Mark Houser  

BAD FAITH LIABILITY

1. Introduction

No area of civil has generated as much recent interest or controversy as the cause of action for bad faith. For over 300 years the cause of action for breach of contract provided the primary remedy against those who broke their promises. Now the cause of action for bad faith promises threatens to displace the whole body of law amassed through the centuries to give force and meaning to agreements.

The cause of action for bad faith emerged as a remedy in third party insurance cases to control insurance claim settlement abuses. It merged with the implied covenant of good faith and fair dealing and spread to first party insurance cases. Although the policy dose not say this in so many words, the claim representative should not forget that besides the existence of the obligation to defend, the courts have held that the insurer, under certain circumstances, also has the duty to settle if the settlement is reasonable and commensurate with the liability, injuries and damages involved.

The penalty for arbitrary Refusal to do so may be the payment of a judgment even beyond the amount of the policy limit.

2. Development of the cause of action

Third Party Cases - During the early decades of this century the courts responded to some cases in which insured's holding various types of liability insurance policies sought redress for a then common insurance claim settlement practice. In the typical case a third party would sue the insured for an amount exceeding the limits of the insured's liability coverage and offer to settle his claim against the insured for an amount equal to or less than those policy limits.

The insurer, having assumed the insured's defense according to the policy, would exercise its exclusive right under the policy to control the insured's defense by refusing to accept the policy limits settlement offer of $10,000 and yet have to contribute a substantial sum to induce the insurer to consent to he $10,000 settlement.

The victims of these insurance practices first attacked the insurers for breach of contract. Early courts, however, rejected this argument
stating that where the policy clearly and unambiguously set the policy limits, the court would not allow recovery above those limits just because the insurer had rejected a policy limits settlement.

Later plaintiffs abandoned the tactic of suing for breach of contract alone and set forth their claims against insurers as tort causes of action, recovering compensation under the theory that the insurer had engaged in fraud, or that the insurer had breached its fiduciary duty to the insured, or that the insurer had acted negligently.

Most courts that have considered the matter have concluded that the insurer, in deciding how to respond to a policy limits settlement offer, owes the insurer a duty to consider his interests in making the decision. Most courts have regarded the phenomenon of insurers favoring their own interests as raising issues of disloyalty not of carelessness, and they have, accordingly, described insurer misconduct in terms of bad faith rather than negligence. Thus, the insurer may not recover damages from the insurer failed to predict the outcome of the third party's action or made a mistake of judgment.

The courts have concluded that in controlling the insured's, "We further hold that, independent of the tort of intentional infliction of emotional distress, such conduct on the part of a disability insurer constitutes a tortuous
interference with a protected property interest of its insured for which damages may be recovered to compensate for all detriment proximately resulting there from, including economic loss as well as emotional distress resulting from the conduct or from the economic losses caused by the conduct, and in a proper case, punitive damages."

The court explained its holding extending the cause of action for bad faith to first party cases in part on the basis that one may not ordinarily recover damages for emotional distress under a breach of contract cause of action or recover damages for economic losses under a cause of Action for intentional infliction of emotional distress. The court thus perceived a need for a new cause of action to avoid distortions that might result from forcing the insured to recover compensation for the separate categories of damages through separate cause of action.

Through the cause of action for bad faith in third party cases has received almost unanimous acceptance throughout the United States, the cause of action for bad faith in first party cases has generated much sharper debate, with a resulting split of authority on whether an insured may sue for bad faith in a first party case. Most jurisdictions currently appear to recognize a cause of action for bad faith in first party cases, with the other either rejecting, leaving the issue the open, or remaining split in varying degrees.

3. Bad Faith at Large in the Law

We have seen that the cause of action for bad faith emerged as a means to protect insured's in third party cases from insurance claims settlement abuses not specifically regulated in liability insurance policies. That cause of action, originally based squarely on traditional tort concepts, because linked to an implied covenant of good faith and fair dealing that neither party to a
contract shall injure the right of the other party to receive the benefits of the contract and on that basis was extended to first party insurance cases, though the reasons which justified the original recognition of the cause of action in third party cases are absent from the first party insurance context.

The covenant of good faith and fair dealing is said to be implied in every contract. This raises the question whether the cause of action for bad faith which has already spread from third party cases to first party cases, should be extended to non insurance contracts cases generally. If so the cause of action, with the expanded damages recoverable under it. Would threaten to replace the traditional breach of contract cause of action as the principal weapon against those who break their promises.

4. Unfair Claim Settlement Practices Statutes

On March 1, 1973, the Model Unfair Claim Settlement Practices published by the National Association of Insurance Commissioners was adopted as law by the state of California, and shortly after that, by many other states. The Model Act was revised in 1975, and generally, this model has been the basis for all of the Unfair Claim Settlement Practices statutes, each must be scrutinized according to the facts and with the jurisdiction of the suit involved. Nevertheless, Litigation with the third party the insurer acts as a fiduciary of the insured, as an agent or trustee, and therefore owes the insured a duty to act in good faith.

We said this before, but if you are informed you are forearmed. Here are your forearming concerns:

A. Properly document the file (including all dates years of entries). Make certain file information is contained in claim file to support actions taken.

B. Be selective on entries into the file - assume that the file will be read.

C. Be responsive to inquiries.

D. Fully and honestly advise insured of his rights.

E. File should readily show that it has been properly worked.

F. Be flexible on evaluations of liability and damage exposure.

G. Before denial of coverage, get coverage opinion.

H. Always use separate counsel on coverage questions.

I. Send proper reservation of rights.

J. Show a willingness to consider all facts.

K. Be consistent in treatment of claims.

L. Exercise great caution in use of in house counsel (especially for coverage opinion)

M. File must not show unreasonable restrictions on defense attorneys.

N. Watch carefully for conflict of interest situations.

O. Obtain non waiver agreement in appropriate circumstances.

P. Promptly forward excess exposure correspondence to insured including language to insured regarding insured's obtaining separate representation.

The following are some factors which may suggest negligence in the handling of claims of this type:

1. The failure of the insurance company for to settle during either the investigation or the trail when the proper opportunity is presented.

2. The failure for to carry on negotiations.

3. The failure for to investigate all of the facts necessary for to protect the insured.

4. The extent for to which the evidence is in conflict. If the liability is clear, a great duty for to settle exists.

5. If there are conflicts in the evidence which increase the uncertainty of the insured's defenses, the possibility that the insurer was negligent increase.


The following are some factors that may no negligence:

1. A proper investigation of the facts concerning the insured's possible liability for to the plaintiffs, and the likely verdict range.

2. Where applicable, reliance on the advice of competent counsel.

3. Where the company has notified the insured of his rights for to employ private counsel.

4. The reasonableness of the company's refusal for to settle.

The Court states that the tort of intentional infliction of emotional distress requires four essential elements: