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Recognizing Subtle Exposures To Avoid Bad Faith Claims

November 21, 2001

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. 15, #14, p. 29 (November 21, 2001). © Copyright Butler 2001.

“The insurer does not . . . insure the entire range of an insured’s wellbeing outside the scope of and unrelated to the insurance policy, with respect to paying third party claims. It is an insurer, not a guardian angel.”

Camelot by the Bay Condominium Owners’ Ass’n, Inc. v. Scottsdale Ins. Co., 27 Cal. App. 4th 33, 52 (4th Dist. 1994).

An insurer does not have an absolute obligation to defend all claims against an insured, or to settle a claim simply because a possible judgment against the insured may exceed the available policy limits. However, insurers must be aware of potential vulnerabilities of their insureds, even those that are not covered under the policy, and may be setting themselves up for a bad faith action if they fail to recognize certain, often subtle, exposures. This article describes several scenarios insurers should be aware of in providing a defense to insureds, and in evaluating cases for settlement.

Consider Attorneys Fees as Potential Exposure

Generally, attorneys fees are not recoverable in a cause of action unless there is statutory authority or a contractual provision upon which to rest such liability. Hubbel v. Aetna Casualty & Surety Co., 758 So. 2d 94 (Fla. 2000). Where an insurance policy does not define “damages,” an insurer may be liable for attorneys fees if the fees are deemed to be damages under the policy. If attorneys fees are not deemed to be damages under the policy, a potential fee award against the insured could result in excess liability on the part of the insured and, therefore, insurers should consider this when evaluating the case.

In the recent case of Scottsdale Insurance Company v. Haynes, 26 Fla. L. Weekly D1568, Sept. 14, 2001, Bush, as personal representative of Haynes, sued Home Away, an adult assisted living facility, claiming it had violated Florida Statutes section 400.429 in its treatment of Haynes while she lived at the facility.(1) A jury rendered a verdict of $150,401 in compensatory damages, and the trial court reserved ruling on plaintiff’s claim for attorneys fees and taxable costs. Scottsdale, the insurer of Home Away, agreed to pay the compensatory damages, but sought to intervene to determine its liability for attorneys fees that could be awarded to plaintiff under section 400.429. The trial court entered summary judgment against Scottsdale.

On appeal, the Florida Fifth District Court of Appeal found nothing in the statutory language of section 400.429 indicating that the Legislature had intended to impose any liability directly on an insurer absent language in the insurance contract that assumed such liability. In addition, the Court stated that attorneys fees are not damages, but are ancillary to damages, and therefore, not a part of the substantive claim. The Court then certified the following question to the Florida Supreme Court:


The Supreme Court of Florida has not yet ruled on this issue, however, if the Court rules in favor of the insured, insurers in similar circumstances will undoubtedly include an estimate of such fees when evaluating exposure in third party cases where fee awards are recoverable by the plaintiff.

Insurers should also consider the potential for an award of attorneys fees when evaluating exposure in cases involving an offer of judgment. Where claimants prevail on an offer of judgment, insurers run the risk of exposing their insureds to separate and individual liability for the eventual fee award. Insurers who fail to accept an offer of judgment triggered by a verdict may face bad faith exposure for failing to communicate with the insured about the effect of the award upon the insured, especially in jurisdictions that do not consider such fees “damages” or supplementary payments.

Give Serious Attention To Punitive Damages Claims

What are an insurer’s duties of good faith where a plaintiff asserts a claim for uninsured punitive damages against the insured? Where there is exposure to the insured for punitive damages, insurers should undertake the same obligations to the insured as they would in an excess liability case. Simply informing the insured of the potential punitive damage claim and stating that such claims are not covered under the policy is not always enough.

In Ging v. American Liberty Insurance Co., 423 F.2d 115 (5th Cir. 1970), the Fifth Circuit Court of Appeals held that an insurance company is under a duty to act in good faith towards its insured once it has undertaken the defense of a non-covered claim. In the underlying case, an action was brought against an insured driver for gross negligence in causing the death of another. A jury awarded compensatory damages of $14,695 and punitive damages of $25,000. American Liberty, the driver’s insurer, filed a post-judgment motion to reduce the compensatory damage award to $11,195, however, made no motion as to the punitive damage award.

Prior to the trial, settlement offers and counteroffers were made between Ging, the administrator of the estate, and American Liberty, which included an offer to settle “for the amount of the insurance coverage.” The insured was not notified timely of the offer, nor were his interests adequately represented at trial in his absence. Ging, as assignee of the insured’s rights under the policy, then brought an action against American Liberty charging bad faith and negligence for failure to inform the insured of settlement offers, failure to warn the insured of the likelihood of a punitive damage award, failure to advise the insured of the outcome of the suit within a reasonable time, and failure to conduct settlement negotiations in good faith. The United States District Court for the Northern District of Florida granted summary judgment in favor of American Liberty.

On appeal, the Fifth Circuit Court of Appeal emphasized that the lower court was not aware that American Liberty undertook the defense of the entire lawsuit filed against the insured, and that American Liberty knew the attorneys it hired to defend the insured were the only attorneys representing the insured’s interests. The Court determined also that insurers must be aware that merely notifying the insured of a potential excess verdict does not always relieve the insurer from the duty to defend the covered and excess claims and to act in good faith toward the insured with regard to all claims. The Court opined that insurers may properly consider their own interests in conducting litigation or settlement negotiations, but stated they must continue to protect the interests of the insured. The case was remanded for a trial on the issue of bad faith.

In several jurisdictions, where an insurer makes a prudent settlement decision, but exposes its insured to punitive damages, it will likely not be liable for bad faith. The New York Court of Appeals has held that, where an insurer has acted in bad faith in relation to an available settlement opportunity in a suit claiming uninsurable punitive damages, the insurer does not have a duty to settle so as to avoid a punitive damages judgment. Soto v. State Farm Insurance Co., 83 N.Y.2d 718, 635 N.E.2d 1222 (N.Y. 1994). In that case, New York’s highest court held that the insurer “is guilty only of placing its insured at risk that a jury will deem him or her so morally culpable as to warrant the imposition of punitive damages. Stated another way, an insurer’s failure to agree to a settlement, whether reasonable or wrongful, does no more than deprive the insured of a chance to avoid the possibility of having to suffer a punitive damage award from his or her own misconduct.”

The Ninth Circuit reached a similar decision in Zieman Manufacturing Co. v. St. Paul Fire and Marine Insurance Co., 724 F.2d 1343 (9th Cir. 1983). There, the insured, Zieman, brought suit against St. Paul alleging that it breached its contractual duty to defend and the implied covenant of good faith and fair dealing. In the underlying products liability suit, plaintiff’s counsel had attempted to settle the case with St. Paul for $200,000 to $250,000. Zieman apparently offered $20,000 of its own funds towards this settlement. St. Paul rejected the settlement and went to trial, resulting in a verdict of $387,107 in compensatory damages and $30,000 in punitive damages. St. Paul paid the compensatory damages, costs, and legal fees of defense counsel hired by St. Paul.

Zieman brought an action in the United States District Court for the Central District of California alleging bad faith failure to settle the case within policy limits, and seeking reimbursement of the fees Zieman paid to its own counsel to defend the punitive damages claim.

The United States Court of Appeals for the Ninth Circuit determined that St. Paul provided a full defense to the underlying claim, including defense of the punitive damages claim. The Court dismissed the case, stating that the test of a good faith settlement is whether a prudent insurer without policy limits would have accepted the settlement offer, and determined that St. Paul had adequately demonstrated that its refusal to settle was prudent, and did not contemplate Zieman’s punitive damages problem.

Defend Immediately and Defend Entirely

Where an insured is being sued for covered and non-covered claims, what action should an insurer take to satisfy the duty to defend? It has been uniformly held that the duty to defend is broader than the duty to indemnify. Ostrager & Newman, Handbook on Insurance Coverage Disputes, § 5.02 (10th Ed. 2000). Most courts hold that an insurer must defend its insured unless and until it can establish, as a matter of law, that the insurer will not be called upon to indemnify the insured under any factual or legal basis. Id. However, it is often not possible to make a complete coverage analysis until the underlying case is concluded, and insurers must be careful to defend until that time comes.

In California, for example, insurers have a duty to provide a complete defense for any mixed action, and failure to do so may cause an insurer to forfeit its right to reimbursement of fees incurred in defending uncovered claims. Concept Enterprises, Inc. v. Hartford Insurance Company of the Midwest, 2001 U.S. Dist. LEXIS 6901. In that case, the District Court found that Hartford breached its duty to defend a case involving trademark and patent claims, and made Hartford pay for all expenses incurred by the insured in defending the underlying action. The District Court further determined that Hartford breached the duty of good faith by refusing to honor its obligation to fund the defense of the entire mixed action, despite being aware of clear law to the contrary.


Insurers should always be aware of scenarios, such as those set forth above, that can potentially evolve into bad faith claims by insureds. A potential award of attorneys fees against an insured may be an important factor in filing an offer of judgment, or in negotiating settlement of a case, where such fees are recoverable by statute. In addition, insurers should always be cautious when an insured faces a punitive damages claim, as failure to seize an opportunity to settle within the policy limits may lead to a bad faith claim in some jurisdictions. Finally, insurers should always assume the defense of an entire action when tendered by an insured, until such time as the covered and non-covered claims in a case are no longer mixed. Insurers who follow these suggestions will often feel like the “guardian angel” of their insureds, but will experience less bad faith litigation as a result.



  1. Section 400.429 creates a cause of action on behalf of residents of nursing homes and health care facilities against facility owners and staff for violations committed by the facility. The statute permits recovery of attorneys fees by the claimant.