Insurance bad faith is a legal term of art unique to the law of the United States that describes a tort claim that an insured person may have against an insurance company for its bad acts. Under the law of most jurisdictions in the United States and in California, insurance companies owe a duty of good faith and fair dealing to the persons they insure. This duty is often referred to as the “implied covenant of good faith and fair dealing” which automatically exists by operation of law in every insurance contract. If an insurance company violates that covenant, the insured person (or “policyholder”) may sue the company on a tort claim in addition to a standard breach of contract claim. The contract-tort distinction is significant because as a matter of public policy, punitive or exemplary damages are unavailable for contract claims, but are available for tort claims. The result is that a plaintiff in an insurance bad faith case may be able to recover an amount larger than the original face value of the policy, if the insurance company’s conduct was particularly egregious.
Insurance Bad Faith Defined
An insurance company has many duties to its policyholders. The kinds of applicable duties vary depending upon whether the claim is considered to be “first party” or “third party.” A common first party context is when an insurance company writes insurance on property that becomes damaged, such as a house or an automobile. In that case, the company is required to investigate the damage, determine whether the damage is covered, and pay the proper value for the damaged property.
Bad faith in first party contexts often involves the insurance carrier’s improper investigation and valuation of the damaged property (or its refusal to even acknowledge the claim at all). Bad faith can also arise in the context of first party coverage for personal injury such as health insurance or life insurance, but those cases tend to be rare.
Third party situations (essentially, liability insurance) break down into at least two distinct duties, both of which must be fulfilled in good faith. First, the insurance carrier usually has a duty to defend a claim (or lawsuit) even if some or most of the lawsuit is not covered by the insurance policy. Unless the policy is expressly structured so that defense costs “eat away” at the policy limits (a so-called “burning limits” policy), the default rule is that the insurer must cover all defense costs regardless of the actual limit of coverage. In California and most states, there is a strong bias in favor of finding coverage.
Second, the insurer has a duty of indemnification, which is the duty to pay a judgment against the policyholder, up to the limit of coverage, but only if the judgment is for a covered act or omission. As a result, most insurance companies exercise a great deal of control over litigation.
Bad faith can occur in either situation—by improperly refusing to defend a lawsuit or by improperly refusing to pay a judgment or settlement of a covered lawsuit.
In California, third party coverage also contains a third duty, the duty to settle a reasonably clear claim against the policyholder within policy limits, in order to avoid the risk that the policyholder may be hit with a judgment in excess of the value of the policy (which a plaintiff might then attempt to satisfy by writ of execution on the policyholder’s assets). If the insurer breaches in bad faith its duties to defend, indemnify, and settle, it may be liable for the entire amount of any judgment obtained by a plaintiff against the policyholder, even if that amount is in excess of policy limits.
Examples of bad faith include undue delay in handling claims, inadequate investigation, refusal to defend a lawsuit, threats against an insured, refusing to make a reasonable settlement offer, or making unreasonable interpretations of an insurance policy.
In some cases, punitive damages are warranted against insurance companies as a mechanism to prevent future behavior.
In California, the plaintiff in a bad faith action may be able to recover some of its attorneys’ fees separately and in addition to the judgment for damages against a defendant insurer, but only up to the extent that those fees were incurred in recovering tort damages (for breach of the implied covenant) as opposed to contractual damages (for breach of the terms of the insurance policy). The allocation of attorneys’ fees between those two categories is usually a question of fact (meaning it usually goes to the jury).
Bad Faith When an Insurance Company Illegally Cancels Your Insurance
Sometimes, an insurance company will cancel (rescind) your insurance policy retroactively after you file a legitimate claim. This practice is known as insurance rescission. In California, post claims underwriting (investigating an insured’s application after a claim is filed) is illegal. Unfortunately for policyholders, many large insurers still illegally rescind insurance policies. When they do, this is also an act of insurance bad faith for which the insured is entitled to damages.
Assignment or Direct Action in a Bad Faith Action
In some U.S. states, bad faith is even more complicated because under certain circumstances, a liability insurer may ultimately find itself in a trial where it is being sued directly by the plaintiff who originally sued its insured. This is allowed through two situations: assignment or direct action.
The first situation is where an insured abandoned in bad faith by its liability insurer makes a special settlement agreement with the plaintiff. Sometimes this occurs after trial, where the insured has attempted to defend himself or herself by paying for a lawyer out of pocket, but went to verdict and lost (the actual situation in the landmark Comunale case); other times it occurs before trial and the parties agree to put on an uncontested show trial that results in a final verdict and judgment against the insured. Either way, the plaintiff agrees to not actually execute on the final judgment against the insured in exchange for an assignment of the assignable components of the insured’s causes of action against its insurer.
The second situation is where the plaintiff does not need to obtain a judgment first, but instead proceeds directly against the insured’s insurer under a state statute authorizing such a “direct action.” These statutes have been upheld as constitutional by the U.S. Supreme Court.
Bad Faith Insurance Litigation
Bad faith lawsuits may result in large awards of punitive damages. Bad faith cases may also be slow, at least in the third party context, because they are necessarily dependent upon the outcome of any underlying litigation.
In many situations, you must obtain a verdict in excess of the at-fault party’s policy limits and then proceed against the insurance company for their failure to reasonably settle the claim when they had the chance within limits.
In 2003, Stuart Chandler obtained a Bad Faith Insurance verdict on behalf of his client against Fire Insurance Exchange for failing to defend its insured. The jury returned a verdict for Mr. Chandler’s client, a farm work, in excess of $26 million dollars. Fire Insurance Exchange is a subsidiary of Farmers Insurance Exchange.
Contact Chandler Law Today for a Free Case Consultation
If you have been a victim of bad faith acts by your insurance company, contact The Chandler Law Firm today at (559) 431-7770. The Chandler Law Firm is well known for equaling the playing field when it comes to their dealings with multi-billion dollar insurance companies.