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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, #14, p. 24 (Nov. 17, 1998). Copyright Butler 1998.
Bad faith litigation is complex and the stakes are high. In such cases, the discoveryprocess has become critical as litigants struggle for advantage. The litigation often raisesissues outside the facts of the particular case or claim. The conduct of the insurancecompany as a whole sometimes is placed on trial.
In the quest for punitive damage awards, policyholders try to show an insurer’s bad faithby viewing its conduct in light of various extrinsic evidence. This includes claim andtraining manuals, reserve and reinsurance information, and claims made by other insureds. This article discusses the scope of allowable discovery in each of these areas includingrecent decisions from jurisdictions across the country.(1)
It should be noted that the outcome of these disputes can have an impact beyond theparticular case. Because the focus is on “institutional” practices, discovery in one casemay be used in another case involving the same insurer. This has led to the sharing ofdiscovery, from case to case, by the plaintiffs’ bar. The fact of this sharing makes thediscovery of claim and training manuals, reserve and reinsurance information, and claimsmade by other insureds even more important to both sides.
Claim and training manuals usually set out an insurer’s approved claim handling practices. Thus they can highlight whether the insurer followed those practices in handling the subjectclaim. Historically, discovery of claim manuals was common in insurance coverage actionsinvolving policy interpretation. Many jurisdictions permitted discovery of claim manuals toallow “a full understanding of the intent of insurance companies in coverage cases.”(2) Then,as bad faith litigation matured, courts faced demands for claim manuals to evaluate theconduct of the insurer. There is a spilt of authority on whether claim manuals arediscoverable in a bad faith case.
In 1991, the U.S. District Court for the District of Maryland ordered production of claimmanuals from co-defendant Travelers Indemnity Company in a bad faith case involving a product liability claim. In Nationwide Mutual Insurance Company v. LaFarge Corporation, the insured served a broad document request for manuals, documents, instructions andtraining materials relating to the investigation or evaluation of claims under Travelers policies.(3) Travelers objected on the basis the request was overly burden some and called for production of attorney-client communications and attorney work product. After the insured narrowed the request to guidelines for products liability claims, the court ordered Travelers to produce those manuals, which Travelers conceded were relevant.
The U.S. District Court for the Eastern District of Pennsylvania took a contrary position in Garvey v. National Grange Mutual Insurance Company and held claim manuals were notprobative of bad faith.(4) The plaintiff requested National Grange produce documents in its underwriting file, claim file, and all manuals pertaining to underwriting and claim handling procedures. National Grange moved for a protective order on the grounds the materials were irrelevant and constituted trade secrets.(5) The court agreed and found the manuals did not pertain to whether the insured had suffered a covered loss, or even whether the insurer had committed bad faith.
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, thefact that the defendant may have strayed from its internal procedures does not establish bad faith on the part of thedefendant in handling the plaintiff’s loss.(6)
The Garvey court observed that the insured could obtain relevant discovery by deposing the employees of National Grange involved in handling the claim.
The latest case on this issue comes from the California Court of Appeal. In Glenfed Development Corporation v. Superior Court, the court ordered production of National Union’s claim manuals even though improper claim handling was not the basis for thealleged bad faith.(7) After exhausting its primary insurance coverage, Glenfed tendered defense of certain third party claims to its excess carriers, including National Union. The claims were denied. Glenfed contended it had purchased broad form coverage and sued National Union for reformation, declaratory relief and bad faith.
Glenfed served a document request seeking production of National Union’s claim manual. National Union did not move for a protective order or assert the manuals were proprietary trade secrets. Instead, National Union argued since Glenfed did not allege improper claimhandling, extrinsic evidence concerning the policy interpretation would be inadmissible attrial. Therefore, the claim manual ought not be discoverable.
The Court of Appeal disagreed. “The claims manual may show how National Union understood and intended to apply the standard language used in its CGL policies, or may disclose the identity of persons involved in the claims handling process.”(8) Moreover, National Union had waived the trade secret objection and no other privileges wereasserted.
The California Supreme Court opened the door to the discovery of other claim files in Colonial Life & Accident Co. v. Superior Court.(9) There, the insured sought the names ofother insureds whose claims were assigned to a particular adjuster to look for a pattern in the way the claims were handled. Colonial Life objected on grounds of relevance, overbreadth and the privacy rights of other insureds. It asserted also that disclosure of the identity of other insureds would promote litigation and create an available “pool” of potential plaintiffs.
The court disagreed. Privacy concerns of other insureds would be protected if they gave consent to disclosure. The court fashioned an order that names of other insureds could notbe disclosed except for purposes of the case at bar. The court opined the discovery could be relevant to the insurer’s intent, for purposes of punitive damages and California Insurance Code Section 790.03(h), which prohibits insurers from committing or performing “with such frequency as to indicate a general business practice” various unfair claim settlement practices.(10)
More recently, the New Jersey Superior Court denied production of other claim files in abad faith lawsuit over an insurer’s alleged failure to investigate environmental claims. In Raclaur v. Allianz Insurance Company, the insured operated a manufacturing plant in Nutley, New Jersey, and was ordered by the State Department of Environmental Protectionto remediate the site.(11) The insured sought discovery of claims by “similarly situated policyholders” to see if its claim had been treated differently. The insurer opposed the request contending other claims could involve other types of environmental sites; for example landfills and not manufacturing sites. Furthermore, other claims arose in differentareas of the country and were governed by different types of environmental regulations.Therefore, the insurer argued, this discovery would not lead to evidence admissible attrial.(12) The court permitted discovery of reserves, claim manuals, and advertising andpromotional documents, but prohibited discovery of other claim files.
Conversely, a similar discovery request in an environmental coverage action was permitted by an Indiana court earlier this year.(13) Northern Indiana Public Service Company v. Certain London Market Insurers involved manufactured gas plant sites. The court ordered production of information of gas plant claims by other insureds. The order required production of the ten earliest and ten most recent claims presented. Interestingly, the court also permitted plaintiff to discover documents regarding the insurer’s claim handling procedures, regardless of whether they were used in processing the insured’s claims. The court allowed discovery of drafting history documents, reserves, reinsurance, and priortestimony concerning policy terms and conditions in dispute as well.
Often insureds will want to discover past determinations that an insurer engaged in unfair settlement practices or violated a duty of good faith and fair dealing. In one such instance, Nationwide Mutual Insurance Company v. LaFarge Corporation,(14) the insured requestedpast “findings” of bad faith by the insurer, Travelers. The U.S. District Court for the Districtof Maryland found the probative value of the discovery would be substantially outweighed by the prejudicial effect and considerations of undue delay per Rule 403 of the Federal Rules of Evidence. The court found the discovery request was extremely overbroad and “details concerning each and every one of these other cases would have to be developedat the trial.”(15)
The court suggested the discovery request might be permissible if limited to cases involving policies and facts similar to those in the subject claim. However, the court worried the result would be a “satellite trial” of each case within the case at bar. The court ruled also that company witnesses could not be required to answer deposition questions about prior findings of unfair settlement practices or adverse verdicts.(16)
Policyholders sometimes seek discovery of reserve information. The purpose is to learn the insurer’s opinion of the value of a claim, and see if its conduct was consistent with that opinion. For example, if an insurer sets a high reserve, and then denies the claim, or offers a substantially lower settlement, plaintiffs might contend this could be evidence of bad faith. But, if the reserve is low on a claim where liability is certain and the insured has suffered substantial damages, this also could support an argument of bad faith refusal to offer a reasonable settlement.
Most states require insurers to set reserves when a claim is presented. The purpose is to meet potential liability and to provide for liquidation of possible future obligations.(17) Because reserves are made at the outset of the claim, prior to a complete investigation orcomputation of the loss, they may be very different from the amount which ultimately isowed. States and companies have a variety of standards for figuring reserves.
Given the regulatory framework and the contingent nature of the calculation, courts have considered reserves not to be an admission either of coverage or the value of a particular claim.(18) Moreover, insurers have objected that reserves constitute proprietary and commercially sensitive information. Despite an insured’s argument that reserves may showa carrier believed a loss was covered, discovery of reserves usually was not allowed. (19)
However, in 1996 the California Court of Appeal approved discovery of reserves in a badfaith case. Lipton v. Superior Court was an action by an attorney against his professionalliability insurer.(20) He moved to compel production of the reserves established in amalpractice action against him. The insurer objected only on the ground that reserve information was irrelevant. After an in camera review, a discovery referee agreed anddenied production of the reserve information. On review, the Court of Appeal reversed.
Loss reserve information cannot be deemed, a priori irrelevant. Such information may well lead to the discovery of evidence admissible on the issues raised by Lipton in his bad faith action against [Lawyers Mutual].(21)
The particular facts of Lipton may have compelled this result. Because of the way Lipton’s policy was structured, it was an important fact in the case whether multiple claims had been made, and whether they had been made in more than one policy period. The result of that determination meant the difference between policy limits of $250,000.00 or $1,500,000.00. Thus, the reserves may have been relevant to that particular factual determination. If theinsurer had set reserves above $250,000.00, it could well have been an admission. This may be distinguished from the many other cases where discovery of reserves was notallowed. In those cases, the alleged relevance was the insurer’s admission of ultimate liability or damages.
Even so, the court in Lipton opined that reserve evidence may be relevant in any bad faith action depending upon the issues.
For example, in a case where the insurer has denied coverageand refused a defense, the fact that a reserve had been set by the insurer might well be relevant to show the insurer must have had some knowledge that a potential for coverage existed.(22)
In addition, the court speculated that reserve information may be relevant to whether aninsurer had conducted a proper investigation or given reasonable consideration to “all of the factors involved in a specific case which might expose its insured to an excess verdict.”(23) But, the court in Lipton did not offer an opinion whether reserves would beadmissible at trial. That issue remains unresolved.
A reinsurance contract is a separate and independent agreement from the original policy between insured and insurer. Because there is no privity of contract between a reinsurerand an insured, a cause of action for bad faith by the insured typically does not lie againsta reinsurer. Therefore, discovery of reinsurance information historically was notpermitted.(24)
In recent decisions, courts have agreed that communications with reinsurers may reflectthe insurer’s position on the underlying claim. They may contain admissions regarding coverage.(25) Insureds also assert that reinsurance information is relevant to clarifyambiguities in the original policy based on “the premise that the reinsurance agreementmirrors the original policy.”(26)
In 1991, the California Court of Appeal first suggested reinsurance information may berelevant in a bad faith action against an insurer in Fireman’s Fund Insurance Company v.Superior Court.(27) That case arose from a third-party claim against the insured,PaineWebber. The insurer, Fireman’s Fund, was asked to produce all documents relatedto any insurance agreement covering the Paine Webber Webber policy, and all documentsrelated to reinsurance of the particular third-party claim against PaineWebber.(28) Paine Webber justified this request because Fireman’s Fund’s former director ofreinsurance claims had testified that on occasion reinsurers communicated with Fireman’s Fund to try and influence the settlement of a claim.
The trial court had ordered production of all reinsurance information. It had done so without an in camera inspection. The California Court of Appeal reversed. However, the rationale was not non-discoverability of reinsurance. Indeed, the court observed that reinsurance “may be relevant to the bad faith cause of action.”(29) The error below had been denial of an in camera inspection.
In 1996, relying on the decision in Fireman’s Fund v. Superior Court, the plaintiff in the Lipton case (discussed above) also requested production of reinsurance documents. The Lipton court stated correspondence between the insurer and reinsurer “which discussesliability, exposure, the likelihood of a verdict in excess of policy limits or coverage issuesmay well be relevant in discovery for the same reasons reserve information may be discoverable”.(30) Yet, the court emphasized that a preliminary in camera review is proper to evaluate privilege and trade secret objections.
The same year, in a bad faith action involving an insurer’s alleged failure to investigate environmental claims asserted against an insured, a New Jersey court followed suit andordered wide production in Raclaur v. Allianz Insurance Company.(31) This included correspondence about reinsurance. The insured had argued correspondence with reinsurers could establish the existence of the terms of lost policies. It might also contain admissions to support the bad faith claim.
Drafting history can be another device to “get inside” the claims process and evaluate if an insurer acted reasonably and consistently with the intent of the policy provisions. There is a large body of law which holds drafting history is discoverable in coverage litigation basedon claims of ambiguity in policy provisions. For example, in environmental coverage litigation there are decisions approving discovery of drafting history to interpret the intent behind certain commercial general liability policy provisions. However, the courts are spilt on whether drafting history is discoverable in bad faith actions.
The U.S. District Court for the Eastern District of Pennsylvania found that drafting history documents were irrelevant to the issue of coverage in a bad faith duty to defend case. In Britamco Underwriters, Inc. v. B&D Milmont Inn, Inc., the insured, a tavern owner, was sued by a patron who asserted he was the victim of an assault and battery on the premises. The insured sought discovery of the drafting history of the assault and battery exclusion. The court stated “[the documents] contain sensitive information of a proprietary nature” and should not be produced given the pendency of a dispositive coverage motion. (32)
The following year the same court also forbade admissibility (on summary judgment) of drafting history documents in a bad faith case. Hyde Athletic Industries Inc. v. Continental Casualty Company was based on the insurers’ allegedly inconsistent interpretation of apollution exclusion.(33) The insureds contended the insurers intentionally “misled state regulators and the public about the scope of the pollution exclusion.”(34) The court addressed whether the drafting history and the regulatory history of the pollution exclusion could be used to support this claim.(35) It noted other jurisdictions had rejected the regulatory and drafting history of the pollution exclusion in cases of alleged fraud by the insurance industry.(36) Thus, the court refused to consider drafting history.
Indeed, the Hyde Athletic Industries court ordered entry of a summary judgment in favor of the insurers. It noted historically insureds have not presented sufficient evidence to support the elements of such a claim in a bad faith coverage action. Because the insureds in the case at bar also had not made a sufficient showing, the court granted summary judgment on the regulatory history-based claims of bad faith.(37)
The California Court of Appeal suggested a contrary position in Glenfed v. Superior Court.(38) The case is significant for its approval of discovery of claim manuals in bad faith actions,as discussed above. However, in dicta, the court opined that drafting history documents “are analytically indistinguishable from the claims manual and are clearly discoverable.”(39)
As bad faith litigation has spread, so has the practice of sharing information by the plaintiffs’ bar. Discovery battles become fierce as insurers try to limit production of confidential and proprietary information. However, the judicial trend appears to allow an increasingly broadscope of discovery in bad faith cases.
Endnotes: