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This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Bad Faith, Vol. 12, #22 (March 16, 1999). Copyright Butler 1999.
Determining which statute of limitations governs a cause of action against an insurer for bad faith is complicated. It depends on whether the action is a first or third party action. It depends also on whether the controlling jurisdiction deems the action to be one sounding in tort or contract.
Generally, the day that a cause of action “accrues” is the day the limitations periodbegins to run. Figuring out when the action accrues also can be complicated. It toodepends on whether the controlling jurisdiction deems the action to be one sounding in tortor contract. It depends also on the identification of the elements comprising the bad faith action and, particularly, determining when all were in existence.
Typically, the period of limitations for a contract action is longer than for a tort action. Also, a contract action usually accrues on the date of breach. A tort action usually accrueson the date the plaintiff “knew or should have known” of the claim. A majority of the courtsreviewed found a first party cause of action in bad faith is a tort.
An explanation for this is set forth in Gruenberg v. Aetna Insurance Co., 9 Cal. 3d566, 510 P.2d 1032, 108 Cal. Rptr. 480 (Cal. 1973). There the California Supreme Court extended the tort of third party bad faith to first party matters. The court found the duty ofan insurer to act in good faith and fairly in handling the claims of third persons against theinsured, and the duty of an insurer to act in good faith and fairly in handling the claim of itsown insured, merely were two different aspects of the same duty. 510 P.2d at 1037. Thisresponsibility is not mandated by the terms of the policy itself. Rather, it is an obligation imposed by law. If the insurer fails to deal fairly and in good faith with its insured, suchconduct may give rise to a cause of action in tort for breach of the implied covenant ofgood faith and fair dealing. Id. The court found the insurer’s duty of good faith and fairdealing, implied by law, was unconditional and independent of the performance of aninsured’s contractual obligations. Other courts have reached the same result for similarreasons. Noble v. National Am. Life Ins. Co., 128 Ariz. 188, 624 P.2d 866 (1991); The BestPlace, Inc. v. Penn Am. Ins. Co., 920 P.2d 334 (Haw. 1996).
Some exceptional jurisdictions hold that a first party bad faith action is a matter ofcontract law. E.g., A & E Supply Co. v. Nationwide Mut. Fire Ins. Co., 798 F.2d 669 (4th Cir. 1986). This is because the duty to act in good faith arises from the agreement andextends only to situations connected with the agreement. Id. at 676.
Still other jurisdictions find bad faith can sound in either tort or contract. E.g.,Woody v. State Farm Fire & Cas. Co., 965 F. Supp. 691 (E.D. Pa. 1997). This raises thequestion of which limitation period to choose. The Woody court relied on an earlierreported opinion of the Pennsylvania Superior Court in Gabriel v. O’Hara, 534 A.2d 488(Pa. Super. Ct. 1987), which dealt with an analogous situation. The Gabriel courtconcluded because no explicit statute of limitations applied, the six-year “catch all” statuteof limitations was applicable. 534 A.2d at 494. The Woody court followed that thinking. 965 F. Supp. at 694.
There also are jurisdictions which find the bad faith cause of action to be a speciesof fraud. The Supreme Court of Alabama reached that conclusion and, as such, found thestatute of limitations for fraud applicable to bad faith as well. Dumas v. Southern Guar. Ins.Co., 408 So. 2d 86, 89 (Ala. 1981). See also McLeod v. Life of the South Ins. Co., 703 So.2d 362 (Ala. App. 1996).
Finally, in jurisdictions such as Florida, there is no common law first party cause ofaction for bad faith at all. McLeod v. Continental Ins. Co., 591 So. 2d 621 (Fla. 1992). The action exists pursuant to statute only and has its own limitations period.
Once a court has determined whether a first party cause of action for bad faithsounds in tort, contract, or something else, it then must identify when the cause of actionaccrued. The accrual date is that point in time when all the elements of the cause of actionhave come into existence.
Generally speaking, an action “accrues” when all the elements are known or, in theexercise of reasonable care, should be known to the plaintiff. In Brown v. Liberty MutualInsurance Co., 513 N.W.2d 762 (Iowa 1994), the Supreme Court of Iowa identified two elements necessary to sustain a first party claim of bad faith failure to pay insurance benefits: (1) the absence of a reasonable basis for denying benefits under the policy, and(2) proof of the insurer’s knowledge, or reckless disregard, of the lack of a reasonable basis for denying the claim. 513 N.W.2d at 763.
The Brown court held a cause of action for bad faith failure to pay workers compensation benefits accrued upon receipt of notification that the carrier had denied the claim. At that point both of the essential elements of the action were, or should with reasonable diligence have been, known to the plaintiff. 513 N.W.2d at 764. In renderingits decision, the court relied on reported opinions out of Alabama and Texas, Alpha Mutual Insurance Co. v. Smith, 540 So. 2d 691, 693 (Ala. 1988), and Davis v. Aetna Casualty &Surety Co., 843 S.W.2d 777, 778 (Tex. App. 1992). Those jurisdictions held a denial of coverage letter puts the claimant on reasonable notice of potential bad faith, there by fixingthe accrual date.
A similar analysis was made in Ness v. Western Security Life Insurance Co., 851P.2d 122 (Ariz. App. 1992). There, the court found an insurance company commits bad faith when it (1) intentionally (2) denies, fails to process, or fails to pay a claim (3) without a reasonable basis for such action. 851 P.2d at 124. A cause of action arises only whenall three elements are present and the period of limitation starts when the cause of action arises. Id.
On the other hand, in 1996 the Court of Civil Appeals of Alabama held that a badfaith cause of action did not necessarily accrue when the insurance company denied coverage. McLeod v. Life of the South Ins. Co., 703 So. 2d 362, 365 (Ala. App. 1996). But that ruling was based on the unique facts of the case. The matter arose out of a refusalto pay benefits under a credit life insurance policy. The insured had concealed her treatment for cancer. Three and a half months later, she died of cancer. The carrier denied the claim. However, the policy had a 90 day “incontestibility” clause which thebeneficiary did not know about. The appellate court held that the beneficiary’s bad faithaction did not accrue on the date of denial. It accrued on the date the beneficiary learned of the incontestibility clause.
The Supreme Court of Florida held an action for first party bad faith does not accrueuntil there has been a resolution of the underlying claim for liability and a determination of damages. Blanchard v. State Farm Mut. Auto. Ins. Co., 575 So. 2d 1289 (Fla. 1991). See also Brookins v. Goodson, 640 So. 2d 110 (Fla. 4th DCA 1994). But see Rubio v. State Farm Fire & Cas. Co., 662 So. 2d 956 (Fla. 3d DCA 1995) (purporting to limit Blanchard to cases involving underinsured motorist coverage).
As with first party causes of action, courts begin their consideration of third party statute of limitations issues by looking at the tort/contract question. In general, in the third party context, an insurer is subject to bad faith actions for failure to settle and for failure to defend. The majority of the courts reviewed found a third party action for failure to settle sounds in tort. E.g., Taylor v. State Farm Mut. Auto. Ins. Co., 913 P.2d 1092 (Ariz. 1996). An action for failure to defend sounds in contract. E.g., Boyd v. Fireman’s Fund Ins. Co., 540 F. Supp. 579 (D. Ala. 1982).
1. Failure to Settle
In Taylor v. State Farm Mutual Automobile Insurance Co., 913 P.2d 1092 (Ariz.1996), the Supreme Court of Arizona accepted review of a court of appeals decision that an insured’s bad faith claim against State Farm was barred by the statute of limitations. At issue was the date of accrual of a bad faith refusal to settle claim. The matter arose out of an automobile accident. The insured was sued by the other drivers involved in the accident. The suit resulted in an excess verdict. The insured then sued State Farm forbad faith refusal to settle within policy limits. 913 P.2d at 1093.
Arizona recognizes a cause of action for bad faith refusal to settle. The cause of action arises out of the duty of good faith and fair dealing implied in all contracts. 913 P.2dat 1094. Although the contract provides the duty, the bad faith breach of that duty is a tort. Id. The court discussed the uniqueness of the insurance relationship, characterized by “elements of public interest, adhesion, and fiduciary responsibility.” 913 P.2d at 1094. Thecourt found this particular uniqueness was the basis of the action, rather than any express contractual provision. 913 P.2d at 1095. See also Robinson v. Continental Casualty Co.,406 S.E.2d 470 (W. Va. 1991), overruled on other grounds, State ex rel. State Farm Fire & Cas. Co., 451 S.E. 2d 721; Lexington Ins. Co. v. Royal Ins. Co., 886 F. Supp. 837 (N.D.Fla. 1995); Hostetter v. Hartford Ins. Co., 1992 Del. Super. LEXIS 284; Evans v. MutualAssurance, Inc., 1999 Ala. LEXIS 12; Vanderloop v. Progressive Cas. Ins. Co., 769 F.Supp. 1172 (D. Colo. 1991).
Some minority jurisdictions find a third party cause of action for bad faith failure tosettle sounds in contract. The basis is that such actions involve a breach of the fiduciary duty owed by an insurer to an insured. The duty is imposed exclusively by the contract of insurance. Bettius & Sanderson, P.C. v. National Union Fire Ins. Co., 839 F.2d 1009 (4th Cir. 1988); Roldan v. Allstate Ins. Co., 149 A.D.2d 20 (N.Y. App. Div. 1989).
An insurer’s duty to defend an insured arises solely from the contract between the parties. Therefore, when an insurer fails to defend, it is a breach of contract. See Lambertv. Commonwealth Land Title Ins. Co., 811 P.2d 737 (Cal. 1991); Boyd v. Fireman’s FundIns. Co., 540 F. Supp. 579 (D. Ala. 1982).
The overwhelming majority of jurisdictions hold that an action for third party bad faith refusal to settle does not accrue until the underlying judgment against the insured becomes final or non-appealable. Taylor v. State Farm Mut. Auto. Ins. Co., 913 P.2d 1092 (Ariz. 1996). The basis for this rule is the impossibility of determining whether the insurer acted in bad faith, or the extent of the insured’s damages, until the underlying liability finally is determined. Lexington Ins. Co. v. Royal Ins. Co., 886 F. Supp. 837, 841 (N.D. Fla. 1995). Additionally, because the essential element of the insured’s third party bad faith case (the entry of a judgment in excess of policy limits) may be reversed or modified on appeal, adifferent rule would result in precautionary or duplicative litigation. Taylor, 913 P.2d 1092. There are other good reasons as well. A rule which required the insured to bring an actionbefore final judgment would force the insured into a suit with his carrier at the same time he was depending on the carrier to represent him in the appeal of the third party claim. The relationship between the parties, the nature of the claim, and judicial efficiency combine to favor the better rule: No suit until the damages are final and irrevocable. See Robinson v. Continental Cas. Co., 406 S.E.2d 470 (W. Va. 1991).
2. Failure to Defend
The statute of limitations for an insurer’s breach of the duty to defend commences also when judgment is final. Lambert v. Commonwealth Land Title Ins. Co., 811 P.2d 737(Cal. 1991); Boyd v. Fireman’s Fund Ins. Co., 540 F. Supp. 579 (D. Ala. 1982); Freedom Trust v. Chubb Group of Ins. Cos., 1998 U.S. Dist. LEXIS 10665 (C.D. Cal. 1998). However, the rationale for this rule is different than in a failure to settle context. The Lambert court, citing Israelsky v. Title Insurance Co., 212 Cal. App. 3d 611 (1989),discussed it thusly:
The Isrealsky court relied on the continuing nature of the duty to defend to hold that ‘the statute of limitation for claims for breach of the duty to defend does not commence until entry of a final judgment in the underlying litigation.’… The Isrealsky court based its decision on the delayed-accrual rule applicable to liability insurance cases. … It concluded the insurer ‘could have assumed this continuing duty at any time, before final judgment. … It could have indicated its willingness to appear and defend at any time before final judgment.’ Therefore, the insured ‘could elect to wait until a final judgment had been entered and the duty to defend had ceased.’
811 P.2d at 739.
In other words, the insurer might elect, at some point, to take up the duty it had shirked. This necessarily would affect such issues as damages in any bad faith case. Thus, until the duty is ended, the consequences of the breach are not realized.
We have seen, then, that bad faith statute of limitations issues have some complexities. In first party cases, one must identify whether the action sounds in tort or contract. The answer to that question decides not only which statute of limitations applies,but when the bad faith claim accrues. This is because all elements of the claim must exist,and the elements differ between tort and contract.
In third party cases, one also must decide whether the action sounds in tort or contract. In those cases, generally, an action for bad faith failure to settle will sound in tort. An action for bad faith failure to defend will sound in contract. In either instance, the cause of action will accrue when a judgment against the insured in the underlying litigation is final.