Asim K. Desai, Esq. Gordon & Rees LLP Los Angeles, CA Kevin Willging Executive Counsel Travelers Companies

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OVERVIEW

“Third-Party Claimant” Person making a claim against the

insured, for which the insured seeks coverage under the policy.

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OVERVIEW “Underlying Action” = Third-Party Claimant v. Insured

“Coverage Action” = Insured v. Insurer (most common)

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OVERVIEW – Terminology Cont. “Direct Action” or "Reach and Apply“: Third-Party Claimant v. Insurer In some states, allowed by statute and/or assignment

of rights. Cal. Ins. Code § 11580 Maine Rev. Stat. Title 24-A, §§ 2903, 2904.

In other states, third-party claimant has greater rights

than insured to sue. Brewington (Mont. 1999).

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BAD FAITH General Principles Bad faith Liability = “Extra-contractual”

Liability “Breach of the implied covenant of good faith

and fair dealing” Insurer should refrain from taking actions that

prevent insured from receiving benefits due under the policy.

Insurer should not hold its own interest over insured’s interest.

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Contractual and Extracontractual Duties

Duty to Defend

Duty to Indemnify

Duty to Investigate?

Duty to Settle?

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“Bad Faith”: Hybrid of Contract and Tort Contract: Did insurer breach policy? Damages:

Compensatory Consequential

Extra-contractual: Was insurer's misconduct tortious? Damages:

Consequential Emotional distress Multiplied damages Attorneys fees Waiver of Defenses Punitive damages

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BAD FAITH - General Principles Cont. Sources of bad faith law: Common Law = judicial decisions

Statutes and Regulations

Majority: Claimant cannot sue; DOI enforces Minority: A few states allow insureds to sue

FL, KY, LA, MA, MT, NM, WA

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BAD FAITH Spectrum of Standards

States vary in the standards required to prove bad faith.

Pro-insured Middle Pro-insurer "Hybrid Negligence- Unreasonable Breach of contract Strict Liability" claims only

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WA CA OR

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OVERVIEW - Choice of Law Can be critical to ultimate case outcome: Reason – the law, fair claims handling /

settlement standards may vary by state. Practical tip Any time more than one

state's name shows up, evaluate choice of law - evaluate current state of law

Zurich v. USF&G (8th Cir. 2012)

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BAD FAITH - West Virginia? Strahin v. Sullivan (W.Va. 2007) "Hybrid negligence-strict liability from Shamblin

If insurer had opportunity to settle within policy limits, thereby

releasing insured from all personal liability, but did not do so, insurer has prima facie acted in bad faith.

Insurer has burden of proof to show, by “clear and convincing” evidence, that Insurer attempted in good faith to settle; Failure to settle was based on “reasonable and substantial

grounds”; and Insurer accorded the insured’s rights and interests “at least as

great a respect as its own.”

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BAD FAITH Spectrum of Standards Howard (Cal. App. 2010) Under California law - bad faith always required

"unreasonable" conduct. Mere mistakes and erroneous coverage decisions are

not sufficient. But totality of circumstances will be examined Insurer cannot rely on "unfair and selective reading" of

facts.

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Defenses to Bad Faith Claims

Genuine Dispute / Fairly Debatable?

No coverage in the first place

Advice of Counsel

Be Warned – Defenses Erode!

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TYPES OF “3rd Party” BAD FAITH CASES Breach of duty to investigate

Breach of duty to defend

Breach of duty to settle

"Procedural" bad faith – violation of statutes or regs

(MA, WA)

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DUTY TO INVESTIGATE General Principles Purpose of investigation – determine if underlying

action is covered Caution – investigation cannot prejudice insured's

defense of underlying action. No EUOs! Duty can continue during coverage litigation and after

denial

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DUTY TO INVESTIGATE - Sources Insuring agreement:

“We may, at our discretion, investigate

any ‘occurrence’ …” or ‘personal and advertising injury’ offense.

ISO Form CG 00 01 10 01.

Judicial decisions

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DUTY TO INVESTIGATE OR DUTY TO DEFEND Scope

"Four corners" states: Complaint (CO, CT, FL, ME, MT, NM, OK, PA)

"Eight corners" states: Complaint + policy (IL, MS, NC, TX)

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DUTY TO INVESTIGATE Scope Extrinsic Evidence States Complaint + Policy + Evidence = Coverage?

Discovery responses Deposition testimony Insured's catalogs Answer to complaint (sometimes)

AL, CA, MD, MN, MO, NY Must consider extrinsic evidence if it creates coverage. Usually cannot consider extrinsic evidence that defeats coverage.

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DUTY TO REALLY INVESTIGATE Wilson (Cal. 2007) Underinsured motorist case 21-year-old insured seriously injured by drunk

driver. Her physician opined she had degenerative disk

changes as a result of the injury. Her insurer rejected claim, asserting that she – Had soft tissue injuries. Was young and would recover. Had pre-existing degenerative changes. Was going “on vacation” to Australia (in fact she

was going to study).

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DUTY TO INVESTIGATE - Wilson (Cal. 2007) California Supreme Court held: To avoid bad faith, insurers must (1) thoroughly

investigate and (2) fairly evaluate claims

Denial of claim based on facts known to insurer, or denial contradicted by facts, may be bad faith

Insurer must focus on facts that support coverage, not just facts that show no coverage

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DUTY TO INVESTIGATE STANDARD Where there is a “genuine dispute” as to whether

coverage exists, or the amount of liability, the insurer can raise the “genuine dispute” as a defense to a bad faith action.

BUT – insurer can raise this defense only if it

properly investigated.

Wilson (Cal. 2007)

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DUTY TO INVESTIGATE “Genuine Dispute” / “Fairly Debatable” Subjective vs. objective standard for genuine dispute: Should courts consider the insurer’s subjective intent?

Or whether its investigation was reasonable under all the circumstances (objective)?

Chateau Chamberay HOA (Cal. App. 2001)

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DUTY TO INVESTIGATE - “Fairly Debatable”

If claim is “fairly debatable,” insurer is not liable for bad faith for not immediately paying the claim.

Knoell (D. Ariz. 2001).

BUT – if bad faith is based on something other than delay in payment, “fair debatability” may not be a defense to bad faith.

Zilisch (Ariz. 2000). AND – even if a trial judge (“erroneously”) agrees there is no

coverage, that does not mean coverage was “fairly debatable.” Lennar (Ariz. 2011)

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Duty to Investigate- Time Limits Many states have strict time limits for investigation

found in statutes and regs

Is violation of time limit per se bad faith? Rebuttable presumption? A factor among many?

Another reason why Choice of Law can be critical

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DUTY TO DEFEND Source Insuring agreement

“We will have the right and duty to defend the insured against

any ‘suit’ seeking [potentially covered] damages. “However, we will have no duty to defend [where] this

insurance does not apply.” ISO Form CG 00 01 10 01.

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DUTY TO DEFEND Scope Separate than duty to indemnify

Broader than duty to indemnify

Broader – but not unlimited

Extends to "groundless, false or fraudulent" claims

Determination made at time of tender

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DUTY TO DEFEND American Best Food (Wash. 2010) Facts: Insured = nightclub. After a dispute inside the nightclub, one

patron shot another outside the nightclub. Nightclub owner instructed employees to

remove the injured patron from the club. Employees allegedly "dumped him on the

sidewalk." Injured patron sued nightclub for post-

assault negligence.

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DUTY TO DEFEND American Best Food Insurer disclaimed on Washington law enforcing "assault

and battery" exclusion, negligence allegations insufficient to trigger coverage.

Insured argued one Texas case supported coverage

Wash Sup Ct held that although persuasive out-of-state cases do not trump binding Washington law, Washington cases were factually distinguishable, so there was a "legal uncertainty" about coverage, requiring insurer to defend.

Out-of-state cases that were factually on point bolstered the court's conclusion that insurer acted in bad faith by not defending.

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DUTY TO DEFEND – The “Mixed Action” Mixed action = some causes of action are potentially covered, some are

not. Insurer must usually defend entire action. In some states, the insurer can reserve the right to recover the costs

allocable solely to defending the non-covered claims. CA (Buss (1997)), NJ

In some states, the insurer can reserve the right to recover defense costs if the underlying action was never covered.

CA (MV Transportation (2005)), FL (if insured signs ROR agreement) In other states, reserving “Buss” rights is not allowed and can be bad

faith. IL, LA, WY

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DUTY TO DEFEND Mixed Action Hypothetical

Underlying action filed in NJ (can reserve Buss rights

= recover costs allocable to defending non-covered claims).

Insured HQ and policy issued in IL (reserving rights on Buss = bad faith).

What should you do?

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DUTY TO SETTLE Sources Insuring agreement:

“We may, at our discretion, … settle any claim or

'suit.'”

ISO Form CG 00 01 10 01.

Judicial decisions

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DUTY TO SETTLE Applies where: Underlying action is covered, or potentially

covered. Settling “mixed actions” is complicated.

Insured’s liability is “reasonably clear.” Risk of excess verdict against insured – but

only if insurer can settle within limits. Risk that failure to settle could bankrupt the

insured. 32

DUTY TO SETTLE - SET UPS BEWARE THE SET-UP LETTERS

Set-up by the insured Set-up by the claimant Set-up by the excess insurer

Set-up by defense counsel

Respond promptly and thoroughly – time to cross T’s

and dot I’s if you have not already.

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DUTY TO DEFEND AND SETTLE - THE ONE-TWO MISSOURI COMBO Insured can reject defense under reservation leaving

insurer choice of waiving defenses or potentially breaching duty to defend. Prairie Framing (Mo.App. 2005)

Insurer who chooses latter waives right to control or contest insured’s handling of defense.

Insured is free to do section 537 settlement, limit recovery to insurance and sit on hands in collusive trial. Insurer cannot dispute reasonableness. Schmitz (Mo. 2011)

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DUTY TO SETTLE O'Neill v. Gallant (IL App. 2000) Insurer did not respond to demand to settle for policy

limits within 30 days. Underlying action: $20k limits $710k compensatory + $2.3M punitives. Coverage Action – Holding :

Insurer that fails to settle may be liable for bad faith.

Insurer can be subject to punitive damages for bad faith failure to settle.

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DUTY TO SETTLE Roehl Transport (Wis. 2010) Insured's policy = $2M limits, $500k deductible. In underlying action, jury verdict against insured for $830k,

consuming entire deductible. In coverage action, insured argued insurer should have

settled for less than the deductible. Wisconsin Supreme Court held insurer acted in bad faith,

"even though the judgment does not exceed the policy limits."

Court noted that in past, settlements within limits cost an insured little, because limits were low. Current prevalence of high-deductible policies means there may be more claims for bad faith failure to settle, even if settlement/verdict is within limits.

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DUTY TO SETTLE Mixed Action “Buss” allocation may apply to an insurer’s

payment to settle.

Insurer can settle – and reserve its right to recover reimbursement from the insured for the settlement payment allocable to the non-covered claims.

Blue Ridge v. Jacobsen (Cal. 2001).

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DUTY TO SETTLE Multiple Claimants Can insurer settle with some claimants – leaving insured

exposed to claims by other claimants? Majority rule:

Yes – as long as the settlements are made in “good faith.”

CT, FL, GA, IL, KS, KY, LA, MD, MA, MI, MS, NJ, NY, NC, PA, RI, SC, TX, WA

Minority rule: No – the insurer may not settle with some claimants to

the detriment of the insured. CA, WI

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DUTY TO SETTLE Multiple Claimants Practical Tips: Investigate liability, potential exposure, other

insurance

Communicate – keep insured advised in writing

Document the file

Declaratory action or Interpleader may be an option

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DUTY TO SETTLE - Multiple Insureds Can insurer settle on behalf of one insured, leaving other insureds

exposed to the claim? Majority rule: Yes – the insurer must do so if it can. With respect to the other insureds,

the insurer fulfills its duties if it tries to settle, even if it is not successful. Shin Crest (11th Cir. 2010) (Florida law), IL, MO, PA, TX

Minority rule: No. An insurer may reject a settlement offer that does not include a

complete release of all insureds, without being liable for bad faith. CA, NY

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DUTY TO SETTLE - Multiple Insureds Practical Tips: Attempt to settle all claims on behalf of all

insureds. If insurer cannot do so, attempt to settle

those claims with the most exposure. Caveat – if the jurisdiction does not permit

the insurer to do this, obtain the insured’s consent to do so.

Goal is to obtain the maximum release for the policy limits.

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PROCEDURAL BAD FAITH Massachusetts The unfair practices statute prohibits insurers from “failing

to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear.”

M.G.L.A. 176D § 3(9)(f); see M.G.L.A. 93A § 2(a).

But no court explains what “reasonably clear” means… Liability is not “reasonably clear,” and insurer has no duty

to settle, where there is a legitimate difference as to insured’s liability, causation, or damages.

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PROCEDURAL BAD FAITH Massachusetts – Bobick (2003) Facts: “Slip and fall” by a mentally disabled man for

$83,000 in medical expenses. He sued the program and van who were caring for

him. He sent a “93A” letter to the insurer, demanding

settlement for policy limits of $250,000. The insurer declined, because liability was not

“reasonably clear.” The insurer offered to settle for $50,000.

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PROCEDURAL BAD FAITH Massachusetts – Bobick (2003) Holding: Liability not “reasonably clear” due to legitimate

difference as to liability of the van (the insured) and the care program (not an insured). Thus, the insurer’s settlement offer was

reasonable. “Reasonably clear” be evaluated case-by-case under

all the circumstances. Insurer’s conduct is usually a question of fact Expert testimony on industry practices may, or may

not be necessary.

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PROCEDURAL BAD FAITH Massachusetts – Gore v. Arbella (2010) Facts: Insured crashed into another car, causing serious

injuries to the other driver. Limits = $20k per person, $40k per accident Insurer investigated and found liability and

damages "reasonably clear" – and that damages exceeded limits by at least $100k. Insured drove through stop sign Insured did not have right of way Insured pled guilty to DUI Insured admitted all of the above at deposition

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PROCEDURAL BAD FAITH Massachusetts – Gore v. Arbella (2010) Insurer did not respond to other driver's policy limits

demand within 30 days. Insured and other driver stipulated to judgment for $450k,

and assignment of insured's rights against insurer. Court found insurer had acted in bad faith by not timely

responding to settlement demand, because liability and damages were "reasonably clear."

Court awarded damages against insurer: $430k excess amount to be doubled or tripled, because

of "willful or knowing" violation Prejudgment interest Attorneys' fees for appeal

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PROCEDURAL BAD FAITH Washington / Insurance Fair Conduct Act Before 2007: Treble damages were capped at $10k. In 2007, voters approved stricter standards, adding:

Insurer may not unreasonably deny coverage or payment of benefits to first-party claimants. Insured does not need to prove elements of bad faith, just that insurer violated the IFCA

Not complying with fair claims practices = bad faith, specifically: Engaging in unfair settlement practices Misrepresenting policy provisions Failing to acknowledge pertinent communications Failing to promptly investigate Failing to promptly, fairly and equitably settle

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PROCEDURAL BAD FAITH Washington / Insurance Fair Conduct Act The IFCA imposes higher damages for violations of

the procedural rules. If first-party claimant prevails, and court finds

insurer acted unreasonably, the court “shall” impose damages:

Actual costs + reasonable attorneys’ fees +

litigation costs + expert witness fees; and Damages can be trebled, with no cap on the

amount. Punitive damages available.

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PROCEDURAL BAD FAITH Washington / Onvia (2008) Facts: Underlying action for fax blasting. Underlying complaint tendered to insurer,

who asserted it did not receive it; re-tendered 6 months later.

Insured and third-party claimant settled underlying action for $17.5M and assignment of insured’s claim against insurer.

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PROCEDURAL BAD FAITH Washington / Onvia (2008) Holding: Under IFCA, insurer can be liable for “procedural

bad faith” – but only if the insured proves “actual harm.”

Significance – Court limited damages to “proven damages,” not

to exceed amounts permitted under statute. Court extended procedural bad faith from first

party to third-party liability context.

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PUNITIVE DAMAGES Public Policy Issues Substantive: Deterring reprehensible conduct. BMW v. Gore (U.S. 1996).

vs. Ratios: Constitutional due process limits –

especially in relation to compensatory damages.

Exxon v. Baker (U.S. 2008); State Farm v. Campbell (U.S. 2003)

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PUNITIVE DAMAGES Substantive Factors The three guideposts: 1. Degree of reprehensibility of the

defendant’s misconduct; 2. Disparity between the harm suffered by the

plaintiff and the punitive damages award; and 3. The difference between the punitive damages

awarded by the jury and the civil penalties authorized in comparable cases.

BMW v. Gore (U.S. 1996).

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PUNITIVE DAMAGES Substantive Factors What is “reprehensibility”? Physical harm as opposed to economic

harm? Does tortious conduct evidence

indifference or reckless disregard of the health or safety of others?

Was plaintiff financially vulnerable? Repeated actions or isolated incident? Intentional malice, trickery, or deceit, or

merely negligent? 53

PUNITIVE DAMAGES Substantive Factors The issue for insurers: What conduct may subject an

insurer to punitive damages?

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PUNITIVE DAMAGES Substantive Factors Erroneous coverage determination ≠

reprehensible. Food Pro (Cal. App. 2008) Claims handling that was "witless,” “shoddy,”

“inept and negligent,” “infected with symptoms of bureaucratic inertia" ≠ reprehensible.

Patrick v. Maryland (Cal. App. 1990) 55

PUNITIVE DAMAGES Substantive Factors Jurisdictions vary: Punitive damages not allowed (NE).

Punitive damages allowed only when

authorized by statute (LA, MA, NH, WA).

Punitive damages allowed when they serve a compensatory, not truly punitive, purpose (MI).

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PUNITIVE DAMAGES Ratios State Farm v. Campbell (U.S. 2004): Underlying auto accident bad faith action. Held: Punitive damages should not exceed a single-

digit ratio, and likely closer to 4:1, unless compensatory damages are very low.

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PUNITIVE DAMAGES Ratios Exxon v. Baker (U.S. 2008):

Exxon Valdez civil litigation. Compensatory damages = $507.5M. Punitive damages:

$5k against Capt. Hazelwood (0.00001:1 ratio). $5B against Exxon (10:1 ratio).

9th Circuit reduced punitives to $2.5B. Reason: Due process.

Supreme Court reduced punitive to 1:1 ratio = $507.5M. Reason: Maritime case.

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PUNITIVE DAMAGES Ratios Ratio caps: Colorado – 1:1, or 3:1 if defendant continued its "willful

and wanton" conduct during trial

Ohio – 2:1

Oregon - 9:1 is the maximum, but should usually be 4:1

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PUNITIVE DAMAGES Ratios

Monetary caps: Virginia – $350,000

Montana – $10M or 3% of defendant’s net worth,

whichever is less (but no cap in class actions)

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PUNITIVE DAMAGES Ratios Ratio or monetary caps: Alaska – 3:1 or $500,000, whichever is greater While states such as South Carolina are Arkansas are

enacting new laws to cap punitive damages, the Arkansas Supreme Court recently struck down Arkansas’s $1 million cap on punitive damages, finding that it violated the state’s constitution

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Punitive Damages Ratios There are ratios and then there are ratios Washington – If attorney fees awarded as

consequential damages, ratio based on compensatory and consequential damages combined.

$37K in damages becomes $425K in damages. 35:1 ratio becomes 3:1 ratio, which is “within due

process limits.” Icicle Seafoods (WA 2012)

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PUNITIVE DAMAGES Ratios Graduated Caps (OK): Punitive Damages specifically for Bad Faith For insurer’s reckless bad faith, $100,000 or the amount of

compensatory damages, whichever is greater. For insurer’s intentional and malicious bad faith, $500,000,

2X compensatory damages, or the financial benefit derived by the insurer as a direct result of its conduct.

For intentional and malicious conduct involving “conduct life-threatening to humans,” no cap.

(SC): general punitive damages, greater of 3:1 or $500,000 4:1 or $2M if motivated for unreasonable financial gain No cap if conduct was intended to, and did, cause harm

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Thank you.

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