the carrier denied based on suspicions that the insured was responsible for the fire. The claim is made that the insurer did not make a through investigation of the claim. This court disagrees with Polasek in that the insured must prove that the carrier denied or delayed payment due to no reasonable basis in fact for such action. Simmons believes that this makes it possible for the carrier to pursue only one line of investigation and not look at all evidence in a case, which deteriorates the degree of care required of an insurer towards its insured. Simmons believes a better rule for dealing with bad faith is did the insurer fulfill its duty by performing a thorough, systematic, objective, fair and honest investigation of the claim?
Prolonged investigation without cause. The court held that an insurer might open itself to bad faith damages for prolonging an investigation beyond reasonable limits in Livingston v. Auto Owners Ins. Co., 582 So.2d 1038 (Ala. 1991). In this case, the court characterized the insurer's behavior in investigation of a fire loss as "a last ditch effort to find some evidence to support its suspicions that the [insureds] started the fire."
The residence in this case had burned on May 14, 1988. The insurer suspected the insured of arson. Auto Owners hired an independent fire investigator and adjuster, whose reports were done by July 15. The state Fire Marshall's report was also complete on July 15. The experts listed the cause of fire as incendiary, but reported no suspicions of involvement of the insureds. On August 16, the insured sued for coverage, including claims for bad faith. The insurer moved for summary judgment on the bad faith issue, but lost. In its denial, citing an earlier case, the court held that "where evidence of arson by the insured was slight, mere suspicion and speculation that new evidence will present itself at some future date is not reasonable grounds upon which to deny a claim." The court remanded the case to the court below for trial.
In Livingstone the insurer's four-month delay in paying the claim -- coupled with the fact that the insurer's actions appeared to the court to be foot-dragging -- was held to be unreasonable. In a similar case, a five month delay in which an interim advance was made by the insurer was held not to be in bad faith in Neal v. State Farm Fire and Cas. Co., 908 F.2d 923 (11th Cir. 1990). The court held the following in denying the insured's claim of bad faith by State Farm:
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1. The insurer did have a reasonable suspicion of insured-arson;
2. Even with this suspicion, the insurer had made a $2,500 advance of policy proceeds, under a reservation of rights as to coverage; and
3. Proceeded in a timely fashion in completing its own investigation prior to confirming coverage.
The court held that the insured's mailing of the ring was not prohibited nor excluded by the policy. Additionally, when the adjuster told the insured not to mail the ring, the court held that he was then adding an extra-contractual limitation on coverage after a loss. This action, thus, triggered the statutory bad-faith damage award.
Non-renewal or policy termination. The Alabama Supreme Court has held that the tort of bad faith does not apply to the insurer's alleged bad faith non-renewal of a policy; Alfa Mutual Ins. Co. v. Northington, 604 So.2d 758 (1992). In this case, the insurance company did not renew a policy of insurance because the insured and the insurance agent had become involved in an argument over the extent of coverage which had been represented. A company representative testified that the policy was not renewed, at least in part, due to the atmosphere of distrust that had arisen between the company and the insured.
The issue, as seen by the court, was whether an insured can sue for the tort of bad faith for a wrongful, bad faith cancellation, nonrenewal, termination, or other repudiation of an insurance policy. In answering no, the court stated that the law in the majority of jurisdictions is that the sole remedy for cancellation or nonrenewal of an insurance policy is under a contract action, and not in tort. Therefore, punitive damages would not be available in such situations.
Bad faith in third-party situations
Several issues arise that involve bad faith in the third-party liability area. They include:
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1. Failure by the insurer to reasonably settle within policy limits;
2. The insurer's wrongful denial of a defense;
3. The assignment, by the insurer, of an insured's bad faith claim to a third party; and
4. The effect of an insured's "judgment-proof" status on an award of excess amounts in a failure to settle situation.
An interesting development in this area is that there may be no duty to settle a case where the insurance company has competently assessed the potential of excess-over-limit damages as unlikely. Such was the result of Stevenson v. State Farm Fire and Cas. Co., 628 N.E.2d 810 (Ill. 1993). In this case, an insured was sued for negligently wounding another person in a shooting incident. The insurance company had a reasonable basis to believe that the policy might not provide coverage due to the intentional acts exclusion. Recognizing its duty to defend in questionable cases and its conflict in so providing a defense where the policy may not provide coverage, the insurer provided independent counsel for the insured. However, when faced with a settlement demand of $87,000, the company offered only $3,000. The policy had a liability limit of $100,000.
The insured then, on the advice of its independent counsel, settled with the injured party for the amount of $87,000. The insured then assigned his rights under the party to the claimant. In exchange the insured received a pledge from the injured party that he would not proceed personally against the insured. The injured party then sued the insurer and included a claim for bad faith in failing to reasonably settle.
The court held that the insurer had competently assessed the claim, and determined that there was little possibility of a verdict or judgment in excess of the policy limits, if indeed the claim was covered. Inasmuch as the insurance company had tendered an independent defense to the insured, because the claim was "fairly debatable" as to coverage, and because of the reasonable decision to try the case rather than settle (and the fact that any likely verdict would be in an amount under policy limits), the plaintiff's bad faith claim failed.
In another unreasonable failure to settle suit, it was held that there was no bad faith where the insurer settled a claim within policy limits without exposing the insured to above-the-limits liability, but where the insured claimed additional damages arising out of the settlement. In Shuster v. South Broward Hospital District Physicians' Professional Liability Ins. Trust, 570 So.2d 1362 (Fla. 1990), the insured was a doctor who claimed the insurer acted in bad faith in settling a malpractice claim within the policy limits because the settlement damaged his reputation and ability to generate income. The insurance policy specifically gave the insurer the right to investigate and settle claims.
The court concluded that "where an insurance policy gives the insurer the right to make such settlement of a claim as it deems expedient and the insurer settles the claim within the policy limits of insurance so that the insured is not exposed to liability, there is no cause of action for bad faith in effecting the settlement. The insurer obligates itself to indemnify the insured for liability on claims, not damage to the insured's reputation as a result of the claim. It is the insurer's funds which are to be used for that purpose. Thus, its insistence on having the broad discretionary right to settle as it deems expedient is not only understandable, but indeed is probably good business. An insurance company may not want to defend an insured's action based upon "principle," for instance, if it can use fewer dollars by settling. Furthermore, it is the public policy of this state to encourage settlement of litigation."
Section 627.4147(1) of Florida statutes was enacted after the Shuster decision (eff.10/1/03) and requires malpractice insurance policies to grant the insurer the sole authority to settle a claim where settlement is within policy limits. The statute also sets a standard for the insurer's exercise of its authority and requires that such a settlement be made in the best interests of the insured. This requires a larger duty on the insurer as Shuster permitted the insurer to settle a claim within the policy limits in its own self-interest, and did not require the insurer to consider the interests of the insured. Rogers v. Chicago Ins. Co.--- So.2d ----, 2007 WL 1427041 Fla.App. 4 Dist.(2007) discusses this further.
While on the subject of duty to settle, some specific advice from Wierck v. Grinnell Mutual Reinsurance Co., 456 N.W.2d 191 (Ia. 1990) is appropriate. "Authorities establish the following principles. We begin with the simple assumption that an insured buys an agreed amount of liability protection for a set premium. The insured, in the first instance, is at risk for the amounts in excess of the protection which has been purchased. The policy limits, however, set a boundary which the insurer cannot misuse to the detriment of the insured. It is bad faith for an insurance company to act irresponsibly in settlement negotiations with respect to the insured's risk in that part of the claim in excess of coverage. It is bad faith for the company to factor in its consideration of settlement offers the limited amount between an offer and the policy limit.
The best standard for good faith in a specific negotiation is to ignore the policy limits. If, but for the policy limits, the insurer would settle for an offered amount, it is obliged to do so (and pay toward settlement up to the policy limits). But the insurer is free to reject the offer if it would have rejected the same offer under policy limits covering the whole claim."
The failure to determine whether there is a duty to provide defense may also be considered bad faith. In Bracciale v. Nationwide Mutual Fire Ins. Co., 1993 U.S. Dist. LEXIS 11606, the complaint against the insured alleged negligence on the part of the insured; however, the insurance company read the complaint as consisting in actuality of a suit for damages due to (the excluded) intentional acts of the insured.
In this case, a police officer who stopped a driver was injured by the passenger in the car during the arrest. The police officer sued the passenger for wanton acts, but also pleaded negligence on the part of the person. The insurance company tendered no defense. After a judgment for more than $400,000 in favor of the officer (based, in part, upon the ground of negligent acts), the insured settled for the assignment of the insured's policy rights. The officer then brought suit against the insurer, including a claim for bad faith.
The court ruled, "An insurer who refuses to defend a claim potentially within the scope of the policy does so at its own peril. If an insurer has refused to provide a defense at trial, it may not later protest that it was deprived of an opportunity to litigate and establish that the underlying claims fell outside its policy coverage. Those insurers who did not contribute a defense are also precluded from arguing that the underlying claims fell outside their policies since they had the opportunity and declined to litigate the claims to conclusion."
The emphasized portion of the above paragraph is of extreme importance to insurers. The correct course of action in a disputed coverage case where a claim for defense is tendered, is to provide a defense under a reservation of rights and bring a declaratory judgment action on the coverage issue. It was specifically held in Zurich Ins. Co. v. Killer Music Inc., 998 F.2d 674 (9th Cir. 1993), that bringing such a declaratory action to determine coverage is not impermissible delay on the part of an insurer and does not, of itself, give the insured cause for a bad faith claim.
Finally, in two cases, it has been held that the inability of the insured to pay an excess judgment over the policy limit has no effect on the insurer's obligation for this amount in a bad faith claim. In Camp v. St. Paul Fire and Marine Ins. Co., 616 So.2d 12 (Fla. 1993), although the insured declared bankruptcy prior to a final judgment in a case against him, and therefore could not be personally liable for a judgment against him, the insurance company was still held liable for the excess amount of the judgment over policy limits. The same result occurred in Frankenmuth Mutual Ins Co. v. Keeley, 461 N.W.2d 666 (Mich. 1990).
Reverse bad faith
Insurers have recently begun to sue their customers for "reverse bad faith," which may be defined as the "tortious breach of the covenant of good faith and fair dealing by the insureds." In other words, insurers are holding their insureds to the same standards that insurers must meet. At least two states, California and Ohio, have declined to allow such actions.
For example, in Stephens v. Safeco Ins. Co., 852 P.2d 565 (Mt. 1993), both the insured and the insurer were held to have acted in bad faith in the settlement of a property claim. The jury had assessed the insured's mental distress damages under his bad faith claim as $38,000. However, the jury had allocated the insured's wrongful conduct at 53 percent, and the insurer's at 47 percent. The insurer argued that the insured could recover nothing on the bad faith claim, as the insured's wrongful conduct exceeded that of the insurer's.
The court disagreed. "Insurance companies have a duty to act in good faith with their insureds, and this duty exists independent of the insurance contract and independent of statute. If this duty is breached the cause of action against the insurer is in tort. However, if the situation is reversed, and the insured breaches the covenant of good faith, the result is not a tort, but a breach of contract." The court held that the tort of bad faith serves to discourage oppression in contracts which necessarily give one party a superior position and that the action is not available to the party in the superior position. Therefore, the insurer could not use the insured's bad faith to off-set its own bad faith conduct.
In citing Stephens, the California Supreme Court went even further to reject the idea of "comparative bad faith" (Kransco v. American Empire Surplus Lines Insurance Company, 54 Cal. App. 4th 1171, 1997). The court said, in part: "The doctrine of comparative bad faith is marked by inconsistencies and complexities... [and] is founded on the faulty premise that the obligations of insurer and insured -- and thus their bad faith -- are comparable. They are not." Even though both parties may have a "reciprocal obligation of good faith and fair dealing," the duties of the two differ because of "the differing performance due under the contract of insurance." Because the disparity between the parties "rests on contractual asymmetry," an insured and an insurer can not be considered to be on "equal footing."
In Agricultural Insurance Company v. The Superior Court of Los Angeles County (70 Cal. App. 4th 385), the California Court of Appeals held that the tort of reverse bad faith "finds no support in case law." It concluded that "an insured may be held liable in contract for breaching the covenant [of good faith dealing], but cannot be held liable in tort." In this case, the insurer contended that the insured (a health club damaged by an earthquake) had committed reverse bad faith when the club turned in questionable and possibly falsified loss notices.
In rejecting Agricultural's position, the Court stated that this argument failed on two grounds. The first, said the Court, was that no evidence existed to suggest that "the Legislature, in enacting [the insurance fraud statute] intended to expose all insureds to suits for 'reverse bad faith' whenever they make an insurance claim."
Secondly, Agricultural contended that the insurance fraud statute "created a new private right of action." The insurer said, in effect, that the concept of reverse bad faith was equivalent to that of fraud. In also rejecting this argument, the court held that "[t]he legislature did not attempt to criminalize 'bad faith' in [the insurance fraud statute] and probably could not do so constitutionally."
The Supreme Court of Ohio also struck down an attempt to create the tort of reverse bad faith, Tokles & Son, Inc., v. Midwestern Indemnity Company (605 N.E.2d 936), 1992. Here the court said that it had "never recognized such a tort and refuses to do so now." The justices went on to call the insurer "the holder of the purse strings" with "certain built-in protection from such evils" (e.g., an insured's attempt to defraud it). Because an insured "often finds himself in dire financial straits after [a] loss," he or she is entitled to the "equal footing" provided by the ability to sue an insurer for bad faith. The court concluded that "other avenues [exist] for an insurer to pursue" in the event of a fraudulent claim.
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Christine G. Barlow, CPCU, is an Assiociate Editor of FC&S, a division of Summit Business Data. Christine has experience in claims, underwriting and training. Before joining FC&S, Christine worked as an Underwriting Supervisor for Maryland Auto Insurance Fund, and as Senior Underwriter/Underwrite... More
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