This is one of a series of articles originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 22, #20 (February 26, 2009).
[Editor’s Note: John C.S. Pierce is a Partner in the Mobile Office of Butler Weihmuller Katz Craig LLP with offices in Charlotte, Miami, Mobile, Tallahassee, and Tampa. He is an experienced trial and appellate lawyer in the firm’s Third-Party Liability, Employment, and Product Liability Departments. Michael Montgomery is a Senior Associate in the Mobile Office. He is active in the firm’s General Liability, Construction Defect, and Property/Casualty Departments. The commentary, other than the quoted material, are the authors’ opinions – not the opinions of Butler Weihmuller Katz Craig LLP nor Mealey’s Publications. Copyright © 2009 by the authors. Responses are welcome.]
Alabama has a reputation for being a “hotbed” of insurance litigation, although recent commentary suggests this may be changing.1 Principal among insurer’s fears is Alabama’s recognition of the tort of bad faith failure to pay a claim. The tort allows a policyholder to sue for bad faith where a plaintiff can demonstrate that coverage under a particular policy was owed and no “arguable” basis existed for the insurer’s denial of a claim.2
For the most part, bad faith in Alabama arises from the plaintiff’s contention that the insurer wrongfully denied a particular claim based on a wrongful intent to deny the plaintiff his or her rights under a policy of insurance. Occasionally, however, the insured proceeds under a theory of what is known as “abnormal” bad faith. This article addresses the differences between “normal” and “abnormal” bad faith in Alabama, along with some of the pitfalls that lead to a finding of “abnormal” bad faith, and comments on how to avoid them. In doing so, we also look at the issue of whether the Courts in Alabama are favoring the theory of “abnormal” bad faith as a viable claim over the traditional, “normal” bad faith action.
The tort of bad faith is certainly not novel to the state of Alabama. Most jurisdictions recognize bad faith in some form, be it the tort itself, contractual principles, or statutory damages.3 Bad faith claims generally arise against insurers and flow, typically, from an insurer’s actions or inactions.4 An action for bad faith generally involves a breach of an insurance contract by denying or failing to adequately investigate a claim, sometimes upon a showing of malice, or with an intentional or reckless disregard, depending upon the jurisdiction.5
Alabama first adopted its version of bad faith nearly 30 years ago in Chavers v. Nat’l Security Fire & Cas. Co., 405 So. 2d 1 (Ala. 1981).6 Subsequent decisions by the Supreme Court of Alabama over the next few years refined the elements of the tort into what is generally accepted today.7 In order to prove a claim for bad faith in Alabama, plaintiffs must prove the following:
“(a) an insurance contract between the parties and a breach thereof by the defendant;
(b) An intentional refusal to pay the insured’s claim;
(c) the absence of any reasonably legitimate or arguable reason for that refusal (the absence of a debatable reason);
(d) the insurer’s actual knowledge of the absence of any legitimate or arguable reason;
(e) if the intentional failure to determine the existence of a lawful basis is relied upon, the plaintiff must prove the insurer’s intentional failure to determine whether there is a legitimate or arguable reason to refuse to pay the claim.
In short, plaintiff must go beyond a mere showing of nonpayment and prove a bad faith nonpayment, a nonpayment without any reasonable ground for dispute. Or, stated differently, the plaintiff must show that the insurance company had no legal or factual defense to the insurance claim.”8
The recognition of the tort of bad faith nearly 30 years ago was soon clarified to include what is now known as the “directed verdict on the contract standard.” As former Justice Janie Shores stated:
As noted by both sides . . ., the tort of bad faith refusal to pay a valid insurance claim is in the embryonic stage, and the Court has not had occasion to address every issue that might arise in these cases. In [National Security Fire & Cas. Co. v. Bowen], we set out the elements of the tort and attempted to show the plaintiff’s burden in these cases. It is a heavy burden. In the normal case in order for a plaintiff to make out a prima facie case of bad faith refusal to pay an insurance claim, the proof offered must show that the plaintiff is entitled to a directed verdict on the contract claim as a matter of law. Ordinarily, if the evidence produced by either side creates a fact issue with regard to the validity of the claim and, thus, the legitimacy of the denial thereof, the tort claim must fail and should not be submitted to the jury.9
Over the years following the first opinions that defined the tort of bad faith, the Court increasingly found situations that it deemed “unusual or extraordinary cases” that did not fall under the “directed verdict” standard. Examples included cases where the insurer “intentionally or recklessly failed to properly investigate the claim or to subject the results of the investigation to a cognitive evaluation and review;”10 cases where in the insurer “created” a factual issue that could have defeated the insured’s tort claim under the “directed verdict” standard;11 and cases where the insurer relied upon subjective interpretations of an ambiguous portion of the policy.12
Eventually, these “exceptions” to the “directed verdict” standard became what is known today as the “abnormal bad faith” case. The “directed-verdict-on-the-contract” claim was called the “normal” bad faith case. Thus, in order to prove bad faith, a plaintiff had to prove his or her claim in either the normal case or the abnormal case. Abnormal cases, however, have generally been limited to four instances:
Nearly 10 years ago, the Supreme Court of Alabama clarified the abnormal bad faith claim in an opinion that has become the seminal decision for abnormal bad faith. In State Farm Fire and Casualty Co. v. Slade, the Court reiterated that “normal” bad faith requires a showing that the plaintiff is entitled to a directed verdict on the breach of contract claim before it can recover for bad faith.14 In the abnormal situation, however, this requirement is not necessary, especially where the situation involves an allegation that the insurer failed to properly investigate the plaintiff’s claims. As noted in Slade:
. . . State Farm argues that it was entitled to a preverdict JML on the Slades’ third theory, i.e., that State Farm denied their claim in bad faith because it did not conduct a proper investigation into the possibility that lightning struck the slab of the Slades’ home. State Farm contends that (the expert’s) testimony did nothing more than create a fact question with regard to the Slade’s contract claim and was therefore insufficient to satisfy the preverdict JML standard for normal bad-faith cases. . . . As stated above, we have concluded that the Slades produced substantial evidence indicating that State Farm did not properly investigate their claim. Therefore, State Farm was not entitled to a preverdict JML on the third aspect of the Slades’ bad-faith claim.15
Since the Court clarified the tort of bad faith in the Slade decision nearly 10 years ago, it has had the opportunity to address the “abnormal” bad faith claim in several decisions. While courts have seen a decline in bad faith cases in Alabama in the last 10-15 years, the abnormal case has maintained a presence. This is especially true where the allegations stem from large loss situations, such as storms or hurricanes that, through the sheer size and scope of the loss, insurers must investigate multiple claims in a short amount of time. This type of major event increases the risk that a particular claim investigation was not handled as thoroughly as it should have been, which, and increases the risk of litigation on many of those occasions.
While reported decisions that deal with the abnormal bad faith claim have not been prolific, the opinions that do address this theory demonstrate that the tort is gaining a foothold, typically arising out of insurer’s failure to adequately investigate a claim.
One of the first post-Slade decisions addressed whether an insurer who denies a claim initially can be held liable for bad faith failure to conduct an adequate investigation during an appeal. In Ex Parte Simmons, the Court held that a proper denial could nevertheless support a bad faith cause of action where the insurer failed to adequately investigate material produced during the claim decision appeal.16 Reversing the Court of Civil Appeals, which found no bad faith, the Court stated:
The Court of Civil Appeals has frozen the bad-faith inquiry at the moment of denial . . . . In (previous decisions) this Court held that postdenial efforts to develop facts that would support a good-faith denial of the claim could not be used to overcome an initial denial made in bad faith . . . . It would stand the logic of (our prior decisions) on its head to say that an insurer acting initially in good faith when denying a claim is thereafter exempt from liability for acting in bad faith if, notwithstanding information subsequently received on reconsideration, it declines in bad faith to alter its position.17
Thus, for the first time, the Supreme Court of Alabama interjected a theory of abnormal bad faith where at least part of the decision-making process had been undertaken in good faith.
Abnormal bad faith was also found to exist where an insurance adjuster failed to appreciate the law of Alabama and its impact on a given claim. In Nat’l Ins. Assoc. v. Sockwell, the Supreme Court of Alabama upheld a jury verdict in excess of $800,000 against an insurer for bad faith in the investigation and delay of payment of a claim for underinsured motorist benefits.18 The Court cited ample evidence against the insurer that supported the jury’s verdict. Most notably, the Court found that the date of the denial was very much in dispute, as the actual decision to deny was made several months before the denial letter was issued. Moreover, the denial had been premised on a policy exclusion that had been rendered void by Alabama law, and even were it valid, the Court found evidence that it had been applied wrongfully.19
A different conclusion was reached a few years later in United Services Automobile Assoc. v. Hobbs.20 In that case, the Court of Civil Appeals examined a claim for property damage that occurred during the insured’s move of his residence to an overseas location. Despite the fact that the Court upheld the jury’s verdict that found the insurer breached its contract of insurance, the bad faith claims were found to be invalid as a matter of law.21 The decision turned on the fact that the insurer undertook an extensive investigation of the claims by taking multiple statements of the insured and other witnesses, making repeated requests for information related to the value of the insured’s claims, and submitted the decision to deny to several evaluators, including the insurer’s legal department. Thus, there was no abnormal bad faith.22
Two more recent decisions by the Supreme Court of Alabama reached different conclusions under similar circumstances. In Singleton v. State Farm Fire & Cas. Co., the Court held there was no claim for abnormal bad faith.23 The insurer refused to pay for damage caused by a windstorm to the insured’s roof. However the Court held that the investigation of the claim was adequate and even noted that, unlike the Simmons decision discussed above, the insurer took steps to investigate the loss post-denial when the insured presented new evidence that it claimed warranted coverage for the wind damage.24 However, in White v. State Farm Fire & Cas. Co., the Court held that the insurer could be held liable for bad faith where it failed to thoroughly investigate whether the roof it authorized was “of like kind and quality.”25
Finally, the most recent decision concerning abnormal bad faith in Alabama dealt with the issue of whether abnormal bad faith could exist where the normal bad faith claim was lacking as a matter of law. In Jones v. Alfa Mut. Ins. Co., the Court answered this question in the affirmative.26 In fact, the Court expressly found that engineer reports generated at the direction of the insurer in regard to a storm damage claim were sufficient to create a question of fact on the issue of whether the insurer breached its contract of insurance. However, the Court also held that the engineers in question, along with the adjusters who investigated the loss, failed to “marshal all facts” necessary to determine whether coverage existed. Therefore, a claim for abnormal bad faith could be found even though there was a question as to whether the contract had even been breached.27
As the Jones decision implies, it appears that abnormal bad faith is essentially a stand-alone tort that can be viable even where the insurer shows a question of fact exists on a claim for breach of contract. It is highly likely that an insurer that writes property coverage in Alabama will eventually deal with the threat of an abnormal bad faith claim. Attorneys representing insurers are likely eager to assert abnormal bad faith claims because, as the decisions above demonstrate, the abnormal bad faith claim has a less stringent threshold to maintain viability of the claim. Plaintiffs proceeding under the normal bad faith claim must be able to prove that they are entitled to a directed verdict on the question of whether the insured breached the contract in order to go forward with their claims. Such is not the case in the abnormal setting. Thus, there is a distinct advantage to asserting the abnormal claim of bad faith.
Of course, by the time litigation ensues, the time for determining whether bad faith has occurred has typically long since passed. Therefore, the insurer should be mindful of some of the pitfalls that may exist that can lead to an allegation of bad faith.
As noted earlier, many of the viable claims for abnormal bad faith arise from situations where a storm or hurricane causes damage (and hence multiple claims) to a wide area.28 In these situations, the insurer must balance the need for quick and efficient claims handling with the sometimes contentious issues of whether the damage claimed was caused by a covered loss. As the Jones decision notes, even in a situation where an arguable basis for denial exists, the insurer can still be potentially liable for abnormal bad faith if it fails to “marshal all facts” necessary to make a reasonable claim determination.29
Although the Courts in Alabama have failed to define what exactly the standard is for “marshaling all facts” it appears that the bar has been set high so that an insurer must investigate virtually every possible lead in making its ultimate coverage determination. Thus, a wise insurer will investigate every reasonable or potential cause of loss in order to determine if the claim is ultimately covered.
In addition, the insurer must submit claims to a “cognitive review process.” Under the case law that has addressed this issue so far, this means more than merely getting approval from a supervisor.30 The prudent insurer will submit contentious claims to multiple levels of review, documenting each along the way, and addressing any dissenting or contrary opinions with further investigation. In addition, Alabama Courts have found that involvement of either the insured’s legal department or retention of outside counsel to address any ambiguities or questions of law will meet the requirement of a cognitive review.31
Insurers should also be aware of the potential risk of relying upon an ambiguous portion of the policy in its decision to deny a claim. Sole reliance on the subjective interpretation of an ambiguous policy provision has been upheld as the basis for an abnormal bad faith claim.32 Therefore, the insurer should include all pertinent policy provisions that support its denial. Also, the insurer could benefit from obtaining a supporting legal opinion on how a particular policy provision is interpreted under Alabama law.
Finally, if an insurer makes available an avenue by which an insured can appeal the denial of a claim, the appeal process must be both independent and subject to the same level of review as the initial claim. Alabama Courts have found that the failure to consider new facts can be actionable bad faith, even where the initial denial was made in good faith.33 Any new evidence must therefore be investigated with the same degree of thoroughness as the information brought to light during the initial claims process.
Although the standard for abnormal bad faith appears to be less stringent – and therefore easier to pursue – than a normal bad faith claim, plaintiffs must still prove that, ultimately, the insurer’s decision was wrong. Despite the fact that the directed verdict standard is not in play for abnormal bad faith, breach of the insurance contract is still an essential element. However, even under the seemingly more relaxed standards of abnormal bad faith, the insurer can protect itself by instituting a thorough claims handling process, submitting that process to a thorough evaluation, and ultimately demonstrating the good faith basis for the claim decision.