This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 14, #6 (July 25, 2000). © Copyright Butler 2000.
Before resolution of a first-party action for coverage or a third-party action to establish an insured’s liability, a plaintiff will often initiate an action for bad faith. By doing so, the plaintiff attempts to gain an unfair advantage in discovery and at trial. This article outlines some of the reasons why the bad faith action should be abated in its entirety or, at the very least, stayed pending resolution of the underlying claim.
To abate means to suspend or to put an end to an action. See Carver v. State, 398 S.W. 2d 719 (Tenn. 1966); Togo’s Eatery of Florida, Inc. v. Frohlich, 526 So. 2d 999 (Fla. 1st DCA 1988). BLACK’S LAW DICTIONARY defines abatement as “[t]he suspension or defeat of a pending action for a reason unrelated to the merits of the claim.” BLACK’S LAW DICTIONARY (7th ed. 1999).
Although the term “abatement” is sometimes used loosely as a substitute for “stay of proceedings,” the two may be distinguished on several grounds. For example, when grounds for abatement of an action exists, the abatement of the action is a matter of right, but a stay is granted in the court’s discretion. And in proper circumstances a court may stay a proceeding pending the outcome of another proceeding although a strict plea in abatement could not be sustained.
1 AM. JUR. 2d Abatement, Survival, Revival § 3 (1994).
Most courts (incorrectly) use the words interchangeably. For this paper, I will use the term “abate” in reference to a mandatory (albeit possibly temporary) extinguishment of the action; and the term “stay” as a discretionary postponement.
A. When Does the Bad Faith Action Accrue?
Some jurisdictions require dismissal or abatement of the bad faith action pending the resolution of the underlying coverage and/or liability issues. For example, the Florida Supreme Court has held that a bad faith claim is premature and does not accrue in a first-party action until there has been a final determination of liability and damages on the contract claim. See Vest v. Travelers Insurance Co., 753 So. 2d 1270 (Fla. 2000); see also Pulley v. Preferred Risk Mutual Insurance Co., 897 P.2d 1101 (Nev. 1995); Bartlett v. John Hancock Mutual Life Ins. Co., 538 A.2d 997 (R.I. 1988).
Where the issue is the insurer’s bad faith refusal to pay, abatement should be mandatory. For example, in Corrente v. Fitchburg Mut. Fire Ins. Co., 557 A.2d 859 (R.I. 1989), the Supreme Court of Rhode Island held:
In effect, we cited with approval the test adopted by the Supreme Court of Alabama in Dutton, that:
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 plaintiff is entitled to a directed verdict on the contract claim and, thus, entitled to recover on the contract claim as a matter of law.
Bartlett, 538 A.2d at 1002 (quoting National Savings Life Ins. Co. v. Dutton, 419 So. 2d 1357, 1362 (Ala. 1982)).
Since the burden of proof on a bad faith claim is so formidable, we are of the opinion that whether or not a discovery issue is involved, it is inherently prejudicial for a trial justice to decline to sever that claim from the breach-of-contract claim. In essence, unless the trial justice finds that the plaintiff is entitled to recover on the breach-of-contract claim as a matter of law, there is no question for the jury on the bad faith claim.
Corrente, 557 A.2d at 861-62; see also O’Malley v. USF&G Co., 776 F.2d 494 (5th Cir. 1985); Vest, supra.
B. Is This A First Or Third Party Claim?
In the context of first-party bad faith claims, the overwhelming majority of state and federal jurisdictions allow judicial discretion as to whether or not to bifurcate and stay the bad faith claim. Accord Light v. Allstate Ins. Co., 506 S.E.2d 64 (W. Va. 1998). On the other hand, some courts have mandated a stay in the context of third-party bad faith claims against the insurer where the underlying liability action against the insured is not complete. See, e.g., State ex rel. State Farm Fire & Cas. Co. v. Madden, 451 S.E.2d 721 (W. Va. 1994). In Light, the Supreme Court of Appeals of West Virginia recognized a distinction between first-party bad faith actions and third-party bad faith actions in applying mandatory abatement versus discretionary stay.
In a first-party bad faith action the insurer is actually the named defendant in both the underlying claim and the bad faith claim. Thus, the primary concern of disclosing the existence of insurance [to the prejudice of the insured] does not exist in a first-party bad faith action.
Light, 506 S.E.2d at 71. The Light court accordingly held that stay of a bad faith claim pending resolution of a first-party action against the insurer is not mandatory. By contrast, the Fourth Circuit Court of Appeals in Maher v. Continental Casualty Co., 76 F.3d 535 (4th Cir. 1996) extended Madden to first-party statutory bad faith claims. In Maher, the Court held that until the first-party action is resolved, a “stay” (i.e., abatement) is mandatory.
This writer suggests that the overwhelming problems inherent in permitting the bad faith action to proceed simultaneously with the liability or coverage case should direct the courts toward mandatory cessation of the bad faith action. The reasons predominate in both first and third party bad faith cases. However, as discussed further below, most courts view the issue as discretionary.
Evidentiary and procedural rules often give the trial judge discretion in deciding whether to bifurcate and stay the bad faith action. Federal Rule of Civil Procedure 42(b) and Federal Rule of Evidence 403 provide the vehicles by which most courts addressing the issue have determined that it is within their discretion to decide whether to bifurcate and stay the bad faith action. F.R.C.P. 42(b) provides:
The court, in furtherance of convenience or to avoid prejudice, or when separate trials will be conducive to expedition and economy, may order a separate trial of any claim, cross-claim, counterclaim, or third-party claim, or of any separate issue or of any number of claims, cross-claims, counterclaims, third-party claims, or issues, always preserving inviolate the right of trial by jury as declared by the Seventh Amendment to the Constitution or as given by a statute of the United States. (Emphasis added).
Fed. R. of Evid. 403 provides:
Although relevant, evidence may be excluded if its probative value is substantially outweighed by the danger of unfair prejudice, confusion of the issues, or misleading the jury, or by considerations of undue delay, waste of time, or needless presentation of cumulative evidence. (Emphasis added).
Each of these rules provide discretionary criteria for the trial judge to consider. Of course, many of the state evidentiary and procedural rules were modeled after the federal rules cited above and provide the same discretionary authority. In evaluating the insurer’s request to “stop” the bad faith action, the rules above are often applied. The balance of this paper endeavors to explain how the discretionary factors weigh heavily in favor of the insurer, requiring a stay of the bad faith action.
A. Prejudice in Discovery
(Disclosure of Litigation, Settlement and Trial Strategy)
One of the primary targets in discovery by a plaintiff in a bad faith action against the insurance company is the insurer’s claim file. An insurer’s claim file usually contains the insurance company’s evaluation of the applicable facts and law, of its exposure to liability, and of its litigation, settlement, and trial strategy. The claim file also typically contains confidential communications with legal counsel.
Plaintiffs will request the claim file to gain an unfair advantage in the underlying coverage or liability action. For a first-party action where the insurer has denied coverage, and the insured sues for breach of contract, disclosure of the claim file would prevent the insurer from defending its denial of coverage on equal footing with the insured. After all, the claim file is the insurer’s litigation work product. Once this is turned over, the insurer will be at a distinct strategic disadvantage in litigation over the coverage case. It is doubtful that the insured would be willing to turn over its own litigation file to level the playing field!
Of course, the insurer could refuse to waive its privileges, allowing the insurer to most effectively defend the coverage action. However, the insurer may want to open its claim file in the bad faith action. The claim file may very well contain documents that prove the insurer acted at all times in good faith. For example, what if the denial is based on the advice of counsel in a coverage opinion letter? By asserting the work product and attorney-client privileges, the insurer is unable to fully defend against the allegations of wrongdoing.
Similarly, in the third-party context, the claim file of the insurer is essentially the litigation file of the insured, prepared in anticipation of litigation initiated by a third-party claimant. If the insurer refuses to disclose this work product, it protects its own insured but may not be able to adequately defend itself in the bad faith action. On the other hand, if the insurer waives work product immunity and discloses its insured’s litigation file, then the insurer exposes itself to allegations of bad faith brought by its own insured for failing to act in the insured’s best interests.
The remedy to prevent discovery prejudice is stay, abatement or dismissal of the bad faith action. See e.g., Boyer-Gray v. Nationwide Mutual Insurance Co., Case No. 90C-01-143, 1991 Del. Super. LEXIS 471 (Del. Super. Ct. 1991); Maryland American General Ins. Co. v. Blackmon, 639 S.W. 2d 455 (Tex. 1982). Once the first-party or third-party action is litigated to conclusion, work product and attorney-client privileges may be waived by the insurer in defense of the extracontractual allegations of bad faith, without prejudice to itself in a coverage action (first-party case) or its insured in a liability action (third-party case).
B. Right to Counsel of Choice
(Legal Counsel as a Witness)
Legal counsel representing the insurer and/or the insured may be a material witness in the bad faith action. Indeed, the attorney may have given legal advice upon which the insurer acted, or may have been involved in communications with the claimant to which the allegations of bad faith are tied. If the bad faith action is allowed to proceed contemporaneously with the underlying coverage or liability action, then the coverage or liability counsel may be forced to withdraw and to testify on behalf of the insurer. Effectively, the plaintiff forces a conflict of interest to deny the insurer its right to have counsel of choice in the coverage action or to deny the insured of the chosen defense counsel in the liability action.
Once again, the solution is simple. Conclude the underlying coverage or liability action before proceeding with the bad faith case. That way, defense counsel may continue to represent the insurer or insured in the coverage or liability action to conclusion. New counsel could be hired thereafter to represent the insurer in the bad faith case.
C. Prejudice at Trial
(Inflammatory Remarks, Confusion of the Issues, Misleading the Jury, Burdens of Proof)
In a first-party bad faith action against an insurer, plaintiff will be attacking the insurer’s credibility, its policies and procedures for handling claims, and the particular manner in which this claim was handled. Plaintiff’s goal is to prove that the insurer has done something wrong. Whether or not the insurer, in fact, has acted in bad faith is completely irrelevant to whether the insurance contract provides coverage or not.(1)
The insurer’s conduct is likewise irrelevant to whether the insured is liable for a third party’s injuries. Moreover, even the jury’s knowledge that the alleged tort-feasor has insurance unfairly enhances the likelihood of a jury verdict in the claimant’s favor. The prejudice is inevitable on the issue of liability where the jury knows that an insurer will be paying the judgment. See e.g. Madden, supra.
Where the issue is bad faith, counsel and witnesses would be inclined to make inflammatory statements at trial concerning the insurer’s inappropriate behavior in adjusting the insurance claim. To allow such prejudicial commentary without any determination of coverage or liability would serve to confuse the issues, and to distract the jurors from a fair determination of whether plaintiff has proven a breach of the insurance contract or liability of the insured. Direct attacks on the insurer’s claim handling practices would also unfairly prejudice the jurors against the insurer. The focus of the trial would shift away from whether there is or is not coverage or liability, to how the claim for proceeds was handled by the insurer and how the insurer reached its decision. See e.g. Madden, supra.
In a first-party bad faith action, the burdens of proof may also be confused. To establish coverage, typically the insured simply needs to show that it had a first-party insurance contract with the insurer, paid its premiums, and suffered damages resulting from a covered cause of loss. The insurer is then required to prove that the loss was subject to some exclusion or condition, that there was a suspension of coverage, or that the policy is void. Usually the insurer will have the burden of proving “no coverage” to prevail in its defense of a first-party coverage dispute. By contrast, the insured has the burden of proving wrongdoing by the insurer. By allowing the issues to be presented together, the burdens of proof may be confused and would likely evade jury comprehension.
D. Judicial Efficiency
The primary argument in opposition to a stay of the bad faith claim is that the alleged wrongdoing arises, at least in part, out of the same facts as the coverage or liability dispute. Accordingly, to require separate litigation and trial would require redundancy. Witnesses may have to be deposed twice and appear before the court in two independent trials. Two juries would have to be impaneled.
While potentially true, this argument overlooks the possibility that there will be a quick and easy final determination in the first action, if there is no coverage or no liability in excess of policy limits. As discussed above, in many jurisdictions if the plaintiff does not prevail in establishing coverage or liability in excess of policy limits, then no bad faith action exists against the insurer. See e.g., Fortson v. St. Paul Fire and Marine Ins. Co., 751 F.2d 1157 (11th Cir. 1985). By bringing the coverage or liability action to trial first, it may relieve the parties from having to go forward with extensive discovery and a lengthy trial on the allegations of bad faith.
The contractual coverage claim or third-party liability claim would not require nearly the amount of time, effort, and expense required in litigating the bad faith action. Discovery would exponentially increase if the bad faith claim is permitted to go forward. Document production and witness testimony on claims handling procedures, guidelines, the manner in which the particular claim was handled, and potentially the general business practices of the insurer would all be explored at length in the bad faith litigation. Indeed, the documentary evidence in a typical bad faith claim is voluminous in comparison to the underlying coverage or liability action. New fact witnesses and expert witnesses would testify about the insurer’s claims practices in the bad faith action. None of this would be required (nor would it be relevant) in the coverage or liability action.
Moreover, almost inevitably, a plaintiff’s tendency is to overreach in discovery during a bad faith action. This will likely bring on objections, motions for protective orders, motions to compel, and hearings before the trial court on the proper scope of discovery. See Dictiomatic, Inc. v. USF&G Co., Case No. 93—2123—CIV-HURLEY (S.D. Fla. 1996). Often, the discovery disputes require appellate intervention by petitions for certiorari review, further exacerbating the unnecessary costs of litigation and depleting judicial resources.
Finally, a three-day trial could become a three-week trial if the coverage/liability and bad faith issues are presented together. And, if an appellate court determines that combining the actions caused unfair prejudice to the insurer, then the judgment will be vacated and the parties will be required to start all over again.
Uniting the actions, I would suggest, builds the framework for a model of inefficiency.
The bad faith action against an insurer (whether first party or third party) should be stopped in its entirety at the outset, when an underlying coverage or liability action is still pending. Unfair prejudice in discovery and at trial is inherent and unavoidable if both actions are allowed to proceed simultaneously. Privileges should be protected. Judicial resources should be preserved. A bad faith action, initiated before the underlying action is resolved, should be abated or stayed.