Insurance Bad Faith
and Extra-Contractual
Liability
Defense Practice Seminar
Course Materials
June 2013
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Course Materials Table of Contents
If We Knew Then What We Know Now—The Evolution of Insurance Bad Faith.................................... 1
Mary K. Cryar
Statutory Bad Faith—How State Legislatures Have Expanded the Contours of
Common Law Bad Faith........................................................................................................................ 9
Michael F. Aylward
Discovery, Discovery, and More Discovery:.............................................................................................. 35
Techniques for Managing Discovery Tactics in Bad Faith Cases
Jennifer D. Eubanks
Claim Manuals and Training Materials:.................................................................................................... 55
How to Address Them During Discovery and Trial
W. Edward Carlton
Emerging Bad Faith Claims:...................................................................................................................... 71
Extra-Contractual Liability Arising Out of Uncovered Claims—Defense Within Limits Policies
Michael F. Aylward
Latest Strategies for Defending Bad Faith Claims.................................................................................... 83
Sara M. Thorpe and Donald M. Carley
Consent Judgments:.................................................................................................................................... 95
Raising the Stakes in Bad Faith Litigation
Kevin J. Willging
Developing and Maintaining a Winning Attorney-Client Relationship for the
Defense of a Bad Faith Case.............................................................................................................. 109
Anne Kevlin and Anthony R. Zelle
The Impact of Social Media and Cutting Edge Technology on Insurance Bad Faith Litigation.......... 117
Paul Berne and Gregory M. Boucher
Ethical Concerns:...................................................................................................................................... 125
Insurers Use of In House Counsel to Defend Policyholders
Melissa Jayne Collins
If We Knew Then What We Know Now—
The Evolution of Insurance Bad Faith
Mary K. Cryar
Degan, Blanchard & Nash
400 Poydras Street, Suite 2600
New Orleans, LA 70130
(504) 529-3333
mcryar@degan.com
Mary K. Cryar is an attorney with the New Orleans firm of Degan, Blanchard &
Nash. She is licensed to practice both in Illinois and Louisiana, and in all federal
courts in both states. In addition to her law degree, she also has an MBA and is a
CPCU. Ms. Cryar concentrates her practice in insurance coverage, both for thirdparty and first-party policies, including commercial liability policies, commercial
property policies and professional services policies. In the bad faith arena, she has
handled numerous cases in both Illinois and Louisiana involving both allegations
of bad faith made by insureds under first-party policies and allegations of bad faith
failure to settle under general liability and professional services policies.
If We Knew Then What We Know Now—
The Evolution of Insurance Bad Faith
Table of Contents
I. The Past............................................................................................................................................................5
II. Why the Change?............................................................................................................................................5
III. Current State of the Law.................................................................................................................................8
If We Knew Then What We Know Now—The Evolution of Insurance Bad Faith ■ Cryar ■ 3
If We Knew Then What We Know Now—
The Evolution of Insurance Bad Faith
I. The Past
a.Hadley v. Baxendale Rule: When you breach a contract for insurance, it is the same as breaching
any other contract. You only are entitled to the damages that were contemplated at the time the
bargain was struck. It was not a tort to breach a contract. Consequential damages were not permitted to encourage a more efficient allocation of resources and greater predictibility. Hadley v.
Baxendale, 156 Eng. Rep. 145 (1854).
b. Insurance contracts were not treated any differently. Consequential damages were not awarded,
nor was there any way to punish the breaching insurer.
i. The only obligation of the insurer was to pay money, and the only damages were the
amount owed, in the case of a breach.
ii. For example, see C. Schmidt & Sons Brewing Co. v. Travelers Ins. Co., 90 A. 653 (Pa. 1914)
and New Orleans Ins. Co. v. Piaggio, 83 U.S. 378 (1872).
c. Even the rules we think of as peculiar to interpreting insurance policies actually were applicable
to all contracts.
i.
Contra proferentum: Interpreting the contract against the drafter.
ii. Doctrine of reasonable expectations.
iii. Even the rule of implied covenant of good faith and fair dealing.
d. In the event of a legal dispute between the insurer and the insured, each party, as in all contracts,
had to bear their own legal costs.
II. Why the Change?
a. Insurance contracts are special because they occupy a unique institutional role in modern society. Insurance contracts spread the risk, and thus have an important public purpose. They thus
take on social importance as society becomes more affluent and develops economically. Insurance plays a vital role in economic development.
b. As the economy grew, insurance took on greater importance. For example, loans for the purchase of houses and cars required insurance and medical costs rose above the cost affordable
without insurance.
The Development of Bad Faith Law
c. The first wave of change came not from the courts, but from state legislatures. As of 1951, one
fourth of the states had enacted statutes providing for the payment of attorney’s fees and penalities.
i. Statutes were enacted to provide for recovery of attorney’s fees, penalties and interest when
the insurer defaulted on its obligation to pay benefits owed under the policy.
1. Some required that the insurer have acted unreasonably.
2. Other statutes were triggered merely by not paying the benefits within a certain time
period.
ii. Most states, however, did not follow suit, and those that did failed to follow a set pattern.
If We Knew Then What We Know Now—The Evolution of Insurance Bad Faith ■ Cryar ■ 5
iii. In the 1970s, the National Association of Insurance Commissioners developed the first
model legislation to combat unfair claim settlement practices in the industry.
1. Only prohibits certain acts when the insurer acts flagrantly and in conscious disregard or if it commits such acts so often as render it a general business practice.
2. Silent as to any remedies for individual claimants.
3. Only enables state insurance regulators to seek injunctive relief or penalties as a way
to enforce the regulations.
4. The majority of courts have held this legislation does not create a private right of
action for insureds.
5. In practice, this legislation did very little to help insureds. It took a large number of
complaints for the insurance commissioners in each state to act, and by then, it was
too late for the individual insureds.
iv. Because of the inadquacy of legislation, the courts began fashioning a remedy for insureds
who were not properly treated by their insurers. Social pressure pushed for relief from
unjustified delays in processing and arbitrary refusals to pay claims, and insureds began
utilizing private attorneys to advance their interests. This forced the courts to finally take a
serious look at the claims process and eventually gave rise to the common-law tort of bad
faith that we have today.
d. The first development in bad faith came from the third-party insurance arena.
i. Originally, liability policies as we know them today did not exist. Rather, third party insurance was via indemnity policies.
1. Indemnity policies only obligated the insurer to pay monies to a third party if two
requirements were met. One, the insured had to have been held liable and two, the
insured actually had to have paid the judgment to the third party. If the insured was
insolvent, or for some other reason, did not pay the third party, the insurer had no obligation to pay any amount. The tort victim similarly had no remedy against the insurer.
2. Liability policies, on the other hand, obligate the insurer to pay the third party once
the liability has been established, without any requirement that insured first pay the
victim.
ii. Eventually, indemnity policies vanished from the third party arena, and were replaced with
liability policies. Why?
1. Public was not satisfied with indemnity policies. It offended common sense for the
insurer to avoid liability solely because the insured could not pay the judgment first.
Sometimes, insurers even colluded with insureds to secure an adjudication of bankruptcy for the latter so the insurer could avoid its obligations under an indemnity
policy. See Merchants Mut. Auto. Liab. Co. v. Smart, 267 U.S. 126, 130 (1925). This
pressure gave rise to court and legislative action.
2. State legislatures began enacting “direct action” statutes.
3. Courts began construing indemnity policies like liability policies, absent clear policy
language that limited the insurer’s obligation to paying what the insurer paid the tort
victim. Courts also began holding insurers to be estopped from denying any obligation to pay third party claimants once the insurer assumed control of the defense.
6 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
4. As a result of these changes, indemnity policies gradually disappeared, leaving insurers issuing liability policies, which contained language that permitted the development of third party bad faith actions.
a. Currently, you usually only see indemnity policies for directors and officer’s liability.
e. Third party bad faith:
i. Liability policies contain a provision that permits the insurer to settle any claim within
policy limits, which renders the insured’s financial destiny much more dependent upon the
insurer’s decision making. The insurer is the sole determiner as to whether the case should
or should not be settled.
ii. When the insurer has unfettered discretion to settle, insureds are at the mercy of insurers.
iii. Even though the policy does not, expressly, impose upon insurers the duty to settle claims,
courts began holding that insurers owed a duty to their insureds to not act solely in their
own interest in deciding whether the settle a case. The power to settle resulted in the duty
to settle when settlement should be made. For example, see
iv. Courts couched this duty in terms of due care, or in terms of exercise of good faith or
avoidance of bad faith. Courts were not clear whether the action was in contract, in tort or
grounded in fidicuary obligations, but one thing was clear: there was now a tort action for
bad faith failure to settle.
f. First party insurance
i. The basis for first-party bad faith came out of two cases from California.
1.In Comunale v. Traders & General Insurance Co., 328 P.2d 198 (Cal. 1958), the California Supreme Court issued the first opinion that would ultimately lead to first party
bad faith. In Comunale, the court held that if an insurer wrongfully refused to defend
the insured, it would be liable for only the amount of the policy and attorney’s fees
and costs, even if the judgment was in excess of the policy limits. But, if the insurer
refused a reasonable settlement offer, it would be liable for the excess verdict, even
though it was not defending. Notably, however, the Court stated that the duty of good
faith sounded in tort, as well as contract. This point, not necessary for the holding in
Comunale, later became the basis for the growth of first party bad faith.
2. Ten years later, in Crisci v. Security Insurance Co., 426 P.2d 173 (Cal. 1978), the court
held that the insured could recover damages for emotional distress arising out of the
insured’s failure to settle. Based upon Comunale, the Crisci court held that tort damages
for mental distress were recoverable against the liabilty insurer who failed to settle.
ii. Six years later, the California Supreme Court completed the loop. In 1973, in Gruenburg v.
Aetna, 510 P.2d 1032 (Ca. 1973), after reiterating the principle that there exists an implied duty
of good faith and fair dealing in all contracts and stating that a breach of contract can give rise
to an action in tort, held that when an insurer failed to pay benefits under a fire insurance policy, the insured was entitled to recover damages for mental distress, as well as economic loss.
iii. In 1978, the Wisconsin Supreme Court joined California in adopting the tort of bad faith
separate and apart from the action for breach of the insurance contract. However, Wisconsin, unlike California, characterized the tort as intentional, and required that the plaintiff
If We Knew Then What We Know Now—The Evolution of Insurance Bad Faith ■ Cryar ■ 7
show not only the absence of a reasonable basis to deny benefits, but also that the insurer
acted with knowledge or reckless disregard of the lack of a reasonable basis to deny the
claim. Anderson v. Continental Ins. Co., 217 N.W.2d 368 (Wis. 1978).
iv. Why first party bad faith?
1. An insurance relationship is one in which the insured seeks security. It is not obtained
for commercial advantage, but is instead protection against a calamity. Noble v. Nat’l
Am. Life Ins. Co., 624 P.2d 866 (Ariz. 1981).
2. The consequencs of the breach of an insurance contract by the insurer were broader
than merely not receiving payment. Instead, the insured would did not promptly
receive payment may suffer financial harm and even emotional distress. To recover
the insured may have to incur attorney’s fees.
III. Current State of the Law
a. Following the decisions in Gruenberg and Anderson, most jurisdictions adopted a cause of action
for bad faith in first party insurance. But, each state’s law is marked by unique aspects that
require considerable care in determing “the law” in a given state. See Robert E. Keeton & Alan I.
Widiss, Insurance Law 907-908 (1988).
b. The jurisdictions can be divided into a few broad categories:
i. Some jurisdictions refuse to recognize a cause of action for first-party bad faith and have
no or limited statutory remedies for violation of claims practice standards.
ii. About half, or perhaps fewer than half, uses a variation of the Gruenberg rule of unreasonable or without proper cause.
iii. A larger group, such as in Iowa, use some version of “fairly debatable” rule, often citing
Anderson.
iv. Others, such as Utah, while recognizing bad faith, have tied it to its contract roots, rather
than creating a tort action.
v. Many jurisdictions have enacted statutes which define bad faith or prohibit unfair claim
practicesm, such as in Georgia and Louisiana.
c. Where do we go from here?
i. Commentators such as Professor Kenneth Abraham have described the “natural history” of
bad faith law as havinng early, dramatic expansion of liability and then an eventual leveling
off. See Kenneth S. Abraham, The Natural History of the Insurer’s Liability for Bad Faith, 72
Tex.L. Rev. 1295, 1295 (1994).
ii. This has been largely borne out in the last twenty years.
1. Those states following the Gruenberg rule have made proving bad faith more difficult
by adding the genuine dispute or genuine issue rule. If the insurer raises a reasonable,
genuine issue of coverage for the claim, the insurer does not act in bad faith by denying the claim. Wilson v. 21st Century Ins. Co., 171 P.3d 1082, 1088 (Cal. 2007).
2. Courts that apply the fairly debatable rule also have limited liability. In those states,
if the policyholder cannot establish, as a matter of law via summary judgment, that
it has a right to recover on the claim, the insurer has not acted in bad faith. Picketts v.
Lloyd’s, 621 A.2d 445, 454 (N.J. 1993).
8 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Statutory Bad Faith—How State
Legislatures Have Expanded the
Contours of Common Law Bad Faith
Michael F. Aylward
Morrison Mahoney, LLP
250 Summer Street
Boston, MA 02210
(617) 439-7556
maylward@morrisonmahoney.com
Michael F. Aylward is a senior partner at Morrison Mahoney LLP in Boston,
where he chairs the firm’s complex insurance coverage practice group. He
obtained a B.A., cum laude, from Dartmouth College in 1976, receiving an honors
degree in history. He studied law at Boston College Law School and received
his J.D. degree, cum laude, in 1981. For the past three decades, Mr. Aylward has
represented insurance companies around the country in coverage disputes involving
environmental and mass tort claims; allegations of clergy abuse; intellectual
property and commercial litigation claims; reinsurance arbitrations and bad faith.
Mr. Aylward is a prolific author and has lectured here and abroad on insurance
coverage issues. His past leadership roles in the defense bar include service on the
DRI Board of Directors and chair of its Insurance Law Committee. He presently
chairs the DRI Law Institute, which coordinates all of DRI’s CLE offerings. He is also
a member of the board of editors of the Journal of the International Association of
Defense Counsel and a past chair of the Excess Surplus and Reinsurance Committees
of the Federation of Defense and Corporate Counsel and the International
Association of Defense Counsel. More recently, he served as the secretary of the
newly-formed Massachusetts Reinsurance Bar Association from 2009 to 2012. Mr.
Aylward has written extensively on bad faith issues, including the Bad Faith chapter
in the new Appleman Insurance Law treatise.
Statutory Bad Faith—How State Legislatures Have
Expanded the Contours of Common Law Bad Faith
Table of Contents
I.Introduction..................................................................................................................................................13
II. Common Law Bad Faith...............................................................................................................................13
III. Statutory Bad Faith.......................................................................................................................................14
A. State Regulation of Insurer Claims Handling......................................................................................14
B. Effect of Regulatory Violations.............................................................................................................15
1. States Barring Private Right of Action..........................................................................................15
2. States Allowing Private Right of Action.......................................................................................16
3. Violations as Evidence of Liability................................................................................................17
IV. Distinction Between Statutory and Common Law Bad Faith....................................................................17
A. Rights and Remedies.............................................................................................................................17
B. Prescribed Conduct...............................................................................................................................17
1. Time for Responding.....................................................................................................................17
2. Statutory Requirements for Response Letters.............................................................................18
3. Duty to Investigate.........................................................................................................................18
4. Failure to Settle..............................................................................................................................19
C. Rights of Third Parties..........................................................................................................................20
D. Recoverable Damages...........................................................................................................................21
1. Common Law Bad Faith Damages...............................................................................................22
2. Statutory Bad Faith Damages........................................................................................................23
V. State by State Summary................................................................................................................................25
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 11
Statutory Bad Faith—How State Legislatures Have
Expanded the Contours of Common Law Bad Faith
I.Introduction
As legal doctrines go, the idea that insurance companies can be sued in tort for the breach of a contract is relatively new. Indeed, the principle that insurers have an implied duty of good faith and fair dealing is
just over fifty years old, dating back to the California Supreme Court’s landmark decision in Comunale v. Traders & General Ins. Co., 50 Cal. 2d 654, 328 P.2d 198 (1958). In the ensuing half-century since Communale, bad
faith law has metastasized in diverse way, reflecting the politics and precedents of the fifty states whose law
governs the interpretation of insurance contracts in America.
While certain generalizations may be made about the common law principles governing bad faith
law in the United States, insurance companies and their lawyers deal daily with the reality that each state has
built upon these common law foundations, adding new rules and requirements through regulations and statutes. It is vital, therefore, to understand both the basic common law foundations of bad faith law and the specific regulatory and statutory requirements that are unique to individual jurisdictions.
II. Common Law Bad Faith
“Every contract carries an implied covenant of good faith and fair dealing requiring that neither
party do anything that will injure the right of the other to receive the benefits of the agreement...Bad faith
means more than mere negligence; it involves a dishonest purpose.” Gupta v. New Britain General Hospital,
687 A.2d 111, 122 (Conn. 1996). As summarized by the California Supreme Court in Gruenberg v. Aetna Ins.
Co., 510 P.2d 1032, 1037 (Cal. 1973):
It is the obligation, deemed to be imposed by the law, under which the insurer must act fairly
and in good faith in discharging its contractual responsibilities. Where in so doing, it fails to
deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its
insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for
breach of an implied covenant of good faith and fair dealing.
For the most part, an insurer’s liability to its policyholder arises in contract. “The mere breach of an
ordinary contract does not constitute a tort; and if there is no liability except that arising out of a breach of a
purely contractual duty, the action must be in contract, and an action in tort cannot be maintained.” Leonard
v. Firemen’s Insurance Company, 111 S.E.2d 773 (Ga. App. 1959).
Over the years, however, courts have permitted policyholders to bring tort claims against their insurers, particularly first party insurers. Arnold v. National County Mutual Fire Ins. Co., 725 S.W.2d 165, 167 (Tex.
1987)(allowing tort actions against first party insurers) and “ First Wyoming Bank v. Continental Ins. Co., 860
P.2d 1064 (Wyo. 1993). As the Wisconsin Supreme Court explained in Anderson v. Continental Insurance Co.,
85 Wis.2d 675, 686, 271 N.W.2d 368 (1978). “By virtue of the relationship between the parties created by the
contract, a special duty arises, the breach of which duty is a tort and is unrelated to contract damages.”
Allowing insureds to sue their insurers for breach of contract under tort theories is a significant
departure from established principles of contract law. Foley v. Interactive Data Corporation, 47 Cal. 3rd 654,
680 (1988). Accordingly, an insurer is subject to tort liability for bad faith only where it unreasonably fails to
provide benefits due under the policy or the law. Carlton v. St. Paul Mercury Ins. Co., 30 Cal. App. 4th 1450,
1456, 36 Cal. Rptr. 2nd 229 (1994).
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 13
Further, an action in tort must be founded on conduct of the insurer that is independent of its contractual duty to provide coverage. Delancy v. St. Paul Fire & Marine Insurance Company, 947 F.2d 1536, 1545
(11th Cir. 1991)(Georgia law) and Cramer v. Insurance Exchange Agency, 174 Ill. 2d 513, 520-21 (1996)(tort
claim must be based on conduct independent of the decision to deny coverage). In New York University v. Continental Ins. Co., 87 N.Y.2d 308, 662 N.E.2d 763, 639 N.Y.S.2d 283 (1995), the Court of Appeals ruled that in
order to sustain an action for tort liability against an insurer, as opposed to an action for breach of contract,
the insured’s complaint must assert a basis for tort liability that goes beyond the breach of the insurer’s contractual duties. As the court concluded:
Plaintiff ’s claim amounts to nothing more than a claim based on the alleged breach of the
implied covenant of good faith and fair dealing, and the use of familiar tort language does not
change the cause of action to a tort claim in the absence of an underlying tort duty sufficient to
support a claim for punitive damages. The cause of action is duplicative of the ...cause of action
for breach of contract and should have been dismissed.
A substantial minority of states have refused to recognize a tort cause of action, however, and have
limited the insured’s recovery to contract claims. See, e.g. Abes v. Shaw, 906 P.2d 642 (Kan. 1995); Kewin v.
Mass. Mut. Life Ins. Co., 409 Mich. 401, 296 N.W.2d 50 (1980) and Haagenson v. National Farmers Union Property & Casualty Co., 277 N.W.2d 648, 652 (Minn. 1979) (“Minnesota . . . follows the traditional rule that a bad
faith breach of contract does not convert the breach of contract into a tort.”) See also Marquis v. Farm Family Mut. Ins. Co., 628 A.2d 644, 652 (Me. 1993) (refusing to recognize independent tort of bad faith; insurer’s
duty of good faith and fair dealing arises from an implied covenant in the insurance contract and limits an
insured’s remedies for breach of the duty to the traditional remedies for breach of contract); Bell v. Liberty
Mutual Insurance Company, 776 A.2d 1260, 146 N.H. 190 (2001))(refusing to recognize tort cause of action)
and Beck v. Farmers Ins. Exch., 701 P.2d 795, 798 (Utah 1985)( the good faith duty to bargain or settle under
an insurance contract is only one aspect of the duty of good faith and fair dealing implied in all contracts and
that violation of that duty gives rise to a claim for breach of contract”).
III. Statutory Bad Faith
A. State Regulation of Insurer Claims Handling
In addition to these common law principles, most states have enacted statutes or regulations governing the manner in which insurers must handle claims from their policyholders and proscribing certain
unfair or deceptive claims handling practices. As part of the consumer movement in the 1960s and 1970s,
most states enacted statutes protecting consumers against unfair business practices. Around the same time,
the National Association of Insurance Commissioners promulgated a Model Unfair Claims Practices Act in
1972 that has since been adopted by over forty states. Modern bad faith litigation is largely driven by the conjunction of these general consumer protection remedies and the insurer-specific claims handling statutes and
regulations.
The Model Act proscribes the following “unfair claims settlement practices:”
(a) Misrepresenting pertinent facts or insurance policy provisions relating to coverages at issue;
(b) Failing to acknowledge and act reasonably promptly upon communications with respect to
claims arising under insurance policies;
(c) Failing to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies;
14 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
(d) Refusing to pay claims without conducting a reasonable investigation based upon all available
information;
(e) Failing to affirm or deny coverage of claims within a reasonable time after proof of loss statements have been completed;
(f) Failing to effectuate prompt, fair and equitable settlements of claims in which liability has
become reasonably clear;
(g) Compelling insureds to institute litigation to recover amounts due under an insurance policy
by offering substantially less than the amounts ultimately recovered in actions brought by such
insureds;
(h) Attempting to settle a claim for less than the amount to which a reasonable man would have
believed he was entitled by reference to written or printed advertising material accompanying or
made part of an application;
(i) Attempting to settle claims on the basis of an application which was altered without notice to, or
knowledge or consent of the insured;
(j) Making claims payments to insured or beneficiaries not accompanied by a statement setting
forth the coverage under which payments are being made;
(k) Making known to insured or claimants a policy of appealing from arbitration awards in favor of
insureds or claimants for the purpose of compelling them to accept settlements of compromises
less than the amount awarded in arbitration;
(l) Delaying the investigation or payment of claims by requiring that an insured or claimant, or the
physician of either, submit a preliminary claim report and then requiring the subsequent submission of formal proof of loss forms, both of which submissions contain substantially the same
information;
(m)Failing to settle claims promptly, where liability has become reasonably clear, under one portion
of the insurance policy, coverage in order to influence settlements under other portions of the
insurance policy coverage; or
(n) Failing to provide promptly a reasonable explanation of the basis in the insurance policy in relation to the facts or applicable law for denial of a claim or for the offer of a compromise settlement.
Beyond the Model Act, most states have a variety of unique rules and regulations governing how insurers must handle claims. Care should be taken to understand and comply with these regulations and statutes.
B. Effect of Regulatory Violations
State law varies widely with respect to whether the breach of such regulatory requirements will support a private cause of action or merely subject the insurer to administrative sanctions from the local Insurance Department.
1.States Barring Private Right of Action
Most states have ruled that an insurer’s regulatory violation does not create a per se right of action for
insureds. O.K. Lumber Co. v. Providence Washington Ins. Co., 759 P.2d 523 (Alaska 1988); Griswold v. Union
Labor Life Ins. Co., 186 Conn. 597, 512 (1982); . Simper v. Farm Bureau Mutual Ins. Co., 974 P.2d 1100 (Idaho
1998); Bell v. Liberty Mutual Ins. Co., 776 A.2d 1260 (N.H. 2001); Elwert v. Pilot Life Ins. Co., 602 N.E.2d 1219,
1228 (Ohio App. 1991); Walker v. Chouteau, 849 P.2d 1085 (Okla. 1993); Machan v. Unum Life Ins. Co., 116
P.3d 342 (Utah 2005); A&E Supply Co. v. Nationwide Mut. Fire Ins. Co., 798 F.2d 559 (4th Cir. 1986)(Virginia
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 15
law); Kranzush v. Badger State Mut. Cas. Co., 307 N.W.2d 256 (Wis. 1981) and Herrig v. Herrig, 833 P.2d 487
(Wyo. 1992).
There is a dispute in Arizona with respect to whether statutory claims for unfair or deceptive practices may be pursued by private consumers. Such a right was apparently recognized by the Arizona Supreme
Court in Sparks v. Republic National Life Ins. Co., 647 P.2d 1127 (Ariz. 1982). However, a third-party tort
claimant has no right to assert bad faith claims against the tortfeasor’s liability insurer. Ring v. State Farm
Mutual Automobile Ins. Co., 708 P.2d 457 (Ariz. App. 1985). Further, the Arizona Unfair Claims Settlement
Practices Act (Ariz. Rev. Stat. Ann. Section 20-461D) states that “nothing contained in this section is intended
to provide a private right of action to or on behalf of any insured...It is, however, the specific intent of this section to provide solely an administrative remedy to the director for any violation of this section...”
2.States Allowing Private Right of Action
Nevertheless, a significant number of states have allowed insureds to pursue bad faith claims against
insurers for statutory or regulatory violations. See Showpiece Homes, Inc. v. Assurance Co. of America, 38 P.3d
47 (Col. 2001); Sammons v. Hartford Underwriters Ins. Co., (Del. April 1, 2010); Zebrowski v. State Farm Fire &
Cas. Co., 673 So.2d 562 (Fla. App. 1996); State Farm Mutual Automobile Ins. Co. v. Reeder, 763 S.W.2d 116 (Ky.
1989).
The North Carolina Supreme Court ruled in Gray v. North Carolina Insurance Underwriting Association, No. 84PA99 (N.C. June 16, 2000) that even though only the Commissioner of Insurance has the authority to pursue violations of the North Carolina Unfair Claims Settlement Practices Statute, violations may be
brought forward as evidence of a private claim for relief under NCGS §75-1.1. Nevertheless, the court ruled
that the insured was not entitled to treble damages as that provision of NCGS §75-16 only applies to damages
that are proximately caused by the insurer’s violation, not the full amount of the underlying claim.
In Gray, the North Carolina Supreme Court held that an insurance company that engages in the act
or practice of “[n]ot attempting in good faith to effectuate prompt, fair and equitable settlements of claims
in which liability has become reasonably clear,” N.C.G.S. §58-63-15(11)(f), also engages in conduct that
embodies the broader standards of N.C.G.S. §75-1.1 because such conduct is inherently unfair, unscrupulous, immoral, and injurious to consumers. Thus, such conduct that violates subsection (f) of N.C.G.S. §5863-15(11) constitutes a violation of N.C.G.S. §75-1.1, as a matter of law, without the necessity of an additional
showing of frequency indicating a “general business practice,” N.C.G.S. §58-63-15(11). Gray, 352 N.C. at 71,
529 S.E.2d at 683.
While a violation of Article 63 creates a per se finding of liability under N.C. General Statute, Section
75-1.1, an insurer may also be held liable for unfair trade practices under N.C. General Statute, Section 75-1.1
even in the absence of a finding of specific violation of one or more of the unfair claims practices set forth in
Section 58-63-15(11). Country Club of Johnson Cty., Inc. v. U.S. Fidelity & Guar. Co., 150 N.C. App. 231, 563
S.E.2d 269 (2002), the Court of Appeals declared that an action for unfair trade practices pursuant to North
Carolina General Statutes, Section 75-1.1 could go forward even though the insured had not established that
USF&G had violated one of the specific claims settlement practices prohibited by N.C. General Statute, Section 58-63-15(11). The court noted that while proof of unfair claims practices constitutes per se proof of an
unfair or deceptive claims practice, failure to prove unfair claims practices does not independently necessitate
judgment as a matter of law against a related claim for unfair trade practices. Relying on Gray, the court held
that “[i]t follows that the other prohibited acts listed in N.C. Gen. Stat. §58-63-15(11) are also acts which are
unfair, unscrupulous, and injurious to consumers, and that such acts therefore fall within the ‘broader standards’ of N.C. Gen. Stat. §75-1.1.” 563 S.E.2d at 279.
16 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
On the other hand, a breach of Section 58-63-15 constitutes a violation of Chapter 75-1.1 as a matter of law. Belmont Land and Investment Co. v. Standard Fire Ins. Co., 403 S.E.2d 924, 926 (N.C. App. 1991). See
also Miller v. Nationwide Mut. Ins. Co., 435 S.E.2d 537, 542 (N.C. App. 1993)(violation of consumer protection
act gives rise to liability under unfair trade practices act).
In West Virginia, a private action may only be based upon alleged violations of W.Va. Code §33-114(9) if the conduct in question constitutes more than a single violation of W.Va. Code §33-11-4(9), that the
violations arise from separate, discrete acts or omissions in the claim settlement, and that they arise from a
habit, custom, usage, or business policy of the insurer, so that, viewing the conduct as a whole, the finder of
fact is able to conclude that the practice or practices are sufficiently pervasive or sufficiently sanctioned by the
insurance company that the conduct can be considered a ‘general business practice’ and can be distinguished
by fair minds from an isolated event.” Barefield v. DPIC Companies, 600 S.E.2d 256, 267 (W. Va. 2004) and
Dodrill v. Nationwide Mut. Ins. Co., 201 W.Va. 1, 491 S.E.2d 1 (1996).
3.Violations as Evidence of Liability
Finally, states such as California, Massachusetts, North Carolina and Wisconsin have ruled that while
a statutory violation may not be prosecuted by the insured, it may be introduced as evidence of the insurer’s
claimed bad faith. See Rattan v. USAA, 84 Cal. App.4th 715 (Cal. App. 2000); Jet Line Servs., Inc. v. American
Employers Ins. Co., 404 Mass. 706, 717 (1989); Gray v. North Carolina Insurance Underwriting Association, 352
N.C. 61, 529 S.E.2d 676 (2000) and Heyden v. Safeco Title Ins. Co., 498 N.W.2d 905 (Wis. App. 1993).
IV. Distinction Between Statutory and Common Law Bad Faith
State insurance claims handling regulations and statutes may create liabilities where none existed at
common law and establish rules and requirements that insurers must take care not to transgress. Such rules
and regulations may also vest rights in parties, notably tort claimants, that could not have sued insurers at
common law.
A. Rights and Remedies
Some states have enacted administrative procedures to resolving first party bad faith disputes that
did not exist at common law. In Maryland, for instance, insureds must now pursue administrative remedies
before the Maryland Insurance Administration before they can sue for bad faith.
Similarly, the Senate Commerce Committee of the New Jersey legislature held a hearing earlier this
year concerning a proposal (S.2460) that would create a private cause of action, including a right to attorneys
fees, for violations of unfair claims settlement practices.
Earlier in 2012, the New Jersey Assembly approved legislation that would require homeowners’ insurers
to provide a one-page summary with their policies detailing “notable” events that are covered or excluded. The
State Department of Banking and Insurance will identify the coverages and exclusions that should be included.
The original proposal was amended at the last minute, however, to clarify that the summary is merely intended
as a guide to the policy’s scope of coverage and is not intended to supplant the actual terms of the policy.
B. Prescribed Conduct
1.Time for Responding
At common law, insurers were merely expected to respond to demands for coverage within a reasonable period of time. Further, the failure to respond was unlikely to warrant bad faith damages unless the delay
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 17
was intended to or actually harmed the insured in some respect. Nowadays, however, most states have set specific time requirements for claims handling and may stipulate penalties for failing to act in a timely fashion.
Most states require that insurers issue a coverage response within fifteen to thirty days. Alabama (30
days – Ala. Admin. Code R. 482-1-125.07); Alaska (15 days – Al. Admin. Code §26.070); Arizona (15 days
– Ariz. Admin. Code R. 20-6-801(G)(1)(a)); Arkansas (15 days – 054-00-043 Ark. Code R. §9(a)(1)); Cal.
Code Regs. Title 10, §1695.5(e) and Cal. Code Regs. Title 10, §2695.7(b) (receipt of claim must be acknowledged within 15 days and a coverage position issued no later than 40 days unless additional documentation is
needed); Colorado (60 days – 3 Colo. Code Reg. §702-5-1-14); Delaware (30 days – 18-900-902 Del. Code. Reg.
§1.2.1.5); Florida (30 days – Fla. Stat. §627.426(2)(a)); Illinois (30 days – Ill. Admin. Code Title 50, §919.50(a));
Iowa (30 days – Iowa Admin. Code R. 191-15.41 (507B)); Kentucky (30 days – 806 Ky. Admin. Regs. 12:095);
Maryland (15 days – Md. Code Ann. Ins. §27-303(12)); Minnesota (60 days – Minn. Stat. Ans. §72A.201, subdivision 4(11)); Missouri (15 days – Mo. Code Regs. Ann. Tit. 20, §100-1.050); Montana (30 days – Mont. Code
Ann. §33-18-232); Nebraska (15 days – Neb. Admin. Code §60-006); Nevada (30 days – Nev. Admin. Code
§686A.665); New Hampshire (30 days – N.H. Code Admin. R. §1001.01); New Jersey (90 days – N.J. Admin.
Code §11:2-17.6); New York (15 days – N.Y. Admin. Code §216.4); North Carolina (30 days – 11 N.C. Admin.
Code 21.0106); Ohio (21 days – Ohio Admin. Code §3901-1-54); Oklahoma (45 days – Okla. Admin. Code
§365:15-3-5); Oregon (30 days – Or. Admin. R. §836-080-225); Pennsylvania (15 days – 31 Pa. Code §146.5);
Rhode Island (15 days – 02-030-073 R.I. Code §6A); South Dakota (30 days – S.D. Codified Laws §58-33-67);
Vermont (30 days – 21-020-008 Vt. Code R. §6(C)); West Virginia (15 days – W. Va. Code R. §114-14-6-6.2(A)).
2.Statutory Requirements for Response Letters
In addition to setting the timetable for responding, a few states mandate the inclusion of certain
types of wording in reservation of rights or denial letter.
In California, all reservations of rights and denial letters are required by law to contain this concluding language:
We are required to advise you that, if you disagree with our position and want to have this matter
reviewed, you may contact the California Department of Insurance at the following address:
California Department of Insurance
Claims Services Bureau
300 South Spring Street, South Tower
Los Angeles, CA 90013
Phone: (800) 927-4357 or (213) 897-8921
In Connecticut, Section 323b of the Insurance Code (Title 38A) requires that any coverage determination contain the following language:
If you do not agree with this decision, you may contact the Division of Consumer Affairs within
the Insurance Department”. The notice shall include the address and toll-free telephone number
for the division and the Insurance Department’s Internet address.
Violations are subject to a fine not to exceed $7,500.
3.Duty to Investigate
At common law, only a few states have imposed an affirmative duty to investigate claims. However,
many states impose such duties by law. For instance, under Montana law, an insurer cannot “refuse to pay
claims without conducting a reasonable investigation based upon all available information.” Montana Code
Annotated Section 33-18-201(4).
18 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
4.Failure to Settle
The failure of an insurer to settle before trial may subject that insurer to common law liability to
its insured for any resulting excess verdict. In some states, however, the failure to settle can create a right of
action on the part of the plaintiff whose claims the insurer failed to settle.
Connecticut law provides that insurers may face certain extracontractual exposures if they reject an
offer to settle before trial:
Sec. 38a-321. Liability of insurer under liability policy. Each insurance company which issues
a policy to any person, firm or corporation, insuring against loss or damage on account of the
bodily injury or death by accident of any person, or damage to the property of any person, for
which loss or damage such person, firm or corporation is legally responsible, shall, whenever a
loss occurs under such policy, become absolutely liable, and the payment of such loss shall not
depend upon the satisfaction by the assured of a final judgment against him for loss, damage or
death occasioned by such casualty. No such contract of insurance shall be cancelled or annulled
by any agreement between the insurance company and the assured after the assured has become
responsible for such loss or damage, and any such cancellation or annulment shall be void. Upon
the recovery of a final judgment against any person, firm or corporation by any person, including administrators or executors, for loss or damage on account of bodily injury or death or damage to property, if the defendant in such action was insured against such loss or damage at the
time when the right of action arose and if such judgment is not satisfied within thirty days after
the date when it was rendered, such judgment creditor shall be subrogated to all the rights of the
defendant and shall have a right of action against the insurer to the same extent that the defendant in such action could have enforced his claim against such insurer had such defendant paid
such judgment.
In Massachusetts, the Supreme Judicial Court has recently ruled that if an insurer willfully fails to
make a reasonable offer of settlement in a case where the liability of its insured is reasonably clear and the
case results in a verdict against the policyholder, the plaintiff can sue the liability insurer for twice the amount
of the verdict plus its attorneys fees. In 1989, the Massachusetts Legislature had amended the state Consumer
Protection Act (G.L. c. 93A) to add a provision stating that “[I]f the court finds for the petitioner, recovery
shall be in the amount of actual damages or twenty-five dollars, whichever is greater; or up to three but not
less than two times such amount if the court finds that the use of employment of the act or practice was a willful or knowing violation of [c. 93A, §2] . . . . For the purposes of this chapter, the amount of actual damages to
be multiplied by the court shall be the amount of the judgment on all claims arising out of the same and underlying transaction or occurrence, regardless of the existence or nonexistence of insurance coverage available in
payment of the claim” (Emphasis supplied).
In Rhodes v. AIG Domestic Claims, Inc., 461 Mass. 486 (2012), a young woman suffered paraplegia
when the insured tractor-trailer rear-ended her vehicle. At trial, the plaintiffs recovered a verdict of $11.3 million after the defendant’s umbrella insurer (National Union) had ignored various opportunities to settle within
its policy limits. Eight months after the verdict, National Union and the underlying insurer (Zurich) were ultimately able to effectuate a settlement of the tort claims but litigation went forward against the insurers for a
claimed bad faith failure to effectuate a settlement in violation of G.L. c. 176D §3(9)(f) for which double damages were sought under G.L. c. 93A.
At trial, the Superior Court found that National Union had only acted in bad faith in failing to settle
soon enough after but concluded that the measure of damages was only the lost interest on the settlement
amount, not a doubling of the $11.3 million verdict. A divided panel of the Appeals Court held on review that
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 19
National Union was also liable for failing to make reasonable offers of settlement in the months leading up to
the verdict but sustained Judge Gants’ valuation of the 93A damages recoverable.
On further review, the Supreme Judicial Court ruled in 2012 that National Union had acted in bad
faith in failing to settle the case before trial. The SJC refused to find that the insurer’s failure to make a reasonable offer of settlement was excused by the apparent futility of such an offer (Rhodes had been quoted as saying that he would never have considered accepting such an offer), declaring that:
the plaintiffs need only prove that they suffered a loss, or an adverse consequence, due to the
insurer’s failure to make a timely, reasonable offer; the plaintiffs need not speculate about what
they would have done with a hypothetical offer that the insurers might have, but in fact did not,
make on a timely basis.
Further, the SJC ruled that the Appeals Court had erred in refusing to give literal effect to the 1989
amendments to 93A, ruling that the double damages owed by AIGDC should be based on the multi-million
dollar award rendered by the jury against GAF, not based on the loss of use of these settlement funds for a
few months. The court rejected AIGDC’s distinction between first and third party cases, declaring that 93A
“does not require a causal relationship between the unfair practice and the underlying judgment itself; rather,
the statutory causation requirement focuses on the relationship between the unfair practice and injury to the
plaintiff.” Similarly, the court rejected AIGDC’s argument that the accident caused by its insured involved a
different transaction or occurrence than that resulting in its 93A liability for failing to settle.
The Supreme Judicial Court also declined to find that an award of damages in this manner exceed the
due process standards for punitive damages awards enunciated by the U.S. Supreme Court in State Farm v. Campbell and other recent cases. The SJC questioned whether Campbell even applied to cases where judges issued
awards (runaway judges are presumed not to be a concern) and declared that, in any event, the award in this case
was two times the actual damages and therefore well within the Supreme Court’s dicta concerning ratios.
C. Rights of Third Parties
In general, courts have found that bad faith claims are personal to an insured. Accordingly, not only
are strangers to the insurance contract not owed any contractual duty by the insurer but the insured’s extracontractual rights may not be assigned. See Quick v. National Auto Credit, 65 F.3d 749 (8th Cir. 1995)(Missouri
law). The general rule is that only parties who are entitled to benefits under an insurance policy can maintain
a cause of action for a breach of the implied covenant of good faith and fair dealing. Murphy v. Allstate Ins. Co.,
17 Cal.3d 937, 944 (1976).
In Macomber v. Travelers Property & Cas. Co., 804 A.2d 180 (Conn. 2002), the state Supreme Court
ruled that third party claimants could not sue an insurer for a claimed breach of the implied duty of good faith
and fair dealing since they were not policyholders or otherwise in contractual privity. For similar reasons, the
court refused to find that an insurer owed a fiduciary duty to these individuals. See also Scribner v. AIU Ins.
Co., 647 A.2d 48 (Conn. Supp. 1994) (third-party tort claimant has no right to assert bad faith claims against
the tortfeasor’s liability insurer).
Indeed, most states have ruled that third-party tort claimant has no right to assert bad faith claims
against the tortfeasor’s liability insurer. Hicks v. Alabama Pest Services, Inc., 548 So.2d 148 (Ala. 1989); Bell v.
Kansas City Fire & Marine Insurance Company, 616 F. Supp. 1305 (W.D. Ark. 1985); Bell v. Tilton, 674 P. 2d 468
(Kan. 1983); Linscott v. State Farm Mutual Automobile Insurance Company, 368 A.2d 1161 (Me. 1977); Bean v.
Allstate Instate Company, 403 A.2d 793 (Md. 1979); Gunny v. Allstate Ins. Co., 830 P. 2d 1335 (Nev. 1992); Murray v. Allstate Insurance Company, 507 A.2d 247 (N.J. Super. 1986); Dvorak v. American Family Mutual Ins.
20 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Co., 508 N.W.2d 329, 332 (N.D. 1993); Allstate Insurance Company v. Amick, 680 P.2d 362 (Okla. 1984); Klekley
v. Northwestern National Casualty Company, 526 S.E. 2d 218 (S.C. 2000); Clark v. Hartford Accident & Indemnity Company, 457 S.W. 2d 35 (Tenn. App. 1970); Sperry v. Sperry, 1999 WL 980319 (Utah October 29, 1999);
Elmore v. State Farm Mutual Automobile Ins. Co., 1998 WL 327671 (W. Va. June 22, 1998).
Not all states have agreed, however. For instance, third party rights of action have been recognized in
Clearwater v. State Farm Mutual Automobile Ins. Co., 780 P.2d 423 (Ariz. App. 1989); Southern General Ins. Co.
v. Ross, No. A97A0546 (Ga. App. June 27, 1997) and Medical Mut. Liability Ins. Society of Maryland v. Evans,
330 Md. 1, 622 A.2d 103 (1993).
Beyond such common law claims, a few states allow tort claimants to pursue statutory recoveries
against liability insurers for bad faith. See Rhodes v. AIG Domestic Claims, Inc., 461 Mass. 486 (2012)(holding
that plaintiff was entitled to recover twice the amount of the verdict against National Union’s policyholder as
damages for the insurer’s failure to try to settle the case before trial).
D. Recoverable Damages
In a breach of contract case, the plaintiff can recover all damages that foreseeably flow from the
defendant’s breach. In a liability coverage dispute, insureds may recover the value of what they paid to settle
the underlying claim, their costs of defense and, in appropriate cases, consequential damages such as lost
business opportunities and injury to reputation if the injury can prove both causation and foreseeability. See
Stockdale v. Jamison, 416 Mich. 217, 224, 330 N.W.2d 389 (1982)(an insurer may be held liable for all consequential damages that flow from its breach of its policy obligations).
In Dechant v. Monarch Life Ins. Co., 200 Wis.2d 559, 547 N.W.2d 592 (1996), the Wisconsin Supreme
Court declared that “ when an insurer acts in bad faith by denying benefits, it is liable to the insured in tort for
any damages which are the proximate result of that conduct.” “When an insurer acts in bad faith, a plaintiff is
allowed to recover for all detriment proximately resulting from the insurer’s bad faith.” Applying this “proximately caused” standard, the court concluded “that attorney’s fees and bond premiums are recoverable by a
prevailing party in a first-party bad faith action as part of those compensatory damages resulting from the
insurer’s bad faith.”
In Beck v. Farmers Ins. Exch., 701 P.2d 795, 801-02 (Utah 1985), the Utah Supreme Court declared
that “[d]amages recoverable for breach of contract include both general damages, i.e., those flowing naturally
from the breach, and consequential damages, i.e., those reasonably within the contemplation of, or reasonably foreseeable by, the parties at the time the contract was made...We have repeatedly recognized that consequential damages for breach of contract may reach beyond the bare contract terms... In an action for breach
of a duty to bargain in good faith, a broad range of recoverable damages is conceivable, particularly given the
unique nature and purpose of an insurance contract.” See also Billings v. Union Bankers Ins. Co., 918 P.2d 461,
468 (Utah 1996)(consequential damages in first-party bad faith actions can be awarded for such things as
attorney fees, loss of a home or business, damages flowing from bankruptcy, and mental anguish, provided
such damages are foreseeable).
A divided Pennsylvania Supreme Court has declared that a professional liability insurer could still be
sued for consequential damages suffered by its insured due to the carrier’s failure to settle within policy limits
even though the insurer ultimately agreed to pay the verdict in full. In The Birth Center v. St. Paul Companies,
Inc., 787 A.2d 376 (Pa. 2001), the majority severely criticized the insurer’s failure to heed repeated warnings
that the case had an excess potential and found that an insurer could not wipe the slate clean by later paying the excess verdict if its claim conduct had caused the insured to suffer other consequential damages. The
majority also refused to find that Section 8371 precludes the award of compensatory damages. A concurring
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 21
opinion authored by Justice Nigro argued that compensatory damages may only be recovered pursuant to a
claim for breach of the insurance contract and are not available under Section 8371. Writing in dissent, Justices Zapalla and Castille contended that only punitive damages could be recovered for the tort of bad faith
refusal to settle within policy limits and that the majority had erred in also allowing recovery on a contract
theory for compensatory damages.
Pershing Park Villas Homeowners Ass’n v. United Pacific Ins. Co., 219 F.3d 895, 901 (9th Cir. 2000) is
another illustration of a case in which an insurer was held liable for all consequential damages flowing from
its bad faith breach of the duty to defend. The underlying claim involved a suit alleging defects and property
damage in the construction of a twelve-unit condominium. The suit was brought against the real estate developers, who in turn tendered it to their property damage insurer for defense. The insurer assumed the defense
under a reservation of rights. Approximately four months prior to trial, the insurer withdrew its defense
on the ground that the damage in question was not covered under the policy. A default judgment was rendered against the developers, who joined with the plaintiffs to bring suit against the insurer alleging, inter
alia, breach of contract and bad faith. The policyholder sought a vast array of alleged consequential damages,
including the amount of the default judgment, plus damages for emotional distress and for loss of prospective
economic advantage.
The Ninth Circuit Court of Appeals held that the insurer was liable to the developers for the amount
of the judgment and all other consequential damages resulting from its entry. Id. at 902. The court based its
holding on California’s long-settled law that “an insurer that wrongfully refuses to defend is liable on the judgment against the insured.” Id. at 901. (Citations omitted). The court further noted that “[w]here the wrongful
refusal to defend is also unreasonable, it violates the covenant of good faith and fair dealing, and the insurer
will be liable for consequential damages regardless of foreseeability.” Id. The insurer could not avoid liability
based upon a defense of non-coverage, for as the court stated: “[i]t is no defense that the ultimate judgment
against the insured is not necessarily rendered on a theory within the coverage of the policy. Nor must the
insured prove that the judgment would have been smaller, or would not have occurred, but for the insurer’s
wrongful failure to defend: such theory would impose upon the insured the impossible burden of proving the
extent of the loss caused by the insurer’s breach.” Id. at 901-02.
1.Common Law Bad Faith Damages
In common law bad faith cases, the measure of damages is not explicitly contractual. In particular, the
insurer’s potential liability is not capped by its policy limit. Rather, most courts have held that an insurer may be
liable for damages in excess of its policy limits if it is found to have denied coverage in bad faith or if it has negligently rejected a settlement offer within policy limits. Purdy v. Pacific Automobile Ins. Co., 157 Cal. App. 3d 59,
74, 203 Cal. Rptr. 524 (1984); Mid-America Bank & Trust Co. v. Commercial Union Insurance Co., 224 Ill. App.
3d 1083, 1087 (1992); Associated Wholesale Grocers, Inc. v. Americold Corp., 934 P.2d 65 (Kan. 1997). Accord,
Short v. Dairyland Ins. Co., 334 N.W.2d 384, 387-89 (Minn. 1983); Dairyland Ins. Co. v. Herman, 954 P.2d 56, 61
(N.M. 1997) and Besel v. Viking Insurance of Wisconsin, 146 Wash. 730, 49 P.3d 887 (2002).
Policyholders will often claim that the insurer’s claims handling caused them to suffer emotional anxiety. Not all courts have agreed that such damages are recoverable in a bad faith case, however.
Alaska: An insured seeking emotional distress damages as a result of the insurer’s breach of the
duty of good faith and fair dealing is not required to prove that the distress was “severe.” Ace v.
Aetna Life Ins. Co., 139 F.3d 1241 (9th Cir. 1998).
California: Claims for emotional distress are not recoverable in a bad faith case unless the claimant also suffered a financial loss. Waters v. USAA, 41 Cal. App.4th 1063, 48 Cal. Rptr.2d 910 (1996).
22 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Florida: A policyholder may pursue a claim for emotional distress as the result of the insurer’s
denial of his claim for disability benefits if he can show that the insurer did not act “fairly and
honestly...and with due regard for his interests” under Fla. Stat. §624.155. DiDomenico v. New
York Life Ins. Co., 837 F.Supp. 1203 (M.D. Fla. 1993).
Indiana: A federal district court has ruled that where an insurer has acted in bad faith, the
insured may recover damages for emotional distress. Patel v. United Fire and Casualty Company,
80 F.Supp.2d 948 (N.D. Ind. 2000).
Iowa: Damages for emotional distress may be awarded in cases where an insurer has acted in
bad faith by failing to pay an insured’s claim. Nassen v. National States Ins. Co., 494 N.W.2d 231,
237 (Iowa 1992).
South Dakota: Damages for emotional distress may result from an insurer’s breach of contract.
Kunkel v. United Security Insurance Company of New Jersey, 168 N.W.2d 723, 734 (S.D. 1969).
Wyoming: In order to recover damages for emotional distress, an insured must allege that as a
result of the insurer’s breach of the duty of good faith and fair dealing, the insured has suffered
substantial other damages, such as economic loss, in addition to emotional distress. State Farm
Mutual Auto Ins. Co. v. Shrader, 882 P.2d 813 (Wyo. 1994). Hospital bills and other medical costs
for treating the emotional distress are insufficient to establish this “other economic damage.”
Farmers Ins. Exchange v. Shirley, 958 P.2d 1040 (Wyo. 1998).
2.Statutory Bad Faith Damages
In addition to these common law damages, certain states allow additional elements of damages by
statute.
a.Penalty Interest
In a handful of states, including Georgia, Michigan and Minnesota, the insured’s recovery for a bad
faith claim is limited to penalty interest. First Financial Ins. Co. v. American Sandblasting Co., 477 S.E.2d 390
(Ga. 1996).
In Michigan, penalty interest of 12 percent may be added to any judgment but requires proof that
the insurer’s position was unreasonable. In Arco Industries Corp. v. American Motorists Ins. Co., 594 N.W.2d 61
(Mich. App. 1999), the court ruled that the purpose of the penalty interest statute is to penalize insurers for
unreasonably delaying payment for meritorious claims, not to compensate an insured for a delay in recovering benefits to which it is ultimately determined to be entitled. To recover interest, a plaintiff is not required to
prove that the defendant acted arbitrarily or unreasonably delayed in payment of benefits. Fortier v Aetna Cas.
& Sur. Co, 346 N.W.2d 874 (Mich. App. 1984). Instead, the statute “only requires that the insured present the
insurer with reasonable proof of loss. If the insurer does not pay the claim within 30 days after receiving this
proof, it becomes liable for interest.”
Likewise, in Louisiana, ten percent penalty interest and attorneys’ fees may be awarded for cases in
which an insurer has denied coverage arbitrarily or capriciously. Louisiana Revised Statutes 22:658 and Haas
v. Audubon Ins. Co., 722 So.2d 1022 (La. App. 1998).
Under Missouri law, an insurer may recover damages and attorneys fees if an insurer’s refusal to
cover a loss was “willful and without reasonable cause, as the facts would appear to a reasonable and prudent person.” Mo. Rev. Stat. §375.420. DeWitt v. American Family Mutual Ins. Co., 667 S.W.2d 700, 710 (Mo.
1984) and New Madrid County v. Continental Cas. Co., 904 F.2d 1236 (8th Cir. 1990). In such circumstances,
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 23
the plaintiff ’s damages shall be enhanced by 20 percent of the first $1,500.00 of the loss and 10 percent of the
amount in excess of that amount and reasonable attorneys fees.
b.Fines and Penalties
Many state statutes provide for penalties that may be imposed on insurers for unfair or deceptive
claims handling.
In Illinois, Section 155 of the Illinois Insurance Code subjects insurers to penalties for “vexatious
and unreasonable” delays in claims handling. Section 155 preempts any common law remedy based upon an
implied duty of good faith as well as any right to recover punitive damages for unfair claims handling. Combs
v. Ins. Co. of Illinois, 497 N.E.2d 503 (Ill. App. (1st Dist.) 1986).
(1) In any action by or against a company wherein there is in issue the liability of a company
on a policy or policies of insurance or the amount of the loss payable thereunder, or for an
unreasonable delay in settling a claim, and it appears to the court that such action or delay
is vexatious and unreasonable, the court may allow as part of the taxable costs in the action
reasonable attorney fees, other costs, plus an amount not to exceed any one of the following
amounts:
(a) 25 percent of the amount which the court or jury finds such party is entitled to recover
against the company, exclusive of all costs;
(b)$25,000;
(c) the excess of the amount which the court or jury finds such party is entitled to recover,
exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the
claim prior to the action.” 215 ILCS 5/155(1).
The Appellate Court of Illinois ruled in Nelles v. State Farm, 318 Ill. App.3d 399 (1st Dist. 2000) that
the statutory penalty for vexatious conduct by an insurer under Section 155 cannot exceed $25,000, rejecting
the insured’s argument that subsection (b) of the statute merely provided one of three alternative remedies.
In other states, a finding that the insurer intentionally breached its duties under the policy allows the
insured to recover double or treble damages. Unlike punitive awards, these exemplary damages are calculated
based on the insured’s covered loss. See, e.g. M.G.L. Chapter 93A (allowing double or treble damages for intentional violations of M.G.L. Chapter 176D, setting forth proscribed unfair or deceptive claim handling practices). See also Mason v. Mortgage America, Inc., 792 P.2d 142 (Wash. 1990) and Keller v. Allstate Ins. Co., 919
P.2d 1140 (Wash. App. 1996)(insurer’s breach of its duty of good faith constitutes an unfair trade practice for
which a insured may recover treble damages and attorneys fees).
In Missouri, Revised Statute §375.420 allows for an award of damages and attorneys fees if an insurer’s refusal to cover a loss was “willful and without reasonable cause, as the facts would appear to a reasonable
and prudent person.” DeWitt v. American Family Mutual Ins. Co., 667 S.W.2d 700, 710 (Mo. 1984) and New
Madrid County v. Continental Cas. Co., 904 F.2d 1236 (8th Cir. 1990). In such circumstances, the plaintiff ’s
damages shall be enhanced by 20 percent of the first $1,500.00 of the loss and 10 percent of the amount in
excess of that amount and reasonable attorneys fees.
There is no common law remedy for bad faith claims in Pennsylvania. However, the Pennsylvania legislature has enacted a statutory remedy (42 Pa.C.S.A. §8371) that provides that in an action arising under an insurance policy, if the court finds that the insurer has acted in bad faith toward the insured, the court may award:
(1) Interest from the date the claim was made by the insured in an amount equal to the prime rate of
interest plus 3 percent;
24 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
(2) Punitive damages; and/or
(3) Court costs and attorney fees against the insurer.
c.Attorneys Fees
In many jurisdictions, the state’s highest court has not addressed the issue of whether attorneys’ fees
can be recovered as an item of consequential damages for breach of an insurance contract, including breach
of the implied covenant. In such jurisdictions, policyholders are advancing creative arguments as to why
such fees should be recoverable as an item of consequential damages that flow from the breach of contract.
See Pugh v. North American Warranty Services, Inc., 1 P.3d 570, 574 (Utah Ct. App. 2000)(“when an insurance company breaches the implied covenant to perform its obligations in good faith, the insured can recover
his or her attorneys’ fees as consequential damages of the breach”); Patel v. United Fire & Casualty Co., 80
F.Supp.2d 948, 960-63 (N.D. Ind. 2000)(“in the context of a bad faith insurance dispute, an insurer’s denial of
coverage in bad faith may lead to a conclusion that the insurer litigated the action in bad faith” so as to trigger
the operation of Indiana statute authorizing an award of attorneys’ fees). See also Builders’ Transport, Inc. v.
Ford Motor Co., 25 F.Supp.2d 739, 747 (E.D. Tex. 1998)(primary insurer could recover attorneys’ fees incurred
in declaratory judgment action against excess insurer as consequential damages where excess insurer found
to have breached contract by refusing to contribute to attorneys’ fees in the underlying case); Brandt v. Superior Court, 693 P.2d 796, 800 (Cal. 1985)(“when the insurer’s conduct is unreasonable, a plaintiff is allowed to
recover for all detriment proximately resulting from the insurer’s bad faith, which detriment includes those
attorney’s fees that were incurred to obtain the policy benefits and that would not have been incurred but for
the insurer’s tortious conduct”).
V. State by State Summary
Alabama
Unfair claims handling by insurers is regulated under Ala. Code §27-12-24 (1975). Unfair or deceptive consumer practices are proscribed by Ala. Code §8-19-1 (Michie 1984 & Supp. 1992).
Alaska
Unfair claims handling by insurers is regulated under Alaska Stat. §21.36.125 (1962). Unfair or
deceptive consumer practices are proscribed by Alaska Stat. §45.50.471 (1980).
Arizona
Unfair claims handling by insurers is regulated under Ariz. Rev. Stat. Ann. §20-461 (1956). Unfair or
deceptive consumer practices are proscribed by Ariz. Rev. Stat. Ann. §44-1521 (1967 & Supp. 1984-85).
Arkansas
Unfair or deceptive consumer practices are proscribed by Ark. Code Ann. §4-88-101 (Michie 1991).
Unfair claims handling by insurers is regulated under Ark. Stat. Ann. §66-3005 (1947).
California
Unfair and deceptive claims handling practices are prohibited by Section 790.03 of the California
Insurance Code.
A comprehensive set of new regulations governing the investigation and handling of claims by
insurers went into effect on January 14, 1993. Among other things, insurers are required to acknowledge the
receipt of claims within fifteen days and must accept or deny a claim no later than 40 days after receiving all
requested pertinent documentation requested from the insured.
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 25
Claims for unfair competition may also be pursued by insureds under Section 17200 of California’s
Business & Professions Code, which defines “unfair competition” as “any unlawful, unfair or fraudulent business act or practice.” State Farm Fire and Cas. Co. v. Superior Court, 53 Cal Rptr. 2d 229 (Ct. App. 1996) (Sec.
17200 applied to insurers where conduct violates common law rights even though same conduct also violates
Insurance Code Sec. 790).
Colorado
Unfair claims handling is regulated under Colo. Rev. Stat. §10-3-1104 (1973). Unfair or deceptive
consumer practices are proscribed by Colo. Rev. Stat. Ann. §6-1-101 (1989 & Supp. 1992).
In 2008, Colorado enacted new first party remedies for bad faith. CRS §§10-3-1115 and 10-3-1116
have been held not to have retroactive application. See New Salida Ditch Co. v. United Fire & Cas. Ins. Co., 2009
WL 5126498 (D. Colo. December 18, 2009), aff ’d on other grounds 2010 WL 4250004 (10th Cir. 2010). See also
James River Ins. Co. v. Rapid Funding, LLC, 2009 WL 524994 (D. Colo. 2009).
Connecticut
Unfair claims practices by insurers are prohibited under the Connecticut Unfair Insurance Practices
Act (CUIPA), General Statutes §38a-815, 816. An aggrieved insured may bring a cause of action for a CUIPA
violation under the Connecticut Unfair Trade Practices Act (CUTPA), G.S. 42a-110 et seq. An insurer may
only be sued under CUTPA for violations of CUIPA if the can show that the CUIPA violation was committed
with such regularity as to constitute a regular business practice of the insurer.
Delaware
Unfair or deceptive consumer practices are proscribed by Del. Code Ann. Title 6 Section 2511 (1975
& Supp. 1992). Unfair claims handling by insurers is regulated under Del. Code Ann. tit. 18 §2304(16) (1974).
Florida
Unfair or deceptive consumer practices are proscribed by Fla. Stat. Ann. §501.201 (West 1985). Additionally, Section 624.155(b) provides that any person may sue an insurer for one or more of the following acts:
(1) not attempting in good faith to settle claims when, under all the circumstances, it could have
and should have done so, had it acted fairly and honestly toward its insured and with due regard
for her or his interests;
(2) making claims payments to insureds or beneficiaries not accompanied by a statement setting
forth the coverage under which payments are being made; or
(3) except as to liability coverages, failing to promptly settle claims, when the obligation to settle a claim has become reasonably clear, under one portion of the insurance policy coverage in
order to influence settlements under other portions of the insurance policy coverage.
Because Florida courts have also recognized a common law cause of action for bad faith, Section
624.155 further provides that a claimant may only obtain a judgment under the common law remedy of bad
faith or under Section 624.155 but not both.
Finally, Section 3A of Section 624.155 provides that as a condition precedent to bringing any such
claim, the insured must give 60 days written notice of the violation to the insurer and the Insurance Department. Furthermore, “no action shall lie if, within 60 days after filing notice, the damages are paid or the circumstances giving rise to the violation are corrected.”
Georgia
Unfair or deceptive consumer practices are proscribed by Ga. Code Ann. §10-1-390 (Michie 1989
and Supp. 1993).
26 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
An insured pressing a claim under Section 33-4-6 must first make a timely demand before the filing
of a suit. Cagle v. State Farm Fire & Cas. Co., 512 S.E.2d 717 Ga. Ct. App. 1999). The demand letter must specifically describe the claimed misconduct and must specifically request remedial relief from the insurer. Arrow
Exterminators, Inc. v. Zurich American Ins. Co., 136 F.Supp.2d 1340 (N.D. Ga. 2001)(letter expressing general
dissatisfaction with insurer did not meet procedural requirements of statute).
Hawaii
H.R.S. Section 431:13-101 (1993) prohibits various unfair methods of competition and unfair and
deceptive acts and practices in the business of insurance. Unfair or deceptive consumer practices are proscribed by Haw. Rev. Stat. §481A (1985).
Idaho
Unfair or deceptive consumer practices are proscribed by Idaho Code §48-601 (1977). Unfair claims
handling by insurers is regulated under §41-1329 (1977).
Illinois
Unfair or deceptive consumer practices are proscribed by Ill. Rev. Stat. ch. 815, 505/1 (Smith-Hurd
1993).
Insurers may also be subject to penalties Section 155 of the Illinois Insurance Code, Ill. RSA c.73
§767 for “vexatious and unreasonable” delays in claims handling. Section 155 provides:
(1) In any action by or against a company wherein there is in issue the liability of a company on
a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious
and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts:
(a) 25 percent of the amount which the court or jury finds such party is entitled to recover
against the company, exclusive of all costs;
(b)$25,000;
(c) the excess of the amount which the court or jury finds such party is entitled to recover,
exclusive of costs, over the amount, if any, which the Co. offered to pay in settlement of the
claim prior to the action.” 215 ILCS 5/155(1).
Indiana
Unfair claims handling by insurers is regulated under Ind. Code §27-4-1-4.5 (1984). Unfair or deceptive consumer practices are proscribed by Ind. Code Ann. §24-5-0.5-1 (West 1980 & Supp. 1992).
Iowa
Unfair or deceptive consumer practices are proscribed by Iowa Code Ann. §714.16 (West 1979).
Unfair claims handling by insurers is regulated under Iowa Code §507B.4 (1981).
Kansas
Unfair claim settlement practices are defined in Kansas by K.S.A. 40-2404. Unfair or deceptive consumer practices are proscribed by K.S.A. §50-623 (1983).
Kentucky
Unfair or deceptive claims handling practices are prohibited by KRS 446.070 and KRS 304.12-230.
Unfair or deceptive consumer practices are proscribed by Ky. Rev. Stat. Ann. §367-110 (Michie/Bobbs-Merrill 1987 & Supp. 1992). The Consumer Protection Act, K.R.S. §§367.170(1), prohibits companies, including
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 27
insurers, from engaging in “[u]nfair, false, misleading, or deceptive acts or practices in the conduct of any
trade or commerce . . . .” K.R.S. §§367.170(1), The statute defines “unfair” as “unconscionable”.
The Unfair Claims Settlement Practice Act, K.R.S. §§304.12-230, holds insurers liable for, inter alia,
“[f]ailing to acknowledge and act reasonably promptly upon communications with respect to claims arising
under insurance policies; [and f]ailing to adopt and implement reasonable standards for the prompt investigation of claims arising under insurance policies . . . .” K.R.S. §§304.12-230(2)-(3).
Louisiana
Unfair or deceptive consumer practices are proscribed by La. Rev. Stat. Ann. §51.1402 (West 1987).
Unfair claims handling by insurers is regulated under Kan Stat. Ann. §40-2404 (1981).
Louisiana
Louisiana Revised Statute 22:1220(A) provides in pertinent part that:
An insurer owes to his insured a duty of good faith and fair dealing. The insurer has an affirmative duty to adjust claims fairly and promptly and to make a reasonable effort to settle claims
with the insured or the claimant, or both. Any insurer who breaches these duties shall be liable
for any damages sustained as a result of the breach.
The statute enumerates various acts that will constitute unfair or deceptive practices, including the
misrepresentation of pertinent policy terms and a failure to pay claims within 60 days of the presentation of a
satisfactory proof of loss. The insurer may be assessed general or special damages for a breach of this duty as
well as a fine not to exceed $5,000.00 or double the damages sustained, whichever is greater.
An insurer may also be liable under Section 1220 for failing to pay a claim within 60 days following
receipt of a satisfactory proof of loss if that failure is “arbitrary, capricious or without probable cause. A violation of Section 22:1220 may expose the insurer to liability for damages, discretionary penalties and attorney’s
fees pursuant to Section 22:658.
Maine
Under Title 24-A MRS §2436-A (2006), a policyholder who suffers injury as the result of the actions
of his insurer may sue for all damages, together with costs and disbursements, reasonable attorney’s fees and
interest on damages at the rate of one and a half percent per month for the following misconduct: (a) willingly
misrepresenting to an insured pertinent facts of policy provisions relating to coverage at issue; (b) failing to
acknowledge and review claims, which may include payment or denial of a claim, within a reasonable time following receipt of written notice by the insurer of a claim by an insured arising under a policy; (c) threatening to
appeal from an arbitration award in favor of an insured for the sole purpose of compelling the insured to accept
a settlement less than the arbitration award; (d) failing to affirm or deny coverage, reserving any appropriate
defenses, within a reasonable time after having completed its investigation related to a claim; or (e) without
just cause, failing to effectuate prompt, fair and equitable settlement of claims submitted in which liability has
become reasonably clear. “Without just cause” is defined in the statute as indicating that the insurer must have a
“reasonable basis to contest liability, the amount of any damages or the extent of any injuries claimed.”
An insurer may also be liable for failure to pay sums owed under a policy within 30 days after receipt of
the insured’s proof of loss. 24-A M.R.S.A., §2436(1). The 30-day period is tolled, however, if the insurer notifies
the insured, orally or in writing, that it is disputing the claim. Curtis v. Allstate Ins. Co., 787 A.2d 760 (Me. 2002).
Maryland
Unfair or deceptive consumer practices are proscribed by Md. Com. Law I Code Ann. §13-101 (1990
& Supp. 1992).
28 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
A new bad faith regime was established by the Maryland legislature in 2007. As set forth in Insurance
Article §3-1701, policyholders may now sue their insurers for first party bad faith. It also amends Maryland’s
Unfair Claims Settlement Practices Act to include as an unfair claims settlement practice the failure of an
insurer to act in good faith in deciding first party property claims. Finally, the law set forth the procedure an
insured must follow to prosecute such claims. The Maryland Insurance Commissioner may impose a penalty
up to $125,000 for each violation and may also order as restitution the damages recoverable under §3-1701.
Before suing for bad faith, an insured must file a complaint with the Maryland Insurance Administration (MIA) detailing the insured’s claimed loss, the applicable coverage and the amount of the claim.
Insurers will then have a thirty day “cure” period in which to respond and must furnish the insured with all
pertinent non-privileged claim documents. Privileged materials must be submitted to the MIA for in camera review. Upon receipt of these filings, the MIA then has 90 days to determine whether the claim is covered
and, if so, what damages the insured should recover and whether the insurer’s conduct was bad faith for which
additional damages may be awarded. The MIA’s finding must be appealed to an administrative tribunal, whose
findings may then be appealed to a trial court, which will hear the claims on a de novo basis.
Massachusetts
Claims for unfair or deceptive practices against insurers are governed by M.G.L. c.176D, whereas the
remedies for unfair or deceptive consumer practices are set forth in M.G.L. ch. 93A (West 1984). Section 9(i)
of Ch. 93A provides that “any person whose rights are affected by another person violating the provisions of
M.G.L. c. 176D may bring an action.” The statute states, however, that an individual entitled to bring a claim
under Section 11 (i.e. businesses) may not also bring a Section 9 claim.
Michigan
Unfair or deceptive consumer practices are proscribed by Mich. Comp. Laws Ann. §445.901 (West
1989). Unfair claims handling by insurers is regulated under Mich. Comp. Laws §500.2026 (1977).
Minnesota
Unfair or deceptive consumer practices are proscribed by Minn. Stat. Ann. §§8.31, 325D.43 (West
1981 & Supp. 1993). Unfair claims handling by insurers is regulated under Minn. Stat. §72A.20 (1980).
In 2008, Minnesota enacted amendments to §604.18 that restrict bad faith claims to instances in
which an insurer denies coverage in the knowledge that its position lacked a reasonable basis or acted in reckless disregard of the lack of a reasonable basis for denying the benefits of the insurance policy. Bad faith under
the new law cannot be pled in the complaint. Like a punitive damages claim, the insured must seek leave to
amend to include the claim and show a prima facie case based on affidavits showing the factual basis for the
motion. Also, the court, not juries, shall consider whether the insurer has proven bad faith. Courts are allowed
to add damages as taxable costs if the jury returns a verdict in the insured’s favor. Damage awards are limited
to an amount equal to one-half of the proceeds awarded that are in excess of an amount offered by an insurer
at least ten days before trial begins, but capped at $250,000. Attorney’s fees may be awarded, but are also
capped at $100,000. Punitive or exemplary damages are not available under the law.
Mississippi
Unfair or deceptive consumer practices are proscribed by Miss. Code Ann. §75-24-1 (1991 & Supp.
1993).
Missouri
Unfair or deceptive consumer practices are proscribed by Mo. Ann. Stat. §407.010 (Vernon 1990).
Montana
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 29
Governed by Montana Unfair Claims Settlement Practices Act, MCA §27-1-101, et seq. and the Montana Unfair Trade Practices Act, MCA §33-18-101, et seq. An award of punitive damages against an insurer
will only be sustained if it meets the nine step test set forth in MCA §27-1-221(7). In 1997, the legislature
enacted MCA 33-18-242(3), which prohibits an insured from bringing an action for bad faith in connection
with the handling of an insurance claim.
Nebraska
Unfair or deceptive consumer practices are proscribed by Neb. Rev. Stat. §59-1601 (1988). Unfair
claims handling by insurers is regulated under Neb. Rev. Stat. §44-1525(9) (1943).
Nevada
Unfair or deceptive consumer practices are proscribed by Nev. Rev. Stat. §§598.360, 41.600 (1991).
Unfair claims handling by insurers is regulated under Nev. Rev. Stat. §686A.310 (1978).
New Jersey
Unfair or deceptive consumer practices are proscribed by N.J. Stat. Ann. §56:8-1 (West 1989 & Supp.
1993). Unfair claims handling by insurers is regulated under N.J. Stat. Ann. §§17B:30-13.1 (life and health
insurance), 17.29B-4(9) (other insurance) (West 1963).
New Mexico
Aggrieved insureds may sued for unfair claims practices under N.M. Stat. Ann. §59A-16-30 (1984).
Unfair or deceptive consumer practices are proscribed by N.M. Stat. Ann. §57-12-1 (Michie 1987 & Supp.
1993). Unfair claims handling by insurers is regulated under N.M. Stat. Ann. §59-11-13 (1978).
New York
Unfair or deceptive consumer practices are proscribed by N.Y. Exec. Law §63(12) (Consol. 1983) and
N.Y. Gen. Bus. Law §349 (Consol. 1980 & Supp.1984). Unfair claims handling by insurers is regulated under
N.Y. Ins. Law §§40-d, 2402(2) (Consol. 1980).
North Carolina
Unfair or deceptive claims practices are prohibited by N.C. Gen. Stat. §58-54.4. and, more generally, by N.C. Gen. Stat. §75.1-1, the North Carolina Consumer Protection Act. Unfair and deceptive acts in the
insurance area are primarily but not exclusively regulated by G.S. §58-63-1 which proscribes unfair methods
of competition and unfair deceptive acts and practices in the business of insurance.
Ohio
Unfair or deceptive consumer practices are proscribed by Ohio Rev. Code Ann. §1345.01 (Baldwin
1988). Unfair claims handling by insurers is regulated under Ohio Admin. Code §3901-1-07.
Oklahoma
Unfair and deceptive claims handling practices are prohibited by 36 Oklahoma Statutes 1. Unfair or
deceptive consumer practices are proscribed by Okla. Stat. Ann. tit. 15 §751 (West 1993) and tit. 78 §51 (West
1993).
Oregon
Unfair or deceptive consumer practices are proscribed by Or. Rev. Stat. §646.605 (1988). Unfair
claims handling by insurers is regulated under Or. Rev. Stat. §746.230 (1981).
Pennsylvania
Unfair or deceptive consumer practices are proscribed by Pa. Stat. Ann. tit. 73, §201-1 (1971 & Supp.
1993). UIPA does not create a private cause of action. Faye v. Erie Insurance Group, 723 A.2d 712, 714 (Pa.
30 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Super. 1999). However, a violation of UIPA may be considered in determining whether an insurer has acted in
bad faith under 42 Pa. CSA §8371.
Rhode Island
Unfair or deceptive consumer practices are proscribed by R.I. Gen. Laws §6-13.1-1 (1985 & Supp. 1991).
In 1993, the Rhode Island legislature also enacted an Unfair Claims Settlement Practices Act (§279.1-1, et seq.). Unlike the bad faith statute, this new law does not create a private cause of action. Rather, an
aggrieved insured must petition the Department of Business Regulation if an insurer has violated one or
more of the sixteen proscribed practices set forth in the regulations accompanying the Act. In particular, an
insurer must acknowledge receipt of a claim within 10 days and make a claim determination within 30 days
unless the insured assents to a longer period of time. Any denial letter must also alert the insured of its right
to appeal to the Rhode Island Insurance Department. An insurer may be fined up to $10,000 for each violation, not to exceed $100,000 in the aggregate, or, if committed flagrantly and in conscious disregard of the Act,
$25,000/$250,000.
Pursuant to Rhode Island’s “Rejected Settlement Offer statute” (General Laws 1956, Section 27-72.2), in any case in which an insurer rejects a written offer by the plaintiff to settle a covered claim in an
amount equal to or less than the coverage limits, the insurer will thereafter be liable for all interest due on the
judgment entered by the Court even if payment of the judgment and the interest totals a sum in excess of the
limit. Furthermore, the insurer must respond in writing within 30 days of receipt of the demand.
Since May 20, 1981, Rhode Island General Laws §9-1-33 has permitted insureds to pursue bad faith
claims against insurers for claims that are denied without any objectively reasonable basis and where the
insured acts with reckless disregard or knowledge of the wrongness of its position. It provides, in pertinent
part, that: “an insured . . . may bring an action against the insurer . . .when it is alleged the insurer . . . wrongfully and in bad faith refused to timely perform its obligations under the contract of insurance.” Successful
claimants may recover compensatory damages, punitive damages and reasonable attorney’s fees.
South Carolina
Unfair or deceptive consumer practices are proscribed by S.C. Code Ann. §39-5-10 (Law. Co-op.
1985). Unfair claims handling by insurers is regulated under S.C. Code Ann. §38-37-1110.
South Dakota
Unfair or deceptive consumer practices are proscribed by S.D. Codified Laws Ann. §37-24-1 (1986 &
Supp. 1993).
Tennessee
Unfair or deceptive consumer practices are proscribed by Tenn. Code Ann. §47-18-101 (1988). Unfair
claims handling by insurers is regulated under Tenn. Code Ann. §56-8-104(8) (1980).
In Myint v. Allstate Ins. Co., 970 S.W.2d 920 (Tenn. 1998), the Tennessee Supreme Court had ruled that,
in appropriate cases, insured could also use Tennessee’s Consumer Protection Act as a vehicle to seek redress
for unfair claims practices. However, on April 29, 2011, Tennessee’s governor signed into law House Bill 1189
that effectively overrules Myint by amending Tennessee Code Annotated Title 56, Chapter 8, Part 1 to declare
that Titles 50 and Title 56 shall provide the sole and exclusive statutory remedies and sanctions available for the
“alleged breach of, or for alleged unfair or deceptive acts and practices in connection with a contract of insurance.”
Texas
Unfair or deceptive consumer practices are proscribed by Tex. Bus. & Com. Code Ann. §17.41 (West
1987 & Supp. 1993).
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 31
Unfair claims settlement practices are prohibited by Article 21.21 of Texas Insurance Code. In 1995,
the legislature amended Article 21.21, Section 4 of the Insurance Code so as to define an “unfair settlement
practice” as including “failing to attempt in good faith to effectuate a prompt, fair and equitable settlement of a
claim with respect to which the insurer’s liability has become reasonably clear.”
An insured may pursue a private right of action for violations of Section 4(10)(a)(ii) under Section 16
or Article 21.21. Section 16(a) proscribes various acts that are deemed to be unfair and deceptive in violation
of Article 21.21 including the misrepresentation of benefits under the policy or untrue and misleading statements regarding the available coverage.
Utah
Unfair or deceptive consumer practices are proscribed by Utah Code Ann. §§13-2-1, 13-5-1 (1992 &
Supp. 1993).
The Timely Payment of Claims Act (Utah Code section 31A-26-301) provides that:
Unless otherwise provided by law, an insurer shall timely pay every valid (1) By rule the commissioner may prescribe the insurance claim made by an insured. kinds of notice and proof of
loss that will establish validity, the manner in which an insurer may make a bona fide denial of
a claim, the periods of time within which payment is required to be made to be timely, and the
reasonable interest rates to be charged upon late claim payments.
This section applies only to claims made by claimants in direct privity of contract with the insurer.
Vermont
Unfair or deceptive consumer practices are proscribed by Vt. Stat. Ann. tit. 9, §2451 (1984 & Supp.
1992). Unfair claims handling by insurers is regulated under Vt. Stat. Ann. tit. 8, §4724(9) (1970).
Virginia
Unfair or deceptive consumer practices are proscribed by Va. Code Ann. §59-1-196 (1992 & Supp.
1993). Unfair claims handling by insurers is regulated under Va. Code §38.1-52.9 (1950).
Washington
Unfair or deceptive consumer practices are proscribed by Wash. Rev. Code Ann. §19.86.010 (West
1989 & Supp. 1993). To establish a claim under the Consumer Protection Act, a claimant must prove (1) an
unfair or deceptive act or practice; (2) occurring in trade or commerce; (3) impacting a public interest; (4)
injuring in the claimant’s business or property; and (5) caused by the act.
Unfair or deceptive claims handling practices are prohibited by RCW 19.96. Liability may arise under
RCW 19.96.020 if an insurer can be shown to have committed any of the specific practices forbidden by WAC
284-30-330, which sets forth specific acts by insurers that will be deemed to constitute unfair methods of
competition or unfair or deceptive acts or practices. Even a single violation of WAC 284-30-330 is a per se
unfair trade practice. Industrial Indemnity Co. v. Kallevig, 792 P.2d 520 (Wash. 1990).
Under Washington law, an insurer has a duty to act promptly in both communication and investigation in response to a claim or tender of defense. (WAC 284-30-330(2)-4, WAC 284-30-360(1) and WAC 28430-370.)
West Virginia
Unfair or deceptive consumer practices are proscribed by W. Va. Code §46A-6-101 (Michie 1992 &
Supp. 1992). Unfair and deceptive practices are proscribed by Section 4 of the West Virginia Unfair Trade
Practices Act, Section 33-11-1. The UTPA prohibits individuals in the business of insurance from engaging
32 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
in certain unfair acts and practices, including a host of unfair claim settlement practices that are set forth in
W.Va. Code, 33-11-4(9) [2002].
Wisconsin
Unfair or deceptive consumer practices are proscribed by Wis. Stat. Ann. §100.20 (West 1988 & Supp.
1992). Unfair claims handling by insurers is regulated under Wis. Admin. Code §INS 6.11(3).
Wyoming
Unfair or deceptive consumer practices are proscribed by Wyo. Stat. §40-12-101 (1993).
Statutory Bad Faith—How State Legislatures Have Expanded the Contours... ■ Aylward ■ 33
Discovery, Discovery, and
More Discovery:
Techniques for Managing Discovery
Tactics in Bad Faith Cases
Jennifer D. Eubanks
Gallivan, White & Boyd PA
55 Beattie Place, Ste. 1200
Greenville, SC 29603
(864) 271-5396
jeubanks@gwblawfirm.com
Jennifer D. Eubanks is of counsel with Gallivan, White & Boyd PA, a litigation
firm with offices in Columbia and Greenville, South Carolina, and Charlotte,
North Carolina. Ms. Eubanks’s practice is devoted solely to the defense of bad faith
litigation and assisting insurance carriers with resolving coverage questions and
disputes. She frequently speaks on bad faith and coverage issues and has assisted
in either authoring or serving as a regional editor for several editions of DRI’s Bad
Faith Compendium.
Discovery, Discovery, and More Discovery:
Techniques for Managing Discovery
Tactics in Bad Faith Cases
Table of Contents
I.Introduction..................................................................................................................................................39
II. Triaging the Bad Faith Case.........................................................................................................................39
III. Developing a Comprehensive Discovery Plan for the Leveraged Coverage Case.....................................40
A. Using Written Discovery to the Insurer’s Advantage..........................................................................40
B. Defending Against Written Discovery in the Leveraged Coverage Case...........................................41
IV. Developing a Comprehensive Discovery Plan for the Genuine Bad Faith Case.......................................42
A. Establishing a Client Liaison and Gathering Information..................................................................42
B. Responding to Written Discovery and the Assertion of Privileges....................................................43
1. The Work-Product Doctrine.........................................................................................................43
2. The Attorney-Client Privilege.......................................................................................................43
3. The Privilege Log............................................................................................................................45
V. Recognizing and Minimizing “Institutional Bad Faith” Discovery...........................................................45
A. Know It When You See It......................................................................................................................46
B. Challenge Relevance..............................................................................................................................46
C. Keeping Discovery Within State Lines.................................................................................................47
D. Keeping It Confidential.........................................................................................................................47
E. It’s a Big Hassel.......................................................................................................................................48
VI. E-Discovery in the Bad Faith Case...............................................................................................................48
A. Issue the Litigation Hold (and Supplement It When Necessary).......................................................49
B. Understand the Insurer’s Document Retention Policy and Electronic Data Systems......................49
C. Understand and Communicate the Consequences of Failure to Cooperate in E-Discovery............49
D. Understand and Communicate the Consequences of Spoliation.......................................................50
E. Easing the Pain of E-Discovery Through Cost-Shifting......................................................................52
VII.Conclusion.....................................................................................................................................................53
Discovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 37
Discovery, Discovery, and More Discovery:
Techniques for Managing Discovery Tactics in Bad Faith Cases
I.Introduction
Discovery, particularly written discovery and document production, in a genuine bad faith case (as
opposed to a leveraged coverage case, a topic discussed later in this article) is not for the lazy or the faint of
heart. One must understand how insurance companies operate, and that includes not only the insurer’s claims
side, but also its underwriting side and, at times, its human resources, financial or regulatory compliance
departments. Discovery for these cases demands a comprehensive plan and a contact within the company who
is committed to assisting the attorney with carrying out the plan. It also requires vigilance and the willingness
to bring discovery overreaching and abuses to the court’s attention in a way that does not alienate the court.
This article focuses on how to triage the bad faith case and develop a comprehensive discovery plan.
It also discusses tactics for managing written discovery and document production requests to keep the case
focused on the issues and to prevent the policyholder’s attorney from engaging in overreaching or abusive
discovery. This article will address e-discovery developments relevant to bad faith litigation, as well as the
appropriate use of “litigation holds”. Allegations of “institutional bad faith” raise their own discovery issues,
including attempts to obtain information on non-related claims and policyholders. This article will offer suggestions on how to respond to discovery seeking information unrelated to the policyholder’s claim.
II. Triaging the Bad Faith Case
Do you have a genuine bad faith case? Or do you have a leveraged coverage case? It matters because
your approach to discovery will likely differ depending on which kind of case you have.
A leveraged coverage case is merely a coverage case with a weak bad faith claim made to “up the
ante.” Frequently, the bad faith claim is asserted as a counterclaim to a declaratory judgment action brought
by the insurer. However, if the policyholder files a declaratory judgment action on the issue of coverage, it may
include a bad faith claim in addition to contractual causes of action. The policyholder reasons that the bad
faith claim will put pressure on the insurer to settle the claim rather than engage in potentially time-consuming, intrusive and expensive discovery on bad faith issues. It is, in its essence, extortion.
The leveraged coverage case’s bad faith claim typically contains little detail. The allegation of bad
faith is generally limited to the insurer’s unreasonable failure to pay the insured’s claim, though occasionally
it also alleges unreasonable delay in the payment of the claim or unreasonable investigation. The bad faith
claim is usually devoid of allegations of conversations or correspondence with the insurer, does not reference
details of the insurer’s investigation and does not contain allegations of damages outside the disputed contractual benefits.
The genuine bad faith claim, as opposed to the leveraged coverage case, will generally contain the
detail lacking in the leveraged coverage case. It will set forth the dates of communication between the insured
and representatives of the insurer and the content of those communications; it will detail investigation done
or which allegedly should have been done by the insurer and often it will allege damages other than the contractual benefits, such as loss of business or earnings, attorney fees or mental anguish.
Once the bad faith claim has been triaged, the attorney can develop a discovery plan. The goal in
dealing with discovery in the leveraged bad faith case is to shut it down, using discovery both offensively and
defensively. However, the goal in managing discovery in the genuine bad faith case is to keep it focused. A cerDiscovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 39
tain amount of bad faith discovery will be relevant and appropriate. The goal is to keep the policyholder from
overreaching and abusing the discovery process.
III. Developing a Comprehensive Discovery Plan for the Leveraged
Coverage Case
A. Using Written Discovery to the Insurer’s Advantage
If the policyholder’s bad faith claim appears meritless, early and aggressive written discovery is the
attorney’s first resource. The goal is to put the case in a position for a successful dispositive motion as to both
the coverage issue and the bad faith claim. With regard to the bad faith claim, written interrogatories should
be used to verify the policyholder’s claims. Interrogatories should focus on the factual allegations of the complaint and request the basis for the bad faith claim.
For instance, the policyholder should be asked to give a detailed statement of the basis for his bad
faith claim, including disclosure of any events allegedly constituting bad faith, any policy provisions applicable to his claim and any case law or statutory law that forms the basis of the claim. He should also be asked to
list every instance or event constituting bad faith on the part of the insurer, with subparts to the interrogatory
requesting the identities of and location information for every participant in the event, the identities of and
location information for any witness to the event, a summary of any communication constituting any event,
whether any document (electronic or otherwise) memorializes the event, and the dates of each event. The
same request for detail should be applied to the policyholder’s damage claim, including the specific elements
of damage, the amount for each element of damage, and how the damages were calculated.
Whether the policyholder made a claim of common law or statutory bad faith, the insurer’s written
discovery should inquire about the elements of the cause of action. For example, if the jurisdiction requires
evidence of malice on the part of the insurer, the insurer will want to ask for a description of any conduct on
the part of the insurer evidencing malice.
As with interrogatories, the goal in serving requests for production is to establish the parameters of
the bad faith claim. Counsel for the insurer will want to request any and all documents, electronic or otherwise, that the policyholder alleges support his bad faith claim. Additionally, the insurer should request all documents or other evidence of damages allegedly caused by its bad faith conduct.
In response to discovery directed at the basis of a bad faith claim in a leveraged coverage case, policyholders often merely reference the vague allegations of their complaints or counterclaims. They produce a
copy of the policy and documents supporting their claim for policy benefits and refer to those documents to
support their bad faith allegations. Left unchallenged, such responses leave the door open for richly embellished tales of bad faith via the policyholder’s affidavit in response to the insurer’s motion for summary judgment. There are two resources the insurer can use to combat vague discovery responses.
First, if only a few discovery responses are vague, the insurer can utilize Requests for Admission
under Rule 36, Fed.R.Civ.P. For instance, the insurer can ask the insured to produce all documents supporting bad faith damages other than damages associated with the claim for benefits under the policy. The policyholder responds, “see attached documents” which include only evidence of the claim under the policy. The
insurer can follow up with a request for admission that the policyholder has no documentary evidence of
damage caused by the insurer’s alleged bad faith conduct other than the documents evidencing the amount he
claims under the policy.
Second, motions to compel should be used to require the policyholder to spell out the details of the
alleged bad faith. If the details are confirmed, the policyholder has little room to escape the weakness of his
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bad faith claim without subjecting himself to impeachment for changing his story. Under Rule 37(a)(2) and
(3), Fed.R.Civ.P., the insurer may move to compel answers to discovery that are complete and not evasive. If
the case is in federal court or in a state court under a scheduling order, the insurer should be sure to file its
motion to compel in accordance with the scheduling order issued by the court, typically a certain number
of days prior to the discovery deadline. Failure to file a motion to compel may lead to a party’s waiver of any
right to challenge discovery responses at trial. See, e.g., Stern v. Cosby, 645 F.Supp.2d 258, 281 (S.D.N.Y. 2009)
(failure of celebrity’s friend to file motion to compel prior to summary judgment to obtain names of anonymous sources for statement in book regarding celebrity’s and friend’s drug use constituted waiver of right to
challenge credibility or reliability of witnesses on motion for summary judgment on defamation claim); In Re
Katrina Canal Breaches Consol. Litigation, 2008 WL 2066999 (E.D. La. 2008) (plaintiffs waived argument for
“substantial need” of photos and videotape by failing to raise it in their motion to compel).
Thus, the use of targeted written discovery in the leveraged coverage case serves to expose the specious nature of the bad faith claim. It also gives the insurer the admissions necessary to pursue summary disposition of the bad faith claim. If the case is, at its core, a coverage dispute, a court will likely grant summary
judgment on the bad faith claim upon determining that the insurer’s coverage position is correct. Even if the
court determines that the insurer’s position is not correct, it may still grant summary judgment as to the bad
faith claim, assuming the insurer has provided the court with lack of evidence supporting the claim, particularly in those jurisdictions with heightened requirements for proving bad faith, such as evidence of malice.
B. Defending Against Written Discovery in the Leveraged Coverage Case
As mentioned above, the primary reason a policyholder files a bad faith claim in what is really a coverage dispute is to gain leverage over the insurer. The insurer takes away leverage through its use of written
discovery. However, the policyholder typically attempts to reassert it by serving onerous discovery requests on
the insurer. The policyholder reasons that if the insurer does not want the expense and aggravation inflicted
by the discovery responses, the insurer will simply settle his claim.
As the defendant in a bad faith suit, the insurer may be reluctant to serve its bad faith discovery until
it receives the policyholder’s discovery, but this is typically a mistake. Obtaining the policyholder’s admissions
of a weak or non-existent bad faith claim makes it easier to defend against the policyholder’s bad faith discovery or obtain a protective order disallowing it. Additionally, the insurer may be able to seek bifurcation of bad
faith discovery in the appropriate case. These options are discussed in greater detail below.
As a first response to oppressive bad faith discovery, the insurer’s attorney may be able to reach an
agreement with the policyholder’s attorney to voluntarily stay bad faith discovery until the coverage issue is
resolved. The success of this tactic is, of course, primarily dependent upon the consent of the policyholder’s
attorney. However, it is not uncommon for a policyholder’s attorney to agree to this arrangement where he or
she realizes that the viability of the policyholder’s bad faith claim is determined by the court’s decision on coverage.
One inducement to the policyholder to enter into such an agreement may be the promise to file an
early motion for summary judgment on the issue of coverage, thus allowing sufficient time to conduct bad
faith discovery should the motion be denied. If the insurer agrees to do so, it should be contingent upon the
condition that the parties agree to the resolution of all coverage related discovery issues to the satisfaction of
both parties in advance of the early summary judgment deadline. It is pointless to agree to an early summary
judgment deadline only to find the policyholder refusing to promptly answer coverage-related interrogatories.
If summary judgment on the coverage issue is granted to the insurer, the policyholder may voluntarily dismiss
his bad faith claim, or the insurer may still be compelled to file a separate motion for summary judgment.
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If the policyholder will not agree to stay the bad faith discovery, the insurer should consider moving to bifurcate the bad faith discovery. To be successful in bifurcating the bad faith discovery, the insurer will
likely argue that the policyholder’s bad faith claim is dependent upon a finding of coverage. Thus, if there is
no coverage, there can be no recovery for bad faith. In Warren v. Federal Insurance Company, 358 Fed.Appx.
670, 676 (6th Cir. 2009) (not selected for publication in Federal Reporter), the Sixth Circuit Court of Appeals
upheld a district court’s decision to bifurcate bad faith discovery while a breach of contract claim was pending. “Because the merits of the bad faith claim depended on whether coverage for the claim was properly or
improperly denied, it was reasonable for the district court to resolve the coverage question before allowing
the bad faith claim to proceed.” Id. See, also, Smith v. Allstate Ins. Co., 403 F.3d 401 (6th Cir. 2005) (upholding bifurcation of bad faith claim where it was dependent on whether policy limitation valid); Karpenski v.
American General Life Companies, LLC, ___ F.Supp.2d ___, 2012 WL 6770970 (W.D. Wash. 2012) (bifurcation
granted in rescission case where determination of rescission claim in insurer’s favor necessarily disposed of
policyholder’s bad faith claim).
In lieu of moving for bifurcation, the insurer should consider moving for a protective order under
Rule 26, Fed.R.Civ.P. The policyholder’s pleadings and responses to the insurer’s discovery requests may
provide the basis for a protective order as to the bad faith claim. A policyholder who admits that he never
communicated with any representative of the insurer, but who requests the personnel files of the insurer’s
employees who handled his claim, arguably seeks irrelevant information. Likewise, a request for claims guidelines arguably seeks irrelevant information if the policyholder admits that his bad faith claim is based solely
on the application of a policy exclusion.
Finally, the insurer must be cognizant of the importance of creating and serving a privilege log in
connection with its assertion of any privileges to document production. In some jurisdictions, insurers are
waiving the right to assert the attorney-client and work product privileges due to a failure to create and serve
a privilege log with their discovery responses. See, Hagar v. Graham, 267 F.R.D. 486 (N.D.W.Va. 2010).
IV. Developing a Comprehensive Discovery Plan for the Genuine Bad
Faith Case
Whereas the focus of the insurer’s discovery plan in a leveraged coverage case the elimination of bad
faith discovery, the genuine bad faith case calls for careful management of discovery. The insurer’s attorney
should start by reviewing the complaint and interviewing the client representative who assigned the case. The
goal is to build a comprehensive understanding of the bad faith allegations, the history of the claims adjustment process and all individuals involved. As discussed in greater detail later in this article, the attorney needs
to assist the client in developing a litigation hold for electronic data and must gather all information deemed
discoverable before the first written discovery is served.
A. Establishing a Client Liaison and Gathering Information
The insurer’s attorney will need the insurer’s help to appropriately respond to bad faith discovery. If
the insurer’s contact is not helpful, the attorney should ask him or her tactfully if there is an assistant who has
the time to act as a liaison. The attorney cannot handle the production of discovery in a bad faith case on his
or her own and, frankly, the insurer doesn’t want that either. Bad faith discovery is like going for a Cub Scout
hike – you need a buddy.
Get a complete copy of the claims file as of the date suit was filed, including any electronic claims
logs, and start a list of persons who sent or received emails or made entries in the electronic claims log. When
42 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
the list is complete, go over the list with the insurer liaison and find out each person’s title, job responsibilities
and whether he or she is still with the company. Ask the insurer liaison to issue a litigation hold to each person
and ask the insurer’s Information Technology department to place a hold on the data of any employee no longer with the company. Each person who received a litigation hold needs to be contacted and asked to submit
any electronic communication or paper documents to the client liaison or directly to the insurer’s attorney.
The data needs to be labeled for potential production or retention under privilege. Having this done before the
first written discovery is received will allow the insurer’s attorney to better prepare discovery and a theory of
the case.
B. Responding to Written Discovery and the Assertion of Privileges
1.The Work-Product Doctrine
The insurer in the genuine bad faith case is, of course, entitled to assert privileges, but it must avoid
being seen as obstructionist. The first consideration will be to carefully consider when the work-product doctrine began. Sometimes, the claims process deteriorates to the extent that the insurer is aware that litigation
is imminent well before suit is ever filed. Other times, a claim is denied and suit is filed without the insurer’s
anticipation. In order to assert the work-product doctrine, the insurer will have to pinpoint the date it first
began to anticipate litigation and the basis for its anticipation. This is not a problem if the basis is a letter from
the insured’s attorney promising to file a lawsuit if the claim is not paid within two days. However, it is rarely
as obvious.
The work-product doctrine protects an attorney’s trial preparation materials from discovery to preserve the integrity of the litigation process. Hickman v. Taylor, 329 U.S. 495, 510-14, 67 S.Ct. 385, 91 L.Ed. 451
(1947). It is also incorporated into Rule 26(b)(3), Fed.R.Civ.P., which protects: (1) “documents and tangible
things”; (2) “prepared in anticipation of litigation or trial”; (3) “by or for another party or its representative”.
Id. To determine whether a document has been “prepared in anticipation of litigation,” and, thus, is protected
work product, courts generally ask (1) whether the document was prepared “because of ” a party’s subjective
anticipation of litigation, rather than because of the ordinary course of business, and (2) whether that subjective anticipation was objectively reasonable. See, In Re Professionals Direct Ins. Co., 578 F.3d 432, 439 (6th Cir.
2009) (citing United States v. Roxbury, 457 F.3d 590 (6th Cir. 2006)); National Union Fire Ins. Co. of Pittsburgh
v. Murray Sheet Metal Co., 967 F.2d 980 (4th Cir. 1992).
The In Re Professionals Direct Insurance Company opinion, supra, is a useful reminder that the workproduct doctrine can provide protection to the insurer in a bad faith case upon the insurer’s initial contemplation of a coverage action against the insured. In Professionals Direct, the Sixth Circuit Court of Appeals upheld
a magistrate’s determination that the work-product doctrine began when an insurer first began to contemplate
a declaratory judgment action against the insured and its attorneys began performing legal work in anticipation of filing the suit. Professionals Direct, 578 F.3d at 439. Thus, even though the insured did not bring a bad
faith action until it filed its counterclaim to the insurer’s coverage action, the Sixth Circuit protected materials generated in anticipation of litigation from the time the insurer contemplated its coverage action. Id. If the
insurer is defending a bad faith counterclaim brought in response to the insurer’s own coverage action, consider whether the insurer can assert the work-product doctrine beginning from the time it reasonably anticipated filing its own coverage action.
2.The Attorney-Client Privilege
The genuine bad faith case is rarely spontaneous. Rather, the claim underlying it has generally been
a thorn in the sides of many adjusters, in-house counsel and outside counsel for months. The claim has been
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the subject of investigation and, possibly, examinations under oath. It has been considered by the adjuster
and the adjuster’s supervisor. A large loss committee has reviewed it and proposed action on it. Perhaps the
insurer’s Special Investigations Unit (“SIU”) has conducted interviews and obtained reports, and possibly the
SIU employee is reporting to the outside counsel who took the examinations under oath. Maybe the insurer
obtained an informal coverage opinion from in-house counsel, then referred it to outside counsel for another
coverage opinion. Possibly outside counsel participates in the large loss review and recommends a declaratory
judgment action. As you can see, when attorneys are involved in the claims investigation process, it becomes
much more difficult to determine when the attorney-client privilege attaches.
“An insurance company, just as any other individual or entity, has the right to seek confidential legal
advice.” Roesler v. TIG Ins. Co., 251 Fed.Appx. 489, 500 (10th Cir. 2007) (footnote and citation omitted) (not
selected for publication in Federal Reporter). In a diversity case, the issue of the applicability of the attorneyclient privilege is governed by state law. Fed.R.Evid. 501 (providing that state law provides the rule of decision
on privilege in diversity cases); see, also, Union County, Iowa v. Piper Jaffray & Co., Inc., 525 F.3d 648 (8th Cir.
2008). Thus, the law of the jurisdiction will apply to claims of attorney-client privilege.
While the law of the state controls on the issue of attorney-client privilege, many jurisdictions have
cited with approval the framework established in United States v. United Shoe Machinery Corp., 89 F.Supp. 357
(D.Mass. 1950). As stated in United Shoe, the attorney-client privilege applies only if 1) the asserted holder
of the privilege is or sought to become a client; 2) the person to whom the communication was made a) is a
member of the bar of a court, or his subordinate and b) in connection with the communication is acting as a
lawyer; 3) the communication relates to a fact of which the attorney was informed a) by his client b) without
the presence of strangers c) for the purposes of securing primarily either i) an opinion on law, ii) legal services, or iii) assistance in some legal proceedings, and 4) the privilege has been claimed and not waived by the
client. United Shoe, 89 F.Supp. at 358-59.
Courts have long recognized that an attorney may act in a capacity other than that of an attorney. See, U.S. v. Davis, 636 F.2d 1028, 1044 (5th Cir. 1981) (attorney who acted as client’s business advisor
or as agent for receipt and disbursement of money and property not acting in a legal capacity). In the context of insurance disputes, to the extent an attorney acts as a claims adjuster, supervisor or merely monitors a
claims investigation, courts have held that the conduct does not invoke the attorney-client privilege. See, Mission Nat’l Co. v. Lilly, 12 F.R.D. 160, 163 (D. Minn. 1986) (communications by attorneys who acted as claims
adjusters in a fire loss claim not afforded attorney-client privilege); Harper v Auto-Owners Ins. Co., 138 F.R.D.
655 (S.D. Ind. 1991) (documents prepared by outside counsel to monitor claim investigation not afforded
attorney-client privilege to extent counsel acted as a claims adjuster); Allendale Mut. Ins. Co. v. Bull Data Systems, Inc., 152 F.R.D. 132, 137 (N.D. Ill. 1993) (production of documents by attorney to insurer not afforded
attorney-client privilege where production reflected “ordinary insurance information.”); Dawson v. New York
Life Ins. Co., 901 F.Supp. 1362, 1367 (N.D. Ill. 1995) (attorneys acting as “couriers of factual information”
rather than legal advisors not engaged in provision of legal advice).
Nevertheless, most courts appear to recognize that an attorney can play a role in a claim investigation
in a legal capacity so long as it is done in the process of providing legal services. See, e.g., Dunn v. State Farm
Fire & Cas. Co., 927 F.2d 869, 875 (5th Cir. 1991); Electronic Data Sys. Corp. v. Steingraber, 2003 WL 21653414
(E.D.Tex. 2003). In Upjohn Co. v. United States, 449 U.S. 383, 101 S.Ct. 677, 66 L.Ed.2d 584 (1981), a corporation’s in-house counsel conducted an internal factual investigation of “questionable payments” made by the
corporation’s subsidiaries to foreign governments. The Supreme Court held that both the giving and receiving of information by the in-house counsel was protected by the attorney-client privilege because it was part
of the process that allowed the attorney to give sound legal advice to the corporation. Upjohn, 449 U.S. at 390.
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Further, the Supreme Court stated that to determine whether an attorney is acting in a legal capacity, the court
must first ascertain the facts and sift through them “with an eye to the legally relevant.” Upjohn, 449 U.S. at
390-91. Upjohn made “clear that fact finding which pertains to legal advice counts as professional legal services.” United States v. Rowe, 96 F.3d 1294, 1297 (9th Cir. 1996).
Thus, the fact that an attorney becomes involved in the claims investigation process does not destroy
the attorney-client privilege. Rather, to preserve the privilege, the attorney’s conduct must be measured by
whether it constituted legal services. If the attorney performed investigation in order to render sound legal
advice to the insurer on the issue of coverage, such conduct and communications should be protected.
3.The Privilege Log
If the insurer is asserting attorney-client privilege in connection with any document, it should prepare a functional privilege log. Fed.R.Civ.P. 26(b)(5)(A)(ii) requires that such logs “describe the nature of the
documents, communications, or tangible things not produced or disclosed – and to do so in a manner that,
without revealing information itself privileged or protected, will enable other parties to assess the claim.” Failure to assert the attorney-client privilege in the privilege log may result in waiver of the privilege. Banks v.
Office of Senate Sergeant-At-Arms, 241 F.R.D. 376, 386 (D.D.C. 2007).
In Victor Stanley, Inc. v. Creative Pipe, Inc., 250 F.R.D. 251 (D.Md. 2008), the Maryland District Court
described an appropriate privilege log:
The most common way [to particularize a claim of privilege] is by using a privilege log, which
identifies each document withheld, information regarding the nature of the privilege/protection
claimed, the name of the person making/receiving the communication, the date and place of the
communication, and the document’s general subject matter.
Victor Stanley, 250 F.R.D. at 264-65. The court in Victor Stanley went on to rule that if the privilege log was
challenged, the party invoking the privilege must come forward to establish an evidentiary basis for the privilege, “by affidavit, deposition transcript, or other evidence” or risk a ruling that the documents be produced.
Victor Stanley at 267.
Privilege logs are a tiresome, though necessary, chore. Alienating the assigned trial judge by producing a haphazardly prepared, vague or late privilege log does the client no favors. Take the time to produce a
functional privilege log.
V. Recognizing and Minimizing “Institutional Bad Faith” Discovery
In bad faith cases, insurers are generally resigned to production of the insured’s claims file, subject to
appropriate withholding of privileged documents. However, when discovery requests come in that seek production of the claims files of other insureds, personnel files for the adjusters, compensation plans for adjusters and a list of bad faith suits filed against the insurer, alarms go off. These are some of the tactics used by
insureds trying to establish institutional bad faith.
Institutional bad faith is generally recognized as an allegation by a policyholder that institutional factors, such as compensation, claims handling mandates, performance standards or programs, caused the insurer’s adjuster to act unreasonably or that the insurer had a scheme or plan in place to unfairly resolve claims
to the insured’s detriment. The policyholder’s goal is to put the insurance industry on trial and to maximize
punitive damages. In the context of discovery, the insured pursuing an institutional bad faith claim will seek
documents outside the confines of the claim itself. Fortunately, there are several techniques to limit this type
of discovery.
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A. Know It When You See It
The following are examples of discovery requests that may be used to support an institutional bad
faith claim:
1) Corporate financial goals
2) Personnel files
3) Expense and indemnity tracking
4) Reserving and reinsurance practices
5) Claim valuation software
6) Employee compensation/bonuses/incentives
7) Identities of insureds with similar claims
8) Identification of litigation involving similar claims
9) Record retention policies
10) Claims/underwriting/training manuals
11) Corporate affiliates and organizational structure
B. Challenge Relevance
A bad faith claim must show that the insurer unreasonably handled the insured’s claim. At its core,
it is a dispute about the handling of a single claim. Thus, any attempt to exceed the bounds of the single claim
is subject to a relevance attack. The policyholder must be able to articulate how the requested discovery could
have a nexus to how his claim was handled.
In Isilon Systems, Inc. v. Twin City Fire Insurance Co., 2012 WL 503852 (W.D. Wash. Feb.15, 2012)
(slip op.), the insured requested copies of reinsurance policies and communications between Twin City and
its reinsurers. The court held that the reinsurance policies had to be produced under Fed.R.Civ.P. 26(a)(1)(D).
However, it held that the insured had to make a showing of relevance in order to obtain the communications.
It noted that the insured argued that the communications would “undoubtedly bear on Twin City’s evaluations” of its claim. Isilon Systems at *3. Twin City presented evidence that the reinsurance policy was part of a
block of business that was subject to treaty reinsurance. Id. The court held the policyholder’s explanation did
not suffice to evidence relevance because there was “no reason to believe that Twin City’s reinsurance decisions are made at a specific, not a general level.” Id.
Many courts appear to be permitting discovery of other claims files, provided the claims and policies are sufficiently similar. See, Southard v. State Farm Fire and Cas. Co., 2012 WL 2191651 (S.D. Ga. June
14, 2012) (reluctantly granting motion to compel similar claims files based on the general breadth of discovery and the relatively limited request for four specific claims files). However, an overbroad request for other
claims files may still be rejected on relevancy grounds. In St. Paul Reinsurance Co. v. Commercial Financial
Corp., 197 F.R.D. 620 (N.D. Iowa 2000), the policyholder sought discovery of information regarding other bad
faith claims against the insurer, asserting that they would supply evidence of the insurer’s knowledge that its
conduct was unreasonable. The court, however, focusing on the single bad faith claim before it, concluded that
the only relevant question was whether the insurer knew or had reason to know that its denial was unreasonable, and to permit the discovery of other bad faith claims amounted to little more than “a ‘fishing expedition’
with little to no relevance to the merits of the bad faith claim as framed by the party asserting it.” St. Paul, 197
F.R.D. 644.
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C. Keeping Discovery Within State Lines
When State Farm Mutual Automobile Co. v. Campbell, 538 U.S. 408, 123 S.Ct. 1513, 155 L.Ed.2d 585
(2003), was issued, insurers were somewhat successful in arguing that the policyholder could not discover
claims arising in a different state. State Farm held:
A State cannot punish a defendant for conduct that may have been lawful where it occurred . . .
. Nor, as a general rule, does a State have a legitimate concern in imposing punitive damages to
punish a defendant for unlawful acts committed outside of the State’s jurisdiction.
State Farm, 538 U.S. at 421. However, the court also held:
Lawful out-of-state conduct may be probative when it demonstrates the deliberateness and culpability of the defendant’s action in the State where it is tortious, but that conduct must have a
nexus to the specific harm suffered by the plaintiff.
State Farm, 538 U.S. at 422. Thus, while it appears the insured may be able to seek discovery of the insurer’s
conduct on claims arising outside the state, the insured must be able to articulate a nexus to the specific harm
he claims.
In Signature Development, LLC v. Mid-Continent Casualty Co., 2012 WL 4321322 (D.S.D. Sept. 18,
2012) (slip op.), the policyholder in a South Dakota bad faith claim, sought discovery of prior litigation in
which the insurer had been involved for an eight-year time period, without restricting the request to cases in
South Dakota. The court, over the objection of the insurer, allowed the discovery. It reasoned that while evidence of out-of-state practices was not admissible for the purpose of pursuing punitive damages, it the context
of the bad faith claim, it was potentially admissible for the purpose of determining whether the insurer acted
knowingly or recklessly. Signature Development at *18.
It is likely that the number of cases in South Dakota, in which [the insurer] was involved, that
included a bad faith or breach of contract claim, are very few. Furthermore, it is not very likely
that the total number of cases that [the insurer] was involved in outside the state of South
Dakota, which involved breach of contract or bad faith claims, are particularly overwhelming.
Therefore, the court finds that [the insured] is entitled to discovery on claims files and transcripts outside the state of South Dakota.
Signature Development at *18. The court’s willingness to speculate on the extent of the burden of production
and the nexus between any bad faith or breach of contract claim and the claim at issue is troubling. It also
serves as a caution to abundantly support opposition to such discovery requests with specific facts as to the
scope of time and expense such a request generates, as well as to focus the court on the policyholder’s burden
to prove a nexus for the requested documents.
D. Keeping It Confidential
Requests for production of personnel files and other claims files implicate confidentiality concerns.
Personnel files may contain patently irrelevant health information, financial information and personal identification information, such as the employee’s Social Security number, address and bank account numbers.
Unrelated claims files may contain similar information. Courts generally will not reject a discovery request
solely on confidentiality grounds, but they will fashion safeguards for the production.
In Moe v. System Transport, Inc., 270 F.R.D. 613 (D. Mont. Sept. 30, 2010), the insured requested copies of employment contracts and documentation of monetary recognition given to the self-insurer’s employees. The court recognized that the requested documents could contain personal information of people who
were not parties to the case. It ordered the production of the documents, but allowed the self-insurer to
Discovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 47
“redact any irrelevant sensitive personal or private identifying information contained” in any responsive document. Moe, 270 F.R.D. at 621.
More commonly, however, the parties in a bad faith case will enter into a confidentiality or protective
order early in the case. Such an order allows for the confidential production of documents without redaction,
so long the documents are properly marked per the order. The order will also typically extend to proprietary
information and trade secrets.
E. It’s a Big Hassel
Insurers have been somewhat successful in eliminating institutional bad faith discovery by asserting
undue burden and harassment under Fed.R.Civ.P. 26(b)(2)(C). In Williston Basin Interstate Pipeline Co. v. Factory Mutual Insurance Co., 270 F.R.D. 456 (D.N.D. 2010), the policyholder sought information on other claims
involving the issue of multiple occurrences for a ten-year period. The insurer attacked the requested discovery
on the grounds of relevancy, confidentiality and undue burden. Williston Basin, 270 F.R.D. at 465-66. Rejecting the insurer’s relevancy and confidentiality arguments, the court nonetheless held that the request constituted an undue burden and significantly narrowed the request.
First, [the insured’s] request for all cases and prior claims in which the number of occurrences
has been an issue is overbroad. [The insured] has not demonstrated that all such cases and
claims would be sufficiently analogous to the case here such that any potential benefit outweighs
the burdens of the discovery. . . . Second, the court concludes that, even after a narrowing of
the prior claims by subject matter, an inspection of each individual claim file in a hunt for cases
where multiple occurrences might have been an issue is not justified by the burden in time and
expense. Third, the volume of information that [the insured] is requesting, particularly with
respect to the interrogatories, is likely to take months to complete and significantly delay the
trial of this case.
Williston Basin, 270 F.R.D. at 466-67.
In order to pursue a judicial determination that the requested discovery is overbroad and unduly
burdensome, affidavits or other evidence should be prepared and presented to the court. This evidence should
outline the cost in of the discovery in terms of both time and employee man hours. The evidence should also
inform the court approximately how many files will have to be searched and whether they can be searched
electronically or if it will require a hands-on search. If the search will, as it would have in Williston Basin, significantly delay discovery and trial, the court should be informed. Counsel for the insurer should also be prepared to reasonably compromise.
VI. E-Discovery in the Bad Faith Case
With the issuance of the Zubulake decisions in 2003 and 2004, and the adoption of amendments to
the Federal Rules of Civil Procedure specifically dealing with e-discovery in 2006, e-discovery is here to stay.
It is also particularly relevant to the bad faith case. The insurance industry is increasingly “paperless” and
“virtual”. A report by The Conference Board, a non-profit business and research association, found that the
proportion of employees who work predominantly from a remote location has more than tripled in many
industries. The Incredible Disappearing Office, Abel, Amy Lui and Levanon, Gad (May 2012). For insurance
underwriters, the proportion who work from a remote location increased 275 percent over the last decade. Id.
The increase in telecommuting employees and paperless files results in the potential for scattered electronic
communication and discoverable material.
48 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
A. Issue the Litigation Hold (and Supplement It When Necessary)
The duty to preserve evidence arises not when a lawsuit is filed, but when litigation is reasonably
anticipated. See, Trask-Morton v. Motel 6 Operating L.P., 534 F.3d 672, 681 (7th Cir. 2008). The first step in the
e-discovery process is the issuance of a “litigation hold”. A litigation hold is a written order issued by the party
to its employees who may have access to evidence potentially relevant to the lawsuit. It also will serve as a
notice to cease the routine destruction of electronic data which may be evidence in the litigation.
Counsel for the insurer must be involved in this process. See, Zubulake v. UBS Waring, LLC (“Zubulake V”), 229 F.R.D. 422 (S.D.N.Y. 2004). Counsel for the insurer must inform the insurer of its obligation to
preserve evidence and ensure that the litigation hold is communicated to (1) adjusters who handled the claim;
(2) supervisors who oversaw the claim; (3) administrative or support staff for the adjuster and supervisor; (4)
anyone who communicated with the insured; (5) any outside counsel who provided legal or investigative services; and (6) anyone else who may have knowledge of any particular practice or policy at issue in the litigation.
Finally, even though a litigation hold is issued at the beginning of litigation, it may become necessary
to supplement it. If review of the records indicates that people not initially served with a litigation hold are
potentially in possession of evidence, a litigation hold letter should be issued to them. Likewise, if discovery
reveals an issue not considered in the original litigation hold, it should be supplemented and recirculated to
all recipients.
B. Understand the Insurer’s Document Retention Policy and Electronic Data
Systems
E-discovery does not require perfection from the parties and their attorneys, but it does require vigilance and understanding of the insurer’s systems. Fed.R.Civ.P. 37(e) creates a “safe harbor” for the routine
destruction of electronic data prior to anticipation of litigation: “Absent exceptional circumstances, a court
may not impose sanctions under these rules on a party for failing to provide electronically stored information
lost as a result of the routine, good-faith operation of an electronic information system.” Thus, it is critical to
understand the insurer’s document retention policy in order to defend it should the question arise.
Even if the destruction of documents is never an issue, the attorney for an insurer must understand
her client’s electronic data systems in order to effectively comply with her e-discovery obligations. What software is the insurer using and for what purpose? How and where is information about the claim and the underwriting of the policy stored? How will the client get this information to you for review and production? Does
the client utilize software that requires a license for you to review it? Does your client have an IT employee it
can assign to assist you with e-discovery questions and issues? Make these arrangements as early as possible
because the amount of time to review and produce e-discovery can be enormous.
C. Understand and Communicate the Consequences of Failure to Cooperate
in E-Discovery
A recent decision by the District Court for the Northern District of Indiana illustrates the danger of
incomplete piecemeal production of electronically stored information. In Illiana Surgery and Medical Center,
LLC v. Hartford Fire Insurance Co., 2012 WL 2049828 (N.D. Ind. June 5, 2012) (slip op.), an unknown person
accessed and destroyed Illiana’s computer system. Illiana at *1. Illiana made a claim under a commercial property policy issued to it by Hartford that included business personal property coverage and coverage for electronic vandalism. Id. Illiana filed a bad faith and breach of contract complaint against Hartford two years later,
apparently with no decision having been made on the claim. Id.
Discovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 49
At an early status conference, the court ordered Hartford to produce the claims file, policies at issue
and transcripts of examinations under oath. Id. Hartford produced documents it represented as its claims file,
with a privilege log, which it later supplemented. Id. Illiana moved to compel and Hartford produced additional documents relating to the claims file. Id. In preparation for a deposition of Hartford’s primary adjuster
on Illiana’s claim, Illiana’s attorneys realized that part of the claims file was still missing. Id. Upon Illiana’s
inquiry, Hartford produced over 1,000 new documents relating to the claims file. Id. Illiana realized that several attachments to emails were missing from the production and again requested documents. Id. Hartford
represented the claims file as complete, but eventually produced 53 new documents, totaling 330 pages. Id.
Days before another Hartford employee’s deposition, Hartford produced an additional 441 documents, none
of which were listed on its privilege log. Id. As a result, the trial judge sanctioned Hartford for failing to comply with its orders compelling production. Id. He also re-opened discovery to allow Illiana to gather any
remaining information. Id.
Illiana’s new discovery included a notice for a 30(b)(6) deposition of a representative of Hartford with
knowledge of how it maintained its electronically stored information. Illiana at *2. Hartford filed a motion for
a protective order, arguing that the deposition would be irrelevant and unduly burdensome because it would
require Hartford to appoint and prepare several representatives. Id. Specifically, Hartford argued that the
information sought could be obtained through less burdensome measures. Illiana at *3. However, the court
rejected the argument, noting that Hartford had not suggested any less burdensome methods, offered any
alternative witness or made a showing of additional expense. Illiana at *4. The court also found the information sought relevant to Illiana’s bad faith claim because it would aid Illiana in determining whether the entire
claims file had been produced. Illiana at *4. Finally, Hartford sought to limit the deposition to its document
retention processes in place since 2006, rather than 2004 as Illiana requested. Id. Hartford argued that because
the Federal Rules of Civil Procedure did not mandate production of ESI prior to 2006, Illiana should not be
permitted to conduct e-discovery before that date. Id. The court held that Hartford was missing the point:
Illiana is seeking general information about the method of locating and preserving electronic
and non-electronic documents pertaining to its claim, which dates back to 2004. It is irrelevant
that the Federal Rules did not require production of such information before 2006. Illiana is not
asking Hartford to produce any documents or punish Hartford for failing to retain any documents it was not required to maintain. Illiana simply is attempting to find out the methods that
were used to retain and store the information, which may suggest whether it has all the information it sought throughout the course of discovery or whether additional documents may have
existed. The retention of documents also may be relevant to Illiana’s bad faith claim.
Illiana at *4.
With apologies to Jane Austen, it is a truth universally acknowledged that e-discovery, by its nature,
is burdensome and expensive for clients and their attorneys. Pride and Prejudice, Austen, Jane, 1813. However,
the Illiana case should be enough to scare us straight. The consequences of incomplete, piecemeal discovery
may be sanctions and the re-opening of discovery, resulting in a far heavier burden than doing a complete and
timely initial production.
D. Understand and Communicate the Consequences of Spoliation
Apart from failure to cooperate, the consequences of spoliation of electronically stored information
can also be severe. Spoliation is “the destruction or significant alteration of evidence, or the failure to preserve property for another’s use as evidence, in pending or future litigation.” West v. Goodyear Tire & Rubber
Co., 167 F.3d 776, 779 (2nd Cir. 1999). A court may sanction a party for spoliation of evidence in violation of a
50 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
court order under Rule 37(b), Fed.R.Civ.P. However, even if the spoliation is unrelated to a court order, a court
may sanction a party through the court’s “inherent power to control litigation.” West, 167 F.3d at 779.
The Zubulake opinions, authored by Judge Shira Scheindlin of the Southern District of New York,
were the first big wave of cases imposing stiff monetary and procedural penalties on parties who destroyed
relevant electronically stored information (“ESI”). In Zubulake V, supra, UBS Waring could not produce several relevant emails that had been destroyed after suit was filed. Zubulake V, 229 F.R.D. at 426-27. Judge
Scheindlin ordered that as sanctions, she would give a jury instruction at trial permitting the jury to infer
that emails not produced by UBS Waring were unfavorable to it. Id. at 437. She also allowed the plaintiff to redepose two witnesses whose emails were produced significantly late in the litigation and awarded the plaintiff
attorney’s fees and costs associated with the depositions. Id.
In Coleman (Parent) Holdings, Inc. v. Morgan Stanley & Co., Inc., 20 So.3d 952 (Fla.App. 4th Dist.
1009), review denied 37 So.3d 846 (Fla. 2010), Coleman alleged conspiracy between Sunbeam and its investment banker, Morgan Stanley, to misrepresent Sunbeams’ financial health in a deal in which Coleman sold its
assets in return for Sunbeam stock. Sunbeam went bankrupt two years after the deal and Coleman sued Morgan Stanley for misrepresenting Sunbeam’s worth. During the course of the litigation, Morgan Stanley was
sanctioned for discovery misconduct in the production of emails and backup tapes. The trial court, as a sanction, granted partial summary judgment to Coleman and shifted the burden of proof to Morgan Stanley to
prove it was not a part of a conspiracy. The result at trial was a $1.5 billion compensatory and punitive damage
award. Coleman, 20 So.3d at 954.
The Florida Court of Appeals, however, reversed on the ground that Coleman failed to prove its damages. Id. Coleman attempted to obtain a new trial by alleging fraud on the court when Morgan Stanley presented notices in the post-verdict phase which allegedly contradicted its statements during discovery motions.
Id. The trial court denied the motion and the Court of Appeals affirmed, finding that any misrepresentations
did not affect Coleman’s ability to prove its damages. Coleman, 20 So.3d at 958-59.
An alternative, but equally frightening, spoliation remedy was crafted by Judge Lee Rosenthal in
Rimkus Consulting Group, Inc. v. Cammarata, 688 F.Supp.2d 598 (S.D. Tex. 2010). In Rimkus, a forensic engineering contractor sued two former employees under a noncompetition employment agreement. The court
found that the defendants destroyed several emails just prior to Rimkus’s suit being filed, but found that the
emails should have been preserved because, although suit had not yet been filed, the employees were already
contemplating filing their own suit. Rimkus, 688 F.Supp.2d 641-42. Ultimately the court found that there was
sufficient evidence of willful spoliation to allow a jury to determine whether the emails were intentionally
deleted in order to prevent their use as evidence in the employment litigation. It crafted a jury instruction that
allowed the jury to decide (1) whether the defendants’ actions were intentional; (2) whether the destroyed
emails were relevant and (3) whether the plaintiff was prejudiced by the destruction of the emails. Rimkus,
688 F.Supp.2d at 645-47. Judge Rosenthal also ordered the defendants to pay the plaintiff ’s fees and expenses
incurred in investigating the spoliation issue and obtaining some of the emails from third parties. Id.
Finally, in Victor Stanley, Inc. v. Creative Pipe, Inc., 269 F.R.D. 497 (D.Md. 2008), a federal magistrate,
faced with a party’s admitted, willful destruction of ESI that resulted in prejudice to the other party, seriously
considered, among other remedies, referring the matter for prosecution of criminal contempt of court. Victor Stanley, 269 F.R.D. at 539-40. While the court ultimately rejected a criminal contempt sanction as unduly
burdensome and ineffective, it ordered the offending party in civil contempt, punishing him to two years in
prison, unless and until he paid the other party’s attorneys’ fees and costs associated with the investigation of
destroyed ESI and the party’s motion for sanctions. Victor Stanley, 269 F.R.D. 540-41.
Discovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 51
The cases presented in this article represent some of the extremes. In a case involving purely negligent failure to retain one or a few documents, courts will generally not impose sanctions. But the lesson here
is obvious: the courts are fed up with sloppy e-discovery compliance. The attorney for an insurer in a bad faith
case needs to get out in front of the e-discovery process, meet and confer with opposing counsel (however distasteful that may sometimes be) and make diligent efforts to comply with e-discovery requirements.
E. Easing the Pain of E-Discovery Through Cost-Shifting
Part of the burden of e-discovery is the often tremendous cost, in dollars and time, for diligent compliance. However, if the insured demands e-discovery that is beyond the insurer’s reasonable production obligations, the insurer can move for protective order to shift or allocate costs of e-discovery.
In Shevlin v. Phoenix Life Insurance Co., 2012 WL 1981793 (D. N.J. June 1, 2012), the plaintiffs
brought an action against Phoenix alleging that Phoenix’s demutualization failed to satisfy their “reasonable
dividend expectations”. Shevlin at *1. During discovery, plaintiffs sought to force Phoenix to conduct a search
of its electronic data systems using specific search terms it proposed. Id. The magistrate judge hearing the
discovery issue ordered the search to be conducted, but also ordered that the plaintiffs would bear the costs
of the search. Id. Phoenix supplied plaintiffs with a cost estimate that included: “(1) $3,000-$4,500 to search
for and retrieve ESI; (2) $7,600-$10,250 to process the ESI data into an appropriate electronic format; and (3)
$250,000-$300,000 to review these documents for responsiveness and privilege, on the ESI is retrieved and
processed.” Id. (citation omitted).
Plaintiffs objected to paying the expense of attorney review of the ESI for responsiveness and privilege. The magistrate judge held that the reasonable costs associated with the ESI production included the costs
of attorney review. Shevlin at *2. Upon review, the trial court remanded the matter to the magistrate to conduct a factual review of the factors supporting the decision to shift the cost of attorney privilege review. Id. It,
however, noted that some jurisdictions supported cost shifting, citing to In re Aspartame Antitrust Litig., 817
F.Supp.2d 608, 615 (E.D.Pa. 2011) (“Because a privilege screen is simply a keyword search for potentially privileged documents, we award that cost as well.”), while others do not permit it, citing to Zubulake v. UBS Waring, LLC, 216 F.R.D. 280, 290 (S.D.N.Y. 2003) (“the responding party should always bear the cost of reviewing
and producing electronic data once it has been converted to an accessible form.”). Id.
Rule 26(b)(2)(B) requires that the court conduct a proportionality review. “[T]he party from whom
discovery is sought must show that the information is not reasonably accessible because of undue burden or
cost. If that showing is made, the court may nonetheless order discovery from such sources if the requesting
party shows good cause, considering the limitations of Rule 26(b)(2)(C). The court may specify conditions
for the discovery.” Fed.R.Civ.P. 26(b)(2)(B). The advisory committee’s notes to the rule indicate that one of the
conditions for such discovery may be “payment by the requesting party of part or all of the reasonable costs
of obtaining information from sources that are not readily obtainable.” Fed.R.Civ.P. 26, advisory committee’s
notes, 2006.
Making reasonable, good faith efforts to comply with e-discovery obligations may favorably influence
a judge deciding whether a policyholder is entitled to additional e-discovery that places undue costs and burdens on the insurer. Moreover, the specter of cost-shifting may deter a plaintiff from making those demands
in the first place. Being able to provide the court with a reasonable estimate of the costs of performing the
additional discovery will play a significant role in the court’s decision as to whether the costs of the plaintiff ’s
requests outweigh the potential benefit.
52 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
VII.Conclusion
Discovery in bad faith cases runs the gamut from negligible to wake-up-at-3:00-am-thinking-aboutit intense. Handling it means triaging it early to determine strategy and pulling together resources needed to
appropriately handle it. It means, in the leveraged coverage case, shutting down the bad faith claim through
focused early discovery. In the genuine bad faith case, it means finding a discovery buddy in the client’s
employ who can assist with the heavy lifting of document production and e-discovery. It also requires the
insurer’s counsel to be vigilant for institutional bad faith claims and to ensure that the client takes e-discovery
obligations seriously, from the issuance of a litigation hold to the manageable production of e-discovery and
maintenance of privileges. Here’s hoping all your bad faith claims are dismissed on summary judgment!
Discovery, Discovery, and More Discovery: Techniques for Managing... ■ Eubanks ■ 53
Claim Manuals and Training Materials:
How to Address Them During Discovery and Trial
W. Edward Carlton
Quilling Selander Lownds Winslett & Moser, PC
2001 Bryan St., Suite 1800
Dallas, TX 75201
(214) 880-1873
ecarlton@qslwm.com
W. Edward Carlton is a shareholder in the Dallas law firm of Quilling Selander
Lownds Winslett & Moser, PC. Mr. Carlton represents business clients in complex
civil litigation. During the last ten years, his practice has focused on defending
insurers and third-party administrators against claims of insurance bad faith,
deceptive trade practices and insurance code violations. Over the last several
years, he has successfully defended to conclusion over fifty bad faith actions. Mr.
Carlton provides consultation and representation in numerous areas of insurance
coverage, including commercial general liability, professional liability, property,
environmental, workers’ compensation and employers’ liability, environmental,
directors’ and officers’ liability, uninsured/underinsured motorist liability and
umbrella liability policies. He provides representation in litigation, including
products liability defense, non-subscribers defense, catastrophic injury, and
first party property claims. He also maintains a commercial litigation practice
representing construction companies, self-insured employers and other business
entities. Mr. Carlton has served in leadership positions with the Dallas Bar
Association and on the board of directors for the Texas Association of Defense
Counsel. He has spoken extensively and has authored numerous articles on
insurance issues, and particularly on appropriate “good faith” claims handling and
common miscues that can result in bad faith allegations.
Claim Manuals and Training Materials:
How to Address Them During Discovery and Trial
Table of Contents
I.Introduction..................................................................................................................................................59
II. Claim Manuals and Guidelines....................................................................................................................59
A.Relevancy...............................................................................................................................................60
B.Limitations.............................................................................................................................................62
C.Privileges................................................................................................................................................62
D.Abatement/Bifurcation.........................................................................................................................63
E. Protective Order....................................................................................................................................64
III. Training Manuals..........................................................................................................................................65
A.Relevancy...............................................................................................................................................65
B.Privileges................................................................................................................................................65
C. Protective Order....................................................................................................................................66
IV. Underwriting Manuals and Guidelines.......................................................................................................66
A.Relevancy...............................................................................................................................................66
B.Privileges................................................................................................................................................68
C. Protective Order....................................................................................................................................68
V.Conclusion.....................................................................................................................................................69
Endnote.......................................................................................................................................................................69
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 57
Claim Manuals and Training Materials:
How to Address Them During Discovery and Trial
I.Introduction
The scope of discovery in federal and most state courts is generally construed broadly. Under the
federal rules, a party may obtain discovery regarding “any non-privileged matter that is relevant to any party’s claim or defense ….” Fed.R.Civ.P. 26(b)(1). Similarly, in Texas a party may obtain discovery regarding
“any matter that is not privileged and is relevant to the subject matter of the pending action ….” Tex.R.Civ.P.
192.3(a). See In re Weekly Homes, L.P., 295 S.W.3d 309, 313 (Tex. 2009). TRCP 192.3(b) “provides for discovery
of documents, [including] electronic information that is relevant to the subject matter of the action.” See also,
Monsanto Co. v. May, 889 S.W.2d 274, 276 (Tex. 1994) (“[a] party is entitled to discovery that is relevant to the
subject matter of the claim, and which appears reasonably calculated to lead to the discovery of admissible
evidence.”) However, courts have also consistently held that discovery should not be a “fishing expedition,”
allowing a party to plead alleged wrongdoing and then pursue discovery to support it. See, e.g., K Mart Corp. v.
Sanderson, 937 S.W.2d 429, 431 (Tex. 1996) (no discovery device can be used to “fish.”).
Given the broad standards of discovery, it is not surprising that in cases in which an insurance company is alleged to have breached a duty or covenant of good faith and fair dealing, courts have generally found
that the insurer’s “claim file,” including internal claims activity notes of the adjuster and claims documents
generated and obtained in connection with the claim, are relevant and, to the extent not privileged, will be
discoverable. See, e.g., Allstate Indemnity Co. v. Ruiz, 899 So. 2d 1121, 1123 (Fla. 2005) (Because “claim file…
presents virtually the only source of direct evidence with regard to the essential issue of the insurance company’s handling of the insured’s claim” the court ordered it disclosed).
But what about other internal insurance documents? What about claims manuals and guidelines?
Does it matter whether they govern the adjuster’s handling of the particular claim at issue? What about underwriting files or manuals? What about materials used for training adjusters with respect to handling claims?
This paper will seek to address such discovery, including a review of how courts have ruled on objections, why
and what privileges and protections might be asserted. Assuming materials are ordered to be disclosed, the
author will evaluate how production can be handled in an attempt to minimize negative impact to the insurance company.
II. Claim Manuals and Guidelines
In suits against insurance companies, including those alleging “bad faith”, policyholders frequently
seek an insurer’s claim manuals and guidelines. Ostensibly, these guidelines are sought in an attempt to establish that the adjuster violated the company’s own policies and procedures in order to prove up the insured’s
bad faith claim. More frequently, however, such materials are being used in an attempt to establish that the
insurer itself used a policy or procedure that was geared to a denial of claims or to what could be argued to
be bad faith practices. See Merlin Law Group, “Getting the Inside Scoop on Insurance Company Claims Practices,” June 18, 2010, http://www.propertyinsurancecoveragelaw.com/ (“[P]laintiffs’ attorneys who obtain
adjuster’s diaries, employee training manuals, and documents showing incentives for employees to put money
into their own pockets instead of the insureds’ pockets, are going to go a long way in proving how their
insured’s claim was improperly handled by the insurer from day one.”)
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 59
A.Relevancy
Some courts have historically limited attempts by an insured to pursue (or add value to) claims by
focusing discovery on company guidelines and practices. One of the earliest cases to address such a request
was Garvey v. Nat’l Grange Mut. Ins. Co., 167 F.R.D. 391 (E.D. Penn. 1996). In that case, National Grange
sought to protect its claims/underwriting manuals from discovery, contending they were not relevant and
were protected trade secrets. A Pennsylvania federal district judge granted a protective order that prohibited
discovery of the manuals, noting as follows: “The contents of these manuals do not pertain to whether the
plaintiff ’s present claim for loss is ‘covered’ under the insurance contract issued by the defendant. Moreover,
the fact that the defendant may have strayed from its internal procedures does not establish bad faith on the
part of the defendant in handling the plaintiff ’s loss.” Id. at 396.
This ruling was consistent with the general belief, at least at the time, that discovery was to be
focused on individual claims handling as opposed to company business policies and practices. See Kosierowski v. Allstate Ins. Co., 51 F.Supp.2d 583, 594 (E.D. Pa. 1999) (“The court agrees that the bad faith statute
is not intended to be a means for individual plaintiffs to attack an entire insurance industry.”). See also, Hyde
Ath. Indus. v. Cont’l Cas. Co., 969 F.Supp. 289, 307 (E.D. Pa. 1997) (“What constitutes a reasonable set of business practices for the investigation and evaluation of claims is a question properly left to the [State] Insurance
Commissioner, not a judge or a jury.”).
However, less than a year after Garvey, a California appellate court, in a matter of first impression for
that state, came to the opposite conclusion. In Glenfed Dev. Corp. v. Superior Court, 53 Cal.App.4th 1113, 62
Cal.Rpt.2d 195 (Cal.App. [2nd Dist.] 1997), the court, noting that claims manuals have generally been recognized as being admissible in coverage actions, determined, based upon relevancy, that a claims manual was
discoverable in connection with breach of contract and breach of implied covenant of good faith and fair dealing claims against National Union with respect to alleged coverage for a construction defect. Id. at 1117. “... it
makes no sense to suggest that the book designed to serve as the instruction manual for the carrier’s employees would be completely silent about policy terms. If nothing else, the claims manual may show how [the
insurer] understood and intended to apply the standard language used in the CGL policies ...” Id. at 1118.
In 2000, a Pennsylvania federal judge also distinguished the Garvey decision in Jones v. Nationwide
Ins. Co., 2000 WL 1231402, *3-4 (M.D. Pa. 2000).
The [insurer] argues that the claims manuals in the present case should not be discov­erable,
based on Garvey v. National Grange Mutual Insurance Co., 167 F.R.D. 391, 396 (E.D.Pa.1996).
The Garvey case, however, is distinguishable and we find that it does not apply to the instant
matter. First, the [insurer] in that case provided copies of the docu­ments to the court to be
reviewed in camera, and the [insurer] in the instant case has not provided manuals to the [Special Master] for review. [citations omitted]
Second, in Garvey, the contents of the claims manuals did not pertain to the underlying issues
that were pertinent in that case, and therefore, the manuals had little relevancy. [cita­tions omitted] The instant case, however, is a different situation, as the insurer alleged that it had a reasonable basis for handling and investigating the claim. By alleging this defense, the [insurer] has
made the claims manuals highly relevant.
The Garvey case can also be distinguished, as in that case, the court found that there had been
no evidence of bad faith. [citations omitted] That has not occurred in the present case, where the
bad faith claim remains a major issue. Finally, the court in Garvey determined that the [insured]
had the opportunity to depose the [insurer]’s employees who were actu­ally involved in the claim.
60 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
However, we find that in the instant case, a deposition on oral rec­ollection alone is insufficient
without accompanying documentation.
Another Pennsylvania federal district court decision, Saldi v. Paul Revere Life Ins. Co., 224 F.R.D.
169 (E.D. Penn. 2004) is often cited by plaintiffs in support of a motion seeking discovery of claims manuals
and other materials of the insurer related to the insurer’s policies and practices in general. In the Saldi decision, the judge cites a number of federal court decisions from Pennsylvania and other jurisdictions and goes
to great lengths to support the position that broad discovery of an insurance company’s internal practices
and procedures should be allowed, limiting the production order only with respect to the time period during
which plaintiff ’s claim was handled and including a protective order to prevent disclosure outside of the suit.
Id. at 178.
In Grange Mut. Ins. Co. v. Trude, 151 S.W.3d 803 (Ky. 2004), the Kentucky Supreme Court addressed
discovery requests including those for manuals that contained Grange Mutual’s internal policies and procedures for evaluating and adjusting claims. In supporting its relevance argument, Grange cited Garvey, supra.
However, the Kentucky Supreme Court determined that the question in that case was not whether the insurance adjuster may have strayed from internal procedures. Instead, it was whether the insurer’s own policies,
as described in the manuals, embodied or encouraged bad faith practices. Thus, the court held that the training and policy manuals were relevant, and absent some sort of privilege or other showing of irreparable harm,
they were discoverable. Id. at 813.
Following the above or similar reasoning, recent courts have held that claims manuals and guidelines
may be discoverable. In U.S. Fire Ins. Co. v. City of Warren, 2012 WL 1454008 (E.D. Mich. Apr. 26, 2012), the
City, among other materials, sought claims manuals and guidelines from certain insurers. The insurers argued
that the information was not relevant. The court disagreed, noting that “internal claims manual or claims
processing guidelines may contain information relevant to resolving any ambiguities in the [insurance] contract….” Id. at *9. Accordingly, the documents were ordered to be produced subject to a stipulated confidentiality order that had been entered into between the parties. Id.
Similarly, in Beazer Homes Corp. v. Hartford Fire Ins. Co., et al., 2012 WL 6210323 (D. S.C. Dec. 13,
2012), a federal magistrate judge concluded that internal insurance documents requested, including claims
handing guidelines, were relevant. Beazer Homes involved a claim by plaintiff that it was an additional insured
under a number of subcontractors’ liability policies and that defendants had a duty to defend and indemnify it
against claims of construction defects in a separate action. After written discovery was exchanged, the magistrate judge addressed several motions, including plaintiff ’s motion to compel production of (1) underwriting
files; (2) underwriting guidelines; and (3) claims handling guidelines for various years from various insurers.
Id. at *1.
With respect to the claims handling guidelines, plaintiff alleged that such guidelines provided insight
as to what the insurance carrier deemed to be good faith, reasonable conduct and might provide specific
timeframes within which particular actions were required by the adjusters handling the claims. According to
plaintiff, whether defendants complied with their own guidelines was relevant and probative as to whether
defendants acted in good faith. In response, insurers argued that: the coverage dispute was limited to the
scope and the amount of the defense obligation and guidelines had no bearing on these issues; and plaintiff ’s
bad faith cause of action had no merit. Id. at *4.
The magistrate, noting the broad scope of discovery under the Federal Rules of Civil Procedure and
the burden on defendants to show the documents requested were not discoverable, concluded that defendant
insurers’ claims handling guidelines were relevant to the handling of plaintiff ’s claims and therefore granted
plaintiff ’s motion to compel. Id. at *4-5.
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B.Limitations
The insurer should not limit its objection to discovery of claims manuals on relevancy grounds, as
courts generally appear willing to find that discovery of claims manuals may be relevant. See, e.g., Platt v. Fireman’s Fund Ins. Co., 2011 WL 5598359 (E.D. Penn. Nov. 16, 2011) (citing Kaufman v. Nationwide Mut. Ins.
Co., 1997 WL 703175 (E.D. Penn. Nov. 12, 1997) (certain claims manuals may be relevant if they pertain to
instructions and procedures for adjusting claims which were given to the adjusters who worked on [Plaintiff ’s] claim)); Safeco Ins. Co. of America v. MES, Inc., --- F.R.D. ---, 2011 WL 6102014 (E.D. N.Y. Dec. 7, 2011)
(claims manuals were relevant to Defendant’s claim that Safeco acted in bad faith); Mid-Continent Cas. Co. v.
Eland Energy, Inc., No. 3:7 MC 78 (CFD), 2007 WL 948154, at *1 (D. Conn. Mar. 26, 2007) (documents concerning an insurance company’s handling of particular claims are relevant to allegations of bad faith); U.S. Fire
Ins. Co. v. Bunge North America, Inc., 244 F.R.D. 638, 646 (D. Kan., 2007) (claims manuals, even those outside
the time the insured’s claims were handled, could be probative of insurer’s policy interpretation guide­lines and
whether the claim was properly handled); JMIC Life Ins. Co. v. Henry, 922 So.2d 998 (Fla. Dist. Ct. App., 5th
Dist., 2005) (lack of relevancy of internal documents, including claim procedure manuals and training manuals, standing alone, was generally not a sufficient basis for granting certiorari relief); Evans v. United Servs.
Auto. Ass’n., 541 S.E.2d 782, 792 (2001) (court could not “say as a matter of law that the information sought is
not ‘reasonable calculated’ to lead to the discovery of admissible evidence”); Hoechst Celanese Corp. v. National
Union Fire Ins. Co. of Pittsburgh, Pennsylvania, 623 A.2d 1099, 1107 (Del. Super. Ct. 1991) (training manuals,
policy memoranda, and guidelines are relevant as they may provide evi­dence how insurers understood and
intended to apply the subject policy language).
With respect to relevancy, some courts have limited discovery to portions of claims manuals relevant
to the processing of the particular claim at issue. Adams v. Allstate Ins. Co., 189 F.R.D. 331, (E.D. Pa. 1999). In
Adams, a federal district judge in the Eastern District of Pennsylvania held that Allstate’s claims manuals were
discoverable, but only the portions relevant to processing the claim in question. Id. at 332. Similarly, while the
court determined that the insurer’s policies regarding independent medical examinations, policies regarding
the relationship with outside counsel, policies regarding uninsured/underinsured policyholders, and other
documents, including Allstate training materials, were also discoverable, the court noted that such manuals
and policies may include confidential information and therefore ordered that plaintiff keep all such information confidential. Id.
Thus, the insurer should attempt to limit the disclosure to those claim manuals of the same subject
matter as the subject claim and to those manuals, or portions of manuals, applicable to the handling of the
subject claim. See Kaufman v. Nationwide Mut. Ins. Co., 1997 WL 703175, at *2 (E.D. Pa. Nov. 12, 1997) (discovery limited to portions of manuals that contained instructions concerning procedures used by adjusters in
handling claims); Bell v. Allstate Ins. Co., 2004 WL 1240627, at *3 (E.D. Pa. 2004) (discovery limited to those
claims manuals given to employees that handled the subject claim); Safeguard Lighting Sys., Inc. v. North Am.
Specialty Ins. Co., 2004 WL 3037947, at *3 (E.D. Pa. 2004) (insurer not required to produce entire library of
insur­ance literature/claims manuals, but only materials given to adjusters who worked on plaintiff ’s claim).
This minimizes both the potential harm and burden to the insurer from having to disclose these materials.
C.Privileges
To the extent applicable, the insurer should also seek protection of claims manuals based upon an
applicable privilege, such as trade secrets. See Tustin v. Motorists Mut. Ins. Co., 668 F.Supp.2d 755 (N.D. W. Va.,
Nov. 10, 2009) (court, without citing any authority, refused to seal claims manual documents, stating that such
62 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
documents “are a part of discovery in most, if not all, insurance bad faith cases” and that defendant did not
follow law to assert any privilege).
If a privilege is asserted, however, the insurer must be able to provide evidentiary support for this
claim. In McCallum v. Allstate Property & Casualty Ins. Co., 204 P.3d 944 (Wash. Ct. App. Div. 2, 2009), a trial
court judge had initially granted Allstate a protective order with respect to Allstate’s claim manuals, claim bulletins, CCPR implementation training manuals, and the “McKenzie” documents.1 The order limited use of the
documents to the subject litigation and limited distribution of the documents to plaintiff, her counsel and her
experts. Pursuant to that protective order, Allstate provided the documents requested. Id. at 418.
Plaintiff ’s counsel then deposed two representatives of the insurer, who had provided declarations to
support Allstate’s claim that the documents at issue were confidential, commercial information and/or trade
secrets. In plaintiff ’s depositions of the insurer’s representatives, those representatives made several admissions as to lack of knowledge with respect to manuals and procedures and specifically whether the insurer’s
processes were unique or that its competitors would want them. Based upon this deposition testimony, plaintiff then moved the court to vacate its prior protective order, which the court did. Id.
Allstate appealed. While the Washington Court of Appeals agreed that Allstate had made reasonable
efforts to maintain the secrecy of the documents at issue (one element of a trade secret), the court found that
the original declarations of the insurer’s representatives failed to provide concrete examples to illustrate how
Allstate’s strategies or procedures in handling claims were materially different from those of its competitors
and therefore did not establish that documents were trade secrets, warranting protection. Nevertheless, the
trial court in its discretion had originally granted the protective order. However, once the representatives testified inconsistent with their previous declarations, the court concluded that the declarations were not credible and the insurer had not provided any additional affidavits or testimony with concrete examples of why the
trial court should consider the documents to be trade secrets and/or confidential materials. Accordingly, the
Court of Appeals held that the trial court had properly vacated the protective order. Id. at 426-28.
See also Grange Mut. Ins. Co. v. Trude, 151 S.W.3d 803 (Ky. 2004) (the court noted that Grange had
only made a conclusory statement that documents contained proprietary trade secrets, and without the documents themselves or a sufficient description of their contents, the court considered this a blanket, vague claim
of privilege that was insufficient); Safeco, 2011 WL 6102014 at *___ (insurer did not establish claims manuals
were privileged attorney-client communications or work-product).
D.Abatement/Bifurcation
If a determination with respect to insurance coverage has not been reached, and the jurisdiction
allows it, the insurer should consider an objection with respect to discovery in connection with the bad faith
allegations until a final determination has been made as to all coverage aspects of the underlying claim. Additionally, or alternatively, a bifurcation (through severance or separate trials) of and abatement of the bad faith/
extra-contractual claims should be considered. In State Farm Mut. Auto Ins. Co. v. O’Hearn, 975 So.2d 633
(Fla.App. [2nd Dist.] 2008), the Court held that the insurer’s underwriting file and claim file were not subject to discovery in the insured’s bad faith action against an automobile insurer until the insurer’s liability for
uninsured motorist (UM) coverage and the amount of the insured’s damages were finally determined. Id. at
637. A number of Florida courts have held that discovery which concerns only potential issues of bad faith or
other purported improprieties in defending a claim are wholly impermissible unless and until it is determined
that the policy provides coverage, see Granada Ins. Co. v. Ricks, 12 So.3d 276 (Fla. Dist. Ct. App. [3rd Dist.],
2009) (citing Allstate Ins. Co. v. Langston, 655 So.2d 91, 94 (Fla. 1995) for the proposition that “discovery
requests [for] – internal procedural memos, claims manuals, and standards for proper investigation of claims
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 63
– do, as the District Court noted, appear irrelevant.”). (But see D’Aprile v. UNUM Life Ins. Co. of America, 2010
WL 3340197 (M.D. Fla. Aug.25, 2010) (although ostensibly denying discovery of an insurer’s claims handling
practices, policies and protocols in a breach of contract claim, court allowed plaintiff to discover rules, guidelines, protocols, standards and criteria used by insurer in processing plaintiff ’s claim).
In Dahmen v. American Family Mut. Ins. Co., 635 N.W.2d 1 (Wis. Ct. App. 2001), a Wisconsin appellate
court allowed bifurcation. There, the insurer denied the insureds’ claim for UIM coverage. The appellate court
held that the trial court erroneously denied the insurer’s motion to bifurcate the bad faith claims and to stay bad
faith discovery because (1) the failure to bifurcate a claim of bad faith from an underlying claim for UIM benefits would significantly prejudice the insurer; (2) the two distinct claims presented differing evidentiary requirements that increased the complexity of the issues and the potential for jury confusion; and (3) a sepa­rate initial
trial on the claim of UIM benefits increased the prospect of settlement and promoted economy by narrowing the
issues for the jury and potentially eliminating the need for a later trial on the bad faith claim. Id. at 553.
However, in Consugar v. Nationwide Ins. Co. of America, 2011 WL 2360208 (M.D. Pa. June 9, 2011),
a federal district judge refused to bifurcate a UIM case from the bad faith claims and withhold discovery of
the claims manuals until the end of the UIM case. Although, as the Defendant pointed out, such procedure
was appropriate in Pennsylvania state court, there was no such requirement in federal court. Thus, according
to the court, the defendant, having removed the case to federal court, was deemed to have chosen this forum
“and must accept the consequences.” Id. at *6.
In the recent case of Henderson v. Property & Casualty Ins. Co. of Hartford, 212 WL 3730533 (D. Nev.
Aug. 28, 2012), a federal magistrate judge addressed the issue of whether an insurer was required to produce
its claims file, claims manuals, training manuals, documents relating to bonuses, and complaints filed against
the insurer in connection with an uninsured motorist suit claiming both breach of contract and breach of the
covenant of good and fair dealing. Hartford argued that the adjuster’s claims notes were not relevant or discoverable with respect to plaintiff ’s breach of contract claim and requested that the court order discovery to
be conducted in phases to avoid future disputes about the appropriate scope of discovery in connection with
the breach of contract claims versus the bad faith claims. Id. at *5. Noting that the district judge had once dismissed plaintiff ’s extra-contractual claims, and that plaintiff sought broad discovery relevant only to these
extra-contractual claims, the Court granted the motion to bifurcate while dispositive motions by the insurer
were pending. Thus, the insurer was not required to further respond to discovery with respect to claims manuals, training manuals, bonuses, and other complaints. Id. at *7. However, the magistrate judge also held that
the claims file was relevant and discoverable with respect to plaintiff ’s breach of contract claim and ordered
the insurer to produce its complete claims file in phase one discovery. Id.
E. Protective Order
Finally, any production of the claims manual ordered should be subject to a protective order. In Platt
v. Fireman’s Fund Ins. Co., 2011 WL 5598359 (E.D. Pa. Nov. 16, 2011), the Court allowed discovery of certain
claims manuals after determining they may be relevant, but ordered the materials to be kept confidential. Id.
at *2. Thus, early in the discovery process, attempts should be made by the insurer to reach an agreement with
the insured with respect to such an order. In addition to claims manuals, other confidential proprietary business information, such as underwriting manuals and materials, and training manuals, should be included to
protect that information from widespread disclosure that could greatly prejudice the insurer. See also U.S. Fire
Ins. Co. v. Bunge North America, Inc., 244 F.R.D. 638, 646 (D. Kan. 2007) (court discussed possibility of potential appropriateness of modification of protective order to include “attorneys-eyes-only” designation in case
where several insurers (competitors) were parties).
64 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
III. Training Manuals
A.Relevancy
Training manuals, which at times appear to be improperly lumped into the same category as claims
procedural manuals, have been held by some courts to be relevant and discoverable in a suit alleging bad faith
claims handling. See e.g. Grange Mut. Ins. Co. v. Trude, 151 S.W.3d 803 (Ky. 2004) (training and policy manuals are relevant to bad faith claim and, absent some sort of privilege, are discoverable); McCrink v. Peoples Benefit Life Ins. Co., 2004 WL 2743420 (E.D. Pa. Nov. 29, 2004) (training, investigation and compliance manuals
relevant to processing of the claim in question found relevant).
Although not involving a bad faith suit against an insurance company, the logic of the Court in Whitfield v. Imperatrice, 2010 WL 1221409 (E.D.N.Y. Mar. 26, 2010), may be instructive. In Whitfield, plaintiff
brought a suit against court officials alleging that they had denied him access to court by refusing to disclose
certain court records. After a magistrate judge recommended denial of plaintiff ’s motion to compel discovery
and impose sanctions, the court addressed the motion, including plaintiff ’s request that defendants disclose
various policy and training manuals. Id. at *4. The magistrate had determined that plaintiff had not established that the policy and training manuals were relevant to his claims because plaintiff had not alleged any
custom, policy or practice that would have led to any alleged constitutional violations. The court held that
plaintiff had merely speculated that the requested manuals may contain some unidentified policy that might
demonstrate the existence of a conspiracy or other constitutional. Thus, the requests were unlikely to lead to
admissible evidence. Id. In the same way, plaintiffs pursuing bad faith suits should not be allowed to conduct
“fishing expeditions” by seeking training materials from insurance companies in hopes of finding recommended policies, procedures or guidelines with which an adjuster has allegedly failed to comply.
Another potentially useful case is Altheim v. Geico General Ins. Co., 2011 WL 1429735 (M.D. Fla.
April 14, 2011). The case involves a motion in limine filed in a bad faith suit arising out of an uninsured/
underinsured motorist claim. Geico’s motion sought to prohibit the plaintiff from presenting evidence of
alleged deviations from company policies by excluding evidence of claims manuals and training materials.
Geico’s argument was that the relevant issue was whether it acted in good faith, not whether it acted in accordance with its own policies; introduction of such evidence would unfairly prejudice the carrier; and the evidence was privileged under Florida’s trade secret statute. Id. at *4. The court determined that relevancy of
such evidence was “in a gray area”, noting that it “[could not] say that failure to comply with company policies, manuals, and training materials will always be evidence of bad faith since a company’s policies, manuals,
and training materials may contain guidelines that may go ‘above and beyond’ what is reasonable and proper
under the circumstances…” Id. at *5. Thus, while the court denied the motion in limine, it did so without
prejudice, allowing the insurer to make appropriate objections at trial. With respect to the trade-secret privilege, the court also instructed the plaintiff that it would be required to address that privilege “and be ready to
explain why non-disclosure of these documents… will result in injustice” if plaintiff sought to introduce Geico’s manuals and training materials at trial. Id.
B.Privileges
While less case authority is available, there appears to be support for a claim of privilege as to training manuals, such as attorney-client or trade-secrets, but supporting evidence will be necessary to prevail. In
Santer v. Teacher’s Ins. and Annuity Ass’n, 2008 WL 821060 (E.D. Pa. Mar. 25, 2008), a federal district judge in
Pennsylvania denied plaintiff ’s claim for training materials which defendant claimed were protected pursuant
to attorney-client privilege. Id. at *1. The court noted that the materials were prepared by in-house attorneys
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 65
for the purposes of answering the insurer’s questions concerning how statutes and court decisions in the area
of bad faith, insurance litigation and privacy affect the way the insurer handles claims. The attorneys then
presented these materials to the claims representatives during training sessions. The court noted that plaintiff ’s cases were not persuasive. Most did not involve training materials or the assertion of attorney-client
privilege. Id. [As a side note, policies and procedures manuals had already been produced.] Thus, if there are
specific attorney-created documents to be used for training adjusters with respect to bad faith type matters,
the insurer may be able to protect those as privileged. However, general policy and procedural manuals with
respect to how a claim should be handled will not likely be so included.
Finally, a recent Florida federal case demonstrates that courts continue to be willing to hold that
training materials may be relevant, but could be subject to privileges. In Pepperwood of Naples Condominium
Ass’n., Inc. v. Nationwide Mut. Fire Ins. Co., 2011 WL 4596060 (M.D. Fla. Oct. 3, 2011) a federal district judge,
addressing a policy-holder’s request for training materials with respect to property losses found the request
to be overly broad but relevant. However, the court limited the request to materials for the claims personnel
involved with the plaintiff ’s claims; entered a protective order of confidentiality; and provided the procedure
for objecting to production based upon privilege, confidentiality or trade secret. Id. at *14.
C. Protective Order
As with other sensitive insurance company documents, insurers should seek a protective order
with respect to any production required of training manuals and materials. In Allstate Ins. Co. v. Scroghan,
851 N.E.2d 317 (Ind. Ct. App. 2006), the Indiana Court of Appeals held that the trial court abused its discretion in denying Allstate’s requests for a protective order in connection with production of documents that the
insurer claimed were confidential and/or trade secrets. Id. at 324. The documents included Colossus materials, the McKenzie documents, employment compensation information, manuals and documents related to
performance, evaluation and compensation, incentive programs and retirement funds, cost control manuals and procedures, and training materials and manuals. The court noted that “the aim of discovery is to provide parties with evidence for use in their present case.” The court found that plaintiff had made no showing
that discovery under a protective order would be detrimental to his case, but discovery without a protective
order could be detrimental to the insurer. Id. Interestingly, however, the court affirmed the trial court’s orders
imposing sanctions against the insurer for evasive responses to discovery. Id. at 325.
IV. Underwriting Manuals and Guidelines
Underwriting guidelines are frequently contained in manuals or internal communications and provide the criteria utilized by an insurance company to analyze a potential risk; in other words, to determine
whether the risk is acceptable, and if so, at what premium.
A.Relevancy
Underwriting guidelines have been held to be discoverable where the insured is alleged to have made
a material misrepresentation in the policy application; such as, for example, in rescission cases. In those cases,
underwriting criteria may be relevant to the issue of whether the insurer would have underwritten the risk
had it known the true facts. For example, in Freeman v. Allstate Life Ins. Co., 253 F.3d 533, 537 (9th Cir. 2001),
the 9th Circuit Court of Appeals determined that Allstate’s underwriting criteria was relevant and admissible
in connection with a rescission action; and the trial court had properly allowed the insurer’s representative
to testify that the insurer would not have issued the policy had it known about the insured’s preexisting medical condition. But see Burlington Ins. Co. v. Okie Dokie, Inc., 368 F. Supp. 2d 83 (D.D.C. 2005) (court held that
66 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
the insurer’s underwriting and claims guidelines were irrelevant to whether the insurer would have issued
the policy without an alleged negligent misrepresentation in the insurance application). The argument to be
made with respect to the lack of relevance of underwriting material is based upon the well-established rule
that external evidence may not be used in interpreting an unambiguous contract. See Safeway Managing Gen.
Agency for State & County Mut. Fire Ins. Co. v. Cooper, 952 S.W.2d 861, 866 (Tex. App.—Amarillo 1997).
Courts in certain coverage cases have allowed discovery of underwriting manuals. See, e.g., Hoechst Celanese, 623 A.2d 1099 (Del. Super. Ct. 1991) (court in a coverage case distinguishes between admissibility and relevance to allow discovery of the underwriting manual); Tinkham v. Conn. Gen. Life Ins. Co., 2000 WL 761802, at
*3 (D. Me. Apr. 18, 2000), (underwriting guidelines discoverable in suit challenging denial of long-term disability
benefits to determine whether insurer followed its own procedures); Westfield, LLC v. Zurich Am. Ins. Co. 2009
WL 5908006, at *4 (D. Md. July 30, 2009) (underwriting material ordered produced where a question of additional insured was at issue); Siligan Containers v. Nat’l Union Fire Ins., 2011 WL 2198141, at *1 (N.D. Cal. June 6,
2011) (allowing discovery of underwriting materials in coverage action relevant to potentially ambiguous terms
in the insurance policy); Tinkham, 2000 WL 761802, at *3, (underwriting guidelines discoverable in suit challenging denial of long-term disability benefits to determine whether insurer followed its own procedures).
However, as with claims manuals and similar materials, courts in bad faith cases were historically
reluctant to allow discovery or use of underwriting manuals as evidence against the carrier. See, e.g., Garvey v.
Nat’l Grange Ins. Co., 67 F.R.D. 391, 396 (E.D. Pa. 1996) (underwriting manuals held to be irrelevant and not
discoverable in suit alleging bad faith). As reflected above, in that case, a Pennsylvania federal district judge
granted a protective order that prohibited discovery of the underwriting manuals, noting: “The contents of
these manuals do not pertain to whether the plaintiff ’s present claim for loss is ‘covered’ under the insurance
contract issued by the defendant. Moreover, the fact that the defendant may have strayed from its internal
procedures does not establish bad faith on the part of the defendant in handling the plaintiff ’s loss.” Id. at 396.
Over the years, courts addressing suits with bad faith allegations have, in certain circumstances,
been willing to allow discovery of underwriting manuals and materials. While not ruling that the materials
were discoverable, in Lanham v. Blue Cross and Blue Shield of South Carolina, Inc., 349 S.C. 356, 563 S.E.2d
331 (S.C. 2002), the Court held that summary judgment was improper on behalf of the insurer in a suit by the
insured for breach of contract and bad faith against his health insurer where the insured had not been allowed
to compel discovery of underwriting standards, policies and procedures. Id. at 363. According to the court,
without being able to conduct such discovery, there was simply no way for the insured to respond to the insurer’s claim that the insured’s failure to divulge his preexisting health conditions was material to its decision to
accept the risk. Id.
Similarly, while not expressly stating that the materials would be discoverable if there were claims of
bad faith, breach of fiduciary duty or breach of contract, the Supreme Court of Idaho implied that underwriting files would be discoverable in Villa Highlands, LLC v. Western Community Ins. Co., 148 Idaho 598, 226 P.3d
540 (Idaho 2010). In that case, the court held that denial of plaintiff ’s insured’s motion to compel discovery of
the underwriting files was not an abuse of discretion, noting that at that stage in the case, there were no claims
directly against the insurer for breach of fiduciary duty, breach of contract, or bad faith. See also Michelman v.
Lincoln Nat’l Life Ins. Co., 2010 WL 3212008 (W.D. Wash. Aug. 10, 2010), in addressing a motion for continuance of the insured in order to take discovery regarding procedures the carrier had implemented to investigate
the claim and the underwriting file, the court that this information may be relevant to claims of bad faith and
consumer protection act, but not her breach of contract claim.
Other recent courts in suits alleging bad faith have allowed discovery of underwriting manuals. U.S.
Fire Ins. Co. v. City of Warren, 2012 WL 14540008 (E.D. Mich. Apr. 26, 2012) discussed earlier, also addressed
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 67
underwriting manuals and guidelines and determined that the information was discoverable for the same reason that the claims manuals were discoverable. “If the City is able to show that the policy terms at issue are
ambiguous, information in the underwriting manuals and guidelines may lead to the discovery of admissible
extrinsic evidence relating to the proper construction of the policy terms, including the company’s course of
dealing and industry usage.” Id. at *9.
Similarly, in Bayley Construction v. Wausau Business Ins. Co., 2012 WL 6553790 (W.D. Wash. Dec.
14, 2012), a federal district judge in Washington denied the insurance carrier’s objection to a Rule 30(b)(6)
request for testimony regarding the underwriting file on the basis of relevancy and being overly burdensome.
Id. at *2. The insurer alleged that the testimony amounted to a “fishing expedition.” The court disagreed and
held that the information in the underwriting file was both relevant to plaintiff ’s claims for denial of coverage and also may lead to discovery of other admissible evidence. The court also held that the insurer failed to
make a showing of prejudice or harm that would occur from the discovery request. Id; see also Beazer Homes
Corp. v. Hartford Fire Ins. Co., et al., 2012 WL 6210323 (D. S.C. Dec. 13, 2012), discussed above (court ordered
production of documents, including underwriting guidelines, after plaintiff argued they were relevant because
such guidelines contained information as to the insurance carrier’s asserted intent and purpose for various
policy provisions, forms and coverages); Penn Nat’l Mut. Cas. Ins. Co. v. Doscher’s Dorchester Road, Inc., 2012
WL 652638, at *5-6 (D.S.C. Feb. 28, 2012) (court denies motion to compel production of the insurer’s policy manual, mission statement, protocols and other documents regarding procedures for handling coverage
issues, along with applications and underwriting materials and “other materials regarding claims, coverage
and the application for coverage”, however does so because there were no claims of bad faith or breach of duty
or contract).
B.Privileges
Insurers faced with discovery requests should seek to protect underwriting guidelines and manuals
as a trade secret. The analysis by which an insurer decides whether, and at what price, it will accept a given
risk can be considered central to the insurer’s business and give it a competitive advantage. As such, underwriting manuals are arguably trade secrets. See, e.g., Fla. Stat. §90.506 (privilege from disclosing trade secret
if will not conceal fraud or otherwise work injustice). For example, in Arkwright Mut. Ins. Co. v. National
Union Fire Ins. Co. of Pittsburgh, 1994 WL 510043 (S.D.N.Y. 1994), a federal magistrate judge limited discovery of an insurer’s underwriting guidelines because the party seeking discovery was a direct competitor and
therefore the court felt that disclosure of such business information should be minimized. Id. at *18.
While not addressing underwriting information, the case of Bridgestone/Firestone v. Superior Court, 7
Cal. App. 4th 1384 (Cal. Ct. App. 1992) appears to be instructive with respect to trade secrets. In that case, the
court held that compelling disclosure of trade secret information where the information was merely relevant
consti­tuted reversible error. Instead, the Bridgestone court held that a party seeking disclosure of a trade secret
must make a heightened particularized showing that the information requested “is relevant and necessary
to the proof of, or defense against, a material element of one or more causes of action… and … is essential to
a fair resolution of the lawsuit.” Id. at 1393. Thus, in cases where the insurer seeks to protect discovery of its
underwriting guidelines, trade secret and “height­ened showing” arguments should be asserted; and to the
extent production is ordered, should seek to limit the production.
C. Protective Order
As with other internal company documents, the insurer should seek to have any production of
underwriting materials subject to a protective order. See, e.g., GBTI, Inc. v. Ins. Co. of the State of Penn., 2010
68 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
WL 2942631 (E.D. Cal. July 23, 2010). In GBTI, the insurer objected to discovery of underwriting guidelines,
manuals and other reference materials on the basis that they were not relevant because the terms of the policy
were not in dispute and plaintiffs had not alleged that the terms were ambiguous. Id. at *3. The court however
found that the materials were relevant and could lead to the discovery of admissible evidence. However, recognizing that the insurer “has a legitimate interest in protecting its trade secrets and other confidential information” (citation omitted), made production subject to the execution of an appropriate confidentiality/protective
order. Id. at *4.
V.Conclusion
Courts were initially reluctant to require insurers to produce internal insurance procedural documents, such as claims manuals and guidelines, underwriting files and guidelines, and training manuals and
guidelines. Over the years, however, courts have been persuaded, particularly in some “institutional” type
bad faith suits, to find that such documents may be relevant. However, the relevancy determination, as well
as whether a particular privilege may apply, is often fact-specific to the particular case. Accordingly, when
faced with requests for such information, insurers’ counsel need to thoroughly analyze plaintiffs’ allegations to
determine whether relevancy objections, objections to limit the scope of the request and/or privileges may be
applicable. In particular, objections to claims manuals trade secrets, objections to training manuals as being
protected by attorney-client or trade secrets and objections to underwriting manuals as being trade secrets
should be considered. Additionally, if coverage with respect to the underlying claim has not been determined
in all aspects, counsel for the insurer should consider the viability and/or legal strategy of objections to the
request, seeking an abatement of any bad faith discovery and/or seeking a bifurcation (through severance or
separate trials) of the extra-contractual “bad faith” causes of action from the underlying breach of contract
claim. Finally, to the extent the insurer is unsuccessful in preventing the discovery of these internal documents, production should be subject to the entry of an appropriate confidentiality/protective order preventing
any further disclosure of such documents beyond those persons necessary to proceed on behalf of the policyholders’ claims in the instant suit.
Endnote
1
McKenzie & Company is a business consulting firm that Allstate hired in the 1990s to analyze its automobile bodily
injury claims and handling procedures. The concepts suggested by McKenzie were summarized in a series of slides,
which have become known as to the “McKenzie documents.” Allstate made changes to its business based upon the
McKenzie documents in its CCPR. Because Allstate published the McKenzie documents on its website, it no longer
maintains that the documents are confidential.
Claim Manuals and Training Materials: How to Address Them During... ■ Carlton ■ 69
Emerging Bad Faith Claims:
Extra-Contractual Liability Arising Out of Uncovered
Claims—Defense Within Limits Policies
Michael F. Aylward
Morrison Mahoney, LLP
250 Summer St
Boston, MA 02210
(617) 439-7556
maylward@morrisonmahoney.com
Michael F. Aylward is a senior partner at Morrison Mahoney LLP in Boston,
where he chairs the firm’s complex insurance coverage practice group. He
obtained a B.A., cum laude, from Dartmouth College in 1976, receiving an honors
degree in history. He studied law at Boston College Law School and received
his J.D. degree, cum laude, in 1981. For the past three decades, Mr. Aylward has
represented insurance companies around the country in coverage disputes involving
environmental and mass tort claims; allegations of clergy abuse; intellectual
property and commercial litigation claims; reinsurance arbitrations and bad faith.
Mr. Aylward is a prolific author and has lectured here and abroad on insurance
coverage issues. His past leadership roles in the defense bar include service on the
DRI Board of Directors and chair of its Insurance Law Committee. He presently
chairs the DRI Law Institute, which coordinates all of DRI’s CLE offerings. He is also
a member of the board of editors of the Journal of the International Association of
Defense Counsel and a past chair of the Excess Surplus and Reinsurance Committees
of the Federation of Defense and Corporate Counsel and the International
Association of Defense Counsel. More recently, he served as the secretary of the
newly-formed Massachusetts Reinsurance Bar Association from 2009 to 2012. Mr.
Aylward has written extensively on bad faith issues, including the Bad Faith chapter
in the new Appleman Insurance Law treatise.
Emerging Bad Faith Claims:
Extra-Contractual Liability Arising Out of Uncovered
Claims—Defense Within Limits Policies
Table of Contents
I. Can There Be Extra-Contractual Liability Absent Coverage?....................................................................75
A. State by State Summary........................................................................................................................76
II. What Is the Effect of “Burning Limits” Policies on Bad Faith Claims?.....................................................80
Emerging Bad Faith Claims: Extra-Contractual Liability Arising Out of... ■ Aylward ■ 73
Emerging Bad Faith Claims:
Extra-Contractual Liability Arising Out of Uncovered
Claims—Defense Within Limits Policies
I. Can There Be Extra-Contractual Liability Absent Coverage?
It would seem self-evident that an insurer should not face extracontractual liability in the absence of
contractual liability. Just as the implied covenant of good faith and fair dealing arises from the existence of a
contractual relationship between the insurer and its policyholder, it would seem to follow that absent a breach
of contract, no basis exists for imposing extra-contractual liability upon the insurer.
Indeed, the rule in most states is that the implied covenant of good faith and fair dealing does not
extend to actions or matters which are not covered under the policy. In re Hennepin County 1986 Recycling
Bond Litig., 540 N.W.2d 494 (Minn. 1995).
As a result, most courts have ruled that the absence of coverage is a complete defense to bad faith.
In short, absent contractual liability, there can be no extracontractual liability. See State Farm Fire & Casualty
Company v. Slade, 747 So.2d 293, 318 (Ala. 1999); Waller v. Truck Insurance Exchange, 11 Cal. 4th 1, 44 Cal.
Rptr. 2d 370, 900 P.2d at 639 (1995); Johnson v. Farm Bureau Mut. Ins. Co., 533 N.W.2d 203 (Iowa 1995); Charter Services, Inc. v. Principal Mutual Life Ins. Co., 117 N.M. 82, 868 P.2d 1307 (1994); Bartlett v. John Hancock
Mutual Life Ins. Co., 532 A.2d 997, 1000 (R.I. 1988); Republic Ins. Co. v. Stoker, 903 S.W.2d 338 (Tx. 1995).
The idea is that the duty of good faith is intended as an adjunct to the primary duties of the insurer to defend
and indemnify, and thus allowing a claim independent of the insurer’s duty of coverage extends the good faith
duty beyond its moorings. Love v. Fire Ins. Exchange, 271 Cal. Rptr. 246, 254-56 (Ct. App. 1990).
In recent years, however, a growing number of jurisdictions have permitted insureds to pursue bad
faith claims in the absence of coverage, if the insured has suffered an independent injury by reason of the insurer’s claim handling. Lloyd v. State Farm Mut. Automobile Ins. Co., No. 1 CA-CV 95-0140 (Ariz. App. October
1, 1996); Delmonte v. State Farm Fire & Casualty Company, 975 P.2d 1159 (Haw. 1999); Glen Falls Ins. Co., 616
N.E.2d 1123, 1126 (Ohio Ct. App. 1992) and State Farm Mut. Auto Ins. v. Shrader, 882 P.2d 813 (Wyo. 1994).
More generally, some courts have concluded that the duty of good faith is a covenant that can be
breached even if the insurer does not have a duty to indemnify or defend the insured Deese v. State Farm
Mut. Auto. Ins. Co., 838 P.2d 1265, 1270 (Ariz. 1992); Best Place, Inc. v. Penn Am. Ins. Co., 920 P.2d 334, 336
(Haw. 1996); Tornetta v. Allstate Ins. Co., 973 P.2d 8, 12 (Wash. Ct. App. 1999)]. Thus, in Tadlock Painting Co. v.
Maryland Cas. Co, 473 S.E.2d 52 (S.C. 1996), the South Carolina Supreme Court ruled that bad faith may exist
independently of an insurer’s contractual obligations under a policy, rejecting the insurer’s contention that
there could not be bad faith if there was no coverage for a third-party claim.
Thus, where an insurer agreed to defend a claim under a reservation of rights and mis-handled the
defense, as by negligently failing to settle within policy limits, some courts have declared that the insurer is
responsible for any consequent damages to the insurer, even though it may ultimately be determined that the
insurer should not have any indemnity obligation but for this mishap. See.e.g. Delmonte v. State Farm Fire
& Cas. Co., 975 P.2d 1159 (Haw. 1999). This is in keeping with the general legal principle that once a party
undertakes a duty, it can be held liable for negligently performing that undertaking even it had no duty to
do so originally. But see Young v. Allstate Ins. Co., 198 P.3d 666 (Haw. 2008) (dismissal of a claimant’s claim of
breach of “assumed” duty of good faith and fair dealing against a tortfeasor’s insurer upheld because the claim
was premised upon a contract between the claimant and insurer that did not exist).
Emerging Bad Faith Claims: Extra-Contractual Liability Arising Out of... ■ Aylward ■ 75
Likewise, some courts have ruled that first party insurers may be held legally liable for any damages
that insureds may suffer as a consequence of the insurer’s claims investigation even if the claim is ultimately
determined to be outside the scope of its coverage. State Farm Mut. Auto Ins. v. Shrader, 882 P.2d 813 (Wyo.
1994). In Coventry Associates v. American States Ins. Co., 961 P.2d 933 (Wash. 1998) the Washington Supreme
Court ruled that even if a first party claim was not covered, an insurer might be held liable for bad faith if it
maintained a pattern or practice of avoid making covering determinations by failing to carry out proper claim
investigations.
A. State by State Summary
Alabama
Under Alabama law, an insurer cannot be held liable for refusing to settle a case for which coverage is
not afforded under the policy. State Farm Fire and Cas. Co. v. Slade, 747 So.2d 293, 318 (Ala. 1999).
Arizona
Under Arizona law, an insurer may be liable for a breach of the implied covenant of good faith and
fair dealing through its improper claims handling even if it is ultimately established that the claims are not
covered. Deese v. St. Farm Mutual Automobile Ins. Co., 172 Ariz. 504, 509, 838 P.2d 1265 (1992). Thus, a cause
of action for bad faith for the insurer’s mishandling of its insured’s defense has been found to exist even where,
in fact, the insurer had no coverage obligation. Lloyd v. State Farm Mut. Automobile Ins. Co., 1 CA-CV 91-0017
(Ariz. November 27, 1992) and Lloyd v. State Farm Mut. Automobile Ins. Co., No. 1 CA-CV 95-0140 (Ariz. App.
October 1, 1996)(Lloyd II). In Lloyd II, the Court of Appeals extended its earlier holding that an insurer can
be sued for inadequately defending a case that it had gratuitously accepted, holding that the insurer’s failure
to properly defend could be considered in the context of its policy. Similarly, an insured may prevail in a bad
faith claim even in the absence of coverage. Rawlings v. Apodaca, 151 Ariz. 149, 726 P.2d 565 (1986) and Deese
v. State Farm, 172 Ariz. 504, 838 P.2d 1265 (1992).
In Little v. USAA Cas. Ins. Co., No. 09-30948 (5th Cir. April 2, 2010), the U.S. Court of Appeals for
the Fifth Circuit predicted that the Arizona Supreme Court would hold that an insurer could not be liable
in bad faith in a case where it had ultimately established that it did not owe coverage for the insured’s claim.
Although the court suggested that there could be cases where a breach of the duty of good faith and fair dealing could exist in the absence of coverage, it held that this case was not among them.
California
When there is no coverage of any kind under an insurance contract, the insured may not hold the
insurer liable for breach of the implied covenant of good faith and fair dealing. Waller v. Truck Ins. Exch., 11
Cal. 4th 1, 37, 44 Cal. Rptr. 2d 370, 900 P.2d at 639 (1995). See also Murray v. State Farm Fire & Cas. Co., 219
Cal. App.3d 58, 65 (1990) and Allstate Ins. Co. v. Salahutdin, 815 F.Supp. 1309 (N.D. Cal. 1992).
The California Court of Appeal ruled that a policyholder has no right to sue her insurer for negligent handling of a mold claim where the court has independently concluded that there is no coverage under
the terms of the policy. In Benavides v. State Farm General Ins. Co., 136 Cal. App. 4th 1241, 39 Cal. Rptr. 3d
650 (2006), the Second District held that an earlier water loss in the condominium was not the predominant
cause of the subsequent mold and therefore fell outside the scope of the “ensuing loss” exception to the mold
exclusion in the policy. Having found an absence of coverage, the second District reversed the jury’s award of
$260,000 for damages allegedly attributable to State Farm’s negligent investigation of the insured’s first party
claim since an insured cannot maintain a claim for tortious breach of the implied covenant of good faith and
fair dealing absent a covered loss. Since no benefits were due under the policy, the court refused to find that
76 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
any negligence on the part of the insurer in its investigation had frustrated the insured’s right to obtain any
benefits to which she was contractually entitled under the policy.
Connecticut
Issue now pending before the Connecticut Supreme Court in Capstone Development Corp. v. American Motorists Ins. Co., No. SC 18886.
Hawaii
The Hawaii Supreme Court ruled that a liability insurer may be subject to bad faith liabilities, even
in the absence of coverage, if it mishandles the defense of the policyholder, causing damage to the insured.
Delmonte v. State Farm Fire & Cas. Co., 975 P.2d 1159 (Haw. 1999). Once assuming the defense, the insurer is
under a duty to pursue the defense in good faith until such time as clear grounds for withdrawing because of
the absence of coverage arise.
Idaho
An insurer may not be held liable for bad faith unless it has breached its obligations under the policy.
Conversely, an insurer may not be sued for bad faith if its coverage position was fairly debatable. Robinson v.
State Farm Mutual Automobile Ins. Co., 45 P.3 829, 835 (Idaho 2002). In Robinson, the Idaho Supreme Court
declared that the availability of a cause of action in tort is not dependent on the availability of a contract claim
and that bad faith damages are therefore recoverable for an insurer’s improper handling of a claim even if it is
ultimately determined that the claim was not covered under the policy. On rehearing, however, the court ruled
on April 10, 2002 that the trial court had erred in failing to instruct the jury that the existence of a contractual
duty to pay is a prerequisite to extracontractual liability. The Supreme Court held that the trial court had erred
in excusing the policyholder from proving that her claim was covered under the policy, holding that the fact
that State Farm had paid the claim after a lengthy delay was not itself evidence that the loss was covered as the
insurer might have paid the loss for various different reasons. See also in Purdy v. Farmers Insurance Company
of Idaho, No. 28023 (Idaho January 24, 2003)(bad faith claims dismissed in the absence of any contractual
obligation to pay benefits under policy).
The Robinson court reaffirmed its ruling in Simper v. Farm Bureau Mutual Ins. Co., 974 P.2d 1100
(Idaho 1998) that an insurer had not acted in bad faith in calculating a renewal premium based on prior
medical benefit payments notwithstanding the fact that it stood to recover some portion of these payments
through subrogation actions. In Simper, the court ruled that there must be a contractual basis for recovery
before there can be any award of damages based upon a claimed breach of the implied duty of good faith and
fair dealing under a contract. If the policy was not yet in existence, the putative insured could not recover bad
faith damages.
Iowa
There can be no bad faith in the absence of coverage. Johnson v. Farm Bureau Mut. Ins. Co., 533
N.W.2d 203 (Iowa 1995).
Kentucky
The Court of Appeals ruled in an unpublished opinion in Kentucky National Ins. Co. v. Shaffer (Ky.
App. December 3, 2004) that where a policy exclusion precluded any contractual basis for coverage, the
insurer was likewise protected from any claim for extracontractual liability.
Massachusetts
The U.S. Court of Appeals has ruled that an individual consumer may not bring an action under the
Massachusetts Consumer Protection Act (G.L. c. 93A) for non-covered claims. Alan Corp. v. ISLIC, 22 F.3d 339
Emerging Bad Faith Claims: Extra-Contractual Liability Arising Out of... ■ Aylward ■ 77
(1st Cir. 1994). However, in John Doe v. Liberty Mutual Ins. Co., 423 Mass. 366 (1996), the Supreme Judicial
Court open the issue of whether businesses could pursue bad faith claims under Section 11 of Chapter 93A
independent of contractual liability, merely holding that the insured had not shown that it suffered any prejudice as a result of the insurer’s six month delay in responding to its request for coverage.
Michigan
An insurer may be held liable for a judgment against an insured, even in the absence of coverage, that
results from its negligent undertaking of the defense of a case. Warren v. Aetna Cas. & Sur. Co., No. 182838
(Mich. App. November 28, 1995) (insurer was negligent in not retaining independent counsel in view of clear
conflict resulting from reservation of rights). But see Warren v. Aetna Cas. & Sur. Co., No. 215045 (Mich. App.
March 28, 2000) (unpublished) (affirming directed verdict for insurer on remand).
Minnesota
The implied covenant of good faith and fair dealing does not extend to actions or matters which are
not covered under the policy. In re Hennepin County 1986 Recycling Bond Litig., 540 N.W.2d 494 (Minn. 1995).
Mississippi
Under Mississippi law, a finding of coverage is a necessary predicate to bringing a punitive damages
claim. See McCain v. Northwestern Nat’l Life Ins. Co., 484 So.2d 1001, 1002 (Miss. 1986) and Sobley v. Southern
Natural Gas Company, 210 F.3d 561 (5th Cir. 2000).
New Mexico
Under New Mexico law, bad faith may not be claimed unless there is a separate finding that the
insurer had a contractual duty to pay under the policy. Charter Services, Inc. v. Principal Mutual Life Ins. Co.,
117 N.M. 82, 868 P.2d 1307 (1994).
Ohio
A cause of action for the tort of bad faith may exist irrespective of any liability arising from a breach
of the insurance contract. Glen Falls Ins. Co., 616 N.E.2d 1123, 1126 (Ohio Ct. App. 1992).
Oklahoma
In Eaves v. Fireman’s Fund Ins. Cos., 148 Fed. Appx. 696 (10th Cir. September 7, 2005), the Tenth Circuit ruled that bad faith may exist, even in the absence of a breach of contract, insofar as the insurer has acted
unreasonably in its claim handling.
South Carolina
In Tadlock Painting Co. v. Maryland Casualty Co., 473 S.E.2d 53 (S.C. 1996), the South Carolina
Supreme Court ruled that bad faith may exist independently of an insurer’s contractual obligations under a
policy, rejecting the insurer’s contention that there could not be bad faith if there was no coverage for a thirdparty claim. The court ruled that a policyholder could still sue for damages arising from unfair claims handling, even if the insurer was ultimately correct in its determination that its loss was not covered.
On the other hand, the Eleventh Circuit ruled that a liability insurer that initially offered to contribute towards the settlement of a case but subsequently withdrew its contribution before the offer was accepted
did not act in bad faith. Applying the law of South Carolina, where the policy was issued, court ruled in Twin
City Fire Ins. Co. v. Colonial Life & Accident Ins. Co., 375 F.3d 1097 (11th Cir. 2004) that as a court later ruled
that Hartford did not owe coverage, it had no duty to contribute to any settlement and therefore could not
have acted in bad faith in withdrawing its initial offer.
Texas
78 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Resolving a question had been left open by its ruling in Viles v. Security National Ins. Co., 788 S.W.2d
566, 567 (Tex. 1990)(tort of bad faith independent of contractual basis for coverage), the Texas Supreme
Court ruled in Republic Ins. Co. v. Stoker, 903 S.W.2d 338 (Tx. 1995) that an insurer may not be held liable
for bad faith if there is no contractual basis for coverage. The Supreme Court reversed the Court of Appeals,
which had found that a liability insurer had acted in bad faith by denying coverage on an erroneous basis,
even though it later found an independent basis on which the court ultimately sustained the coverage denial.
See also Beaumont Rice Mill, Inc. v. Mid American Indemnity Ins. Co., 948 F.2d 950 (5th Cir. 1991)(Texas law)
(absence of coverage defeats possibility of bad faith).
The Texas Supreme Court ruled in Progressive County Mut. Ins. Co. v. Boyd, 177 S.W.3d 919 (Tex.
2005) that a trial court did not err in dismissing an uninsured motorist’s bad faith claims even though the jury
had not yet entered judgment for the insurer with respect to the insured’s claim for breach of contract. The
Supreme Court held that any error on the part of the trial court was harmless as no basis existed for pursuing
a claim for common law bad faith or for damages under Article 21.21 of the Insurance Code in the absence
of any contractual right to recovery. While acknowledging that it had left open the possibility that an insured
might be entitled to bad faith damages even in the absence of coverage in cases such as American Motorist Ins.
Co. v. Fodge, 63 S.W.3d 801, 804 (Tex. 2001), the court noted that such an extra-contractual obligation could
only arise if the insurer’s conduct was extreme and produced damages unrelated to and independent of the
policy claim. In this case, the insured’s claims were that the insurer had improperly denied his UIM claim and
had failed to fairly investigate the facts of the accident, which the court found neither extreme nor independent of the policy claim.
Utah
The Utah Supreme Court ruled in Christiansen v. Farmers Insurance Exchange, 116 P.3d 259 (Utah
2005) that an insured was permitted to pursue discovery with respect to a bad faith claim arising out of Farmer’s denial of the insured’s UIM claim notwithstanding Farmer’s effort to obtain a protective order to stay bad
faith discovery until such time as the insured had established that it had breached its contractual duties under
the auto policy. The court observed that “if we were to condition discovery in litigation of a bad faith claim on
violation of the expressed terms of the contract, the insurer could escape liability for its failure to honor the
good faith duty to bargain or settle with its insured by ultimately paying the claims, regardless of any wrongful
delays or obstructions that may have occurred in the process.”
Vermont
If the claims are found not to be covered, the bad faith claims must fail as well. Serecky v. National
Grange Mutual Ins., 857 A.2d 775 (Vt. 2004).
Virginia
Liability for first party bad faith in Virginia can only arise from the contract and extends only to
situations connected with the policy. A&E Supply Co. v. Nationwide Mut. Fire Ins. Co., 798 F.2d 559 (4th Cir.
1986).
Washington
An insurer’s liability for breach of the covenant of good faith and fair dealing is not dependent on
whether coverage actually exists. . Kirk v. Mount Airy Ins. Co., 134 Wash.2d 558, 951 P.2d 1124 (1998) and
Tank v. State Farm Fire & Cas. Co., 715 P.2d 1133 (Wash. 1986)
Further, a liability insurer’s duty in this regard is not limited to cases in which it has been found to
owe a duty to defend. In St. Paul Fire & Marine Ins. Co. v. Onvia, Inc., 196 P.3d 664 (Wash. 2008), the court
ruled that a liability insurer might potentially be liable for violations of the Consumer Protection Act and variEmerging Bad Faith Claims: Extra-Contractual Liability Arising Out of... ■ Aylward ■ 79
ous insurance claims handling regulations based on its delay in issuing a denial letter refusing to defend or
otherwise cover claims against its insured.
Wisconsin
In the absence of a claim for actual damages, a party cannot recover punitive damages. Tucker v.
Marcus, 418 N.W. 2d 818 (Wis. 1988); and Vasen v. Progressive Insurance Companies, No. 99-2834 (Wis. App.
August 24, 2000).
On the other hand, the fact that an insured was unable to recover contract damages due to the statute of limitations was held not to preclude a tort recovery for the insurer’s bad faith. In Jones v. Secura Ins. Co.
638 N.W.2d 575 (Wis. 2002), the Supreme Court held that the language in Dechant v. Monarch Life Ins. Co. 547
N.W. 2d 592 (1996) declaring insurers to be “liable for any damages which are the proximate result” of bad
faith included damages that could also be recoverable independently in a breach of insurance contract action.
As the tort of bad faith and breach of an insurance contract are two separate claims or causes of action, the
Supreme Court found that it would be inconsistent to prohibit pursuit of some bad faith damages because of
application of the statute of limitations for a breach of an insurance contract claim.
As a result, Wisconsin courts have generally that the trial of the insured’s bad faith claims should be
bifurcated from the contract claims. See, e.g. Dahmen v. American Family Mutual Ins. Co., 635 N.W.2d 1 (Wis.
App. 2001).
The Wisconsin Supreme Court ruled in Brethorst v. Allstate Property & Cas. Ins. Co., 2011 WI 41
(Wis. June 14, 2011) that an insured could proceed with discovery on its bad faith claims, holding that its
Dahmen analysis, which requires bifurcation of contract bad faith claims until the insurer’s breach of contract has been established, did not apply in a case where a party elects to bring only a claim of bad faith. The
Supreme Court ruled that breach of contract and first-party bad faith are separate claims and that an insured
may file a bad faith claim without also filing a breach of contract claim. On the other hand, the court held that
an insured may not proceed with discovery on a first-party bad faith claim until she has pleaded a breach of
contract as part of a bad faith claim and satisfied the court that she has established such a breach or will be
able to prove such a breach in the future. In this case, the court ruled that the insured had pleaded such facts
as Allstate had refused to reimburse her for nearly $5000 in medical expenses on the “theory” that such a
minor accident could not have re-aggravated a pre-existing injury.
Wyoming
An insurer may be held liable in bad faith for its investigation of a first party claim even if the claim
is ultimately determined to be outside the scope of its coverage. State Farm Mut. Auto Ins. v. Shrader, 882 P.2d
813 (Wyo 1994); Hatch v. State Farm Fire & Cas. Co., 842 P.2d 1089 (Wyo. 1992).
On the other hand, Judge Johnson ruled that an insured could not pursue a Hatch claim for “procedural bad faith” in Sinclair Oil Corp. v. Republic Ins. Co., 967 F.Supp. 462 (D. Wyo. 1997) despite the insured’s
claim that its insurers acted in bad faith by delaying making a coverage determination to obtain more files and
information from the insured before filing an action for declaratory relief.
II. What Is the Effect of “Burning Limits” Policies on Bad Faith
Claims?
Historically, the duty to defend contained in general liability policies was not tied to the limits of
coverage. Accordingly, GL carriers could (and sometimes did!) spend millions of dollars to defend claims for
which their indemnity obligations were only a few thousand dollars. Conversely, many types of professional
80 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
liability insurance and “claims made” forms of coverage tied the defense to the overall limits so that it was
possible for an insurer to exhaust its coverage obligations through the expenditure of defense dollars.
In recent years, insurers have increasingly adopted so-called “burning limits” or “wasting limits” provisions within commercial general liability policies. Such defense within limits provisions, which cause the
overall limits of coverage to be reduced by incurred defense costs, are particularly prevalent in add on coverages where insurers seek through endorsements to limit the scope of their obligations with respect to claim
types, such as abuse, assault and battery, liquor liability and the like, that would otherwise be excluded altogether. They may also commonly be used for risks where the costs of defense are likely to be substantial, even
if the insured’s ultimately liability is unlikely.
The effect of such provisions was discussed by the California Supreme Court in a footnote to its decision in Aerojet-General Corp. v. Transport Ind. Co., 17 Cal. 4th 38, 949 P.2d 909 (1997) discussing whether environmental engineering and consulting expenses should be treated as a cost of “defense” or “indemnity.” While
noting the fact that the costs of defense could vastly exceed the insurers’ ultimate indemnity duties, the court
observed:
We observe that Aerojet may indeed have gotten from the insurers more in defense costs than it
could have gotten in indemnification costs. But it got no more than it had a right to: Although
indemnification costs were limited by the pertinent policies, defense costs were not. The insurers
might perhaps have avoided such a pass, as through the issuance of “self-consuming” or “burning limits” policies, under which the indemnification limit is reduced dollar for dollar by defense
costs until zero is reached and the duty to indemnify and the duty to defend are then terminated
(see Croskey et al., Cal. Practice Guide: Insurance Litigation 2, supra, ¶ 7:656, p. 7B-34). They
apparently did not attempt to do so.
“Wasting limits” provisions can be a mine field for insurers, however. In particular, insurers may be
sued for prematurely withdrawing from their insured’s defense or failing to fund a settlement based on an
erroneous determination that they have exhausted their coverage.
A key issue, therefore, is whether the plaintiff ’s claims are wholly subject to the sub-limit to which
defense costs apply. For instance, in National Union Fire Ins. Co. of Pittsburgh, PA v. West Lake Academy, 48
F.3d 8 (1st Cir. 2008), an emotionally-troubled teenager who became pregnant as the result of having sex with
the insured’s employee sue the Academy. National Union defended for a time but withdrew after its $100,000
sub-limit for sexual abuse claims was exhausted by the insured’s costs of defense. The First Circuit rejected
the claimant’s argument that the “wasting” language was ambiguous or that attorney’s fees were not included
within the “expenses” language in the sexual abuse endorsement.
Likewise, a federal district court in Nevada has recently rejected a third party claimant’s bad faith
challenge to an insurer’s claim that it had no further duty to defend after interpleading its remaining limits
to resolve competing claims. Everest Ins. Ind. Co. v. Aventine Tramonti, 2012 U.S. Dist. LEXIS 33860 (D. Nev.
March 13, 2012).
The inclusion of such provisions may have an impact on the willingness of a plaintiff to discuss settlement. Indeed, care must be taken not to mislead plaintiff ’s counsel concerning the nature of this coverage
when counsel asks “what are the policy limits” to avoid repercussions and recriminations years later when
plaintiff discovers that they have won a hollow victory as the insured’s limits have dwindled or disappeared in
the interim.
The inclusion of a “wasting limits” provision may also have a significant impact on settlement strategy. An insured may well press an insurer to settle early, when there is a maximum amount of coverage.
Emerging Bad Faith Claims: Extra-Contractual Liability Arising Out of... ■ Aylward ■ 81
In Pueblo Country Club v. AXA Corporate Solutions, 2007 WL 951790 (D.Colo. May 31, 2007), the
insured country club was sued for employment discrimination by its former golf course manager Arcenio
Garcia. It tendered the defense of these claims to AXA under a D&O policy with a $1 million limit, including defense costs. The case ultimately settled for $1.5 million, of which AXA paid less than $700,000, having
expended over $300,000 in defense costs by then. The insured sued to recover more than $800,000 that it had
been forced to contribute to the settlement, claiming that AXA had ignored numerous requests by to settle
the Garcia Suit within the Policy’s limits, controlled defense of the Garcia Suit in a manner that prevented
settlement and caused defense costs to be spent, failed to offer its Policy limits to settle the case prior to judgment, and placed its interest above the interests of its insured. In denying AXA’s motion for summary judgment, Judge Wiley “found that numerous material facts are in dispute concerning whether AXA’s conduct with
regard to settlement of the Garcia Suit was reasonable, and rejected AXA’s contention that it is entitled partial
summary judgment in its favor on what it characterizes as “PCC’s claim to recover the amount of liquidated
damages awarded to Garcia.” The District Court observed that “PCC has presented evidence…that AXA was
aware that attorneys’ fees and costs were reducing the available policy limits, and that PCC was exposed to a
judgment in excess of the available limits, and nevertheless acted unreasonably with regard to settlement of
the case. The jury is entitled to consider this evidence.”
Care should also be taking to ensure that such provisions are enforceable and in keeping with state
insurance regulations.
Defense within limits provisions are barred in Minnesota with the exception of professional liability
policies in excess of $100,000, large commercial risks and environmental impairment liability insurance. Minnesota Statute, Section 60A.08 subdivision 13.
Or. Rev. Stat. §742.063(1) provides that liability insurance containing defense within limits provisions must be filed and approved by the Director of the Department of Consumer and Business Services.
New York Insurance Department regulations permit defense within limits provisions only in certain
circumstances and the amount of expenses that can reduce the policy limits is capped at 50 percent of the policy limits unless the insured is given full control of its defense. N.Y. Comp. Codes Rules and Regulations Title
XI, §71.3.
Finally, some courts have declared that such terms may be unenforceable as being against public policy. In NIC Ins. Co. v. PJP Consulting, LLC, No. 09-0877 (E.D. Pa. October 22, 2010), Cavanaugh’s River Deck,
was sued by a bar patron for failing to prevent an assault in which four other patrons had savagely assaulted
him. NIC defended under a reservation of rights, seeking a declaration that its coverage obligations to the bar
were capped at the $50,000 sub-limit set forth in its Assault and Battery Limits of Liability Endorsement and
that its defense obligation would cease once defense costs exceeded that amount. Nevertheless, Judge Surrick
declined to jurisdiction over NIC’s DJ, declaring that, as the issue of whether burning limits policies are against
public policy is an unsettled issue of state law in Pennsylvania, the case would be better addressed in a pending state court action. The District Court took note of the fact that “defense within limits” provisions had been
barred or limited by regulators and legislators in various other states and found that such provisions create
potential bad faith and ethical issues for insurers and defense counsel as they put the insured in the position of
swiftly losing its available coverage through aggressive defense activity if a case cannot be settled early on.
82 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Latest Strategies for Defending
Bad Faith Claims
Sara M. Thorpe
Gordon & Rees LLP
275 Battery Street, Suite 2000
San Francisco, CA 94904
(415) 986-5900
sthorpe@gordonrees.com
Donald M. Carley
State Farm
One State Farm Plaza, B-3
Bloomington, IL 61710-0001
(309) 766-8465
don.carley.mcse@statefarm.com
Sara M. Thorpe is partner at Gordon & Rees LLP, which has more than 25 offices
across the county and over 525 lawyers, with a large number of those lawyers
representing insurance companies in litigation. Ms. Thorpe represents insurers in
declaratory relief, breach of contract, and “bad faith” actions and has in her over 20
years with Gordon & Rees tried a number of cases in state and federal court, both
bench and jury. Ms. Thorpe acknowledges assistance with this article from Seth
Manfredi, an associate in the insurance practice group in the San Francisco office
of Gordon & Rees, and contributions from partners in Gordon & Rees’ wide-spread
insurance practice group, including Dennis Brown (Hartford), Peter Schwartz (Los
Angeles), Robin Taylor Symons (Miami), Don Verfurth (Seattle), and Bill Shelley
(Philadelphia).
Donald M. Carley, Associate General Counsel at State Farm Mutual Automobile
Insurance Company, contributed to this article. Mr. Carley currently manages the
“bad faith,” class action, and other commercial litigation matters filed against State
Farm. Prior to joining State Farm, Mr. Carley was a partner at what is now known as
SNR Denton, where he litigated complex commercial matters, including insurance
“bad faith” cases.
Disclaimer
The views expressed in this paper are those of the authors and contributors. Nothing
contained in this paper should be misconstrued as representing the position of their
firm or employer. Further, none of the information or suggestions contained in this
article convey the position or opinion of any particular insurance company. This article
is not intended to provide advice on the handling of any particular insurance claim.
Latest Strategies for Defending Bad Faith Claims
Table of Contents
I.Introduction..................................................................................................................................................87
II. Getting Started: Know the Facts, Policy, and Case Law.............................................................................87
III. Reminder: Don’t Throw Out Tools That Work............................................................................................88
IV. Litigation Strategies to Consider..................................................................................................................88
A. Early Case Resolution Through Settlement.........................................................................................88
B.Pleadings................................................................................................................................................88
1. Scope of Lawsuit............................................................................................................................88
2. Affirmative Claims.........................................................................................................................89
3. An Early Motion to Dismiss..........................................................................................................89
C.Defenses.................................................................................................................................................90
1. Genuine Dispute/Reasonably Debatable......................................................................................90
2. Focus on Core Dispute...................................................................................................................90
D.Discovery...............................................................................................................................................91
E.Experts...................................................................................................................................................91
F. Dispute Resolution Alternatives...........................................................................................................91
G. Ongoing Claim Handling......................................................................................................................92
V.Conclusion.....................................................................................................................................................93
Latest Strategies for Defending Bad Faith Claims ■ Thorpe and Carley ■ 85
Latest Strategies for Defending Bad Faith Claims
I.Introduction
The pleadings against your company or client include allegations the company acted “unreasonably,”
“unfairly,” and “in bad faith” “for its own financial advantage” and “with conscious disregard for the rights and
interests of its insured.” You have handled these types of allegations before. They can be complicated. A lawsuit alleging bad faith raises a number of significant issues ranging from fundamental questions regarding
whether the insurer made an error in the handling of the claim that requires correction to questions regarding
the scope of discovery and trial.
No single approach exists for handling a claim alleging bad faith conduct. Indeed, every case by its very
nature requires a rigorous individual analysis of the legal and factual issues presented. The nature of the case
itself will determine what legal approach would best defeat or limit the potential risk posed by these claims.
This article suggests a number of approaches and strategies that can be effectively employed by counsel to effectively defend against a claim of bad faith conduct by the insurance company. The underpinning for
each is that the company and its lawyer should know the case better than the adversary. Of course, the touchstone in any case is the claim file itself. Further, the company and its counsel should approach the defense of
the case in a strategic and broad-based fashion. One size does not fit all, and if one approach does not initially
work, consider trying another.
This article is organized with some preliminary points – including a reminder not to throw out old
tools which may work in a particular situation – and then an outline of additional litigation tools to consider
through pleadings, motions, discovery, alternative dispute resolution methods, and steps that can be taking in
an ongoing claim handling process.
This article does not discuss at length strategies that should already be part of the lawyer’s repertoire,
including developing an effective professional relationship with opposing counsel, resolving the case through
an existing business relationship between insurer and policyholder, and many procedural and discovery tools
commonly used by litigators.
Viability of any of the courses of action suggested in this article depend on whether they are available
under a particular state’s law and may depend on whether the lawsuit is pending in state or federal court. Case
law, practice guides, and local court rules should be consulted.
II. Getting Started: Know the Facts, Policy, and Case Law
The most important foundation to formulating a successful strategy is getting to know the claim.
This includes not only reviewing all relevant insurance policies, the claim file, claim notes, key aspects of the
underlying litigation, and information about the insured, but also interviewing key company witnesses in
order to understand their perspective, motivations, and actions. Lawyers make assumptions based on past
experience and those assumptions may not be true. Be curious. It will lead to better understanding. It is also
important to be familiar with the applicable state’s law regarding what the insured will have to prove in order
to succeed on its “bad faith” claim. Review the elements of the causes of action and what are likely to be the
jury instructions. Learn about the judge (if one has been assigned to the case) including his/her experience
litigating coverage and bad faith disputes and specific rules and procedures that need to be followed in that
department. And find out the opposing counsel’s reputation and experience. All of this information will help
delineate strategies.
Latest Strategies for Defending Bad Faith Claims ■ Thorpe and Carley ■ 87
III. Reminder: Don’t Throw Out Tools That Work
There are many options in the litigator’s tool box. They include, as an initial matter, figuring out if
jurisdiction and venue are appropriate and whether there is a better alternative. If diversity of the parties is an
issue, consider whether there are other parties that should logically and necessarily be included that would
either create or defeat diversity. The policyholder’s complaint should be reviewed to determine if it is technically sufficient, but consideration should be given to the cost/benefit of challenging a pleading that may only
result in a better pled claim. The question should be asked about whether there are grounds (e.g., immunity,
preconditions to suit, lack of jurisdiction) that should be raised as threshold issues.
One common strategy in bad faith cases is, through various means, to get the legal coverage issue
bifurcated and decided first before discovery and adjudication of the “bad faith” claim in jurisdictions where
both are plead in the same lawsuit. But this should not be the knee-jerk approach. While in some cases this
is entirely appropriate and can reduce the time and expense of litigating a bad faith case, in many instances
there are clear advantages to trying both the breach of contract and bad faith case together. Insurance coverage and claims handlings issues can be challenging and there may be a clear benefit to ensuring the jury has
the opportunity to stand in the shoes of the insurance adjuster in hearing the evidence as to whether there
was a contractual breach, while also evaluating whether any error was more than an honest mistake. This may
be a more preferable scenario than the risk that the jury will be impaneled with the Court instructing that the
Judge has already found the insurer to have breached the contract and all the jury hears and decides is the bad
faith claim.
Early use of motions for summary judgment or, in the alternative, summary adjudication, to defeat
the entire case or limit the scope of the lawsuit is also a well-used tool. The motion can be filed with no discovery or after limited discovery focused on the key legal elements of the insured’s claim. Given tremendous challenges faced by the courts, stipulating to filing cross-motions for summary judgment to resolve the legal issues
presented at the outset of the case is often welcomed by the court. If appropriate, entering into stipulated facts
regarding the basic elements of the claim can avoid the cost and potential risks that arise during discovery,
even if this approach does not provide the entire story the insurer might want to tell.
IV. Litigation Strategies to Consider
There are many other strategies to consider.
A. Early Case Resolution Through Settlement
While settlement may not be the first approach to case resolution that comes to a litigator’s mind,
sometimes it is the best and most appropriate approach. In order to make this recommendation, it is critical
that counsel carefully evaluate all legal and factual issues relevant to the claims determination. At times, the
policyholder is correct and the insurance company made a mistake. When there has been a claims handling
mistake, often the best approach is to attempt to resolve the case and evaluate the circumstances that gave rise
to the mistake so it is not repeated. Different settlement methods are discussed later in this article.
B.Pleadings
1.Scope of Lawsuit
If the lawsuit is one that is unlikely to be resolved early or involve resolution of a straightforward,
narrow issue, and while this is not necessarily what an insurer would usually want to do, it may be appropriate to consider expanding the lawsuit beyond the one claim or situation to include other claims. Consider
88 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
including other unresolved claims that involve interpretation of the same policy provision so as to avoid later
duplicative and potentially inconsistent results. This also may allow the insurer to show it applies its policy
language consistently.
2. Affirmative Claims
In addition to identifying defenses to the claims, counsel should evaluate whether there are affirmative claims the insurer should be making against this policyholder. By way of example, are there prior claims
that were overpaid, deductibles that have not been paid, or amounts to which the insurer is entitled to reimbursement? Are there grounds for rescinding or reforming the policy?
In some jurisdictions, an insurer has the right to seek reimbursement of defense costs from its policyholder. For example, in California, insurers defending under a reservation of rights that have reserved the
right to reimbursement, can seek recovery of defense costs paid to defend non-covered claims. Buss v. Superior Court, 16 Cal.4th 35 (1997) (insurer right to reimbursement from insured). The right to reimbursement
for defense costs paid to defend non-covered claims has also been upheld by the supreme courts of Colorado,
Connecticut, New Jersey, and Montana. See Hecla Mining Co. v. New Hampshire Ins. Co., 811 P.2d 1083, 1089
(Colo. 1991); Security Ins. Co. of Hartford v. Lumbermens Mut. Cas. Co., 826 A.2d 107, 124 (Conn. 2003); SL
Indus., Inc. v. America Motorists Ins. Co., 607 A.2d 1266, 1280 (N.J. 1992); Travelers Cas.& Sur. Co. v. Ribi
Immunochem Research, Inc., 108 P.3d 469, 480 (Mont. 2005).
The rationale is that the insurer should not have to provide a defense for claims for which it did not
receive a premium. Other state appellate courts and federal courts have also upheld the right to reimbursement.
In some jurisdictions, there is no such right unless the insurance policy expressly so provides or the
insurer and its policyholder have reached an agreement to this effect. The supreme courts of Texas, Hawaii,
Illinois, Wyoming, and Pennsylvania have refused to enforce a reservation of the right to seek reimbursement
of defense costs. Excess Underwriters at Lloyd’s, London v. Frank’s Casing Crew & Rental Tools, Inc., 246 S.W.3d
42, 45-46 (Tex. 2008); First Ins. Co. of Hawaii, Inc. v. State by Minami, 665 P.2d 648, 654 (Haw. 1983); General
Agents Ins. Co. of America, Inc. v. Midwest Sporting Goods Co., 828 N.E.2d 1092, 1099 (Ill. 2005); Shoshone
First Bank v. Pacific Employers Ins. Co., 2 P.3d 510, 516 (Wyo. 2000); Am. & Foreign Ins. Co. v. Jerry’s Sport Ctr.,
Inc., 606 Pa. 584, 613 (Pa. 2010). The reason these courts disallow reimbursement is the insurer should not be
permitted to unilaterally amend the policy, especially when the insured may be unschooled in the issues. Also,
such a reservation puts the policyholder in the position of making a “Hobson choice” between accepting this
condition to the insurer providing a defense or having to provide its own defense.
In some states an insurer that settles an action against its insured may be entitled to reimbursement
of that portion of the settlement payment attributable to noncovered claims. See Blue Ridge Ins. Co. v. Jacobsen, 25 Cal.4th 489, 492-493 (2001); Nobel Ins. Co. v. Austin Powder Co., 256 F.Supp. 2d 937, 940 (W.D. Ark.
2003) (applying Arkansas law); Travelers Prop. Cas. Co. of Am. v. Hillerich & Bradsby Co., 598 F.3d 257, 268
(6th Cir. 2010) (applying Kentucky law). Other states have held an insurer is not entitled to reimbursement of
settlement payments attributable to noncovered claims. See US Fid. v. US Sports Specialty, 270 P.3d 464, 470
(Utah 2012); Medical Malpractice Joint Underwriting Ass’n v. Goldberg, 680 N.E.2d 1121, 1128 (Mass. 1997);
Mt. Airy Ins. Co. v. Doe Law Firm, 668 So. 2d 534, 539 (Ala. 1995).
3.An Early Motion to Dismiss
In most jurisdictions, the policyholder in filing its coverage lawsuit is required to attach a copy of the
policy or quote all relevant policy provisions in the complaint. So a common practice, if the policyholder fails
Latest Strategies for Defending Bad Faith Claims ■ Thorpe and Carley ■ 89
to do so plead, is to file a motion to dismiss, especially if it will enable a second, substantive pleading attack to
resolve all or a portion of the claims at issue.
Where the policyholder has plead enough to set up resolution of the coverage dispute, another initial strategy may be try to resolve the case by motion to dismiss - right out of the gate based on the insured’s
pleadings (even if the pleadings do not tell the whole story). This approach is best utilized when the question
is a purely legal issue of coverage under the policy. Where the material facts about the claims are not disputed
(e.g., where the question is whether the underlying pleadings stated a claim potentially covered by the insurance policy), interpretation of the insurance policy is a legal issue for the court (not a jury) to decide. See Garcia v. Truck Ins. Exchange, 36 Cal.3d 426, 439 (1984); United States Fid. & Guar. Ins. Co. v. Commercial Union
Midwest Ins. Co., 430 F.3d 929, 933 (8th Cir. 2005) (applying Minnesota law).
Further, to the extent the insured has not included all relevant parts of the policy in describing the
coverage, or has not included the underlying pleading in its complaint, the court can be requested to take
judicial notice of pleadings and documents referenced in the bad faith complaint even if not attached to the
complaint. Galbraith v. County of Santa Clara, 307 F.3d 1119, 1127 (9th Cir. 2002); United States v. Corinthian
Coll., 655 F.3d 984, 999 (9th Cir. 2011).
C.Defenses
1.Genuine Dispute/Reasonably Debatable
There is no bad faith if the insurer did not act “unreasonably” or without proper cause. In some states
this defense is handled through eliminating the elements of the insurer’s claim. See Adams v. Auto Owners Ins.
Co., 655 So.2d 969, 971 (Ala. 1995); Pickett v. Lloyd’s (A Syndicate of Underwriting Members), 621 A.2d 445,
450 (N.J. 1993). In other jurisdictions, a bad faith claim can be defeated by showing there was a “genuine dispute” or the claim was “fairly debatable.” See Chateau Chamberay Homeowners Association v. Associated. International Ins. Co., 90 Cal.App.4th 335, 346 (2001); Griffin Dewatering Corp. v. Northern Ins. Co. of N.Y., 176
Cal.App.4th 172, 209 (2009); Lunsford v. American Guarantee & Liability Ins. Co., 18 F.3d 653 (9th Cir. 1994)
(applying California law); Travelers Ins. Co. v. Savio, 706 P.2d 1258, 1275 (Colo. 1985).
Even if there is no state law, this defense should be raised because it is common sense. If there was no
legal precedent on the coverage issue and the reason the insurer took the position it did was sound, the insurer’s position cannot have been unreasonable.
2.Focus on Core Dispute
As companies and their lawyers are aware, bad faith claims are often included in lawsuits not because
they are legitimate, but because there is at least the perception that they afford the policyholder with additional leverage, and possibly increased damages. Policyholders use these claims as tools to resolve disputes.
Where the facts and law do not support the asserted bad faith claim, counsel needs to evaluate how to effectively highlight this fact to the court, and even the policyholder, in a civil and professional manner. This can
be done in the mediation or settlement conference process because there is a neutral person who can help
convey this information. But it can also be communicated in the course of the lawsuit. In depositions, for
instance, asking questions of the policyholder that make it clear his/her lawyer is creating more work, being
difficult, manufacturing disputes, or misrepresenting information to the insurer can be suggested in the questions asked. Testing the policyholder’s counsel’s credibility in its client’s or the court’s presence can help redirect the focus of the case back to the core issues, which involve good faith disputes over the existence and
scope of coverage or the value of the case – not dishonest, mean-spirited, or even indifferent conduct.
90 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
D.Discovery
Rather than barraging the other side with voluminous discovery requests, consider instead specific
discovery with difficult questions that go to the heart of the claim. Are there requests for admissions that will
require the policyholder to admit or deny a fact that is at the core of the dispute? Are there representations or
arguments the policyholder has made in support of the bad faith claim that can be dissected in written and
deposition discovery?
Also, use social media to secure informal discovery, e.g., review materials posted by the policyholder
on-line. Consider the source of the information and the evidentiary issues that use of these materials may
present in using the information in a motion or at trial. Do not wait for the motion or the trial to figure that
out.
In addition to written discovery, when evaluating what discovery is needed to prepare the case for
motion and/or trial, consider whether there are depositions that will have a significant impact on the case and
further the client’s overall objectives, e.g., to settle the case at an early stage of the litigation, to secure admissions for purposes of a motion for summary judgment. As part of the overall discovery plan, there may be an
opportunity to take the deposition of key adverse witnesses that will materially improve the overall posture of
the case.
E.Experts
While the lawyer in consultation with his/her client determines the case strategy, a powerful tool is
to use the expert hired to address claims handling, underwriting, or financial issues in the case to identify
other potential strategies. The expert has likely had experiences in his/her field and as a consultant/expert,
and likely seen similar situations, that might suggest other alternative arguments and approaches. Engage
the expert as soon as possible, give that person all the relevant information, and listen not only to the opinion that will be rendered for the motion or trial, but also to the expert’s other observations, thoughts, and
suggestions.
For example, the expert may from past experience indicate there are other things the insured could
have done to mitigate the damages claimed, e.g., federal and state programs, low-interest loans. The expert
may suggest a way to explain the policy provisions in dispute. The expert, if a good teacher, may have ideas
about how to make the judge understand the underwriting process in a way that will give the judge a better
understanding of why the policy operates the way the insurer is advocating.
F. Dispute Resolution Alternatives
Most companies and their lawyers are very familiar with settlement conferences and mediations. Far
less have tried other ADR tools. Courts have a number of different options that vary by location that should be
considered. These include Voluntary Dispute Resolution programs, Neutral Evaluation, Arbitration, Retired
Judge Settlement Conference, court-supervised mediation, and private mediation.
Arbitration can be an attractive alternative, especially in light of the financial demands placed on
many state and federal court systems. For example, as a result of budget cuts in many states it can take many
years for a case to get to trial and trial dates are often continued to address other priority matters, including
criminal cases. Trial delays increase the costs of resolution for both sides, and can cause difficulties in scheduling witnesses. While a policyholder may need to be educated on the time value of money or unpredictability
of juries, there are certainly studies and commentary publicly available that can be forwarded to the opposition to support a proposal to resolve the case another way.
Latest Strategies for Defending Bad Faith Claims ■ Thorpe and Carley ■ 91
Private mediators are also creating their own options for resolving disputes. Many mediators have
been involved in literally thousands of disputes and, if asked, can suggest alternatives the parties may want to
consider. For example, a mediator can organize a mock jury exercise on an important issue in the case. Where
the parties’ dispute hinges on a technical issue (e.g., scientific, technology-driven), the mediator can have the
parties hire an independent consultant to participate in the mediation process. The parties may want to agree
that a consultant should be retained to assist the mediator in understanding issues and arguments the parties
were raising that are outside the mediator’s experience and expertise.
Because so many cases are decided during settlement conferences and mediations, the approach
taken in this forum should be carefully considered. While by the time the parties are at mediation, often the
parties are well-aware of their respective positions, consideration should still be given to insisting on an initial meeting when all parties are in the same room. Insurer’s counsel should use that time to talk directly to
the policyholder and sincerely express concern, if appropriate, for the situation, and the insurer’s desire to
resolve the dispute without tremendous time and cost. A direct connection with the policyholder may cause
the insured to take the insurer’s offers seriously and defuse ill feelings, which can make for a more productive
and amicable resolution.
Further, take the opportunity to educate the mediator prior to the mediation. Provide the mediator with a short neutral road map of the parties and their positions. Preview for the mediator the issues and
obstacles to resolving the matter. Even if the mediation does not resolve the case that day, consider having the
mediator continue to work with the parties afterward. Even if unsuccessful, evidence of the insurer’s efforts
may (depending on evidentiary rules and case law) be admissible to show the insurer acted in good faith in
trying to resolve the dispute.
G. Ongoing Claim Handling
While the litigation is underway, in some states the insurer is required to still handle the claim. See
e.g., White v. Western Title, 40 Cal.3d 870, 886 (1985). The insurer argued in White that: “once suit has been
filed, the insurer stands in an adversary position to the insured and no longer owes a duty of good faith and
fair dealing.” Id. Not so, said the court, explaining that as a “matter of principle, it is clear that the contractual
relationship between insurer and the insured does not terminate with commencement of litigation.” Id. The
court continued: “what constitutes good faith and fair dealing depends on the circumstances of each case,
including the stage of the proceedings and the posture of the parties.” Id.
In other states, the fact that the policyholder or insurer filed a lawsuit may absolve the insurer from
having to communicate further on the claim and may prevent an insurer from introducing (even where it
benefits the insurer) conduct that occurred after suit was filed. See e.g., Gates v. State Farm County Mut. Ins.
Co., 53 S.W.3d 826, 832 (Tex. App. 2001).
Where an insurer is required to or has the right to continue to handle the claim, consideration
should be given to taking steps that would improve the insurer’s position. This requires an appreciation of
many factors including the personality of the policyholder, the business relationship between insurer and
insured, and what took place prior to the lawsuit being filed. Suggestions of what can be done range from
improving communication, paying all or part of the claim where appropriate, to even, if warranted, an
apology.
For example, if the problem has been a lack of communication, then even though there will certainly
be the necessity of explaining why it took the filing of a bad faith case to cause communications to happen,
there should be communication. Perhaps a meeting between the insured and insurer would be helpful (with
lawyers involved unless there is an agreement that lawyers not be involved). Anything said (or misunder92 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
stood) may be used against the insurer (unless there is an agreement otherwise), so it may be necessary to
carefully script and practice. Has there been confusing communication? Consider having the insurer draft a
letter to the policyholder explaining more clearly the insurer’s position and outlining a proposed reasonable
resolution. If the dispute was created, even in part, by a real or perceived lack of additional information being
forwarded by the policyholder, then consider outlining specifically what information is still needed, with an
explanation as to how that information impacts the ability to make a coverage determination and resolve the
claim.
Has a reservation of rights been sent? If not, in some states and situations, reserving rights, albeit
belatedly, can help the insurer’s legal positions. In California, for example, a general reservation of rights
is sufficient, and where no reservation was previously made, the issue will be whether the reservation was
waived or the insurer is estopped from raising the reservation – both factual issues. Waller v. Truck Ins. Exchg.,
11 Cal.4th 1, 31-34 (1995). To prove waiver the policyholder would have to show: (1) the insurer intended to
relinquish its rights, or (2) the insurer’s conduct induced a reasonable belief in the insured that the insurer did
not intend to enforce the terms of the policy. Id. The California Supreme Court rejected an automatic waiver
rule against insurers. (Id.)
Whether an insurer acted in bad faith may take into consideration whether the insurer was willing to reconsider the claim and acted appropriately on reconsideration. Shade Foods, Inc. v. Innovative Products Sales, 78 Cal.App.4th 847, 880 (2000). Mistakes happen. They can be compounded by being bull-headed.
However, a change in course can also lend support to a claim that the initial decision was wrong and in “bad
faith,” so the ramifications of taking, or not taking, this approach should be carefully considered.
Where the continued nonpayment of policy benefits entitles the policyholder to collect attorney fees
for pursuing coverage, the coverage position needs to be re-examined to determine if it was right. If the claim
should be paid, payment may stop the risk of paying attorney fees. Consideration should also be given to paying interest (even if not asked), and/or the other side’s attorneys fees (even if not asked). If done right, this can
take the wind out of the sails of the policyholder’s “bad faith” boat. In California, attorney fees are only recoverable for pursuing benefits that were withheld unreasonably and without proper cause. Brandt v. Superior
Court, 37 Cal.3d 813, 817-818 (1995). If benefits have been paid, there is no right to attorneys fees for proving
bad faith. Id. at 818. This is not the law everywhere. See e.g. Olympic S.S. Co. v. Centennial Ins. Co., 811 P.2d
673, 681 (Wash. 1991) (policyholder entitled to attorneys fees for having seeking amounts owed under the
policy).
And, if a mistake was made, what about an apology? Several years ago, review of a bad faith claim
lead to an understanding that all the insured really wanted was an apology. The policyholder felt wronged
because his claim had been ignored and it had taken too long to resolve. But he really had no additional damages. While at first skeptical as to whether this was really a set-up, the apology was delivered and the case
resolved.
V.Conclusion
While facing a bad faith case can put the company and its counsel on the defensive, which is completely appropriate, leave room for creative thinking and planning. A decision tree can help with this process.
Diagramming out various different strategies and the different results that might come from those paths can
help formulate a plan, knowing there are risks and uncertainties in every option.
The plan must include an understanding of the company’s concerns about, among other things, prior
experience, allocation of resources, making bad law, establishing precedent, damages, and punitive damageIn
Latest Strategies for Defending Bad Faith Claims ■ Thorpe and Carley ■ 93
trying out new techniques the old adage comes to mind of “nothing ventured, nothing gained.” A claim of bad
faith should not prevent a company and its counsel from considering creative options to resolve or narrow the
issues presented.
94 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Consent Judgments:
Raising the Stakes in Bad Faith Litigation
Kevin J. Willging
Travelers
111 Schilling Road
Hunt Valley, MD 21031
(443) 353-1919
kwillgin@travelers.com
Kevin J. Willging is Senior Counsel - 2nd Vice President for Travelers and is based
in Hunt Valley, MD. He is responsible for managing extra-contractual litigation
against the company. Mr. Willging was admitted to the Maryland bar in 1993. In
1996, he began work with Niles, Barton and Wilmer in Baltimore, MD, focusing
his practice on insurance coverage and defense litigation. In 2000, he joined the
St. Paul Companies as coverage counsel, providing in-house coverage advice and
managing coverage litigation. In 2002, he assumed responsibility for managing
extra-contractual and bad faith litigation against St. Paul, and he continued in that
function following St. Paul’s merger with Travelers. He works closely with defense
counsel in preparing pleadings, formulating strategy, coordinating consistent
discovery tactics, negotiating settlements and preparing cases for trial. Mr. Willging
is a frequent speaker on bad faith and extra-contractual issues and litigation, as well
attorney-client relations. He owes great appreciation to his assistant Lori Myers for
her invaluable help in aiding in the research and content of this paper.
Consent Judgments:
Raising the Stakes in Bad Faith Litigation
Table of Contents
I.
II.
III.
IV.
What Is a “Consent Judgment”?...................................................................................................................99
What Are the Dynamics That Lead to Consent Judgments?....................................................................100
Why Do Some Courts Uphold Consent Judgments?................................................................................101
Potential Issues to Examine When Faced with a Consent Judgment or the Prospect of Same.............101
A.Fraud/Collusion/Unreasonableness...................................................................................................102
B. Should the Carrier Have to Pay a Consent Judgment if the Insured Was Never Obligated To?.....104
C. Other Considerations..........................................................................................................................105
1. Proof of Coverage.........................................................................................................................105
2.Cooperation..................................................................................................................................106
3. Is proof of bad faith necessary to recover the excess judgment?..............................................106
4. Is the amount of the Consent Judgment binding on the insurer?............................................107
V. Potential Tool?.............................................................................................................................................107
VI.Conclusion...................................................................................................................................................108
Consent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 97
Consent Judgments:
Raising the Stakes in Bad Faith Litigation
Imagine, as an insurance professional or attorney, that a case comes to your desk with pretty significant – but not outrageous – damages. Your insured has some pretty viable liability defenses that could reign
in the settlement value of the case. On top of that, there are very strong coverage defenses, which could mean
that the carrier has no exposure to defense costs or indemnity. It would appear that the carrier is in a position
of great leverage. But that feeling of over-confidence can be quickly replaced with panic when the following
happens:
• The insured and the plaintiff consent to a stipulated judgment;
• The amount of that judgment, is several times more than the value of the case, in your opinion,
and well beyond the policy limits;
• The stipulation contains a covenant-not-to-execute against the insured and assigns the insured’s
rights to enforce the full judgment amount to the tort-plaintiff;
• The stipulation contains admissions of fact which, if binding on the insurer, could defeat the
insurer’s otherwise solid coverage defenses.
• Suit is filed against the insurer alleging breach of contract and bad faith, and seeks recovery of
the full amount of the judgment, plus interest and attorneys’ fees.
How could this happen?
Through the magic of consent judgments.
This paper will cover the following topics:
• What is a consent judgment
• What are the potential pitfalls of a consent judgment
• What issues should you consider if your jurisdiction allows consent judgments
• How can you use a consent judgment as a tool for your client’s benefit
Consent Judgments are highly jurisdiction-specific. Perhaps, the only piece of advice that applies to
practitioners around the country, on the topic of Consent Judgments, is that one must look at the specific law
of the governing jurisdiction when faced with a Consent Judgment scenario or the potential therefor.
Because the issues are so jurisdiction-specific, careful planning is essential on issues such as the initial decision by the carrier to reserve rights or deny a defense to the insured and to participate in settlement
discussions notwithstanding a denial or reservation. After the entry of a Consent Judgment, the carrier should
examine the law within the governing jurisdiction to determine whether to challenge: (1) the reasonableness
or apparent collusiveness of the judgment amount, (2) the absence of any obligation on the part of the insured
to pay for that judgment, (3) any factual stipulations which may bear on the insured’s underlying liability or
coverage and/or (4) the binding effect of the judgment amount or factual stipulations on the carrier, which
typically was not invited to participate in the discussions leading up to the Consent Judgment.
I. What Is a “Consent Judgment”?
“Stipulated Judgments” or “Consent Judgments” are known by a variety of different names throughout the country, and usually receive their moniker from the state landmark decision that first recognized or
sanctioned such a judgment. In Minnesota, Consent Judgments are known as “Miller-Shugart” agreements.
Consent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 99
Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982). In Arizona, these agreed-upon judgments are called “Damron” or “Morris” Agreements. Damron v. Sledge, 460 P.2d 997 (Ariz. 1969); USAA v. Morris, 741 P.2d 246 (Ariz.
1987). In Florida, they are known as “Coblentz” agreements. Coblentz v. American Surety Company of NY, 416
F.2d 1059 (5th Cir. 1969) (applying Florida law). And in Washington, they are referred to as a “covenant judgment.” RSUI Indemnity Co. v. Vision One, 2013 WL 662966 (W.D. Wash., February 21, 2013). Whatever the
name, the features of a Consent Judgment are frequently the same, but the manner in which the courts in a
jurisdiction will treat that judgment vary greatly from one jurisdiction to another.
In almost every case, the core features of a Consent Judgment are the same. They include an agreement between the insured and the tort-plaintiff bearing following elements:
i) A Judgment against the insured, establishing its liability and the amount of damages;
ii) A covenant not to execute, given by the tort-plaintiff, freeing the insured from any obligation to
pay the judgment amount. The only source of recoverable funds carved out in the agreement is
the carrier – from the policy itself and/or through an extra-contractual recovery; and
iii) An assignment by the insured of its rights – contractual and extra-contractual – against the carrier, to the tort-plaintiff.
II. What Are the Dynamics That Lead to Consent Judgments?
What is the genesis of Consent Judgments? Why are insureds and tort-plaintiffs motivated to enter
into them?
Let’s begin with the insured. Most Consent Judgments arise when the carrier has reserved rights or
has denied coverage outright. Therefore, there is at least the potential that the insured will bear 100 percent of
the exposure on the underlying tort claim. Even with potentially viable liability defenses, most insureds will
not be able to financially withstand an uninsured judgment against them in cases of moderate to significant
exposure. Those that can financially weather such an exposure certainly will not want to. As one court put it,
“when the insurer exposes its policyholder to the sharp thrust of personal liability by breaching its obligations, the insured need not indulge in financial masochism.” Samson v. Transamerica Ins. Co., 636 P.2d 32,
45 (Cal. 1981) citing Critz v. Farmers Ins. Group, 41 Cal.Rptr 401, 408 (Ct. App. 1964). When an insurer has
denied a defense to the claim, the insured not only faces a significant uninsured judgment, it will also have
to bear the burden of defense fees through protracted litigation. A Consent Judgment allows the insured to:
avoid those defense fees, and avoid any exposure to the tort-plaintiff. Choosing between (a) paying defense
fees and potentially facing a significant uninsured exposure, and (b) paying limited/no defense fees and having no exposure is quite frankly no choice at all.
The benefits to the tort-plaintiff are multi-fold. First, the tort-plaintiff avoids his/her own fees and
expenses common in a lawsuit with significant damages. Second, the tort-plaintiff can essentially fix the
amount of damages they stand to recover, at a level they would not likely have obtained through a contested
trial. Third, the tort-plaintiff will have little resistance from the insured-defendant as to the amount of the
Judgment. There is simply little or no motivation for an insured to try to whittle down a judgment amount
that they will never have to pay. Fourth, the Judgment amount, in many jurisdictions, cannot be undercut absent affirmative proof of fraud or collusion. Fifth, the parties to the Consent Judgment may be able to
include stipulated facts which either weaken or eradicate the insurer’s defenses to coverage. Sixth, the tortplaintiff can move quickly into coverage/bad faith litigation that presents a jury with a victim versus corporate-defendant dynamic: should we award money to the innocent, injured victim of an accident, or side with a
large multi-billion dollar insurance company, forcing the innocent victim to walk away with nothing? Consent
100 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Judgments are not always upheld against the carrier but if the insured was going to be judgment-proof anyway, there is little downside risk for the tort-plaintiff to pursue a deep-pocketed insurer.
III. Why Do Some Courts Uphold Consent Judgments?
Anyone involved in insurance litigation is probably aware that insurance companies are not the most
sympathetic litigants in our mainstream society. Even still, there is something almost unclean about allowing
insureds and tort-plaintiffs to “fix” the amount of a judgment, which the carrier must then pay (potentially).
So, why do courts allow these arrangements to stand?
The courts have advanced essentially two rationales for sanctioning Consent Judgments. The first is
based on the insured being placed in a Hobson’s choice when the insurer reserves its rights to indemnify or
refuses to defend, particularly if that refusal was wrongful. If the insurer reserves its rights on indemnity, the
insured faces the potential of a runaway verdict, all of which may fall on its shoulders. And when a carrier
abandons its insured by breaching the duty to defend, the insured is “left to [its] own resources,” Coblentz, at
1063 – which it may not have, to defend the lawsuit. After all, the duty to defend is frequently referred to as
“litigation insurance,” Miller v. Westport Ins. Corp., 200 P.3d 419, 423 (Kan. 2009) citing Jerry & Richmond,
Understanding Insurance Law, §111[a] (4th ed.2007) (citing Allstate Ins. Co. v. Campbell, 334 Md. 381, 392,
639 A.2d 652 [1994] [quoting Brohawn v. Transamerica Ins. Co., 276 Md. 396, 410–11, 347 A.2d 842 (1975) ];
Auto Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131, 818 N.Y.S.2d 176, 850 N.E.2d 1152 [2006] ) - a kind of coverage that protects insureds against the financial costs associated with being sued, and when that benefit of the
bargain is denied to the insured, the insured is permitted to “protect himself in the best was possible.” Steil v.
Florida Physicians Insurance Reciprocal, 448 So.2d 589 (Fla. 2d. Dist. Ct. App., 1984).
The second rationale that courts will use to sanction the use of Consent Judgments is that they are a
tool to strongly encourage carriers to fulfill their obligations under the contract. If a carrier defends its insured
from the outset, it could be in a better position (depending on the jurisdiction) to avoid exposure to any backalley deals that the insured may otherwise wish to strike with the claimant. See e.g., Wright v. Fireman’s Fund
Ins. Co., 14 Cal.Rptr.2d 588, 595-96 (Ct. App. 1992). The thought is that exposure to extra-contractual damages is far more likely to get a carrier’s attention, than merely exposure to contractual damages alone. Rawling
v. Apodaca, 726 P.2d 565, 575 (Ariz. 1986). Finally, the dark cloud of a lofty Consent Judgment could have the
effect of encouraging carrier to negotiate settlements and avoid line-in-the-sand stances.
IV. Potential Issues to Examine When Faced with a Consent
Judgment or the Prospect of Same
Very often, a Consent Judgment carries the threat of significant extra-contractual exposure and may,
in fact, influence a carrier’s decision to deny a defense or reserve its rights on indemnity. But there are a still a
number of questions concerning the enforceability of Consent Judgments. Those questions include:
• Must a Consent Judgment be fair and reasonable?
• What if a Consent Judgment is created through fraud and/or collusion? And whose burden is it
to prove/disprove that element?
• What if the insured is not “legally obligated to pay”?
• Must coverage be established in order to enforce a Consent Judgment against the carrier?
• Does a Consent Judgment violate a policy’s “cooperation” provision and thereby negate coverage?
• Does a plaintiff need to prove bad faith in order to recover amounts in excess of the policy limits?
Consent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 101
• Is a Consent Judgment amount binding on the carrier?
A.Fraud/Collusion/Unreasonableness
It is an unofficial certainty that a Consent Judgment will be entered in an amount far above what
an impartial fact-finder might conclude. Remember, the tort-plaintiff has every incentive to maximize the
amount of the Consent Judgment, because at best, they will get to recover it, and at worst, it can be used as
leverage against a carrier in negotiations. The tort-plaintiff is likely to meet with little resistance from the
insured, whose only goal is to be relieved from responsibility for the Judgment amount. As long as that goal is
met, the insured is not likely to fight hard on what the amount should be. So, if neither party to the Consent
Judgment is constrained to agree upon a fair number, the Consent Judgment figure is likely to be large. What
arguments can the carrier advance to limit its exposure to a Judgment amount bearing no reasonable relationship to the true value of the case?
Many courts have recognized the potential for inflated damages through a Consent Judgment. An
appellate court in Florida had this to say:
[I]n the instant case or one involving a consent judgment with a covenant not to execute, the
settlement figure is more suspect. The conduct of the insured can hardly be characterized as
fraudulent simply because he stipulates to a large settlement figure in order to obtain his release
from liability. He has little or nothing to lose because he will never be obligated to pay. As a consequence, the settlement of liability may have very little relationship to the strength of the plaintiff ’s claim.
Steil at 592. And a California appellate court stated:
[T]o sanction such a transaction would be to invite collusion between the claimants and insured
by allowing them to ‘bootstrap their damages with the ingenious assistance of counsel.”
Smith v. State Farm Mutual Automobile Insurance Co., 7 Cal.Rptr.2d 131, 138 (Ct. App. 1992) quoting Doser v.
Middlesex Mut. Ins. Co., 162 Cal.Rptr. 115, 120-121 (Ct. App. 1980).
Accordingly, a number of courts, recognizing the potential that Consent Judgments may be fertile
ground for, in essence, writing a blank check on the insurer’s account, have imposed some restrictions on
Consent Judgment amounts.
The existence of fraud or collusion in reaching the Consent Judgment is widely recognized as a basis
for challenging such a Judgment. Metcalf v. Hartford Acc. & Indem. Co., 126 N.W.2d 471, 476 (Neb. 1964)
(“the judgment, if obtained without fraud or collusion will be conclusive against him . . .”) (emphasis added);
Coblentz, at 1063 (“a [consent] judgment entered against the indemnitee or insured, in the absence of fraud
or collusion is conclusive against the indemnitor or insurer as to all material matters determined therein.”)
(emphasis added); Spence-Parker v. Maryland Ins. Group, 937 F. Supp. 551, 560-61 (E.D. Va. 1996). Some
courts adhere to the standard that when a carrier wrongfully refuses to defend its insured, the insurer cannot later challenge the consent Judgment entered in the underlying action unless the Judgment was obtained
through fraud and collusion. Almost 50 years ago, the Nebraska Supreme Court held:
It is a well-settled principle that where a person is responsible over to another, either by operation of law or express contract, and he is duly notified of the pendency of the suit against the
person to whom he is liable over, and full opportunity is afforded him to defend the action, the
judgment, if obtained without fraud or collusion, will be conclusive against him, whether he
appeared or not.
Metcalf, at 476. The 5th Circuit reiterated this principle in the Coblentz decision:
102 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Where either an indemnitor or liability insuror has notice of a proceeding against his indemnitee
or insured, and is afforded an opportunity to appear and defend, a judgment rendered against
the indemnitee or insured, in the absence of fraud or collusion, is conclusive against the indemnitor or insuror as to all material matters determined therein.
Coblentz, at 1062-63. The same holds true, in Arizona, when a carrier wrongfully refuses to defend. Parking
Concepts, Inc. v. Tenney, 83 P.3d 199, 22, note 3 (Ariz. 2004). An appellate court there went even a step further, finding that the carrier was not only bound by the Judgment amount, but for purposes of coverage, by any
issues determined by the stipulated judgment. Colorado Cas. Ins. Co. v. Safety Control, 269 P.2d 693, 696 (Ariz.
App. 2012); See also Travelers Property Casualty Co. of America v. AF Evans Co., 2012 U.S. Dist LEXIS 134189
(W.D. Wash., September 19, 2012) (when an insurer refuses to defend in bad faith, the amount of the underlying stipulated judgment is, in the absence of fraud or collusion, the presumptive measure of damages). The
Safety Control decision presents a significant danger to carriers, not only in terms of the ultimate exposure, but
also their ability to effectively rely on their coverage position. Virginia and Connecticut also require the carrier
to show of fraud and collusion in order to challenge a consent judgment. Spence-Parker v. Maryland Ins. Grp.,
937 F. Supp. 560-61 (E.D. Va. 1996), Black v. Goodwin, Loomis & Britton, 681 A.2d 293, 302 (Ct. 1996).
Most states have a lesser standard for upsetting the Consent Judgment, requiring only a showing of
unreasonableness in the amount of the Consent Judgment. Typically, this standard will apply in situations in
which the carrier defended its insured, but reserved its rights on an indemnity obligation. In Arizona, when
a carrier does defend, “neither the fact nor amount of liability to the claimant is binding on the insurer unless
the insured or claimant can show that the settlement was reasonable and prudent.” USAA v. Morris, 741 P.2d
246 (Ariz. 1987). See also Red Giant Oil v. Lawlor, 528 N.W.2d 524, 532 (Iowa (1995) (adopting an objective
“reasonably prudent person” test); Rhodes v. Chicago Ins. Co., 719 F.3d 116, 120 (5th Cir. 1983)
There are two cases in particular which applied the reasonableness standard even though the carrier had denied its insured a defense. In Steil v. Florida Physicians Ins. Reciprocal, a Florida appellate court
held that “the settlement of liability and damages may have very little relationship to the strength of plaintiff ’s
claim. Due to this problem, the ordinary standard of collusion or fraud is inappropriate.” Steil at 592. In Continental Cas. Co., v. Hempel, the 10th Circuit held that the insured’s settlement must be reasonable in order to
make an insurer that breached the duty to defend liable to pay it. 4 Fed. Appx. 703, 715 (10th Cir. 2001) (applying New Mexico law).
Several courts have refused to allow the entry of a Consent Judgment when the carrier agreed to provide a defense. In Wright, the California Court of Appeals held that “where an insurer provided a defense to
the insured in the underlying litigation and the insured, without the participation or consent of the insurer,
stipulated to judgment without evidentiary support and with no potential for personal loss, such judgment is
insufficient to impose liability on the insurer in a later action against the insurer.” Wright at 1024. Courts in
Minnesota, Texas and Ohio reached similar conclusions. See Romstadt v. Allstate Ins. Co., 844 F. Supp. 361, 366
(N.D. Ohio); Burbach v. Armstrong Rigging and Erecting, 560 N.W.2d 107 (Minn. Ct. App. 1997); State Farm
Fire and Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996) The Supreme Court in Alaska has held that a reasonable Consent Judgment may be enforceable even though the carrier was defending, if the carrier committed
some other “material breach” of the policy.” Great Divide Ins. Co. v. Carpenter, et rel., 79 P.3d 599, 609 (Alaska,
2003); see also Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa, 2000).
At least one court has held that even when the insurer has defended the insured, the insured can still
enter into a Consent Judgment, for an amount excess of policy limits, and the claimant can attempt to collect
the full amount of the Consent Judgment based on the insurer’s bad faith refusal to settle. Great Divide Ins. Co.
v. Carpenter, et rel., 79 P.3d 599, 609 (Alaska, 2003); see also Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637 (Iowa,
Consent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 103
2000). Although the Nunn case has not received widespread support around the country, it raises concerns
about plaintiffs’ and insureds’ ability to “set-up” carriers. Imagine a scenario in which an injured party makes
a multi-conditional, time-limited demand against the insured’s carrier and the case fails to settle. Under the
Nunn Court’s rationale, the claimant could enter into a Consent Judgment, far above the limits, against the
insured and pursue the carrier for the full extent of that Judgment.
Some of the factors courts will examine when considering the reasonableness of a settlement are:
• The damages involved;
• The merits of plaintiff ’s liability theory;
• The merits of defendant’s theory;
• The defendant’s relative fault;
• The risks and expenses of continued litigation;
• The defendant’s ability to pay;
• Any specific evidence of collusion;
• The extent of the investigation and preparation of the case;
• The interests of the parties not being released from liability
• Comparable jury awards;
• Categorizing all damages as compensatory, none as punitive;
• An agreement to reimburse settling insurers after recovering from non-settling insurers;
Red Oaks Condominium Owners Assoc. v. Sundquist Holdings, Inc., 116 P.3d 404, 407 (Wash. Ct. App. 2005);
Firemen’s Fund v. Imbesi, 826 A.2d 735 (N.J. Superior Ct) cert. denied 834 A.2d 406 (N.J. 2003)
The burden of proving reasonableness (or the lack thereof) likewise varies from jurisdiction to jurisdiction. One line of cases places the initial burden on the tort-claimant to show that the Consent Judgment
was reasonable and not in bad faith. Grigg v. Bertram, 443 A.2d 163 (NJ 1982); see also Steil at 591. Other
courts take a different approach – requiring the tort-plaintiff to make an initial showing of reasonableness but
then shifting the burden onto the carrier to prove fraud and collusion. Miller v. Shugart, 316 N.W.2d 729, 73436 (Minn. 1982); see also USAA v. Morris at 253-54.
B. Should the Carrier Have to Pay a Consent Judgment if the Insured Was
Never Obligated To?
One of the fundamental principles of liability insurance is that it provides “indemnity” to its insured
when the insured suffers a “loss” or “becomes legally obligated to pay (sums) as damages . . .” One of the key
features of a Consent Judgment is that the insured is never obligated to pay the claimant anything. This inherent contradiction begs the question: if the insured never has to pay, why does the insurer?
Some courts have in fact held that a Consent Judgment cannot be enforced against an insurer
because of the absence of any obligation on the part of the insured. In Lida Mfg. Co. v. U.S. Fire Ins. Co., a
North Carolina Court of Appeals focused on the language in the insurance policy in refusing the enforce a
Consent Judgment against an insurer:
The issue presented is whether the settlement agreement, which contains a covenant not to
execute a confession of judgment against [the insured] precludes [the] plaintiffs from recovering payment against [the insurer’s] policy . . . which provide[s] coverage only if [the insured] is
“legally obligated to pay” damages.
104 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
. . .
When an insurance policy contains language such as ‘legally obligated to pay’ an insurer has no
obligation to an injured party where the insured is protected by a covenant not to execute.
448 S.E.2d 854, 856-57 (N.C. Ct. App. 1994). Additionally, if the insured is completely released from liability before it assigns any rights to the claimant, then the Consent Judgment cannot be binding on the insurer.
Fidelity & Cas. Co. v. Cope, 462 So.2d 459, 461 (Fla. 1985) (the release has the effect of extinguishing the
insured’s liability, and therefore, all of the insured’s rights against the insurer that subject to assignment). The
Eighth Circuit recently reached a similar result. “Because the Assignment Agreement that transferred to the
[claimant] the limited right to sue [the insured] for insurance proceeds absolved [the insured] from payment,
the $56 million [Consent Judgment] is not a “Loss” as required by the plain language of the policy. U.S. Bank
Nat’l Assoc. v. Federal Ins. Co., 664 F.3d 693, 696-699 (8th Cir. 2011) (applying Missouri law) (policy contained
a policy definition of “Loss” to mean “the total amount which any Insured Person becomes legally obligated to
pay on account of each Claim).
Nevertheless, a good number of courts will allow the parties to the Consent Judgment to carve out
the obligations of the insurer and keep them intact. Red Giant at 532-33 (distinguishing a release from a covenant not to execute and finding a legal obligation to pay remains in a covenant not to execute). Arizona has
held that “the covenant not to execute is not a release which would permit the insurer to escape its obilgations.” State Farm Mut. Auto Ins. Co. v. Paynter, 593 P.2d 948, 953 (Ariz. Ct. App. 1979) In Florida, the Supreme
Court distinguished its earlier decision in Cope and held that:
The key with regard to whether Cope applies is whether the underlying claim continues to exist
after the settlement agreement . . . The settlement between [plaintiff] and [the insured] constituted a covenant not to execute . . . The settlement agreement was not a release of [the insured]
. . . The agreement did not provide a legal impediment to the litigation with [the insurer] to
resolve the coverage dispute, which litigation was clearly within the contemplation of the parties.
Rosen v. Florida Ins. Guar. Ass’n, 802 So.2d 291, 297-298 (Fla. 2001) citing Cope supra note 35. See also Appelman on Insurance Law and Practice §142.1.
C. Other Considerations
1.Proof of Coverage
In addition to the issues discussed above, there are some additional issues which bear mentioning.
Many states require that, before a tort-plaintiff can attempt to collect any money pursuant to a Consent Judgment, it must be first established that there was actually coverage under the policy. Remember, many
Consent Judgments arise following an insurer’s disclaimer of coverage or reservation of rights. Florida has recognized that “as a condition precedent to any recovery against the carrier, [plaintiff] will have to prove that
her claim against [the insured] was within the coverage of the policy. Steil supra note 8 at 592. Texas, Pennsylvania and Maine follow this position as well. Quorum Health Res., LLC v. Maverick County Hospital Dist., 308
F.3d 451, 468 (5th Cir. 2002) (applying Texas law) (“Even if an insurer wrongfully refuses to defend, it still has
the right to assert the defense of noncoverage and will only be liable to indemnify the insured up to the policy
limit.”) Keystone Spray Equip., Inc. v. Regis Ins. Co., 767 A.2d 572, 576 (Pa. Super. Ct. 2001) (“when an insurer
wrongfully declines to defend an insured, the insured may enter a reasonable settlement agreement and subsequently seek indemnification from the insurer to the extent that there is actual coverage for the claim.”)
(emphasis added); Patrons Oxford Ins. Co. v. Harris, 905 A.2d 819, 827 (Me. 2006) (“damages are binding on
the insurer only if the insured or claimant can show the reasonableness of the amount and can establish coverConsent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 105
age.”) (emphasis added). Illinois has a slightly different approach, placing the burden on the insurer to prove
that there was no possibility of coverage:
[Only] if the policy did not afford even potential coverage at the time of denial, then. . . [is] the
insurer’s refusal to defend . . . not actionable.
Maneikis v. St. Paul Ins. Co. of Ill., 655 F.2d 818, 823 (7th Cir. 1981).
2. Cooperation
Most liability policies contain a provision requiring the insured to cooperate with the carrier. Many
courts have found that when the insured actively assists the claimant’s action, there has been a breach of the
duty to cooperate, and coverage is therefore jeopardized. See e.g., Elliott v. Metropolitan Cas. Ins. Co., 250 F.2d
680 (10th Cir. 1957); Span Inc. v. Associated Int’l Ins. Co., 277 Cal. Rptr. 828 (Ct. App. 1991). Some courts have
held that the agreement to enter into a Consent Judgment in exchange for a covenant not to execute breaches
the cooperation as well. Wolff v. Royal Ins. Co., 472 N.W.2d 233 (S.D. 1991); Warren v. American Nat’l Fire
Ins. Co., 826 S.W.2d 185 (Tex. Ct. App. 1992). Conversely, a number of courts recognize that when the insurer
breaches its contract and abandons its insured, the insured may protect itself by entering into an agreement
with the claimant. Hospital Underwriting Group, Inc. v. Summit Health Ltd., 63 F.3d 486 (6th Cir. 1995). The
Alaska Supreme Court held:
Ordinarily the insured is barred by the cooperation clause of the policy from settling without the
insurer’s consent. But the prior breach by the insurer precludes it from relying on the cooperation clause as a defense to liability for the settlement.
Great Divide Ins. Co. v. Carpenter, et rel., 79 P.3d 599 (Alaska, 2003). Similarly, the Iowa Supreme Court recognized:
[W]here an insurance company refuses to defend the insured against a claim covered by the policy, the insured is free to settle with the injured party by stipulating to the entry of a judgment
that is collectible only from the insurer. The right of the insured . . . to settle the claim against it
resulted from the insurance company’s refusal to defend. Under such circumstances, the ‘insurer’s unjustified refusal to defend relieves the insured from his or her contract obligations not to
settle and the insured is at liberty to make a reasonable settlement or compromise without losing
his or her right to recover on the policy.’
Kelly v. Iowa Mut. Ins. Co., 620 N.W.2d 637, 641 (Iowa, 2000) quoting Red Giant.
3.Is proof of bad faith necessary to recover the excess judgment?
If there has been a finding that the insurer was incorrect in disclaiming coverage, should the plaintiff be able to recover the full amount of the Consent Judgment, regardless of policy limits? At least one case
attempted to tee that issue up. In Capel v. Plymouth Rock, the question presented to the Connecticut court of
appeals was: “In claims against [the insurer] for breach of contract for failure to defend and indemnify [the
insureds] brought by the [plaintiffs] as judgment creditors are the damages limited to the limits of the putative liability policy? Capel v. Plymouth Rock, 2013 WL 1197225 at *2-3 (Conn.App., April 2, 2013) (declining
to answer the reserved question because the issue of coverage, in the first instance, was not finally resolved).
There is a split in the caselaw in Florida, with one court holding that the breach of the contract, in itself, subjects the carrier to all damages which flow from the breach. Thomas v. Western World Ins. Co., 343 So.2d 1298
(Fla. 2d Dist. Ct. App. 1977). And other courts in Florida have suggested a plaintiff must establish the insurer’s
bad faith conduct (under the totality of the circumstances) before being able to recover any amounts above
the policy limit. Robinson v. State Farm Fire and Cas. Co., 583 So.2d 1063, 1068 (Fla. 5th Dist. Ct. App. 1991).
106 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
A federal court in Washington recently affirmed that a tort-plaintiff, suing to enforce a “covenant
judgment” in excess of the policy limit, must demonstrate “bad faith before allowing [plaintiff] to recover
more than the policy limits.” RSUI v. Vision One, LLC, 2013 WL 662966 (W.D. Wash. February 21, 2013) at *3,
citing Besel v. Viking Ins. Co., 49 P.3d 887 (Wash. 2002).
4.Is the amount of the Consent Judgment binding on the insurer?
Another consideration is whether the Consent Judgment amount is binding on the insured, which,
most likely, did not participate in the “negotiation” of the Consent Judgment. Like most of the other issues discussed in this paper, there is a split of authority. Washington recently held that the covenant judgment amount
was binding on the carrier. A.F. Evans supra; see also Metcalf supra. And while California has recognized that
Consent Judgments may bind insurers in some circumstance, they will not bind an insurer that is providing a
defense. Wright supra note 9 at 599 citing Samson v. Transamerica Ins. Co., 636 P.2d 32 (Cal. 1981) and Clemmer v. Hartford Ins. Co., 587 P.2d 1098 (Cal. 1978). In McLaughlin v. National Union Fire Ins. Co., a California
court of appeals held that while a stipulated judgment was a conclusive finding of liability, the court rejected
that the amount of the judgment was the proper measure of damages in a bad faith action. 29 Cal.Rptr.2d 559,
572 (Ct. App. 1994).
V. Potential Tool?
With all of the discussion about Consent Judgments being weapon of the plaintiff ’s/policyholder’s
bar, it would be easy to become defensive at the mere mention of entering into a Consent Judgment. But in
certain circumstances, a Consent Judgment can be a tool for the carrier to protect its insured, limit expenses
and guard against a runaway verdict.
Consider the following scenario:
A claimant makes a multi-conditional, time-limited demand against the insured, via its carrier. The carrier claims that it lacks sufficient documentation in support of the claim and/or that
its investigation is not complete; therefore, the carrier does not accept the demand. The claimant takes the position that this was the one and only opportunity to settle the case and that her
intention is to take the case to verdict. Subsequently, the carrier completes its investigation and
determines that the value of the claim is far in excess of policy limits. The carrier tenders those
limits, and, true to her word, the claimant rejects the tender and proceeds to litigation. The carrier has no coverage defenses and agrees to defend its insured without a reservation of rights.
In this scenario, the insured and claimant would not be entitled to enter into their own Consent Judgment because the carrier is defending without reservation. The carrier believes that it did not act in bad faith
but recognizes that the verdict potential is great. The verdict will be in excess of limits, but with the unpredictability of jury verdicts, it could be well above even the carrier’s expectations. Additionally, both the carrier
and plaintiff will face defense fees and litigation expenses. Once a verdict and judgment are entered in the tort
action, a bad faith (for failure to settle) suit will certainly ensue.
This might be an excellent situation to consider entering into a Consent Judgment with the plaintiff. Everyone stands to benefit. As part of the Consent Judgment, the insured will be freed from any financial responsibility, preventing another potential avenue for bad faith damages. The plaintiff avoids the time,
expense and uncertainty of the tort litigation and can move directly to the bad faith phase. Additionally, as
part of the agreement, the plaintiff can be guaranteed to receive at least the policy limit, if the insurer is not
found in bad faith. The insurer avoids fees and expenses associated with the underlying tort suit, avoids the
Consent Judgments: Raising the Stakes in Bad Faith Litigation ■ Willging ■ 107
potential for a run-away verdict and can move directly to the essence of the dispute – whether the failure to
settle was in bad faith or not.
Florida has a similar mechanism – known as a Cunningham Agreement. Cunningham v. Standard
Guar. Ins. Co., 630 So.2d 179 (Fla. 1994) (trial court had jurisdiction to decide the insurer’s liability for bad
faith handling of claim prior to a final determination of the underlying tort action for damages brought by a
motorist against the insured-driver, where the parties stipulated that the bad faith action could be tried before
the underlying negligence claim.). In such an agreement, the parties agree to try the bad faith case first. If
there is no bad faith, the plaintiff gets the policy limit and the case ends. If there is bad faith, the tort trial goes
forward and the carrier is responsible for the verdict amount. In both scenarios, the insured faces no personal
exposure. The Consent Judgment avenue is somewhat different in that it completely eliminates the need for
the tort trial regardless of the outcome of the bad faith case.
The difficulty may lie in reaching an agreement as to the amount of the Consent Judgment. Plaintiff
will be loathe to give up on the possibility of the runaway verdict, and may insist on a Judgment in an amount
above the carrier’s valuation. The carrier will certainly want the Judgment amount to bear some relationship
to its valuation. Both sides may be willing to compromise on the number in exchange for the savings both will
enjoy from avoiding the tort litigation. At a minimum, entering a Consent Judgment may be an option that
the carrier wants to entertain. Before formalizing such an agreement, the carrier should include its insured
(and counsel) in the discussion, since a Judgment amount could have negative implications for the insured.
VI.Conclusion
Consent Judgments pose a potentially significant threat and exposure to carriers. States view such
Judgments in a variety of ways, and the carriers’ decisions to decline a defense or reserve rights can have a
profound impact on the direction that the underlying tort suit takes. When there is clearly no coverage for a
loss, the insurer may well wish to deny its insured a defense; however, most cases fall into a gray area in which
arguments can be made both for and against coverage. The carrier, through its in-house professionals and
outside attorneys, should be well-informed as to what the plaintiff and insured may do in the event of a disclaimer/reservation. The decision to deny or reserve should be made, only after a thorough examination of the
controlling law so that the carrier is fully aware of whether/how a Consent Judgment may impact the carrier’s
exposure.
108 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Developing and Maintaining a Winning
Attorney-Client Relationship for
the Defense of a Bad Faith Case
Anne Kevlin
Beazley Group
141 Tremont Street, Suite 1200
Boston MA 02111
anne.kevlin@beazley.com
Anthony R. Zelle
Zelle McDonough & Cohen LLP
101 Federal Street
Boston, MA 02110
tzelle@zelmcd.com
Anne Kevlin is claims counsel for Beazley Group in Boston, a Lloyd’s MGA. She
manages outside law firms and oversees legal strategy on property claims, including
those with bad faith allegations. Ms. Kevlin has more than 15 years of insurance
litigation experience, and is AV rated. She has expertise in the Lloyd’s Market, and
is a recipient of the CII Award in London Market. Ms. Kevlin is a member of the
Massachusetts bar and the program co-vice chair for this seminar.
Anthony R. Zelle, the founder of Zelle McDonough & Cohen LLP in Boston
and New York City, represents insurers in coverage, bad faith, and other extracontractual claims. He served as lead counsel for insurers in Boston’s “Big Dig”
construction litigation. His victories have been cited in the “Top Ten Most Important
Defense Verdicts” and “Top Ten Jury Verdicts” in Massachusetts Lawyers Weekly.
A former chair of DRI’s Insurance Law Committee, Mr. Zelle is a member of DRI’s
Center for Law and Public Policy.
Developing and Maintaining a Winning
Attorney-Client Relationship for the
Defense of a Bad Faith Case
Table of Contents
I.Introduction................................................................................................................................................113
II. The Ten Commandments1..........................................................................................................................113
Endnote.....................................................................................................................................................................116
Developing and Maintaining a Winning Attorney-Client Relationship... ■ Kevlin and Zelle ■ 111
Developing and Maintaining a Winning Attorney-Client
Relationship for the Defense of a Bad Faith Case
I.Introduction
The vast majority of bad faith claims do not involve malicious, reckless, wilful, intentional, or even
negligent claims handling practices. However, that is what is typically alleged and allegations of such conduct
tend to create distress, defensiveness, and even distrust on the part of the lawyers and claims professionals
involved in both the underlying actions and the bad faith claim itself. In our presentation at the symposium,
Anne Kevlin and I will discuss the team effort necessary for the successful resolution of bad faith lawsuits.
However, in this paper Anne details the fundamental elements of the attorney-client relationship that are
required to ensure a sound working relationship between the claim professional directing the defense of a bad
faith claim and outside counsel.
Like the biblical Ten Commandments, Anne’s Ten Commandments are part of the social fabric that
cloaks an outside counsel’s relationships with our insurance industry clients. It is incumbent on outside counsel to comprehensively consider Anne’s Ten Commandments to fully appreciate that the expectations of our
insurance industry clients reach far above and beyond achieving a favourable resolution (although that does
go a long way).
As all experienced insurance professionals and their attorneys know, the prosecution of a bad faith
claim is frequently marked by overzealous advocacy and high drama, commonly unmoored from objective facts
or any actual or actionable wrong. While the high drama and emotion can be infectious, it is critical to the bad
faith defense attorney’s relationship with our clients to maintain focus on the nuts and bolts analysis. Keeping
with the construction analogy, Anne’s Ten Commandments provide a blueprint for outside counsel to build the
defense, while at the same time ensuring that the architect is sufficiently well-advised to deal with the owner.
As you read and consider Anne’s Ten Commandments, I expect you will realize how beneficial it is
to have a client who not only knows, but explicitly tells you, what they want. You should also realize that these
Ten Commandments do not in any way invade the analytical or decision-making process which is the purview
of outside counsel. Like the biblical Ten Commandments, Anne’s Ten Commandments are quite simple to follow and while they may not be written in stone, you can expect that the extent to which they are not followed
will have a direct impact on the beneficence of the higher power in the attorney-client relationship.
II. The Ten Commandments1
Thou shalt not
Delay early assessment and action plan for a new matter.
Thou shalt not
Fail to identify and quantify all exposures to insurer.
Thou shalt not
Underestimate the litigation budget.
Thou shalt not
Soft-pedal bad news to spare feelings.
Thou shalt not
Ignore the reputational risk of a bad faith claim to an insurer.
Developing and Maintaining a Winning Attorney-Client Relationship... ■ Kevlin and Zelle ■ 113
Thou shalt not
Miss reporting deadlines or ignore emails from client.
Thou shalt not
Jeopardize privileges.
Thou shalt not
Request extensions of time or allow matter to collect dust because you are too busy.
Thou shalt not
Proceed to bad faith trial without discussing trial themes, focus groups, mock jury exercises.
Thou shalt not
Conduct research (or have your associate conduct research) on legal issues that are well-established
or well-known to insurers.
Thou shalt not
Delay early assessment and action plan for a new matter.
You, as the attorney the insurer has retained, may be perfectly comfortable waiting until the eleventh
hour to devise a strategy. Or, perhaps you have a brilliant strategy completely formulated and residing safely in
your brain. But I am not like you. I lie awake at nights mulling the various worst case scenarios, and the anvils
that are about to drop onto my head. Do not keep me in suspense. Develop an action plan as soon as possible,
and tell me what it is. Work with me early in the process to ensure that you understand our appetite for risk –
trial versus settlement – and our resolution goals. Much will depend on your early assessment. For me, your
thoughtfulness and thoroughness during this early assessment will set the tone for our relationship.
Also, consider whether an advantage might be gained by early acknowledgement of a bad faith claim.
Did the insurer mess up? Would a fast remedy, or possibly an apology, mitigate the exposure? Is our key witness about to retire to Honduras? Is federal court a better venue? Is statutory interest running?
Early resolution is almost always best, so do not delay your initial assessment.
Thou shalt not
Fail to identify and quantify all exposures to insurer.
I get it. Litigation means deadlines and the need to act quickly. There are moving parts, and this is
not the only matter you are handling. But my job is to inform others at my company about risks and liabilities.
I may not know what minefields exist in your jurisdiction. I may have only glanced at the Complaint. Spell it
out for me, as soon as you are able. List and explain all the exposure “buckets,” such as:
• Contractual damages: what are the various components?
• Statutory bad faith or other extracontractual damages: what are they?
• Common-law bad faith: does it exist in your jurisdiction?
• Interest: how much, and how long does it run?
• Penalties: how much, and what triggers?
• Attorney fees and costs: how calculated; what is included?
Give me your best estimates of exposure ranges in dollars, and odds of prevailing. If you don’t know,
then tell me what information you need before you can offer a reasonable estimate.
Thou shalt not
Underestimate the litigation budget.
114 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
I know you want to put a smile on my face and shame your competition by telling me that the costs
to litigate through discovery, summary judgment motion, trial, and appeal to the U.S. Supreme Court will not
exceed $50,000.
Not only will I seriously question your judgment when I get this budget, but you will have some serious explaining to do when the insurer forgoes a settlement for $500,000 and at the end of the trial that we
lose, we get your firm’s invoice for $1,000,000.
An accurate litigation budget is essential for assessing settlement value. By far the biggest, most
frequent gripe I get from claim colleagues is that the litigation budget crept up continually as litigation progressed. I know we can’t predict every development during litigation, but the job of an attorney is to anticipate
worst case scenarios. This is no less true when it comes to predicting your own expense.
Thou shalt not
Soft-pedal bad news to spare feelings.
The thing is, humans do make mistakes. No attorney wants to tell his or her client bad news, especially when it may involve the client’s own actions. But here, the client is a corporation, with stakeholders who
count on employees to accurately gauge liabilities. It is the sometimes uncomfortable obligation of the insurer
attorney to honestly assess the risk, perhaps upsetting the individual claim employee in the process.
Tell us the bad news, and be prepared to soothe ruffled feathers with an action plan for how to best
resolve an unpleasant situation. Find a team leader, manager, or litigation manager to filter the news if a claim
representative made a human mistake. Remember that your client is the corporation. Be kind, be empathetic,
but be honest.
Thou shalt not
Ignore the reputational risk of a bad faith claim to an insurer.
Not every insurance claim generates media interest, but when they do, the insurance company will
require more than just a courtroom defense. Anticipate, and have a plan for, media inquiries in high exposure
bad faith actions. Discuss with your client whether or how to respond to reporters. Understand your clients’ marketing or public relations capabilities. Know what publicly available marketing and corporate reports the plaintiffs have access to. Prepare yourself and your clients for the many ways an insurer will be made to look bad.
Thou shalt not
Miss reporting deadlines or ignore emails from client.
Reporting deadlines are deadlines. Like you, the insurer is juggling numerous claims. A well-run
insurance organization requires periodic claim reviews by various layers of management. These can be routine
scheduled meetings, or these can be unexpected requests for status updates. You can choose to have the insurer
rep chase you for reports and status updates, or you can choose to put the claim representative in a good light
by timely reporting and proactively updating so that your client always has the most recent information.
When issuing formal reports, be sure you understand your client’s reporting structure needs. Is there
a reporting template unique to your client? If so, follow it. Are you requesting that your client respond to your
inquiry? If so, make the inquiry stand out in the report by bolding, underlining, putting it in a box, etc.
• Don’t miss a reporting deadline without giving your client advance notice of the delay, along
with a good reason for the delay.
• Don’t be passive about updating clients between reporting periods.
• Don’t ignore an email from a client. If you can’t materially respond to an email the day you
receive it, respond at least with an explanation of unavailability, and a timeframe for a more subDeveloping and Maintaining a Winning Attorney-Client Relationship... ■ Kevlin and Zelle ■ 115
stantive response. Then respond when you say you will. Simply not responding, even for a day or
two, is unprofessional and inconsiderate.
• Don’t send a motion or pleading for a client to review a few hours before it is due.
Thou shalt not
Jeopardize privileges.
The application of privilege and work-product varies from jurisdiction to jurisdiction. A prudent
insurance company with business in multiple states, or even multiple countries, will take a conservative
approach to protecting privileged communications, particularly email. This means consistently labelling privileged emails and other communications. Your privileged email to an insurance client may need to be produced in subsequent, unrelated litigation. Protect your client and promote best practices by labelling your
communications.
Thou shalt not
Request extensions of time or allow matter to collect dust because you are too busy.
An extension of time to respond to a Complaint or other pleading or motion may be necessary when
the attorney legitimately needs time to obtain and review information. An extension of time to respond is not
appropriate when other matters are preventing the attorney from responding. Routinely requesting extensions
of time lets me know that you are too busy to handle my matter, or that my matter is less important to you
than other matters.
Remember that your insurer client is watching not only the quality of your legal representation, but
the duration each matter requires. Every day a matter is open with your law firm is another day of uncertain
liability for the insurer and another day of human resourcing requirements. Multiply that day by hundreds, or
thousands, of claims referred to legal counsel, and you get the picture.
Your goal should be to open and close the file in the shortest amount of time possible while obtaining
the best result possible. Each day matters.
Thou shalt not
Proceed to bad faith trial without discussing trial themes, focus groups, mock jury exercises.
This discussion should occur as soon as trial becomes a likelihood. What will the theme of the
defense be? What problem areas will the plaintiffs spotlight, and how will the defense address these? If the
exposure warrants it, early use of focus groups will help the defense team land on an appropriate trial theme.
A mock jury will assist with settlement valuation. Waiting until the last few weeks to make these decisions will
not earn you the confidence of your insurance company client.
Thou shalt not
Conduct research (or have your associate conduct research) on legal issues that are well-established or well-known to insurers.
It is likely that you second-year associate recently became familiar with an obvious or even obscure
area of the law. But your insurer client deals with insurance issues routinely, even the obscure ones. We keep
legal memos on file even after matters resolve. When in doubt, ask before you research.
Endnote
1
Of a happy insurer and attorney relationship.
116 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
The Impact of Social Media and
Cutting Edge Technology on
Insurance Bad Faith Litigation
Paul Berne
Lancer Insurance Company
734 Alpha Drive, Suite L
Cleveland, OH 44143
pberne@lancerinsurance.com
Gregory M. Boucher
Saul Ewing LLP
131 Dartmouth Street, Suite 501
Boston, MA 02116
gboucher@saul.com
Paul Berne joined the Lancer Financial Group in 1992 and is currently Senior
Vice President, Claims. He has over 32 years of experience in Claims Management.
Previously, Paul was Vice President of Claims with Progressive Casualty Insurance
Company. He holds a BS from Syracuse University and the Associate in Risk
Management designation. Paul is a past President and Treasurer of the Trucking
Industry Defense Association (TIDA) and is currently Chair of the Endowment
Committee. Paul is a Member of the CLM Bad Faith and Transportation
Committees, and the PCI Claims Committee.
Gregory M. Boucher is attorney in Saul Ewing LLP’s Boston office and a member
of the firm’s Insurance Practice Group. Greg regularly publishes articles in Saul
Ewing’s Bad Faith Sentinel, a monthly newsletter that monitors relevant bad faith
decisions across the country. Email Greg if you would like to be added to the Bad
Faith Sentinel’s distribution list.
The Impact of Social Media and Cutting Edge
Technology on Insurance Bad Faith Litigation
Table of Contents
I. Introduction/Social Media Definition.......................................................................................................121
II.Complexity..................................................................................................................................................121
III.Cases............................................................................................................................................................121
IV.Conclusion...................................................................................................................................................124
The Impact of Social Media and Cutting Edge Technology on... ■ Berne and Boucher ■ 119
The Impact of Social Media and Cutting Edge
Technology on Insurance Bad Faith Litigation
I. Introduction/Social Media Definition
Social networking sites are web-based services that allow individuals to construct a public or
semi-public profile with a bounded system, choose from a list of other service users with whom
they intend to share a connection, and navigate among those connections and those made by
others within the system. Users create a unique user identity, establish relationships with others
who have done the same, join communities of users who share connections, and exchange information among one another.
Trail v. Lesko, 2012 Pa. Dist. & Cnty. Dec. LEXIS 194 (Allegheny Co. Com. Pl. 2012)
An informal poll reveals that to most people, “social media” includes virtually anything that results in
the transmission of messages, photos, audio/video, or any other form of text or image within the framework
of an easily available, easy to use, seemingly everywhere platform that could be accessed via cell phone, smart
phone, tablet, laptop, PC, television, radio or any other medium or device you can think of.
II.Complexity
An examination of recent headlines from the Homeland Security Newswire (http://www.homelandsecuritynewswire.com) provide insight into how social media and related electronics are impacting our lives.
Some of the headlines include:
— Expert show how to crack every common password in under six hours
—Social media as preventative method for infectious disease
— Thwarting facial-recognition, photo-tagging software
— Chinese hackers attack the New York Times
—NATO commander target of persistent Facebook cyberattacks
— Social networks helping during disasters
— Smartphones turned into secure and versatile keys
— iPhones can reveal a lot about their owners to law enforcement
III.Cases
Courts are more likely to order access to a social media account upon a showing that there is a reasonable likelihood that access to a party’s private social media account will reveal discoverable information.
When A Party’s Public Social Media Profile Indicates That Private Profile Information May Contain Discoverable Information, Courts Have Ordered Parties To Turn Over Their Social Media
Login Information And Prohibited Parties From Deleting Any Account Information; Courts Also
Have Determined That A Party’s Privacy Rights Are Not Violated By Production of Social Media
Accounts/Information.
McMillen v. Hummingbird Speedway, Inc., 2010 Pa. Dist. & Cnty. Dec. LEXIS 270 (Pa. County Ct. Sept. 9,
2010).
The Impact of Social Media and Cutting Edge Technology on... ■ Berne and Boucher ■ 121
Plaintiff alleged possible permanent impairment and inability to enjoy certain pleasures in life as
a result of being rear-ended in an automobile accident. Defendants moved to compel Plaintiff to provide
Defendants with Plaintiff ’s password login information for Plaintiff ’s Facebook and MySpace accounts. Plaintiff ’s public portion of his Facebook and MySpace websites showed that Plaintiff may have engaged in certain
activities that he alleged the accident has impaired him from engaging.
Addressing the issue of privacy, the Court concluded that a party to a lawsuit may not claim that their
Facebook and/or MySpace user account is confidential and therefore barred from discovery. Both Facebook’s
and MySpace’s privacy policies warn users that they should not expect full privacy protection of the information contained in their accounts, and that Facebook/MySpace may share user information in response to a
subpoena or court order. Additionally, users know that information they share on these websites might be
shared by their “friends” or connections that receive their user information/postings.
The Court ordered Plaintiff to produce his Facebook and MySpace login information, and also
ordered Plaintiff not to delete or alter existing information on his accounts. The Court stated that “[w]here
there is an indication that a person’s social network sites contain information relevant to the prosecution or
defense of a lawsuit . . . access to those sites should be freely granted.” Here, there was an indication that Plaintiff ’s social media sites contained discoverable information because Plaintiff ’s public Facebook and MySpace
postings indicated that Plaintiff exaggerated his injuries.
Romano v. Steelcase, Inc., 907 N.Y.S. 2d650 (N.Y. Sup. Ct. 2010)
Plaintiff alleged permanent injuries that affected her enjoyment of life. However, public portions of
Plaintiff ’s Facebook and MySpace accounts revealed that Plaintiff engaged in out-of-state travel since her accident, activities she alleged her injuries prohibited (Plaintiff alleged to be largely confined to her home and
bed). As a result, the Court found that there was a reasonable likelihood that the private portions of Plaintiff ’s
Facebook and MySpace accounts would contain evidence concerning her ability to enjoy life.
The Court further held that a Facebook or MySpace user does not have a reasonable expectation of
privacy to the information contained in his or her account. The Court took into consideration the fact that a
user voluntarily chooses to disclose information to others via his or her Facebook or MySpace account, and
Facebook’s and MySpace’s privacy policies warn users that their accounts are not private as a result of their
sharing of information with other website users.
The Court ordered Plaintiff to provide an authorization for Facebook and MySpace to provide Defendant with access to Plaintiff ’s Facebook and MySpace records, including any records previously deleted or
archived.
Zimmerman v. Weis Markets, Inc., 2011 Pa. Dist. & Cnty. Dec. LEXIS 187 (Pa. County Ct. May 19, 2011).
Plaintiff alleged a permanent disability and an inability to enjoy life as a result of a left leg injury.
Plaintiff ’s public MySpace webpage included photographs of Plaintiff riding his motorcycle after his accident,
which contradicted portions of his deposition testimony.
Ruling in Defendants’ favor, the Court found that based upon the review of the publically available
portions of Plaintiff ’s Facebook and MySpace profiles, “there is a reasonable likelihood of additional relevant
and material information” on the private portions of Plaintiff ’s Facebook and MySpace accounts.
The Court ordered Plaintiff to produce his Facebook and MySpace login information, and also
ordered Plaintiff not to delete or alter existing information on his accounts.
Social media account not discoverable without showing a reasonable likelihood that access to a party’s
private social media account will reveal discoverable information.
122 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Tompkins v. Detroit Metropolitan Airport, 278 F.R.D. 387 (E.D. Mich. 2012).
Plaintiff alleged that her life was impaired due to back and other injuries sustained as a result of an
airport accident. Defendant requested full access to Plaintiff ’s Facebook account. The Court denied Defendant’s motion as an improper fishing expedition. Defendant’s only evidence that Plaintiff ’s Facebook account
contained relevant information was a public Facebook photograph of Plaintiff holding a dog weighing less
than five pounds and also surveillance photographs of Plaintiff pushing a shopping cart. The Court found that
these mundane activities did not warrant further inquiry into Plaintiff ’s Facebook account. The Court stated
that Defendant would have a stronger argument if it had photographs of Plaintiff horseback riding or playing
golf. Additionally, the Court declined to conduct an in camera review of Plaintiff ’s Facebook account, stating
that an in camera review should be conducted for privilege, not relevance.
Courts have prevented defendants from obtaining full access to a plaintiff ’s social media account.
Some Courts Will Agree To An In Camera Review To Determine Relevancy Of A Party’s Social
Media Website Information; However There Also Is A Sentiment That Parties Should Disclose
Relevant Social Media Information Without A Court Order Or In Camera Review.
Loporcaro v. City of New York and Perfetto Contracting Company, 35 Misc.3d 1209(A), (N.Y. Sup. Ct.
Apr. 9, 2012).
Plaintiff alleged a permanent disability as a result of right knee injuries sustained during the course
of his employment. However, Plaintiff also testified in another matter that he had been employed in some
capacity since his alleged injuries, and the public pages of Plaintiff ’s Facebook account reflect that Plaintiff
lives an active lifestyle. In ruling that Plaintiff ’s social media account was not confidential and possibly discoverable, the Court stated “[s]ince it appears that plaintiff has voluntarily posted at least some information about
himself on Facebook which may contradict the claims made by him in the present action, he cannot claim
that these postings are now somehow privileged or immune from discovery.” As a result, the Court ordered
Plaintiff to provide the Court with certain Facebook postings, including deleted material, so that the Court
could perform an in camera inspection to access the materiality and relevance of the information.
Offenback v. L.M. Bowman, Inc., 2011 U.S. Dist. LEXIS 66432 (M.D. Pa. June 22, 2011).
A District Court Judge ordered an in camera review by a Magistrate Judge of Plaintiff ’s Facebook and
MySpace accounts to determine if information properly was subject to discovery. Plaintiff alleged significant
physical impairment as a result of back and shoulder injuries in a car accident. The Court found the majority
of the information irrelevant. However, the Court concluded that certain information concerning Plaintiff ’s
physical activities and travels may be relevant, discoverable and should be produced by Plaintiff. In a footnote, the Court commented that it believed that Plaintiff should have produced the relevant information in
Plaintiff ’s Facebook account without a Court Order. The Court’s footnote may be an indication that courts may
warm to the idea of sanctions when a party refuses to voluntarily produce relevant information from a social
media website.
Appellate court finds that a trial court order allowing full access to social media accounts is overbroad
and must be limited to only relevant information.
Patterson v. Turner Construction Co., 2011 N.Y. App. Div. LEXIS 7391 (N.Y. App. Div. 1st Dep’t. Oct. 27,
2011).
An appellate court reversed a trial court’s overbroad order for Plaintiff to produce to Defendant all
of Plaintiff ’s Facebook records compiled since the incident giving rise to Plaintiff ’s complaint. The appellate
court ordered the trial court to limit its order to only the production of relevant information from Plaintiff ’s
The Impact of Social Media and Cutting Edge Technology on... ■ Berne and Boucher ■ 123
Facebook account. The opinion further commented that Plaintiff ’s relevant Facebook information is not confidential/privileged merely because Plaintiff used Facebook’s privacy settings to restrict access to his account.
Plaintiff ’s social media postings may be admissible at trial.
Sylvia Morales and Luis Perez v. Vonda Barnhart and Erica Browning, Case No. 2010-17655 handled in
Harris County District Count, 157th, TX
Plaintiffs were injured after being struck by Defendants’ vehicle while Plaintiffs were stopped on the
side of a highway. At trial, because the defendant driver’s sobriety was at issue, the Court allowed into evidence the defendant driver’s MySpace posting that read “made it thru this week with only one hangover …
YEAH.”
The author of a text message must be ascertainable for a text message to be properly authenticated and
admissible for trial; rule may apply to social media postings.
Commonwealth v. Koch, 2011 Pa. Super. LEXIS 2716 (Pa. Super. Ct. Sept. 16, 2011).
Defendant was convicted of possession with intent to deliver/distribute marijuana. In support of the
Commonwealth’s case, the prosecution was allowed to enter evidence of text messages sent from Defendant’s
cell phone. On appeal, the Court reversed the conviction and remanded for a new trial because there was no
evidence to prove that Defendant, as opposed to someone else, sent incriminating text messages from Defendant’s cell phone. Evidence tending to favor reversal included testimony from the Commonwealth’s own witness stating that another person occasionally used Defendant’s cell phone, an officer conceded that the author
of the text message could not definitely be ascertained, and, while the Commonwealth knew that the phone
was near Defendant at the time of the arrest, the location of the phone was unknown in the days and weeks
prior to the arrest, when incriminating text messages were sent.
Additionally, the Court ruled that the text messages were hearsay, and that the admission of a party
opponent hearsay exception does not apply when it cannot be conclusively determined that Defendant sent
the incriminating text messages.
Lastly, the appellate court disagreed with the trial court’s determination that the lack of information concerning whether Defendant sent the text messages went to the weight of the evidence, as opposed
to admissibility. The appellate court instead found that authentication of a text message is a prerequisite to
admissibility. Absent proper authentication, it was improper to admit the text message evidence into evidence.
IV.Conclusion
The law relating to social media is rapidly evolving. State laws may vary and should be evaluated
accordingly. Nothing described herein or during the seminar presentation represents the practices of any
specific insurance company. The material is intended to be general in nature and includes the impressions of
defense counsel, and technicians and management at several organizations. Claims personnel are encouraged
to consult with counsel when evaluating the impact of any area discussed on general practices or cases.
124 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
Ethical Concerns:
Insurers Use of In House Counsel
to Defend Policyholders
Melissa Jayne Collins
Beazley Group
1270 Avenue of the Americas, 12th Floor
New York, NY 10020
(646) 943-5913
melissa.collins@beazley.com
Melissa Jayne Collins is a claims manager for the Lawyers Professional Liability
Group at Beazley. Prior to joining Beazley in 2006, Ms. Collins spent seven years as
a litigator with Chadbourne & Parke LLP in New York. She handled commercial and
employment litigation in state and federal courts around the country, participating
in numerous bench trials, jury trials, arbitrations and mediations. Ms. Collins
completed her undergraduate degree at Cornell University and graduated from
Fordham University Law School.
Please be advised that the information provided and the views presented in this article
are those of the author and do not represent Beazley Group’s corporate position.
Ethical Concerns:
Insurers Use of In House Counsel to Defend Policyholders
Table of Contents
I.Introduction................................................................................................................................................129
II. Key Ethical Issues........................................................................................................................................129
III. The Majority View.......................................................................................................................................129
A. Is there a conflict of interest?..............................................................................................................129
B. Does the use of in-house counsel constitute the unauthorized practice of law?.............................132
C. Is the use of in-house counsel deceptive to policyholders?..............................................................133
1. Disclosure of Employment Status...............................................................................................133
2. The firm name..............................................................................................................................133
IV. The Minority View......................................................................................................................................134
A.Kentucky..............................................................................................................................................134
B. North Carolina.....................................................................................................................................135
C.Arkansas...............................................................................................................................................135
V. Practical Tips...............................................................................................................................................135
A. Know the rule in the relevant jurisdiction.........................................................................................135
B. Ensure that attorneys are properly licensed......................................................................................136
C. Ensure that there are no conflicts of interest.....................................................................................136
1. Staff counsel must appropriately consider the scope of the law firm of
which they are a part...................................................................................................................136
D. Ensure that policyholders are adequately informed.........................................................................136
E. Inform policyholders as to the proper scope of the representation.................................................137
F. Ensure that the insurer does not interfere with the attorneys exercise of
professional judgment.........................................................................................................................137
G. Ensure that the in-house attorney does not participate in any investigation
or determination with respect to insurance coverage.......................................................................137
VI. Implications for Vicarious Liability and Bad Faith...................................................................................137
A. Courts holding that an insurer is not vicariously liable for damages resulting
from the alleged negligence of defense counsel................................................................................138
B. Courts holding that an Insurer is vicariously liable for damages resulting from
the alleged negligence of defense counsel.........................................................................................139
C. Vicarious liability and bad faith in the staff counsel setting............................................................140
VII.Conclusion...................................................................................................................................................140
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 127
Ethical Concerns:
Insurers Use of In House Counsel to Defend Policyholders
I.Introduction
It is the practice of some insurance companies to appoint staff counsel employed by the insurance
company on a full time basis to defend insureds in lawsuits to which the carrier is not a party. Throughout the
years, more and more insurance companies have turned to in-house counsel, staff counsel or captive attorneys to defend policyholders or manage claims or litigation. Insurance companies have touted the benefits of
this arrangement, noting that it results in significant cost savings, increased trust among the claims staff and
defense counsel and shorter life cycles for claims.
This arrangement, however, also presents interesting ethical issues and mine fields to recognize and
avoid, including the potential for conflicts of interest, unauthorized practice of law, and unfair and deceptive
practices. Throughout this presentation we will discuss these ethical issues, identify the majority and minority
views and review some practical tips.
In deciding whether to utilize staff-counsel to defend policyholders, Insurers should also consider the
extent to which they may be held vicariously liable or in bad faith for staff counsel’s acts.
II. Key Ethical Issues
The majority of cases, ethics opinions and scholarly articles on this topic have identified three primary ethical considerations in insurance companies utilizing staff counsel to defend policyholders.
First, is there a conflict of interest? It has been argued that the use of insurance company in-house
or staff counsel to defend policyholders creates an inherent conflict of interest because “no attorney can serve
two masters.”
Second, does the use of in-house counsel constitute the unauthorized practice of law? Corporations cannot practice law. It has been argued that insurance companies are practicing law by defending insureds through
the use of employee-attorneys and that the attorneys are not independently representing the policyholders.
Third, does the use of in-house counsel deceive policyholders and the public? In some situations,
in-house attorneys may appear to be private, independent law firms, when in fact they are paid for and managed by the insurance company. Without an adequate disclosure, a policy holder may presume that the Firm
retained to defend his/her interests is independent from the insurance company.
III. The Majority View
Most courts and ethics opinions have held that it is permissible for an attorney employed by an insurance company to represent the company’s insureds. Courts are Divided in Whether Insurer’s In-House Counsel
May Represent Insureds, ABA/BNA Lawyers Manual on Professional Conduct, Current Reports, 27 LMPC 158,
2011 WL 892789 (Mar. 16, 2011). This conclusion has been reached through consideration of the three ethical
areas described above, which are discussed in detail below.
A. Is there a conflict of interest?
Under the Model Rules of Professional Conduct, the primary standard for determining whether there
is a conflict is Rule 1.7, which provides:
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 129
“(a)A lawyer shall not represent a client if the representation of that client will be directly adverse to
another client, unless:
(1) the lawyer reasonably believes the representation will not adversely affect the relationship
with the other client; and
(2) each client consents after consultation.
(b) A lawyer shall not represent a client if the representation of that client may be materially limited
by the lawyer’s responsibilities to another client or to a third person, or by the lawyer’s own interests, unless:
(1) the lawyer reasonably believes the representation will not be adversely affected; and
(2) the client consents after consultation. When representation of multiple clients in a single
matter is undertaken, the consultation shall include explanation of the implications of the
common representation and the advantages and risks involved.” Rule 1.7 of the Model Rule
of Professional Conduct [hereinafter the “Model Rules”].
Whether a conflict of interest arises in the tripartite relationship among the insurer, the insured and
defense counsel for the insured has given rise to a great deal of interest and analysis among scholars, courts
and ethics committees. Dwayne D. Hedges, Brown v. Kelton: The Arkansas Prohibition on the Use of Employed
Attorneys to Defend the Insured, 65 Ark. L. Rev. 953, 956, (2012) [hereinafter “Hedges at ___”], citing, Daniel
M. Martinez, Insurance Companies Use of “Captive” or In-house Counsel to Represent Insureds Constitutes the
Unauthorized Practice of Law: Is American Home the Right Decision for Texas?, 34 St. Mary’s L.J. 1007, 1028
(2003). It has been recognized that the duties running between the insurer, the insured and defense counsel
can result in a source of tension. Hedges at 956. On one hand, the attorney is retained to represent the interests of the policyholder and the policyholder is owed the attorney’s loyalty. On the other hand, the insurer is
paying the bill.
Commentators and courts differ on whether the insurer is itself a client, or merely a third-party
payer of the attorney; but in either case, it is generally recognized that the attorney has some degree of loyalty to the insurer with whom he or she has an established relationship. With the insurance defense attorney
pulled in different directions by these conflicting loyalties, conflicts of interest can arise. Timothy W. Burns,
John D. Shugrue & Traci M. Braun, The Ethical Minefield: Insurers’ Use of In-House or Captive Counsel to Represent Policyholders, ABA Section of Litigation Insurance Coverage Litigation Committee, Volume 11, No. 2
(Mar/Apr 2001).
Although this potential for conflict has been recognized, it has also been noted that the actual divergence of interests is infrequent. William T. Barker, Laying the Foundation for Staff Counsel Representation of
Insureds, 39 Tort Trial & Ins. Prac. L.J. 897, 904 (Spring 2004) [hereinafter, “Barker at __”]. The ABA Standing
Committee on Ethics & Professional Responsibility (hereinafter “the ABA”) has noted that, ordinarily, “a community of interest exists between the company and the insured growing out of the contract of insurance with
respect to any action brought by a third person against the insured within the policy limitations. The company
and the insured are virtually one in their common interest.” ABA Standing Comm. on Ethics & Prof. Responsibility, Formal Op. 282 (May 27, 1950), in Opinions of the Committee on Professional Ethics 622 (ABA
1967). The ABA later reaffirmed this point, stating that “in the great majority of liability cases, the interests of
insureds and their insurance companies do not collide.” ABA Standing Comm. on Ethics and Prof. Responsibility, Formal Op. 03-430 (July 9, 2003) [hereinafter ABA Formal Op. 03-430”].
The question here is whether staff counsel’s employment by the insurance company creates a greater
potential for conflict, such that the practice of staff counsel representing insureds should be disallowed. Most
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ethics opinions and courts have held the practice to be permissible, noting that this arrangement poses no
greater conflict than the typical tripartite relationship.
The ABA concluded that the employment relationship among staff counsel and the insurance company does not itself create a conflict preventing joint representation and stated:
“We do not view the employment status of insurance staff counsel as itself creating a conflict
between the insurance company and the insured when they are both represented by insurance
staff counsel in a lawsuit. In fact, the Model Rules dealing with conflicts of interest between coclients specifically contemplate lawyers representing multiple clients. Of course, if a conflict of
interest between the insurance company and the insured does arise in the course of the representation, the lawyer immediately must resolve it by either obtaining the insured’s informed consent
or terminating his representation of the insured.” ABA Formal Op. 03-430.
Critics have argued that when an insurance company uses insurance staff counsel to defend its insureds,
the opportunity for undue influence by the insurance company is too great. In response, the ABA has stated:
“[E]ven if it were assumed that the insurance company has more control over its employees than
it does over retained lawyers in private practice, that circumstance is of no significance in the
full coverage case ‘in which there is no temptation to favor the insurer’s interests over that of the
insured.’” ABA Formal Op. 03-430.
A majority of courts have agreed. By way of example, a Texas appellate court concluded that “the
insurance staff attorney, like the outside attorney, may face conflicts; however, his status as an employee is not
an irreconcilable conflict. There is no evidence in the record that staff attorneys face conflicts not faced by outside attorneys.” Am. Home Assurance Co., Inc. v. Unauthorized Practice of Law Comm., No. 11-02-002120CV,
2003 WL 22532817, at *3 (Tex. App. 2003).
Similarly, a California appellate court concluded that:
“Counsel’s status as a salaried employee of the insurer does not inherently create a temptation to
violate or disregard ethical rules. We reject the argument that such a relationship supports the
presumption that in-house counsel will always favor the insurer’s interests. Conflicts of interests may arise in such circumstances, but the same is true for an outside law firm that might be
dependent upon a particular insurance company for a substantial amount of business.” Gafcon,
Inc. v. Ponsor & Assocs., 120 Cal. Rptr. 2d 392, 411 (Ct. App. 2002) (footnote omitted).
Accordingly, the majority view is that the conflict problems faced by employee counsel are not significantly different from those faced by law firm counsel. See, In re Petition of Youngblood, 895 S.W.2d 322,
328 (Tenn. 1995); For the latter, the insurer is typically a source of repeat business, and may well be the dominant source of the business of the law firm or the particular attorney. Both employee and law firm counsel are
obliged to provide insureds with undivided loyalty, and the prevailing view is that there is no basis for imposing different rules on one than on the other. Barker at 905-06.
The ABA has advised, however, that staff counsel constantly be mindful of their obligation to exercise
independent professional judgment in advising clients. ABA Formal Op. 03-430.
The ABA notes Model Rule 5.4(C) which provides: “[a] lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such legal services.”
This rule underscores the importance of undivided fidelity to the insured-client. Nothing in the status of insurance staff counsel as employees diminishes their obligation or ability to comply with Rule 5.4(c) or
any of the other Model Rules. ABA Formal Op. 03-430.
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 131
Accordingly, although the majority view is that staff counsel are permitted to represent insureds,
such counsel are advised to be particularly vigilant in ensuring that their independent professional judgment
is not compromised.
B. Does the use of in-house counsel constitute the unauthorized practice of
law?
All jurisdictions forbid those not admitted to the bar to engage in the practice of law. Barker at
900, citing, Deborah L. Rhode, Policing the Professional Monopoly: A Constitutional and Empirical Analysis of Unauthorized Practice of Law Prohibitions, 34 Stan. L. Rev. I (1981). Corporations cannot practice law
and cannot do so indirectly by furnishing lawyers to provide legal services to their own customers in matters
where the corporation has no interest other than providing customer service. Barker at 900.
The rationale prohibiting a corporation from retaining attorneys to provide legal services to third
parties is premised on the personal relationship of trust and confidence between attorney and client which
would be undermined by a corporation undertaking to furnish its members with legal advice, counsel and
professional services. California State Bar Standing Committee on Professional Responsibility and Conduct
Formal Opinion 1987-91 (1987), citing, People v. Merchants Protective Corp., 189 Cal. 531, 538 (1922). Courts
have concluded that in such a case, an attorney owes his first allegiance to his immediate employers, the corporations, and owes, at most but an incidental, secondary, and divided loyalty to the clientele of the corporation. People v. Merchants Protective Corp., 189 Cal. at 538.
That being said, however, corporations are permitted to employ in-house lawyers to protect their own
interests. Barker at 900-01. Relying on this premise, a majority of courts and ethics opinions have held that an
insurer which retains lawyers to represent the interests of its insureds in litigation in accordance with its duty
to defend the insured does not engage in the unauthorized practice of law because of its right to defend its
own direct financial interest in the litigation. Propriety of Insurers Use of Staff Attorneys to Represent Insureds,
2 A.L.R.6th 537 (2005).
In Gafcon, Inc. v. Poncor & Assoc., a California appellate court noted that an insurance company has
a direct pecuniary interest in the underlying third party action against its insured and having such an interest, is entitled to have counsel represent its own interests and those of its insured, as long as their interests are
aligned. In the present situation, the insurer is representing its own interests through licensed attorneys who
also happen to be its employees. Gafcon, Inc. v. Poncor & Assoc. 98 Cal.App.4th 1388, 1411 (2002). See also, In
re Youngblood, 895 S.W.2d 322, 330 (Tenn. 1995) (the furnishing of legal services to an insured by a liability
insurance company has generally been found not to constitute the unauthorized practice of law because of the
identity or community of financial interest between insured and insurer in defending the claim and because
of the insurer’s contractual obligation to defend the insured at the insurer’s expense); King v. Guiliani, 1993
WL 284462 *5 (Conn. Super. 1993); Liberty Mutual Insurance Co. v. Jones, 130 S.W.2d 945 (1939); Strothers v.
Ohio Casualty Insurance Co., 5 Ohio Supp. 362 (1939) (An insurance company has a right to protect its pecuniary interest through attorneys of its own choosing. So long as the company does not employ laymen to perform the acts, it is not engaged in the practice of law. The company is defending against claims and lawsuits in
which it is directly and financially interested).
Accordingly, the majority view is that since a corporation cannot appear in court except through a
licensed attorney, an insurer would be powerless to defend its legitimate interests, and those of its insureds,
without retaining counsel and the practice is thereby permitted. Woodruff v. McDonald Rest. 75 Cal. App.3d
655, 142 Cal. Rptr. 367 (1977); Propriety of Insurers Use of Staff Attorneys to Represent Insureds, 2 A.L.R.6th 537
(2005).
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C. Is the use of in-house counsel deceptive to policyholders?
Although the majority view is that an insurer’s use of in-house counsel to defend policyholders
is permissible, courts and bar associations have repeatedly stated that policyholders must be adequately
informed of this arrangement. Accordingly, significant focus has been placed on ensuring early and proper
disclosure to insureds.
1.Disclosure of Employment Status
Model Rule 1.8(f) requires a lawyer to communicate with the client, and convey information ‘sufficient to permit the client to appreciate the significance of the matter in question.”’ ABA Formal Op. 03-430,
citing ABA Formal Op. 96-403 (1996). Specifically, the Rule provides:
“A lawyer shall not accept compensation for representing a client from one other than the client
unless:
(1) the client gives informed consent;
(2) there is no interference with the lawyer’s independence of professional judgment or with
the client-lawyer relationship; and
(3) information relating to representation of a client is protected as required by Rule 1.6.”
The ABA interprets this Rule to require insurance company staff counsel to disclose their employment status and affiliation with the insurance company to all insured-clients. ABA Formal Op. 03-430. The
ABA further notes that a prudent lawyer should inform the client of “basic information concerning the nature
of the representation and the insurer’s right to control the defense and settlement under the insurance contract.” ABA Formal Op. 96-403. Such information can be routinely included in a retainer letter, or otherwise
provided near the outset of the representation.
In a situation in which staff counsel is representing an insured, the ABA requires insurance staff
counsel to disclose their employment status and affiliation with the insurance company to all insureds-clients
at the earliest opportunity practicable, such as during the initial meeting with the client or through appropriate language in the initial letter to the client. ABA Formal Op. 03-430.
2.The firm name
One area of disclosure that has generated significant discussion is the name utilized by staff counsel.
Courts and ethics opinions alike note the importance of ensuring that the name of the firm provides a clear
indication to insureds that such firm is employed by the insurance carrier. However, courts also “recognize the
genuine interest of the [firm] in being permitted to practice under a name that they believe reflects the nature
of their association.” In re Weiss, Healy & Rea, 536 A.2d 266, 269-70 (N.J. 1988).
The ABA has considered whether an association of insurance staff counsel constitute a “firm” or “law
firm” within the meaning of the Model Rules and has answered this question in the affirmative. ABA Formal
Op. 03-430.
Whether an association of lawyers constitutes a “law firm” turns upon (1) the manner in which the
association functions, and (2) the association’s compliance with the responsibilities of a law firm, including
those imposed by the Model Rules. ABA Formal Op. 03-430.
Staff counsel are employees of an insurer and defend claims against that insurer’s insureds. They
do not solicit or accept representation of any clients other than those assigned by their employer-insurer.
Barker at 907. Staff counsel are commonly unincorporated divisions of the insurance company’s corporate
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 133
law department. Often their offices are physically and organizationally separate from the insurance company’s
business operations. ABA Formal Op. 03-430; Barker, Laying the Foundation at 907.
Typically, a managing attorney is the lead counsel of the office and exercises the same supervisory
responsibility over the other attorneys in the office as he would were he a sole proprietor and they his employees.
The lawyers practice collectively and assist one another when needed. ABA Formal Op. 03-430; Barker at 907.
Having shouldered the responsibilities associated with law firm status, the ABA has determined that
insurance staff counsel are permitted to refer to themselves as a “firm,” “law firm,” or an “association” of lawyers, provided that the firm name satisfies Rule 7.5(a), which cautions that, “[a] lawyer shall not use a firm
name, letterhead or other professional designation that violates Rule 7.1.” Rule 7.1, in turn, reads:
“A lawyer shall not make a false or misleading communication about the lawyer or the lawyer’s
services. A communication is false or misleading if it contains a material misrepresentation of
fact or law, or omits a fact necessary to make the statement considered as a whole not materially
misleading.”
Many courts and ethics opinions have held that the use of traditional law firm names, without more,
might mislead insureds who do not know the firm’s affiliation with the insurance company. See ABA Formal
Op. 03-430; In re Youngblood, 895 S.W.2d 322 (Tenn. 1995) (holding that the staff counsel office is not a separate and independent law firm and that the representation that the attorney-employee is separate and independent from the employer is false, misleading and deceptive); Cincinnati Insurance Co. v. Wills (holding that
the use of the name “Berlon & Timmel” was misleading as it implied independence and might be thought to
be some form of outside counsel).
Although there is no one accepted manner of identifying the firm, a number of courts and ethics
opinions have held that, a name such as “John Smith and Associates,” or “Law Offices of John Smith” can be
used in connection with explanatory language on the letterhead, business cards, office entry signs, and court
pleadings that identifies the lawyers in the firm as employees of the insurance company, e.g., “Employees of
the Corporate Law Department of ABC Insurance Company.” ABA Formal Op. 03-430; Cal. State Bar Standing
Comm. on Prof. Responsibility & Conduct, Formal Op. 1987-91, 1987 WL 109707, at *6 (1987) (noting that
letterhead used must indicate the relationship between the firm and the Law Division and could contain an
asterisk identifying the firm as the Law Division of Insurance Company.); accord N.Y. State Bar, Op. 726, 2000
WL 567960, at *2 (2000) (“We concur with those authorities that permit the use of a law firm name as long as
it is accompanied by an explanation that the lawyers are employees of the [insurance company]”); Or. State
Bar Ass’n, Formal Op. 1998-153, 1998 WL 717727 (1998) (quoting and following California 1987-91); W. Va.
State Bar, Op. 99-01 (Sept. 1999) (“captive law firms” must “disclose their affiliation with the insurance company on their letterhead ... and explain this relationship to each client”).
IV. The Minority View
Three states, Kentucky, North Carolina, and most recently, Arkansas, have elected to follow the
minority rule and do not permit the use of insurance company staff counsel to represent insureds. In support
of their decisions, these Courts have held that this practice violates the ban on practice of law by corporations
and further noted their concerns over conflicts of interest.
A.Kentucky
In American Ins. Ass’n. v. Kentucky Bar Association, the Kentucky Supreme Court declined to review
a 14-year-old unauthorized practice of law opinion prohibiting liability insurers from using salaried attorneys
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to defend claims against insureds. 917 S.W.2d 568, 571 (Ky. 1996). The Court noted that its prior opinion combined legal precedent with ethical rules to reach the conclusion that, in a typical insurance contract action,
the insured, rather than the insurer, was the party-defendant, and that the insurance company was required to
hire members of the private bar to represent the insureds.
The decision was primarily based upon the long standing rule which proscribes a corporation from
being licensed to practice law. The Court noted that a corporation cannot obtain a license to practice law
because it is incapable of acquiring the educational qualifications and cannot, in its corporate name, possess
the necessary moral character for the practice of law. American Ins. Ass’n. 917 S.W.2d at 571.
The Court also noted its concern over conflicts of interest and stated that “no situation is more illustrative of the inherent pitfalls and conflicts therein than that in which house counsel defends the insureds
while remaining on the payroll of the insurer.” American Ins. Ass’n. 917 S.W.2d at 571.
B. North Carolina
The North Carolina Supreme Court similarly held that permitting a licensed attorney who is a fulltime employee of the insurance company to represent the company’s insured violates the ban on practice of
law by corporations pursuant to N.C. Gen. Stat. §84-5. Gardner v. North Carolina State Bar, 316 N.C. 285, 341
S.E.2d 517 (1986).
In this opinion, the Court reaffirmed its earlier rulings banning the use of in-house counsel and
based its decision on the rationale that if an insurance company, through its employees, appears for an
insured, it is appearing as an attorney for someone else because the insurance company is not the party to
the action. The insured is the actual party. Thus, the Court determined that the conduct fell within the ban of
unauthorized practice of law by a corporation and violated the North Carolina policy favoring personal representation. Gardner 341 S.E.2d at 519-520.
C.Arkansas
Most recently in a 2011 Supreme Court decision, Arkansas joined the ranks of the minority. Brown et
al. v. Kelton, 2011 Ark. 93, 380 S.W.3d 361 (2011).
The Supreme Court of Arkansas relied on Section 16-22-211 of the Arkansas Code in holding that an
insurance company’s use of a staff-attorney to represent an insured violates the ban of the practice of law by
corporations. The Court stated: “In the instant case, it is undisputed that [the insurer] is not a party and will
not become a party to the underlying lawsuit. Therefore, it was prohibited by Ark.Code Ann. Section 16-22211 from assigning [its insureds] one of its in-house counsel to defend the insureds in litigation. Brown, 380
S.W.3d at 365.
V. Practical Tips
Given the split of authority as to the permissibility of staff counsel representing insureds and the ethical considerations raised even in a jurisdiction in which such practice is permitted, insurance companies and
staff counsel must undertake such representation with caution. Some practical tips are discussed below.
A. Know the rule in the relevant jurisdiction
Before assigning staff counsel to represent an insured, be sure that the relevant jurisdiction allows
such representation.
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 135
B. Ensure that attorneys are properly licensed
If you are working in a jurisdiction that follows the majority view, ensure all in-house attorneys are
fully licensed in the state in which they are to practice.
C. Ensure that there are no conflicts of interest
Perform an appropriate conflict check. Upon recognition of any actual or potential conflict of interest, properly advise the insurer and the client and obtain the necessary written waivers, or withdraw as the circumstance would dictate.
1.Staff counsel must appropriately consider the scope of the law firm of
which they are a part
One unique question for staff counsel in considering conflicts of interest is the scope of the law firm of
which they are a part. Unfortunately, there is little authority addressing the issue of whether multiple in-house
law offices within a single larger organization should be regarded as one law firm or several. Barker at 921.
Model Rule 1.10(a) provides that “[w]hile lawyers are associated in a firm, none of them shall knowingly represent a client when any one of them practicing alone would be prohibited from doing so.” Comment
[1] to this Model Rule provides that whether two lawyers should be treated as associated depends on the specific facts and provides:
“Two practitioners who share office space and occasionally consult or assist each other ordinarily
would not be regarded as constituting a firm. However, if they present themselves to the public
in a way suggesting that they are a firm or conduct themselves as a firm, they should be regarded
as a firm ... The terms of any formal agreement between associated lawyers are relevant in determining whether they are a firm, as is the fact that they have mutual access to information concerning the clients they serve.”
There is authority that different offices within a single legal services organization will be treated as different firms if they neither share confidential information nor have a supervisory relationship to one another.
The Restatement ordinarily imputes conflicts among different legal offices within a larger organization, but recognizes that “imputation between the legal offices might be inappropriate where, despite common management
in other respects, the legal offices of the affiliated organizations are separately operated.” Barker at 921.
The most extensive opinion on the issue of when lawyers should be deemed “associated in a law firm”
for purposes of imputing conflict is contained in ABA Formal Opinion 88-356 on law firm use of temporary
lawyers. Barker at 922. This Opinion concludes that whether a temporary lawyer is treated as being associated
with a firm for purposes of imputing conflicts between the temporary lawyer and firm lawyers, depends on
whether the relationship is such that the temporary lawyer has access to information relating to the representation of firm clients other than the client on whose matters the lawyer is working and the consequent risk of
improper disclosure or misuse of information relating to the representation of other clients of the firm.
Based on the foregoing, although there is no law specifically on point, it appears that separate staff
counsel offices that are careful to treat one another as totally separate law firms, with different insured clients,
should not have conflicts imputed from one office to the other.
D. Ensure that policyholders are adequately informed
Staff attorneys may not hold themselves out as independent counsel or in any other manner deceive
a policy holder into believing that they are anything other than in-house counsel. Accordingly, staff attorneys
136 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
are best advised to inform the insured at the outset of the engagement about the full dimension of the relationship between the insured, insurer and staff counsel.
Staff counsel should also ensure that the firm name under which they practice provides sufficient disclosure to clients and complies with the applicable rules in the relevant jurisdiction.
E. Inform policyholders as to the proper scope of the representation
The only role staff counsel can properly play in a lawsuit is to defend the insured against the plaintiff ’s claims. It bears noting, however, that the insured may have affirmative claims that can only be prosecuted
by other counsel or pro se. Most jurisdictions will treat these affirmative claims as compulsory counterclaims
and will bar them if they are not asserted in the original action. Barker at 937.
Unless the insured is expressly told that staff counsel will not handle affirmative claims, they may
rely on staff counsel to do so. If such a claim is lost, either to the statute of limitations or by dismissal of the
original action, the insured may have a malpractice action against staff counsel (and the insurance company).
To protect the insured’s rights, staff counsel must explain that the insured needs to contact separate counsel
to discuss and join any related claims in the original action and should make clear that staff counsel will not
be representing the insured with respect to such claims. Barker at 937. This should be explained in every case
where there is any substantial possibility that the insured may have suffered an injury, regardless of apparent
liability. Counsel should not be making the decision whether to assert a claim that might be viable.
The statute of limitations applicable to any affirmative claims is not pertinent to the defense of the
claims made against the insured and is outside the scope of staff counsel’s representation. However, it may be
appropriate or necessary to warn the insured that the period may be about to expire, or of a date by which it
might expire, so that the insured appreciates the need to act promptly in retaining other counsel if the insured
desires to pursue affirmative claims. Barker at 938.
Once staff counsel has explained the limits of the defense representation, there should be no duty to
explore possible affirmative claims that the insured might have.
F. Ensure that the insurer does not interfere with the attorneys exercise of
professional judgment
Given the nature and complexity of the tripartite relationship and the added complexity brought on
by the use of staff-counsel, such counsel must be at all times cognizant of the imperative of exercising independent professional judgment. The insurer must also be cautious not to attempt to control the details of the
attorney’s performance or restrict the use of the attorney’s discretion in representing his client.
G. Ensure that the in-house attorney does not participate in any
investigation or determination with respect to insurance coverage
Like independent counsel, staff counsel must not share information with the insurer where such
information would be adverse to the insured’s coverage position.
VI. Implications for Vicarious Liability and Bad Faith
The use of staff counsel (in a jurisdiction where the practice is permitted), may have significant
implications for an insurance carrier with respect to vicarious liability and bad faith.
It is generally understood that if defense counsel negligently defends an insured and the insured is
damaged as a result, the insured may sue the lawyer for malpractice. If the attorney’s offensive conduct is the
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 137
product of a scheme by the insurer to favor its financial interests, by steering a case out of coverage or otherwise undermining the defense, the insured also may sue the insurer for bad faith. Douglas R. Richmond,
Liability Insurers’ Right to Defend Their Insureds, 35 Creighton L. Rev. 115, 136 (Dec. 2001) [hereinafter “Richmond at __”].
Courts however, are split on the issue of whether insurers are vicariously liable for the negligence of
the defense attorneys it hires to defend its insured. This issue may be further complicated in situations involving the use of staff counsel.
An understanding of vicarious liability turns on agency principles. An agent is someone who agrees
to act on behalf of a principal and submits to the principal’s control. A servant is an agent whose performance
is controlled by the principal. In contrast, an independent contractor contracts with the principal to perform
a service, but is not subject to the principal’s control or right to control the performance of the project or
service. Richmond at 136-37.
Although a principal may be liable for the torts of a servant committed in the course and scope of
their employment, a principal is generally not liable for torts committed by an independent contractor unless
the principal steps in to control the details of the independent contractor’s work. Richmond at 137.
Of course, the independent contractor rule does not absolve a principal of its own negligence. A principal may be found to be negligent for hiring an incompetent contractor, or for failing to exercise appropriate
control and supervision. In the present context, an insurer who engages unqualified or incompetent counsel
to defend its insured might face liability for breaching its duty to defend even if the attorneys are independent
contractors. Richmond at 137.
A. Courts holding that an insurer is not vicariously liable for damages
resulting from the alleged negligence of defense counsel
Numerous courts have held that an insurer is not vicariously liable to the insured for damages resulting from the negligence of an attorney retained by it to defend the insured.
In Merrit v. Reserve Ins. Co, 34 Cal.App.3d 858 (Cal. 1973), the insurer employed outside defense
counsel on behalf of its insured to defend against a claim in excess of policy limits. Defense counsel failed to
properly investigate the claim, was inadequately prepared for litigation, and repeatedly advised that the matter
was one of non-liability. A judgment in favor of the claimant $334,000 in excess of policy limits resulted. Merrit brought a bad faith action against the insurer on the theory that it was vicariously liable as the employer of
negligent defense counsel.
The court held that vicarious liability does not fall on an insurer who retains independent trial counsel on behalf of an insured when that counsel conducts the litigation negligently. Id. at 881-882. The Court
held:
“We do not accept the claim that vicarious liability falls on one who retains independent trial
counsel to conduct litigation on behalf of a third party when retained counsel have conducted
the litigation negligently. In our view independent counsel retained to conduct litigation in the
courts act in the capacity of independent contractors, responsible for the results of their conduct
and not subject to the control and direction of their employer over the details and manner of
their performance.” Id. at 880-881.
Other courts have similarly held that “a liability insurer is not vicariously responsible for the conduct
of an independent attorney it selects to defend an insured.” State Farm Mutual Automobile Insurance Co. v.
Traver, 980 S.W.2d 625, 628 (1998); see also, Ingersoll–Rand Equip. Corp. v. Transportation Ins. Co., 963 F.Supp.
138 ■ Insurance Bad Faith and Extra-Contractual Liability ■ June 2013
452, 454–55 (M.D.Pa.1997) (“The attorney’s ethical obligations to his or her client, the insured, prevent the
insurer from exercising the degree of control necessary to justify the imposition of vicarious liability.”); Aetna
Cas. & Sur. Co. v. Protective Nat. Ins. Co. of Omaha, 631 So. 2d 305, 306 (Fla. Dist. Ct. App. 3d Dist. 1993),
on reh’g in part, (Feb. 8, 1994); Brown v. Lumbermens Mut. Cas. Co., 90 N.C. App. 464, 369 S.E.2d 367, 371,
review allowed in part, 323 N.C. 542, 373 S.E.2d 542 (1988) and decision aff ’d, 326 N.C. 387, 390 S.E.2d 150
(1990); Feliberty v. Damon, 72 N.Y.2d 112, 531 N.Y.S.2d 778, 527 N.E.2d 261 (1988); Mentor Chiropractic Center, Inc. v. State Farm Fire And Cas. Co., 2000 WL 1473888 (Ohio Ct. App. 11th Dist. Lake County 2000) (noting that defense counsel is an independent contractor and that an insurer is generally not liable for counsel’s
negligence, but noting the possibility that counsel would not be considered an independent contractor if the
insurer interfered with counsel’s strategy).
B. Courts holding that an Insurer is vicariously liable for damages resulting
from the alleged negligence of defense counsel
In contrast, courts favoring the imposing of liability on the insurer for the malpractice of defense
counsel have done so on the theory that defense counsel is acting as the agent of the insurer. National Farmers
Union Property & Cas. Co. v. O’Daniel, 329 F.2d 60, 65 (9th Cir. 1964); Smoot v. State Farm Mut. Auto. Ins. Co.,
299 F.2d 525, 530 (5th Cir. 1962); Pacific Employers Ins. Co. v. P.B. Hole Co., Inc., 804 F.Supp. 137, 142 (D. Kan.
1992) (noting that the attorney was no mere independent contractor, but was hired to fulfill the insurer’s duty
to defend the claim in good faith and stating that under Kansas law, where injury to a third party results from
an employer’s failure to perform a duty, he is not permitted to avoid liability by letting the performance of the
work to another); Continental Ins. Co. v. Bayless and Roberts, Inc., 608 P.2d 281, 294 (Alaska 1980); Stumpf v.
Continental Cas. Co., 102 Or. App. 302, 794 P.2d 1228, 1231–32 (1990)
In Majorowicz v. Allied Mutual Insurance Co., Allied’s insured, Artha Majorowicz, was involved in
a car accident with William Grams. Grams, who was injured in the accident sued Majorowicz and the jury
awarded damages against Majorowicz in excess of the policy limits. After the verdict was rendered, Majorowicz sued Allied for bad faith for failing to settle the case within its policy limits.
The trial court held Allied responsible for the negligence of the attorney it hired to defend Majorowicz and instructed the jury that:
“The relationship between an attorney and his or her client is one of agency, and is governed by
the same rules applicable to other agencies. A principal, in this case, Allied Mutual Insurance
Company, is responsible for the acts of its agents for which the agents have been given authority.
This is true regardless of whether the agent commits a fraud or acts against his principal’s interest. An insurer’s duty to act in good faith in its dealings with its insured is non-delegable. An
insurer cannot escape liability for bad faith by delegating its responsibilities to attorneys or other
agents.”
Although Allied argued that under traditional agency principles, it could not be vicariously liable
for the negligence of defense counsel because an insurer has no right to control the independent professional
judgment of the lawyer it hires to defend its insured, the Court disagreed and explained:
“Here, we have a special fiduciary duty created by an insurance contract. Under Wisconsin case
law, it is clear that an insurance company owes an affirmative duty to the insured of good faith
treatment of any covered claims against the insured . . . The fundamental basis for this duty to
deal with a claim in good faith arises by reason of the insurance contract that the insured purchased. . . . The provisions of an insurance contract give the insurance company the right and the
correlative duty to defend suits against the insured and have the effect of placing absolute and
Ethical Concerns: Insurers Use of In House Counsel to Defend Policyholders ■ Collins ■ 139
exclusive control over the litigation in the insurance carrier. Allied cannot practice law. Legal
matters affecting the insurance contract are handled by counsel and are delegable. Although
Allied must delegate performance of the obligation, it may not delegate the responsibility for the
performance of the obligation.”
C. Vicarious liability and bad faith in the staff counsel setting
Although the debate over vicarious liability has generally focused on outside lawyers retained by
insurance carriers, courts may be more willing to hold liability insurers vicariously liable for errors committed
by staff counsel.
The fact that staff counsel are employed by the insurance carrier may make courts more likely to hold
that such counsel are not independent contractors, but rather are agents of the insurance company. It has been
argued that because corporations act through their employees, just as an insurer can be liable for bad faith
when a claims adjuster errs, so should it be liable when the offending employee is a lawyer. Richmond at 151.
One law review article on the subject noted that: “[E]mployees are their employers’ servants when acting in
the course and scope of their employment; that principle--and the vicarious liability that goes along--does not
change just because the employee is an attorney and the employer is a liability insurer. While it is true that
staff attorneys have independent professional obligations to the insureds they represent, the fact remains that
they are insurance company employees . . [E]ven if an insurance company’s duty of good faith and fair dealing
were delegable, which in all probability it is not, it would be illogical to argue that the company could avoid
liability by delegating that duty to a select category of employees.” Richmond at 150-51.
The counter-argument to this is that outside counsel and staff counsel are not qualitatively different.
Both depend on the insurer for their work and both owe the insureds they represent duties of loyalty and honesty. As a majority of courts have held, there is no reason to believe that insurance company staff counsel are
any less ethical than their private counterparts. Where the insurance carrier has not interfered with the staff
counsel’s use of independent judgment, there is no reason to believe that such counsel are any less of an independent contractor than outside counsel.
Based on the foregoing, however, even in jurisdictions in which the use of staff counsel is permitted,
insurance carriers may want to consider the potential vicarious liability/bad faith issues that may arise and
should proceed cautiously.
VII.Conclusion
In summary, although a majority of jurisdictions permit insurers to utilize in-house or staff counsel
to represent policy holders, courts and ethics opinions have consistently noted that this arrangement can present a host of ethical issues, including the potential for conflicts of interest, unauthorized practice of law, and
unfair and deceptive practices. Accordingly, insurers and staff counsel must be sure to proceed with caution in
this type of representation.
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