This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey’s Litigation Report: Bad Faith, Vol. 13, #5, p. 21 (July 1, 1999). Copyright Butler 1999.
Since the early 1970s, when first-party bad faith actions came into being,(1) a considerable body of law has developed on the standard of care for insurers to avoid liability. In creating and defining such standards, courts have struggled to balance the interests of insureds and insurers. This article is a general review of those decisions and standards.
In the absence of statutory mandate, at least 26 state courts of last resort have recognized the tort of bad faith in first-party cases.(2) Five others have allowed recovery of extracontractual damages without the tort.(3)
At least four state courts of last resort have rejected the “tort” of bad faith in first-party insurance cases.(4) Several others have rejected first-party bad faith at common law in tort or contract.(5) Still others expressly have refused to extend the cause of action for bad faith to a first-party case.(6)
Several jurisdictions have statutory causes of action for bad faith either by recognizing the tort directly, or otherwise allowing a private cause of action under unfair claim settlement practices statutes, consumer protection, or unfair competition statutes. These include Colorado (Colo. Rev. Stat. § 10—3—1113), Florida (Fla. Stat. § 624.155),Georgia (Ga. Code Ann. § 33—4—6), Louisiana (La. Rev. Stat. Ann. § 22:1220),Pennsylvania (42 Pa. Cons. Stat. § 8371) and Rhode Island (R.I. Gen. Laws § 9—1—33). Others, including Massachusetts, Montana, New Hampshire and New Mexico, permit private causes of action under Unfair Claim Settlement Practices statutes. MassachusettsGen. Law, Chapter 93A, § 9 (making violations of Massachusetts’ Unfair Claim Settlement Practices Statute actionable under the Massachusetts Consumer Protection Statute);Mont. Code Ann. § 13—18—242; New Hampshire Rev. Stat. Ann. § 417:19(I); and N.M. Stat.Ann. § 59A—16—30. Similarly, consumer protection and unfair competition statutes exist in other states, including Illinois, New Hampshire, North Carolina, Pennsylvania, Texas,Washington, Alaska, California, Louisiana, Michigan, and New Jersey.
All jurisdictions which recognize first-party bad faith actions have essentially adopted either: (1) the “fairly debatable” standard, or (2) a negligence standard. Although some courts have articulated more elaborate variations of these standards, and others have utilized terminology that appears different, in practice the differences largely are semantic. Most jurisdictions fall into one of these two categories.
Under the “fairly debatable” standard, an insurer may be liable for bad faith only when a denial or delay in payment lacked any reasonable basis. Where the insurer’s position was one on which reasonable minds could differ, the insurer will not be liable as a matter of law.
The highest courts in at least sixteen different states have adopted the “fairly debatable” standard or a variation. National Security Fire & Cas. Co. v. Bowen, 417 So.2d 179 (Ala. 1982); Rawlings v. Apodaca, 726 P.2d 565, 572 (Ariz. 1986); Travelers Ins.Co. v. Savio, 706 P.2d 1258, 1275 (Colo. 1985); White v. Unigard Mut. Ins. Co., 730 P.2d1014, 1018 (Idaho 1986); Dolan v. Aid Ins. Co., 431 N.W. 2d 790, 794 (Iowa 1988);Wittmer v. Jones, 864 S.W.2d 885, 890 (Ky. 1993); Andrew Jackson Life Ins. Co. v.Williams, 566 So. 2d 1172, 1184—85 (Miss. 1990); Tynes v. Bankers Life Co., 730 P.2d1115, 1124 (Mont. 1986); Pickett v. Lloyd’s, 621 A.2d 445, 453 (N.J. 1993); Tokles & Son,Inc. v. Midwestern Indem. Co., 605 N.E.2d 936, 943 (Ohio 1992); Rumford Property & Liab.Ins. Co. v. Carbone, 590 A.2d 398, 400 (R.I. 1991); Walz v. Fireman’s Fund Ins. Co., 556N.W.2d 68, 70 (S.D. 1996); Billings v. Union Bankers Ins. Co., 918 P.2d 461, 464—65 (Utah1996); Bushey v. Allstate Ins. Co., 670 A.2d 807, 809 (Vt. 1995); Warmka v. HartlandCicero Mut. Ins. Co., 400 N.W.2d 923, 925 (Wis. 1987); State Farm Mut. Auto. Ins. Co. v.Shrader, 882 P.2d 813, 825 (Wyo. 1994).
Other states have not expressly used the term “fairly debatable.” For example, in Anderson v. Continental Ins. Co., 271 N.W.2d 368, the Wisconsin Supreme Court held the insured must prove: (1) the absence of a reasonable basis for denying benefits of the insurance policy and (2) the insured’s knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. Similarly, in Erie Ins. Co. v. Hickman, 622 N.E.2d515, 519 (Ind. 1993), the Indiana Supreme Court held an insured must plead and prove two elements. First, the insured must prove the insurer breached its obligation to refrain from (1) making an unfounded refusal to pay policy proceeds, (2) causing an unfounded delay in making payment, (3) deceiving the insured, or (4) exercising any unfair advantage to pressure an insured into a settlement of his claim. Erie, 622 N.E.2d at 519. Second, the insured must establish the insurer acted with intent. 622 N.E.2d at 520. As an example, an insured may satisfy the intent element by proving the insurer acted “knowing that there is no rational, principled basis” for denying or delaying a claim. Id. The mere lack of a diligent investigation is insufficient. Id., citing Continental Cas. Co. v. Novy, 437N.E.2d 1338 (Ind. Ct. App. 1982). In other words, under Indiana law, bad faith is an “intentional” tort which cannot be established upon evidence of mere negligence.
Indiana’s requirement of intent is in accord with decisions in other states. By requiring the insured to establish intent, the courts are seeking a balance between the insured’s right to be compensated and the insurer’s obligation to investigate and reject non-compensable claims. E.g., Anderson v Continental Ins. Co., 271 N.W.2d 368, 376 (Wis.1978) (knowledge or reckless disregard of no reasonable basis); Aetna Cas. & Sur. v.Broadway Arms, 664 S.W. 2d 463 (Ark. 1984) (misconduct must be dishonest, malicious, or oppressive in an attempt to avoid liability under a policy); Hoskins v. Aetna Life Ins. Co.,452 N.E.2d 1315 (Ohio 1983) (bad faith is more than bad judgment or negligence; it imports conscious wrong doing).
The Alabama Supreme Court has given a nice discussion of the approach.
An insurer is liable for its refusal to pay a [first-party] claim when there is no lawful basis for the refusal, coupled with actual knowledge of that fact. No lawful basis “means that the insurer lacks a legitimate or arguable reason for failing to pay the claim.” When a claim is “fairly debatable,” the insurer is entitled to debate it, whether the debate concerns a matter of fact or law. (Citations omitted.)
National Security Fire & Cas. Co. v. Bowen, 417 So. 2d 179, 183 (Ala. 1982). The plaintiff must go beyond a mere showing of non-payment and prove a “bad faith non-payment, anon-payment without any reasonable ground for dispute. . . . The plaintiff must show that the insurance company had no legal or factual defense to the insurance claim.” Id.
In a later case, the Alabama Supreme Court placed a heavy burden on the plaintiff.
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 and, thus, entitled to re cover on the contract claim as a matter of law.
National Savings Life Ins. Co. v. Dutton, 419 So. 2d 1357, 1362 (Alabama 1982). The Rhode Island Supreme Court expressly has adopted the bad faith standard described in Dutton. Rumford Property and Liability Ins. Co. v. Carbone, 590 A.2d 398, 400 (R.I. 1991)(plaintiff must be entitled to a directed verdict on the contract claim).
Similarly, the Arizona Supreme Court held an insurer that intentionally and unreasonably denies or delays payment, breaches the covenant of good faith owed to its insured. Rawlings v. Apodaca, 726 P.2d 565, 572 (Ariz. 1986), citing Noble v. NationalAmerican Life Ins. Co., 624 P.2d 866 (Ariz. 1981) (failure to pay a claim is unreasonable unless the claim’s validity is “fairly debatable” after an adequate investigation). The Rawlings court emphasized the following principles: (1) the fair dilatability of a claim cannot be created by the insurer’s reliance on ambiguity in the policy, because such a rule would encourage insurers to write ambiguous insurance contracts; and, (2) the fair debatability cannot be raised where an insurer failed to make an adequate investigation. Id. at 572. Of course, not every breach of contract is a breach of the covenant of good faith and fair dealing.
Insurance companies, like other enterprises and all human beings, are far from perfect. Papers get lost, telephone messages misplaced and claims ignored because paper-work was misfiled or improperly processed. Such isolated mischances may result in a claim being unpaid or delayed. None of these mistakes will ordinarily constitute a breach of the implied covenant of good faith and fair dealing, even though the company may render itself liable for at least nominal damages for breach of contract in failing to pay the claim.
Id. at 573.
The Colorado Supreme Court also has required a measure of intent. An insurer acts in bad faith in delaying the processing of or denying a valid claim “when the insurer’s conduct is unreasonable and the insurer knows that the conduct is unreasonable, or recklessly disregards the fact that the conduct is unreasonable.” Travelers Ins. Co. v.Savio, 706 P.2d 1258, 1275 (Colo. 1985). The first element of the test — unreasonable conduct — will be determined on an objective basis and will require proof of the standard of conduct in the industry. Id. With respect to the second element of the test, the court stated:
The second element of the test reflects a reasonable balance between the right of an insurance carrier to reject a non-compensable claim submitted by its insured, and the obligation of such carrier to investigate and ultimately approve a valid claim of its insured. . . . [R]ecognition of the permissible scope of an insurer’s right to refuse invalid claims requires the conclusion that in the context of a first-party claim, the insured must establish the insurer’s knowledge or reckless disregard of the fact that a valid claim has been submitted.
In adopting the “fairly debatable” standard, the Idaho Supreme Court stated, “An insurer does not act in bad faith when it challenges the validity of a `fairly debatable’ claim, or when its delay results from honest mistakes.” White v. Unigard Mut. Ins. Co., 730 P.2d1014, 1020 (Idaho 1986) (citations omitted). Rather, the insured must show the insurer “intentionally and unreasonably denies or delays payment. . . .” Id.
The Iowa Supreme Court has held, to establish bad faith, the following must exist: the “absence of a reasonable basis for denying benefits of the policy and defendant’s knowledge or reckless disregard of the lack of a reasonable basis for denying the claim.” Dolan v. Aid Ins. Co., 431 N.W.2d 790, 794 (Iowa 1988), citing Anderson v. ContinentalIns. Co., 271 N.W.2d 368, 376 (1978).
Where a claim is fairly debatable, the insurer is entitled to debate it, whether the debate concerns a matter of fact or law(citations omitted). This test creates an objective standard and makes clear the intentional nature of the tort. Also, as noted in Anderson, It is appropriate, in applying the test, to determine whether a claim was properly investigated and whether the results of the investigation were subjected to a reasonable evaluation and review. . . .
Dolan, 431 N.W.2d at 794.
Under Kentucky law, an insured must prove three elements to establish first-party bad faith: (1) the insurer must be obligated to pay the claim under the terms of the policy;(2) the insurer must lack a reasonable basis in law or fact for denying the claim; and, (3) the insurer either knew that no reasonable basis for denying the claim existed, or acted with reckless disregard as to whether such a basis existed. Wittmer v. Jones, 864 So. 2d885, 890 (Ky. 1993).
The Mississippi Supreme Court took an interesting approach. Under that state’s law, it is the trial judge’s responsibility to determine whether an “arguably reasonable basis, either legal or factual, for denying the claim” existed. Andrew Jackson Life Ins. Co. v.Williams, 566 So. 2d 1172, 1184 (Miss. 1990). The determination whether an insurer rendered its denial fairly and in good faith generally will be considered by the trial judge when he rules on a motion for directed verdict on the underlying contract action. Id. Furthermore, “[i]f the judge is unable to make the determination, then logic generally dictates that the insurer’s rightful or wrongful denial of the claim was not reached in bad faith.” Id.
Under Montana law, there can be no liability for bad faith where the insurer had “reasonable grounds to debate the coverage in a court of law.” Tynes v. Bankers Life Co.,730 P.2d 1115, 1124 (Mont. 1986). Where there is a “debatable question” of insurance coverage which provides the insurer with a “reasonable and valid ground on which to oppose payment of the proceeds,” the insurer has the right to have the coverage question determined in a court of law. Id.
The New Jersey Supreme Court held an insured must prove “no debatable reasons existed for denial of the benefits.” Pickett v. Lloyd’s, 621 A. 2d 453, 457 (N.J. 1993). Regarding delay, the insured must prove “no valid reasons existed to delay processing the claim and the insurance company knew or recklessly disregarded the fact that no valid reasons supported the delay.” 621 A.2d at 457—458.
The Ohio Supreme Court has held an insurer breaches its duty of good faith by “intentionally refusing to satisfy an insured’s claim where there is either (1) no lawful basis for the refusal coupled with actual knowledge of that fact, or (2) an intentional failure to determine whether there was any lawful basis for such refusal. Tokles & Son, Inc. v. Midwestern Indem. Co., 605 N.E.2d 936, 943 (Ohio 1992). The requisite degree of intent that caused the failure may be inferred and “imputed to the insurer when there is a reckless indifference to facts or proof reasonably available to it in considering the claim.” Id. Under Ohio law, where a claim is fairly debatable, the insurer is entitled to refuse the claim, provided the refusal is based on a genuine dispute over either the status of the law at the time of the denial, or the facts giving rise to the claim. Id.
Similarly, the Supreme Court of South Dakota has held:
For proof of bad faith, there must be an absence of reasonable basis for denial of policy benefits and the knowledge or reckless disregard [of the lack] of a reasonable basis for denial, implicit 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 a reasonable basis for denial, or a reckless indifference to facts or to proofs submitted by the insured. . . . [A]n 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.
Walz v. Fireman’s Fund Ins. Co., 556 N.W.2d 68, 70 (S.D. 1996).
The Utah Supreme Court held a first-party insurer does not breach the implied covenant of good faith where the insured’s claim was fairly debatable. Billings v. UnionBakers Ins. Co., 918 P. 2d 461, 464—65 (Utah 1996). The implied obligation of good faith performance requires the insurer to: (1) diligently investigate the facts to enable it to determine whether a claim is valid, (2) fairly evaluate the claim, and (3) act promptly and reasonably in rejecting or settling the claim. Id. at 465. The court explained:
It is entirely consistent with this overall approach to hold that when an insured’s claim is fairly debatable, the insurer is entitled to debate it and cannot be held to have breached the implied covenant if it chooses to do so.
Id., citing Western Cas. & Sur. Co. v. Marchant, 615 P.2d 423, 427 (Utah 1980).
The Vermont Supreme Court held a Plaintiff must show (1) the insurance company had no reasonable basis to deny the benefits under the policy, and (2) the company knew or recklessly disregarded the fact that no reasonable basis existed for denying the claim. Bushey v. Allstate Ins. Co., 670 A.2d 807, 809 (Vt. 1995). An insurance company may challenge claims that 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.” Id., quoting Booska v. Hubbard Ins. Agency, Inc., 312, 627 A.2d 333, 337 (Vt. 1993).
Under Wyoming law, a cause of action for first-party bad faith exists where an insurer “knowingly or recklessly denied a first-party claim for insurance benefits without having a reasonable basis for doing so.” McCullough v. Golden Rule Ins. Co., 789 P.2d855, 860 (Wyo. 1990). Where the claim is not fairly debatable, the refusal to pay would be in bad faith and would give rise to an action in tort. A claim is “fairly debatable” when a reasonable insurer also would have denied or delayed payment under the particular facts and circumstances. 789 P.2d at 860. To establish a breach of the duty of good faith and fair dealing, the insured must show: (1) the absence of any reasonable basis for denying a claim for benefits; and (2) the insurer’s knowledge or reckless disregard of the lack of reasonable basis for denying the claim for benefits. Id. at 860.
Finally, Wisconsin law requires the absence of a reasonable basis for denying benefits under the terms of the policy and the Defendant’s knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. The Plaintiff cannot maintain a cause of action for the tort of bad faith if the validity of the claim was fairly debatable. Anderson v. Continental Ins. Co., 271 N.W. 2d 368, 376 (Wis. 1978) (“It is apparent, then, that the tort of bad faith is an intentional one”). Implicit in this test is the court’s conclusion that the knowledge of the lack of a reasonable basis may be inferred and imputed to the insurance company where there is a reckless disregard or a lack of a reasonable basis for denial or a reckless indifference to the facts or to proofs submitted by the insured. Id. at377. The Anderson court made clear, however, that an insurance company may challenge claims and will be liable only where it has “intentionally denied (or failed to process or pay)a claim without a reasonable basis.” Id.
We are satisfied that the application of the test formulated above, which recognizes the intentional nature of the tort of bad faith and puts the test upon an objective basis, will minimize the fears expressed by the defendant insurance company that to permit claims for bad faith will result in extortionate lawsuits. Such result cannot follow when an insurance company in the exercise of ordinary care makes an investigation of the facts and law and concludes on a reasonable basis that the claim is at least debatable. . . .Insurers in Wisconsin need not be mulcted by extortionate or questionable claims if they adhere to the standards of care which we have set forth above.
As noted above, some jurisdictions equate bad faith with negligence. For example, under California Law, bad faith simply means the insurer acted tortuously or negligently. See Gruenberg v. Aetna Ins. Co., 9 Cal. 3d 566, 108 Cal. Rptr. 480, 510 P.2d 1032 (1973);Lunsford v. American Guar. & Liab. Ins. Co., 775 F. Supp. 1574 (N.D. Cal. 1991). Remarkably, in Idaho, an inference of bad faith can be established by the “merest showing that the insurer’s conclusions . . . are or may be incorrect or that the insured’s investigation was not complete in all details.” State Farm Fire & Cas. Co. v. Trumble, 663 F. Supp. 317,321 (D. Idaho 1987).
Overall, only a few jurisdictions follow a broad standard of care which would impose liability on an insurer for mere negligence. Those that do appear to follow the lead of Gruenberg in defining the standard. “[The] duty not to withhold unreasonably payments due under a policy,” the duty to “act fairly and in good faith in discharging its contractual responsibilities,” and, the duty to avoid “refusing, without proper cause, to compensate its insured for a loss covered by the policy.” Gruenberg v. Aetna Ins. Co., 510 P.2d 1032,1037 (Cal. 1973). Other jurisdictions adopting the negligence standard include North Dakota in Seifert v. Farmers Union Mut. Ins. Co., 497 N.W.2d 694 (N.D. 1993); Oklahoma in Roach v. Atlas Life Ins. Co., 769 P.2d 158 (Okla. 1989); South Carolina in Nichols v.State Farm Mut. Auto. Ins. Co., 306 S.E.2d 616, 619 (S.C. 1983), and; Washington in Safeco Ins. Co. of America v. JMG Restaurants, Inc., 680 P.2d 409 (Wash. 1984).
The North Dakota Supreme Court described the standard as the “duty not to withhold unreasonably payments due under a policy. . . .” Seifert v. Farmers Union Mut. Ins.Co., 497 N.W. 2d 694, 698 (N.D. 1993). Where an insurer fails to deal fairly and in good faith with its insured “by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing.” Id., quoting Gruenberg, 510P. 2d at 1037.
Under Oklahoma law, bad faith is established by evidence of the “insurer’s unreasonable, bad-faith conduct, including the unjustified withholding of payment due under a policy. . . ” McCorkle v. Great Atlantic Ins. Co., 637 P.2d 583, 587 (Okla. 1981). Where there exists conflicting evidence from which different inferences may be drawn regarding the reasonableness of an insurer’s conduct, then what is reasonable is “always a question to be determined by the trier of fact by a consideration of the circumstances in each case.” Id. at 587.
The South Carolina Supreme Court held an insured can recover consequential damages in tort where there was “bad faith or unreasonable action by the insurer in processing a claim under their mutually binding insurance contract. . . . ” Nichols v. StateFarm Mut. Auto. Ins. Co., 279 S.C. 336, 306 S.E.2d 616, 619 (S.C. 1983). Public policy justifications support this cause of action, as the insurance business is “affected with a public interest” and the “insured ordinarily possesses no bargaining power and no means of protecting himself. . . . ” Id. at 618.
Absent the threat of a tort action, the insurance company can, with complete impunity, deny any claim they wish, whether valid or not. During the ensuing period of litigation following such a denial, the insurance company has the benefit of profiting on the use of the insured’s money.
Id. at 619.
The Florida Supreme Court specifically has rejected the “fairly debatable “standard and adopted a “totality-of-the-circumstances” approach. State Farm Mut. Auto.Ins. Co. v. Laforet, 658 So. 2d 55 (Fla. 1995). The Court outlined at least five factors whichshould be taken into consideration in determining whether an insurer engaged in bad faith:(1) whether the insurer was able to obtain a reservation of the right to deny coverage if adefense were provided; (2) efforts or measures taken by the insurer to resolve thecoverage dispute promptly or in such a way as to limit any potential prejudice to the insureds; (3) the substance of the coverage dispute or the weight of legal authority on thecoverage issue; (4) the insurer’s diligence and thoroughness in investigating the factsspecifically pertinent to coverage; and (5) efforts made by the insurer to settle the claim inthe face of the coverage dispute. Id. at 63. By rejecting the “fairly debatable” standard, the Florida Supreme court took the issue out of the hands of the court, as a matter of law,and placed it into the hands of the jury.
The writers believe the “fairly debatable” standard fairly embodies the public policydetermination that an insurer has a “right to disagree” as to the amount and validity of aclaim. As the Indiana Supreme Court has stated:
It is evident that the exercise of [the right to disagree asto the amount of recovery] may directly result in theintentional infliction of temporal damage, including thedamage of interference with an insured’s business(which an insured will undoubtedly consider to beoppressive). The infliction of this damage has generallybeen regarded as privileged, and not compensable, forthe simple reason that it is worth more to society than itcosts, i.e., the insurer is permitted to dispute its liabilityin good faith because of the prohibitive social costs ofa rule which would make claims non-disputable.
Erie Ins. Co. v. Hickman, 622 N.E.2d 515, 520 (Ind. 1993), quoting Vernon Fire & Cas. Co.v. Sharp, 264 Ind. 599, 349 N.E.2d 173, 181 (Ind. 1976).
Jurisdictions holding to a negligence standard arguably have invited bad-faithlitigation over any claim even where reasonable minds could differ as to the amount ortiming of the claims handling. In these jurisdictions, insurers may be more likely simply topay questionable or even fraudulent claims, rather than litigate and risk an adversejudgment.