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. 13, #12, p. 17 (October 19, 1999). © Copyright Butler 1999.
First-party bad faith cases are typically based on conduct or events (e.g., settlement offers, investigations and evaluations) occurring during the time period after a claim is made but before any litigation is commenced. Once a breach of contract or declaratory action is filed, it is generally understood that the insured and insurer stand in an adversarial relationship which presumably entitles each party to zealously pursue its litigation tactics and strategy. Thus, courts generally will not permit an insurer’s litigation conduct to be admitted as evidence of bad faith. Over the years, however, a significant number of courts have held an insurer owes a continuing duty of good faith to an insured throughout the litigation process and, therefore, an insurer’s post-filing conduct may be admitted as evidence of bad faith. This article is a brief review of some of the leading cases addressing the continuing duty of good faith and its ramifications affecting insurance companies and defense counsel.
The cases discussed in this article are not the only cases that address the insurer’s continuing duty of good faith. However, they demonstrate the ways in which plaintiff-insureds attempt to introduce the insurer’s postfiling conduct as evidence of bad faith. The White decision created new concerns for insurance companies and defense counsel. While not the earthquake it seemed at first, it is a sleeping volcano nonetheless.
The continuing duty of good faith was addressed in detail by the Supreme Court of California in a case of first impression in California. White v. Western Title Ins. Co., 710 P.2d 309 (Cal. 1985). Today the initial shock waves of the White decision have subsided. The disastrous consequences, which at first seemed imminent, have not yet occurred. But the case still is good law. It has been embraced, albeit tepidly, in other jurisdictions. Accordingly, the decision warrants further consideration and analysis.
In White, the plaintiffs were buyers of 84 acres of river-front land. Three years before the sale to the Plaintiffs, the sellers of the land had conveyed by deed to a community mutual water corporation, an easement to drill wells, build and maintain a pipeline, and pump water from beneath the land. The easement deed was recorded. At the time of the purchase, the buyers knew nothing of the easement. They obtained preliminary title reports and title insurance policies from Western Title and went ahead with the purchase of the land. The reports and policies did not mention the easement.
The buyers discovered the easement when the community water corporation notified the buyers of their intention to implement the easement. The buyers made claim to Western Title under the title policies for $62,947 in damages, based on an appraisal of the diminished value of the land. Western Title “rejected” the claim under a policy exclusion for “loss or damage . . . [arising] by reason of . . . water rights, claims or title to water.” The buyers then filed suit against Western Title for breach of contract (on the title insurance policies) and negligence (in preparing the preliminary title reports).
Western Title moved for summary judgment on the policy exclusion. The trial court denied the motion. Then Western Title got its own damage appraisal, which came in at $2,000. Based upon that estimate, Western Title offered to settle the case for $3,000 (the “first offer”). However, Western Title did not give the buyers a copy of the $2,000 appraisal. The buyers rejected the first offer. One month later, Western Title made an “offer to compromise” under the California Code of Civil Procedure for $5,000 (the “second offer”). The buyers rejected the second offer. Instead, the buyers amended the complaint to include breach of the covenant of good faith and fair dealing.
The trial court bifurcated the issues for trial. The first part of the case, liability for breach of contract and negligence, was bench tried. The trial court found against Western Title on the issue of liability. Western Title then showed the $2,000 appraisal to the buyers and filed a new “offer to compromise” for $15,000 (the “third offer”). Again, the buyers rejected the third offer.
The case went to jury trial on the remaining issues. The jury found actual damages of $8,400 for the breach of contract claim. In the “bad faith” phase of the case, the Plaintiffs planned to present evidence of Western Title’s conduct during the whole course of litigation, including introducing evidence of the settlement offers. The trial court admitted evidence of the first offer and the second offer but excluded evidence of the third offer. The jury returned a verdict against Western Title on the covenant of good faith and fair dealing, awarding the plaintiff compensatory damages of $20,000 but declining to impose punitive damages.
On appeal, the California Supreme Court rejected Western Title’s position that evidence of things done after suit was filed (i.e., the first offer and the second offer) should have been excluded at trial. On appeal, Western Title argued that the trial court erred in admitting, as evidence of breach of the covenant of good faith and fair dealing, settlement offers and other matters occurring after commencement of litigation. Western Title urged that an adversarial position was created by the litigation, and that any insurer is handicapped in defending itself if postsuit actions are discoverable and admissible in evidence. Also, the attorney who prepared the case for trial would be barred from trying the case because he or she would be a critical witness to the insurer’s good faith during the pretrial period.
All these arguments were rejected by the majority. The California Supreme Court held that the insurer’s duty of good faith and fair dealing extends beyond the filing of suit; the duty continues throughout the litigation. The court reasoned that the insured would find it difficult to prove pre-litigation conduct unreasonable if it could not present evidence of the postlitigation conduct by way of contrast. Thus, according to the majority, the insurer’s postfiling conduct could be relevant and admissible to determine the insurer’s bad faith.
A thoughtful minority, however, warned that the White decision “cavalierly hobbled” the right of insurers effectively to defend themselves. Justice Lucas, dissenting from the bad faith judgment, stated that:
Scylla and Charybdis had nothing on my colleagues for making life difficult – if not impossible. An insurer who refuses to pay its insured on a disputed claim is now not only at risk that its refusal will subject it to damages for breach of the covenant of good faith and fair dealing, but must also be conscious that any aspect of its conduct during litigation of the original claim of coverage may be used as significant evidence in an ensuing breach of good faith action.
Justice Lucas went on to postulate about the likely consequences of such a rule:
Confronted with such evidence and unfamiliar with the vagaries of litigation[,] the jury will, I submit, in all likelihood regard any settlement attempts as prejudgment admission of liability, and standard defense tactics as indications of a lack of good faith.
Also dissenting, Justice Kaus noted another result of the continuing duty of good faith. In the perceptive words of Justice Kaus:
It seems to me that attorneys who handle policy claims against insurance companies are no longer interested in collecting on those claims, but spend their wits and energies trying to maneuver the insurers into committing acts which the insureds can later trot out as evidence of bad faith.
Id. at 328, n 2.
Subsequent decisions of the California courts of appeals have criticized and limited the majority’s holding in White regarding the admissibility of postfiling conduct to prove bad faith. First, in an noninsurance breach of contract case, a California court of appeal found that White was not controlling outside of the insurance context. Palmer v. Ted Stevens Honda, Inc., 238 Cal. Rptr. 363, 368(Cal. Ct. App. 1987). In Justice Brauer’s three-sentence concurring opinion, he indicated his recognition that White. . . seriously compromises the right of [insurance companies] to defend themselves in court.” Id. at 370—71 (Brauer, J., concurring). He also stated his hope that the California Supreme Court will “find an early opportunity to re-examine that decision.” Id. at 371.
In Nies v. National Automobile & Casualty Insurance Co., 245 Cal. Rptr. 518 (Cal. Ct. App. 1988), at issue was the admissibility of the pleadings filed by the insurer in defense of the bad faith action. In Nies, the insurer, National Automobile and Casualty Insurance Company (“National”) issued an automobile policy that provided uninsured motorist coverage. The plaintiff was injured by an uninsured motorist who was driving a dune buggy. The insured made a claim under his automobile policy for his injuries from the accident. National denied coverage based upon its interpretation of the definition of “uninsured motor vehicle” in the policy.
The attorney hired by the plaintiff questioned National’s interpretation of the applicable provisions in the policy and again made demand for payment. In response, National filed a declaratory judgment action on the issue of coverage. A day later, the plaintiff filed an action for tortious breach of insurance contract against National. A couple of weeks later, the insurer’s attorney discovered a California case that decided the same coverage issue. That case appeared to require payment of uninsured motorist benefits to the plaintiff. Immediately National paid to the plaintiff the policy limits of $30,000.00 for the uninsured motorist coverage. The jury found for the Plaintiff-insured in the bad faith action and awarded him $35,000.00 in general damages and $70,000.00 in punitive damages.
In the bad faith action, National filed motions in limine seeking to exclude any evidence or testimony pertaining to National’s conduct after it paid the $30,000 in uninsured motorists benefits to the Plaintiff. “In particular, defendants sought, unsuccessfully, to prevent any reference to pleadings filed by [National] in defense of plaintiff’s lawsuit for tortious breach of the insurance contract.” 245 Cal. Rptr. at 522. On appeal, National argued that its responsive pleadings, filed after payment of uninsured motorists benefits, were irrelevant to prove that it acted in bad faith when it initially denied coverage on the plaintiff’s claim. The court of appeals agreed with National. Id.
In addition, the court noted that the “plaintiff’s reliance on White v. Western Title Ins. Co. [was] not well taken.” Id. at 524. Instead, Nies court adopted a narrow reading of White:
The [White] court did not decide specifically what types of postlitigation activity would or would not be relevant or admissible on the issue of bad faith, nor did it address the policy issues involved in permitting a lay jury to impute proper motives to the imposition of a legally proper defense.
Id. at 524. The court then concluded that “White is not authority for declaring that the disputed evidence in this case was relevant.” Id.
Similarly, the holding in White was limited by the California Fourth District Court of Appeal in California Physicians’ Service v. The Superior Court of San Diego County, 12 Cal. Rptr. 2d 95 (Cal. Ct. App. 1992). In this case, the plaintiff filed suit against the insurer when it failed to pay medical treatment costs under a health insurance policy (“Blue Shield”). Plaintiff’s amended complaint asserted causes of action for tortious breach of the insurance contract, fraud, breach of the covenant of good faith and fair dealing, and intentional infliction of emotional distress (by groundlessly refusing to pay policy benefits). In response to the amended complaint, Blue Shield filed an answer that included eleven affirmative defenses.
Plaintiffs countered by seeking and obtaining permission to file a supplemental complaint for bad faith and intentional infliction of emotional distress. As a basis for the supplemental complaint, the plaintiff characterized Blue Shield’s eleven affirmative defenses as spurious and untenable, as “attempts to ‘try out an untested legal argument against its own insured,’ and generally unprivileged and unreasonable acts which constitute a continued violation and breach of Blue Shield’s duty of good faith and fair dealing.” 12 Cal. Rptr. at 97 (quoting Plaintiff’s supplemental complaint). Blue Shield filed a general demurrer to the supplemental complaint, which the court overruled. The trial court concluded that the averment of defenses that are “patently untenable” would constitute bad faith because the insurer’s duty to act in good faith continues after litigation is filed.
The appellate court granted extraordinary review of the trial court’s overruling of the demurrer. The court of appeals stated that the conduct cited in the supplemental complaint as grounds for additional damages for bad faith “is a judicial pleading, clearly within the privilege of [California] Civil Code section 47.” In reversing the trial court and upholding Blue Shield’s demurrer, the court of appeals distinguished White from the case at bar: “The effort here is not to use trial tactics as evidence of prior bad faith, but to mount a new cause of action for severable damages on the theory of bad faith defense.” Id. at 98. The court held that defensive pleadings, “even though allegedly false, interposed in bad faith, or even asserted for inappropriate purposes, cannot be used as the basis for allegations of ongoing bad faith.” Id. at 100.
However, the importance of this decision lies in its lengthy discussion of White. “We have some doubt as to the current vitality of White.” Id. at 98. The court noted that although White is still good law, “[t]reatment of the White precedent by the Courts of Appeal has, however, to the extent possible by the intermediate appellate courts, limited its application.” Id. at 99. The court then analyzed the appellate decisions that have discussed White. Finally, White’s holding was restated by the appellate court as follows:
White stands for the proposition that ridiculously low statutory offers of settlement may be introduced in a bifurcated trial, after liability has been established, as bearing on the issue of bad faith of the insurance company.
Id. at 100. Thus, the intermediate appellate courts of California have limited the applicability of White in several regards. It remains, then, unclear what types of postfiling conduct will be admissible as evidence in California of an insurer’s breach of the continuing duty of good faith.
The continuing duty of good faith was addressed by the other courts around the same time as White. See, Spadafore v. Blue Shield, 486 N.E.2d 1201, 1204 (Ohio Ct. App. 1985)(“evidence of the breach of the insurer’s duty of good faith occurring after the time of filing suit is relevant so long as the evidence related to the bad faith or handling or refusal to pay the claim”).
In T.D.S. Inc. v. Shelby Mut. Ins. Co., 760 F.2d 1520 (11th Cir. 1985), Shelby Mutual Insurance Company (“Shelby”) protested on appeal that the assessment of punitive damages against it was based on Shelby’s decision to raise an arson defense. In holding that the post-filing conduct was admissible, the Eleventh Circuit stated:
Certainly the litigation conduct of Shelby was relevant to the claim that Shelby or those acting on its behalf dealt dishonestly with TDS. Although this conduct occurred after the denial of TDS’s claim, it did corroborate TDS’s contention that Shelby deliberately deceived it while Shelby was investigating the fire.
Id. at 1527.
The White decision has been cited by the courts of other jurisdictions concerning various types of postfiling conduct.
1.The Palmer Case
The White decision was approved in Tucson Airport Authority v. Certain Underwriters at Lloyd’s et al., 918 P.2d 1063, 1066 (Ariz. App. 1996). In addition, White was followed but qualified in Palmer v. Farmers Insurance Exchange, 861 P.2d 895 (Mont. 1993). The Palmer case was a first-party action for uninsured motorist benefits and bad faith. The counts were bifurcated. Plaintiff won both and got a judgment for punitive damages. Most of plaintiff’s evidence in the bad faith trial consisted of the postfiling conduct of the insurer including “the strategy and litigation tactics of Farmers’ attorneys who defended the underlying case. . . .” 861 P.2d at 901.
The Supreme Court of Montana reviewed the trial court’s decision to admit the postfiling evidence. In doing so, the court followed the teaching of White; the insurer’s post-filing conduct, while “rarely actionable in and of itself,” 861 P.2d at 916 (emphasis added), “may bear on the reasonableness of the insurer’s decision and its state of mind when it evaluated and denied the underlying claim.” Id. at 915. Therefore, evidence of that kind is not per se inadmissible. However, the court warned that “courts should rarely allow such evidence. . . .” Id. at 914.
The Palmer court applied a more-than-nominal balancing test. “[T]he court must weigh its probative value against the inherently high prejudicial effect of such evidence, keeping in mind the insurer’s fundamental right to defend itself.” 861 P.2d at 915. Indeed, “the proper inquiry should be into the extent to which such conduct casts light on the reasonableness of the original denial of the policyholder’s claim.” Id. at 916. According to the Palmer court “[t]he most serious policy consideration in allowing evidence of the insurer’s post-filing conduct is that it punishes insurers for pursuing legitimate lines of defense and obstructs their right to contest coverage,” Id. at 914, a consideration that was ignored by the majority in White.
Similarly, the Tenth Circuit Court of Appeals was asked to determine whether the litigation conduct of the insurer’s counsel was admissible to prove bad faith in Timberlake Construction Co. v. U.S. Fidelity & Guarantee Co., 71 F.3d 335 (10th Cir. 1995)(applying Oklahoma law). In that case, U.S. Fidelity and Guarantee Company (“Fidelity”) appealed a jury verdict in favor of its insured on the bad faith claim, awarding compensatory and punitive damages. On appeal, Fidelity challenged the district court’s admission of evidence regarding the insurer’s postfiling conduct. Specifically, Fidelity pointed out as error the admission of the following: (1) evidence of Fidelity’s counterclaim against the insured; (2) evidence of its motion to join Wal-Mart as a necessary party; and (3) a letter from Fidelity’s counsel to a Fidelity adjuster.
The Tenth Circuit concluded that the district court erred in permitting “the jury to consider these standard and facially permissible litigation steps as evidence of Fidelity’s bad faith.” 71 F.3d at 340. This was an issue of first impression in Oklahoma. Id. The Tenth Circuit largely relied on Palmer. It followed the general rule from Palmer that an insurer’s postfiling litigation tactics and strategies are rarely relevant and admissible as evidence of the insurer’s bad faith denial or handling of the claim. Id. at 340—41 (citing Palmer v. Farmer’s Ins. Exchange, 861 P.2d 895, 915 (Mont. 1993)). The court noted some of the same policy considerations for its decision as were mentioned in Palmer. In addition, it recognized that “permitting allegations of litigation misconduct would” unfairly penalize insurers by inhibiting their attorneys from zealously and effectively representing them within the bounds permitted by law. Id. at 341 (citing International Surplus Lines Ins. Co. v. University of Wyoming Research Corp., 850 F. Supp. 1509, 1529 (D. Wyo. 1994), aff’d, 52 F.3d 901 (10th Cir. 1995). Thus, like the Palmer court, the Tenth Circuit held that “while evidence of an insurer’s litigation conduct may, in some rare instances, be admissible on the issue of bad faith, such evidence will generally, be inadmissible, as it lacks probative value and carries a high risk of prejudice.” Id.
In contrast, the Florida Fourth District Court of Appeal found such postfiling evidence admissible in a first party bad faith action against an insurer. Home Insurance Co. v. Owens, 573 So. 2d 343 (Fla. 4th DCA 1990). The insurer pled numerous defenses in its answer to the insured’s claim for breach of contract, including expiration of the policy, laches, waiver and estoppel, policy exclusions, and lack of consideration. The plaintiff-insured then amended his complaint to include a claim for bad faith. However, ultimately, the insurer admitted coverage existed for the insured for this claim.
At trial, the insured tried to admit the insurer’s pleadings into evidence. The trial court denied the admission of the pleadings. However, it did permit the insured to use the pleadings to impeach the testimony of the insurer’s claims manager. On appeal, the insurer argued that evidence relating to the insurer’s pleadings in response to the breach of contract action was inadmissible to prove bad faith. However, the Fourth District Court of Appeal found that the trial court had not committed reversible error. In support of its decision, the court cited to T.D.S. Inc. v. Shelby Mutual Insurance Co., 760 F.2d 1520 (11th Cir. 1985), for the proposition that, in a bad faith case, “the insurer’s litigation conduct [is] admissible relevant evidence.” Owens, 573 So. 2d at 344.
Similarly, the United States District Court for the Southern District of New York relied on T.D.S. Inc. v. Shelby Insurance in Journal Publishing Co. v. American Home Insurance Co., 771 F. Supp. 632 (S.D.N.Y. 1991) (applying New Mexico law). In this case, the district court granted the plaintiffs’ motion to amend the complaint to include claims for bad faith, a violation of New Mexico Unfair Trade Practices Act, and punitive damages. The defendants claimed that they were prejudiced by the proposed amendments to plaintiffs’ complaint. Specifically, the defendants objected to plaintiffs’ introduction of evidence of the insurers’ postfiling conduct. The court held that the “plaintiffs may introduce evidence of the manner in which defendants have conducted their defense to the extent that such evidence is relevant to the legally recognizable claims contained in the proposed amended complaint.” Id. at 637 (citing T.D.S. Inc., 760 F.2d at 1527).