This is one of a series of articles originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 23, #8, page 30 (August 27, 2009). © 2009
[Editor’s Note: Julius F. “Rick” Parker III is a senior associate with the law firm of Butler Weihmuller Katz Craig LLP with offices in Tampa, Tallahassee, Miami, Mobile, and Charlotte. He is an experienced trial lawyer in the firm’s Third-Party Coverage and Extra-Contractual Departments. This commentary, other than the quoted material, is the author’s opinion; not his law firm’s, and not Mealey’s Publications’. Copyright © 2009 by the author. Responses are welcome.]
“He behaved like an ostrich and put his head in the sand,
thereby exposing his thinking parts.”1
On August 5, 2009, the South Dakota supreme court joined an exceedingly small minority of courts in the United States that have imposed a duty to conduct a reasonable investigation into first-party claims in order to avoid “bad-faith” liability.2 As they say, the road to Hell is paved with good intentions. This decision certainly affirms the truth of that old saw.
In Dakota, Minnesota & Eastern Railroad Corporation v. Acuity,3 the court considered an appeal from the trial court’s grant of summary judgment in favor of Acuity, a mutual insurance company, finding that it had not committed bad faith in the adjustment of an uninsured/underinsured motorist claim. Finding that material fact issues existed, the court reversed and remanded for a trial of the factual issues.
At first glance, that disposition seems innocuous enough – issues of fact exist; therefore, let the jury decide. However, upon close examination, it becomes clear that, rather than simply narrowing the scope of the “fairly debatable” doctrine, the court added an unnecessary and wasteful layer of complexity to an area of the law that needs simplification.
The insured, Dakota, Minnesota & Eastern Railroad Corporation (“DM & E”), owned a commercial automobile liability policy, which contained coverage for damages caused by accidents involving uninsured/underinsured motorists (“UIM”). Oddly, the policy apparently included as insureds the corporation’s employees.4 One of the corporation’s employees, Julian Olson, was entering an Interstate highway, driving a company-owned truck equipped to travel on railroad tracks,5 when he encountered an unusually slow moving vehicle, which he attempted to pass. After changing lanes, he found himself too far left, he over-corrected, lost control of the vehicle, and crashed into a ditch on the right side of the highway. He never came into contact with another vehicle. As a result of the accident, Olson was rendered a paraplegic.6
Olson initially sued DM & E under the Federal Employers Liability Act7 based upon negligent maintenance of the truck. Following that action, Olson brought a successful UIM claim against Acuity, which was affirmed on appeal.8 On remand, he asserted a bad faith claim, based upon Acuity’s failure to conduct a proper investigation of the claim.
Critical to an understanding of the UIM claim is a special provision in the policy, which stated:
If the hit-and-run vehicle does not hit an insured, a covered auto, or a vehicle an insured is occupying, the facts of the accident must be corroborated by competent evidence provided by an independent and disinterested person and not by the insured or any person occupying the same vehicle as the insured.9
Obviously, this provision was intended to prohibit the insured from fabricating an accident involving a “phantom vehicle” in order to recover UIM benefits. Therefore, the existence of corroborating third-party witnesses was critical to recovering UIM benefits.
Following the accident, and during the defense of the FELA claim, Acuity retained outside counsel to provide a coverage opinion10 regarding the existence of UIM coverage. The court summed up outside counsel’s opinion thus:
[Counsel’s] letter asserted that the policy afforded no coverage for the UM claim because “[n]o evidence has been provided by an independent witness … to corroborate the facts of the accident as [Olson] has related them.” … The letter cited the accident report of a state trooper, which noted the existence of knowledgeable witnesses. [Counsel’s] letter stated that none of the individuals with knowledge had “come forward with information that would verify [Olson’s] story.” [Counsel] also noted the narrative from the accident report which stated: (1) Olson began passing a slower moving vehicle; (2) Olson then drifted left, and overcorrected back to the right and then crossed both lanes of traffic, entered the ditch and rolled.11
The court then noted that DM & E obtained recorded statements from the three independent witnesses shortly after the accident, all of whom corroborated Olson’s account of the accident. According to the record, Acuity did not interview Olson, or any of the three witnesses listed in the accident report. Neither did it make “any attempt to gather facts to assess the fault of Olson, the unidentified driver, or any other party.”12 Ultimately, the court concluded that Acuity had in essence sub-contracted the adjustment of the UIM claim to its outside counsel.13
From these facts, the court was faced squarely with the question of whether Acuity’s “sub-standard” investigation could form the basis of a “bad-faith” claim. The court began its analysis by restating the “fairly debatable” standard as it applied in South Dakota:
[F]or proof of bad faith, there must be an absence of a reasonable basis for denial of policy benefits [or failure to comply with a duty under the insurance contract] and the knowledge or reckless disregard [of the lack] of a reasonable basis for denial, implicit [sic] in that test is our conclusion that the knowledge of the lack of a reasonable basis may be inferred and imputed to an insurance company where there is a reckless disregard of a lack of reasonable basis for denial or a reckless indifference to facts or to proofs submitted by the insured.
Under these tests of the tort of bad faith, an insurance company, however, may challenge claims which are fairly debatable and will be found liable only where it has intentionally denied (or failed to process or pay) a claim without a reasonable basis.
So far, so good. The court acknowledged that, under South Dakota law, first-party bad faith is an intentional tort. Moreover, for the insurer to escape liability, it only must show that, based upon the information available to it at the time, its decision to deny the claim was “fairly debatable.” From this point, the court took clear precedent and, not only dispensed with the intent requirement, but turned what is otherwise a clear question of law into a question of fact.
The court considered decisions from other states that have imposed the requirement of a reasonable investigation into the standard for judging first-party bad faith.14 It then concluded its analysis with the following:
Jury questions remain concerning whether Acuity’s investigation and denial of the UM claim was unreasonable, and whether it knew or recklessly disregarded the lack of a reasonable basis for denial under the policy. Fact questions also exist as to whether the claim was fairly debatable. Because Acuity has failed to show the absence of genuine issues of material fact, the circuit court’s entry of summary judgment on the bad faith and vexatious failure to pay claims is reversed and the matter is remanded for further proceedings.15
The court based its decision to “punt” the issue back to the trial court on the supposed lack of a fully developed factual record. However, in doing so, it utterly ignored the prior precedent, which it previously quoted.
The record was abundantly clear. It demonstrated that the insured obtained statements from three separate disinterested witnesses, all of whom corroborated Olson’s contention that the phantom vehicle caused the accident. Therefore, those facts were both known and knowable. Under the court’s cited precedent, such facts “may be inferred and imputed to an insurance company where there is a lack of reasonable basis for denial….”16 Why then did the court not simply impute knowledge of these facts to Acuity, and decide as a matter of law that the basis for its denial was not “fairly debatable?” After all, it is abundantly clear from the opinion that the court did not find Acuity’s position to be fairly debatable. Why then require a jury to decide facts which were already established?
The concept of imputed knowledge is one that was created to prohibit those who turn a blind eye to facts that are readily ascertainable from claiming lack of knowledge as a defense. “A person cannot avoid being charged with constructive knowledge, as in this case, by hiding her head in the sand like an ostrich, and proclaim lack of actual knowledge.”17 In this case, however, the court, while acknowledging that its precedent required imputation of such knowledge to the insurer, nevertheless sidestepped that remedy, choosing instead to create a jury question. Certainly, the court’s intentions were good – prohibit an insurer from conducting no investigation, or a deliberately superficial one, in order to avoid knowledge of facts creating coverage – but the method it chose to remedy that problem was not only contrary to precedent, but created a needless layer of complication to first-party bad faith claims.
Would it not have been much simpler for the court simply to apply its precedent and impute knowledge of the existence of the three corroborating witnesses to Acuity? Once Acuity was charged with knowledge of those facts which it allegedly avoided knowing, the court’s inquiry became simple: was Acuity’s denial “fairly debatable” in light of the existence of corroborating witnesses? The answer to that question under those facts was, “No,” and the court could have exercised its power so to hold, rather than turning a clear legal question into one of fact for a jury. After all, the insured was appealing from an order granting summary judgment; thus, exercising de novo review, the court could easily have held that Acuity’s denial was not fairly debatable as a matter of law.18
The court’s disposition raises more questions than it answers. For example, on remand, how is the trial court now to instruct the jury on the fairly debatable standard? Will the jury be asked to decide whether Acuity intentionally denied coverage? Or will it be asked to decide whether Acuity recklessly disregarded facts available to it? Perhaps the jury will consider only whether Acuity conducted a “reasonable” investigation before denying the claim. Unfortunately, the court’s decision offers no guidance in this regard.
Following the decision, will it ever be possible for either party to obtain summary judgment in a first-party bad faith case? On remand, the trial court could attempt to grant summary judgment in favor of the insured, relying on the court’s statement that Acuity must be charged with constructive knowledge of facts it chose to ignore. But does the mere imputation of knowledge resolve the intent inquiry? Probably not. The question of intent was always a jury question, and will remain so following the Acuity decision.
It is that aspect of the decision which is the most troublesome. In an effort to penalize Acuity, the court took a relatively simple inquiry – was the insurer’s position fairly debatable? – and turned it into a fact question. Given that unnecessary extension of precedent, is there any chance that an insurer in South Dakota will ever be able to defend a first-party bad faith claim by dispositive motion? The Acuity decision suggests that it will be a rarer case which is decided as a matter of law.
Courts which have rejected the invitation to require a “reasonable investigation” as part of the fairly debatable inquiry have rightly noted that such an inquiry is a waste of judicial resources. For example, the court of appeals of Nebraska recently explained:
If a lawful basis for denial actually exists, the insurer, as a matter of law, cannot be held liable in an action based on the tort of bad faith…. It must be determined whether, at the time of each denial, the insurer had an arguable basis on which to deny the claim, and if the insurer had such a basis, the insured’s bad faith cause of action fails as a matter of law regardless of the manner in which an investigation was or was not conducted…. Whether a claim is fairly debatable is appropriately decided by the court as a matter of law, and such a determination is based on the information available to the insurance company at the time the demand is presented.19
The Nebraska court recognized the fallacy of adding a layer of fact-finding to the fairly debatable analysis. All a court need do is look at the information available to the insurer at the time of the denial, and resolve whether it had a legitimate basis to deny the claim.
In the Acuity case, that inquiry would have been simple. The only fact that needed to be considered is the fact that three independent witnesses corroborated the insured’s account of a phantom vehicle causing the accident, which was, by South Dakota law, imputed to the insurer. That being the case, the only basis for denial of the claim did not exist.
The Acuity decision illustrates the general trend in the law, and in particular, the law of bad faith, away from simplicity and toward complexity. The case could have been decided under existing law without adding an additional layer of analysis. Unfortunately, however, in attempting to ensure that insurers adequately investigate claims, the South Dakota supreme court took an unnecessary detour and added a needless layer of complication to an area of the law that needs simplification.
The other lesson from the Acuity decision is that insurers cannot simply delegate the investigation of a first-party claim to outside counsel as a failsafe insulation from bad faith liability. While it seems backward to require the insurer to attempt to discover facts which would create coverage (a burden that in any other context would properly belong to the other party to the contract), some courts will continue to impose this requirement on insurers in one form or another. Even in jurisdictions which adhere to the majority “fairly debatable” doctrine, an insurer who puts its head in the sand to avoid discovering facts adverse to coverage will be charged with knowledge of those facts nonetheless. Therefore, the “head-in-the-sand” approach is ill-advised in any jurisdiction.