Insurance Bad Faith

Bad Faith Defenses of Insurer

Every contract, including an insurance policy, contains an implied covenant that both parties will exercise good faith and fair dealing so that the other party's right to the benefits of the agreement is not hindered. A breach of such duty may result in bad faith litigation.

Duties of insurer

An insurer is required to exercise good faith and fair dealing in handling its own insured's claims properly, defending the insured in a third-party action, and settling a third-party action against the insured when necessary.

Breach by insurer

A breach by an insurer of its duty of good faith and fair dealing with regard to handling an insured's claims, defending the insured, and settling actions against the insured is found under different circumstances in different jurisdictions. Some courts find a breach if the insurer acted unreasonably. Other courts require the insured to show that the insurer consciously committed a wrong because of a dishonest purpose, moral obliquity, or ill will.

If the insurer breaches its duty with respect to any of its obligations under the policy, the insured may bring a bad faith action against it under either contract or tort law. Although the potential for a bad faith claim is real, the insurer may continue to contest claims that it reasonably believes are not covered and try cases that it reasonably believes should not be settled.

Insurer's defenses

An insurer's defenses to a bad faith claim may vary greatly, depending on the jurisdiction. Some states treat the claim as a contract action while others treat it as a tort. Some states have statutes that address the issue. Thus, the insurer's counsel should conduct a thorough investigation of state law to determine how to proceed in the defense. The following are some general approaches to defenses.

Sufficiency of the complaint

At the outset, the insurer may challenge the sufficiency of the insured's complaint. Some bad faith complaints attempt to assert private causes of action under the state's Unfair Claims Practices Act, but most courts do not permit such a private cause of action under that Act.

"Comparative" or "reverse" bad faith

The insurer may assert that the insured exhibited bad faith, resulting in loss to the insurer. Comparative bad faith is an affirmative defense to the insured's action. Courts will analyze the insured's conduct along the lines of a contributory negligence standard. Reverse bad faith is a claim by the insurer for affirmative relief (e.g., the insured acted fraudulently). Some jurisdictions have rejected one or both of these claims. In jurisdictions that allow an excess insurer to bring a bad faith claim against a primary insurer, the primary insurer may attempt to assert a comparative fault claim against the excess insurer.

Standard of proof

An insurer may defend on the ground that an insured did not meet his burden of proof. Some states require the insured to prove bad faith by a preponderance of the evidence. Other states require proof by the more stringent burden of clear and convincing evidence.

Fairly debatable question

An insurer may directly attack the claim of bad faith by arguing that its denial of coverage was based on a fairly debatable question. For example, it construed the meaning of an ambiguous policy provision, upon which reasonable minds could differ, so as to deny coverage.

Time Limitation

The suit limitation clause in the policy that requires the commencement of a suit within a certain time may bar an insured's action. However, if the court treats the bad faith claim as an independent action in tort rather than as arising under the contract, the contractual suit limitation clause may not be applicable. Similarly, if the bad faith claim is a statutory cause of action, the contractual suit limitation clause may not be applicable.

The insurer should also determine if the insured's action is untimely under the state's statute of limitations for either a contract action or a tort action.

Advice of counsel

An insurer may be able to defend its actions based on the assertion that it followed the advice of its counsel. Such a defense is an attempt to show that the insurer did not act in bad faith because it had proper cause for its decisions. The defense may also enable the insurer to mitigate claimed punitive damages for the insurer's lack of intent. In order to assert the defense, the insurer must show that it disclosed to the attorney all information necessary to make the coverage decision, that the attorney acted as the insurer's attorney in providing the advice, that the insurer relied on the attorney's advice in good faith, and that the insurer acted on the advice. However, the insurer should be aware that asserting the advice of counsel defense waives the attorney-client privilege as to communications relating to the advice. Thus, the decision of whether to assert the defense is critical.

Proximate cause

Once an insured establishes that an insurer breached its duty of good faith and fair dealing, he must then prove that the breach was the proximate cause of his damages. The insurer may argue that causation is lacking. For example, the insurer may attempt to argue that the third party who sued the insured would not have accepted a settlement; therefore, the third party's conduct was a superseding cause of the insured's injury. The insurer may also argue that its failure to investigate the third party's claim did not cause damage because an investigation would have disclosed a reasonable basis for the insurer's failure to settle.

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