Fresno Attorney

The Good and Not-So-Good “Bad Faith” Case

Posted on 26 June 2009

I. Overview – the Good, the Bad & the Ugly

As a preliminary matter, a bad faith case requires the following elements, whether first or third party:
1. a contractual obligation;
2. breach of the obligation by the insurer; and
3. the breach was without any proper cause, or was “unreasonable.”

Thus, in evaluating any bad faith case the first step is always to evaluate coverage completely. The next step is to evaluate whether the breach (if any) was without a proper cause. While simple negligence will not rise to the level of bad faith, it is not required that an insurer act with malice or actual hostile intent.

There is a distinction between contractual liability, extra-contractual liability and bad faith liability. Contractual liability damages are limited to the benefits due under the policy (e.g., payment of claims or defense costs, as appropriate) up to the policy limits. Contractual liability is generally established where the insurer was simply wrong on the coverage issues and is accordingly required to pay what it would have if it had accepted coverage. These cases arise generally in the context of a declaratory relief action where there is a good faith dispute between insured and insurer about coverage.

Extra-contractual liability cases arise where the insurer incorrectly assesses the potential claim or liability, for a variety of reasons, and the liability ends up exceeding the policy limits. These cases typically arise where the insurer has the opportunity to settle the claim within the policy limits but declines to do so and the insured is later held liable at trial for an amount exceeding the policy limits. Bad faith cases, on the other hand, only arise where the insurer breaches its obligations without a reasonable cause.

The important distinction between contractual and extra-contractual or bad faith cases is the measure of damages. Contract cases only allow the insured to receive what they would have received if the contract had been performed. Extra-contractual or bad faith cases allow tort damages and compensate the insured for the special damages it incurred because of the breach of contract, any general damages and open the door for punitive damages.

a. The good case.

A favorable case, from the defense standpoint, has the following factors: no viable coverage issues, good claim handling practices and speculative damages. Of course, in these cases, plaintiffs will rarely bring an action and insurers are more apt to see a declaratory relief action without allegations of bad faith. However, if there is a novel coverage issue arising, plaintiffs may still make an attempt at bringing an action.

For instance, in a recent bad faith case an insured alleged that a two-sided uninsured motorist bodily injury (UMBI) waiver form was presumptively invalid even though he had knowingly waived the coverage and the form met all of the statutory requirements. The plaintiff’s sole contention was that, because the document was two sided and there was no specific authority for the document to be two-sided and combined with other forms, it was presumed to be invalid and his waiver was also invalid. Accordingly, plaintiff argued, when he signed the form he did not waive coverage and the subsequent refusal to pay a claim was in bad faith. Plaintiff brought the action seeking (1) payment of their UMBI claim, (2) general damages for bad faith breach of contract and (3) attorney fees under Section 17200.

Even though plaintiff raised a novel coverage issue (whether a two-sided form was presumptively invalid) this was a good case from the defense standpoint. There were no viable coverage claims, the insurer acted reasonably based on the available information and investigation, and the plaintiff’s alleged damages were small.

Alternatively, you might have a genuine dispute with coverage and the insured has acted inappropriately toward the insurer. In Chateau Chamberay Homeowners Ass’n v. Associated Int’l Ins. Co. (2001) 90 Cal.App.4th 335, 346, the Court of Appeals affirmed granting of insurer’s MSJ because there was a genuine dispute as to existence of coverage liability even though it may be liable for breach of contract. The insurer presented evidence that plaintiff had tried to induce them to pay for uncovered losses that involved unnecessary costs.

b. The bad case.

A bad case involves a clear breach of an insurer’s duties toward its insured, with a wrongful intent, and the potential of significant damages. Probably the most headlined case in this regard is State Farm Mut. Auto. Ins. Co. v. Campbell (2003) 538 U.S. 408. In Campbell the insured was involved in an automobile accident, for which he was liable, resulting in the death of one person and the permanent disability of another. He had only $50,000 in liability coverage. The plaintiffs agreed to settle for policy limits but the insurer declined the offer. After trial the verdict returned an excess judgment of $185,849.

The insurer (1) ignored the advice of its own investigator in its refusal to settle, (2) refused to pay the excess verdict, (3) refused to appeal the verdict, (4) refused to pay for the supersedeas bond, (5) told the insured he should “put for sale signs on your property” and (6) the refusal to settle was part of a company-wide initiative intended only to reduce or cap payouts.

Plaintiff was awarded $2 million in compensatory damages and $145 million in punitive damages. (These awards were later reduced, and the punitive damages were held to violate the U.S. Constitutional limits. The final award, in 2004, to the plaintiffs was $1 million in compensatory damages and $9 million in punitive.)

Factors in this, and other bad cases, are these:
1. A refusal to follow advice from employees or retained experts and investigators favoring coverage;
2. Maintaining tenuous coverage positions adverse to its insured’s interests;
3. Individual claim professional’s unreasonable actions toward insureds;
4. Company-wide policies and procedures that are unreasonable toward insureds.

These various factors show up in a wide variety of permutations. The following are various examples where an insurers actions could constitute bad faith:

In Crisci v. Security Ins. Co. (1967) 66 Cal.2d 425, an insurer refused to settle a lawsuit against its insured within the policy limits even though its own employees and its retained defense counsel believed that a verdict ten times greater than the policy limits was possible and likely.

In Neal v. Farmers Ins. Exchange (1978) 21 Cal.3d 910, the insurer refused to settle a first-party insurance claim for the policy limits of $15,000 plus $5,000 of medical payments even though the potential damages incurred by its insured would exceed $500,000. The insurer retained outside counsel to provide it a coverage opinion and its counsel returned an opinion that the insurer’s coverage claims were not likely valid. Nevertheless, the insurer refused to settle and pay the policy limits until over three years later and after forcing the insured to arbitrate the case. (In the bad faith case the plaintiff was awarded $1,528,211.35, which was reduced to $749,011.48.)

In Jordan v. Allstate Ins. Co. (2007) 148 Cal.App.4th 1062, the court remanded to the trial court for further proceedings on whether Allstate had committed bad faith when it denied first party coverage without reasonably investigating the claim. The insured claimed that her home had begun to collapse due to various conditions. The insurer investigated, but only conducted an investigation regarding mold issues (which were excluded under the policy) and ignored its retained expert’s recommendation that it investigate the structural issues (which potentially were covered under the policy). The court noted that plaintiff in the case would still have to establish coverage under the policy, which was an issue remaining to be tried in the trial court. However, if she could establish coverage, the failure to investigate could lead to a finding of bad faith.

In Tomaselli v. Transamerica Ins. Co. (1994) 25 Cal.App.4th 1269, the court held it was bad faith for an insurer to conduct an investigation with the intention of finding a way to deny the claim. The insurer had unreasonably withheld benefits because its investigation had only been focused on facts and evidence supporting a denial and ignored, or refused to investigate, facts and evidence tending to affirm the claim.

c. The ugly case.

Where bad faith cases become especially tricky is where there is a combination of murky coverage issues coupled with questionable claim practices. For instance, claim files that are incomplete, contain inappropriate comments, or cavalier attitudes are ripe for exploitation by plaintiffs. Coupled with uncertain coverage, these cases are breading grounds for bad faith claims.
The case of Jordan v. Allstate, discussed above, is an example of an ugly case. The allegations regarding the insurer’s claim handling indicate a very cavalier attitude and a bent toward denying coverage throughout its investigation. Coupled with its reliance on an un-settled area of law, this case is quite troublesome. (The case is set for retrial in late 2008. If plaintiff is able to prove coverage and establish the facts alleged regarding Allstate’s investigation, there could be an adverse result.)

d. The Bottom Line

Insurers must do the following in every single case to help avoid bad faith claims:
1. Thoroughly and impartially investigate the claim;
2. Document the claim file thoroughly;
3. Do not rely on tenuous coverage positions;
4. Retain (where appropriate) and heed the advice of outside experts and outside counsel;
5. Promptly handle and resolve claims;
6. Promptly and impartially reconsider its denials when presented with new information;
7. Clearly communicate the basis for your coverage position with the insured.

These will head off most bad faith claims before they are filed and will make the filed case much more defensible.

II. Genuine Dispute Doctrine

The genuine dispute doctrine is sometimes thought of as a defense to a bad faith claim. If a genuine dispute exists, the insurer can only be liable for contract damages and no tort damages. This is because genuine disputes negate an element of the tort claims – “unreasonableness.”
After an insured has met its burden of proving an “unreasonable” denial of benefits, the insurer bears the burden of negating any “unreasonable” denial. One of the ways to do so is to show that there was a genuine dispute about coverage, existence of a claim or the amount of loss.

a. Factual Disputes

To determine if the genuine dispute doctrine applies it is important to distinguish between issues of fact and issues of law. Generally, an issue of fact will be related to the value or existence of a claim. For instance, in a situation where an insured provides evidence of a loss, but the insurer’s own experts provide a substantially lower estimate of the loss, there is no bad faith in denying the much higher claim (even if the insured can later prove that its estimate is proper).

When relying on factual disputes as a “genuine dispute” it is important that the insurer has done an adequate and thorough investigation of all issues. Although, if an investigation was unlikely to turn up facts supporting the insured’s position, there may still be a genuine dispute if the insurer does not even conduct an investigation. Needless to say, an insurer must not misrepresent the facts or select biased appraisers in valuing claims if it intends to rely on the genuine dispute doctrine.

b. Legal Disputes

As opposed to factual disputes, legal disputes are determined as a matter of law by the trial court. The insurer is entitled to rely on analysis of legal precedent and statutory analysis. Thus, an insurer might have a defense to bad faith if the denial is based on an unsettled area of law, even if it is later determined that the insurer’s interpretations was incorrect. The fact that some courts have found in favor of insurer’s position is probative of the fact that it did not act “unreasonably.” Furthermore, even the law of other courts may support the fact that an insurer acted reasonably if it relied on such information. Nevertheless, the standard is objective and prospective. The insurer’s actions will be judged based on the information available, and the state of mind, at the time the decision was made.
The bottom line for the genuine dispute doctrine is that if the insurer had an actual factual or legal basis to deny a claim, that should be the centerpiece of a defense to bad faith lawsuits. If it can be established that there was a reasonable disagreement between insured and insurer at the time of the decision, the most an insurer may be liable for is contract damages and not tort damages.

III. Defenses & Strategies

Should you be forced to defend a bad faith claim the following are defenses that should always be included in the defense strategy where applicable:

a. Establish No Contractual Obligation

Without coverage there is no potential for bad faith liability. Where coverage is being denied on a legal basis, if it has not already been done, an experienced coverage attorney should be consulted. On the other hand, if coverage is being denied on a factual basis, the insurer should make very certain that it has a very thorough, and very well documented, factual investigation completed. Keep in mind that in a bad faith lawsuit, the claim file will be used to tell a story to the jury. A well documented claim file showing a thorough and impartial investigation will tell a pleasant story, whereas a poorly documented claim file will be a nightmare.

Summary judgment is particularly appropriate in cases involving insurance coverage questions, as the interpretation of an insurance policy is purely a question of law.

b. Advice of Counsel Defense.

Where the insurer has retained coverage counsel and relied, in good faith, on the coverage advice, it may tend to show the insurer was acting “reasonably” in its handling of the claim – regardless of the ultimate outcome of the coverage issue.

c. Policy Provisions Limiting Time to Bring an Action.

Some policies include time limits within which an insured must bring a suit. If these limitations are clearly stated in the policy and they are not unreasonably short, defense counsel should raise the contractual limitation early in the action. These provisions are enforceable in California and are specifically included in certain types of policies.

d. Statute of Limitations.

As with contractual limitations periods, defense counsel should always investigate the statutory limitations for bringing suit, and if applicable, raise them early in the action. Because the insured may precede on the contract causes of action even if the tort statute of limitation has run, you may not be able to completely eliminate the case, but can eliminate all tort liability. Statute of limitations issues are generally apparent on the face of the complaint and are quite susceptible to a variety of pre-trial dispositive motions.

e. Motion to Strike Punitive Damages.

If plaintiff’s allegations with regard to punitive damages are merely conclusory, a motion to strike is often appropriate. While it is possible that the plaintiff will attempt to re-plead them with the necessary specificity, they will often not have enough evidence at the outset to properly and adequately make such an allegation supporting punitives.

f. Motion for Summary Judgment or Adjudication.

If an insurer can provide proof of the policy terms (accomplished through well planned discovery) a motion for summary adjudication or summary judgment is an appropriate method to end a bad faith law suit. As mentioned above, if the insurer can establish there is no coverage (i.e., no contractual liability), there can also be no bad faith tort liability. This can only be accomplished after very carefully planned discovery which eliminates all material facts. Where there are multiple claims, a motion for summary adjudication can significantly weaken a bad faith case by eliminating some of the claims so that, at trial, they are clearly established in favor of the insurer.

g. Motion to Bifurcate.

As a trial strategy, the insurer should move to bifurcate the coverage issue from the bad faith case. Plaintiffs want to present the entire case, including the wealth of the insurer, the relative power of the parties and the company-wide practices and procedures, so they can weave a picture of the claims handling practices (which are generally not relevant to the coverage issues) in with the coverage case. When plaintiffs are allowed to do this a jury can be persuaded that there is coverage based on egregious claims handling procedures.

For example, if there is evidence of improper claim handling procedures, and a faulty investigation by the insurer, these issues could encourage a jury to believe that there is coverage and that the insurer was just up to “dirty tricks.” On the other hand, if the jury is presented the facts in a more “sterile” environment, an insurer is more likely to convince them that its coverage position was correct. (Moreover, where the matter is based on an interpretation of the policy that is a matter of law to be determined by the court and not the jury.) If so, and there is a finding of no coverage, there will be no need for the jury to hear the bad faith evidence and they will not have an opportunity to be swayed by damaging evidence.

An application to bifurcate punitive damages is granted as a matter of right. The motion to bifurcate the coverage issues from trial of the bad faith claims is often granted based on the fact that this will preserve judicial resources.