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. 16, #10, p. 26 (September 18, 2002). © Copyright Butler 2002.
What happens when an insurer’s employee, insured, adjuster or attorney alters or destroys critical evidence? Can spoliation of evidence also constitute bad faith? Although there is no published decision directly on point, it appears that some courts may be willing to extend an insurer’s exposure to include extra-contractual damages for such conduct.
In recent years, there has been much case law and commentary concerning spoliation of evidence. Nearly all of the spoliation case law concerns litigants in the course of the investigation of a loss, or in the pursuit of litigation, causing critical evidence to be lost, altered or destroyed. The case law addressing spoliation then determines the fairest remedy under the circumstances, and the courts applying that remedy assist in the ultimate resolution of the dispute.
The case law also holds that insurers are viewed as professional litigants, and the courts have thus held them to the highest standard when adjudicating their conduct with respect to the saving of evidence. See e.g. Chapman v. Auto Owners Ins. Co., 469 S.E.2d 783 (Ga. App. Ct. 1996); Cincinnati Ins. Co. v. Synergy Gas, Inc., 585 So. 2d 822 (Ala. 1991). The imposition of this “high standard” also comports with the concept of an insurer as a fiduciary to its insured. Liability insurers are fiduciaries to their insureds. First-party insurers are not. However, some argue that even this “debtor-creditor” relationship should be deemed a fiduciary relationship as a matter of public policy and law. See Powers v. USAA, 962 P. 2d 596 (Nev. 1998), reh’g den. with opin., 979 P. 2d 1286 (Nev. 1999).
The expectation of a well performed investigation for the benefit of an insured is well illustrated by Fada Indus., Inc. v. Falchi Bldg. Co., 730 N.Y.S. 2d 827 (N.Y. Sup. Ct. 2001), where the New York appellate court expressed a willingness to recognize a tort for spoliation arising from insured-insurer relationships, even though New York law generally does not recognize the tort of spoliation. This is an obvious recognition of the “special relationship” between insureds and their insurers.
From a policy perspective, the obligation of the insurer to defend must carry with it the obligation to preserve key evidence relied upon by its insured to defend against property damage claims. The recognition of a negligent spoliation claim under such circumstances clearly “would be reasonably manageable within our legal system.” The recognition of spoliation of evidence as an independent tort is a logical next step in the evolving recognition that there is a remedy for spoliation of evidence, as between parties to an action, separate and apart from sanctions. . . . It is fitting that a party should have a remedy against a non-party, particularly when that non-party is the party’s insurer, for the non-party’s loss or destruction of key evidence.
Id. at 838 (citation omitted). As the Fada court ultimately explains, the insurer “took possession of the [evidence] during the course of its investigation, [and] it is not unreasonable to hold it responsible for its destruction or loss and to subject it to third party liability for indemnification to [the insured], which has nothing to defend itself against plaintiff’s cause of action against it.” Id. at 842.
In Sterbenz v. Attina, 205 F. Supp. 2d 65 (E.D.N.Y. 2002), the United States District Court for the Eastern District of New York considered a case where bad faith allegations were made by an insured arising, partially, from an insurer’s disposal of critical evidence. In Sterbenz, the plaintiff filed suit against an insurer who purchased and then sold an automobile that had been involved in an accident involving the carrier’s insured. The insurer in Sterbenz purchased a vehicle that had been in an accident, after making payment for the damages to the vehicle, and then sold it for salvage. Upon such facts, the plaintiff pursued a bad faith claim against the carrier. The Sterbenz court found that there was no breach of the policy’s covenant of good faith since there had been no contractual breach of the policy, and New York law did not recognize an independent tort claim for bad faith.
As plaintiff identifies no contractual breach — other than the alleged breach of the implied covenant of good faith — nor loss of any contractual benefit, her amended complaint fails to state a claim for breach of the implied covenant of good faith and fair dealing.
Id. at 70. Additionally, New York law did not recognize a private claim for a breach of any statutory duty of good faith, and thus, such a claim was also denied. Id. at 71. Further, the Sterbenz court explained that while New York law recognized that a spoliation claim could exist between an insurer and insured, the actual facts in Sterbenz did not support a spoliation claim because the insurer acted “reasonable under the circumstances.” Id. at 72.
The holding in Sterbenz begs the following questions: What would happen in a jurisdiction that recognized a private cause of action for improper claims investigations? What would happen in such a jurisdiction where there was both a breach of the policy and spoliation? How would the court respond if the insurer had not been reasonable under the circumstances? Unfortunately, the Sterbenz court, like other courts, ultimately did not address the issue. See Ellwein v. Hartford Accident and Indemnity Company, 15 P.3d 640 (Wash. 2001). One would assume, however, that in the right scenario and in the right court, where spoliation law is highly developed and a private cause of action for breaches of claims handling practices can be litigated, a bad faith claim for spoliation may actually exist.(1)
In the context ohttps://www.butler.legal/blog/spoliation-as-bad-faith/ an investigation of a claim, it seems reasonable to expect that some day, some court could determine that “spoliation of evidence” also constitutes evidence of “bad faith.” However, while the questions have now begun to be identified, no courts have yet made a clear determination. For example, in Hyde Athletic Indus., Inc. v. Continental Cas. Co., 969 F. Supp. 289 (E.D. Pa. 1997), the insureds sought bad faith damages arising from an insurer’s failure to retain certain insurance policies in storage. Hyde Athletic arose from complex litigation concerning enforcement of the Comprehensive Environmental Response, Compensation and Liability Act, 42 U.S.C. § 9601, et seq. In Hyde Athletic, the insureds, after being found liable for environmental pollution, sought coverage from their liability insurer for indemnification. In one count, the plaintiffs sought a direct damages claim for fraud and deceit arising, in part, from the destruction of expired insurance policies, which were allegedly destroyed solely for the purpose of avoiding coverage. In another count, the plaintiffs sought damages pursuant to Pennsylvania’s bad faith statute, alleging that the insurers had committed bad faith because of the method by which they retained and searched for the subject insurance policies. The insureds alleged in Hyde Athletic that the insurers knew that the subject liability policies would have a “long tail;” and therefore, they argued that the insurers had a greater duty to preserve such policies in the event liability claims would be made at a much later date.
With regard to both allegations, the Hyde Athletic court found that the insurer acted properly, and thus, the claims for bad faith damages arising from the lost policies failed.
Plaintiffs have failed to produce any evidence of the misrepresentation by the Defendant insurers about the retention policy, of the Plaintiffs’ reliance on a reasonable understanding that the Defendants would retain the policies, or any damages resulting from the retention policies. Nor has Plaintiffs’ research or the research of this court revealed a case in which a document retention and destruction policy supported a cause of action for deceit against the insurer. Summary judgment for the Defendant insurers is therefore appropriate on this element of the claim.
Id. at 302. Further, the court in Hyde Athletic found that the insurers’ conduct in investigating the loss, and specifically in searching for its insurance policies, did not create bad faith.
Plaintiff’s assertion that Continental’s search for the missing policies and investigation of their claims were not up to standard, does not create a factual question of bad faith for the jury. . . . Plaintiffs could not locate the missing Continental insurance policy themselves, despite what they have described as an exhaustive search. Given the totality of the search effort, Stevens’ [the insurance adjuster’s] omissions arise at most to the level of negligence. A reasonable jury could not find them reckless, and Plaintiffs presented no evidence that Stevens or Continental acted with ill will.
See Id. at 309. However, the Hyde Athletic court clearly demonstrates that under certain facts, such spoliation-type conduct could result in a viable bad faith claim.
Another case that further illustrates this point is Betco Scaffolds Co., Inc. v. Houston United Cas. Ins. Co., 29 S.W.3d 341 (Tex. Ct. App. 2000). In Betco Scaffolds, the Court of Appeals of Texas considered whether spoliation of a claims file, or a portion thereof, constituted actionable bad faith. Betco Scaffolds arose from a coverage claim for the loss of inventory due to a theft. The Court of Appeals of Texas in Betco Scaffolds found that an inventory exclusion negated the insured’s claim for coverage. Accordingly, and for apparently that reason only, the court found that an extra-contractual claim for bad faith damages was not actionable. “Betco’s fourth point of error argues that the summary judgment against its extra contractual claims was improper because Houston United was liable for bad faith acts of its agent in spoliating the papers in Betco’s claims file and in failing to investigate Betco’s claim.” Id. at 348. However, the court consequently found:
In this case, because Houston United had a reasonable basis for denying Betco’s claim based on the inventory exclusion provision, it did not breach its contract or its duty of good faith and fair dealing to Betco with regard to that denial. In addition, Houston United’s investigation revealed evidence sufficient to legitimately sustain a basis for denial of the claim, and Betco has cited no authority or evidence imposing an obligation on Houston United to investigate beyond that. Therefore, Betco has not shown error in granting summary judgment with regard to its bad faith claim for failure to investigate.
Lastly, although Betco alleged conduct by Houston United to show its bad faith, such as spoliation of papers in Betco’s claim file, it alleged no act by Houston United that was so extreme as to cause Betco injury independent of its policy and bad faith claims. Under these circumstances, the negating of Betco’s claims for a breach of contract and bad faith denial and failure to investigate also defeated Betco’s remaining extra contractual Insurance Code and DTPA claim.
Id. at 348.
It is clear that the Betco Scaffolds, Hyde Athletic and Sterbenz cases illustrate a growing acknowledgment by the courts that spoliation of evidence may actually constitute bad faith. Betco Scaffolds addressed a claim arising from the loss of a claims file. Hyde Park dealt with the loss of a relevant liability policy. Sterbenz considered the loss of critical evidence during a liability investigation. Although none of these cases approved a finding of “bad faith” due to “spoliation of evidence,” these cases demonstrate that such bad faith claims are potentially viable as a matter of law. The only real issue is if and when a court will find such conduct to actually constitute bad faith. Only time may tell.
Obviously, for the plaintiff’s bar, establishing that an insurer has lost, purged or destroyed potentially relevant evidence provides arguments and “spin” that can only help poison the judge and jury against a large corporate insurer. Note what the destruction of documents did to Arthur Andersen. Accordingly, an insurer should go to great pains (and expense) to make sure that a spoliation argument cannot be made against it. If this entails great costs to manage corporate archives, so be it. The downside of becoming the target of a spoliation as “bad-faith” argument is simply too great a risk.