By William T. Barker, Kirk R. Ruthenberg and Kenneth J. Pfaehler
Maryland common law never recognized a cause of action for first-party insurance bad faith. Johnson v. Federal Kemper Ins. Co., 74 Md. App. 243 (1988). But Maryland created private statutory rights, effective October 1, 2007. A federal district court has decided the first significant case under the statute. Ceclila Schwaber Trust Two v. Hartford Acc. & Indemn. Co., 636 F. Supp. 2d 481 (D. Md. July 14, 2009). This commentary reviews that case and analyzes the statutory standard of liability in light of the case.
The statute provides both judicial and administrative remedies where a first-party insurer has failed to act in good faith. These include award of actual damages (not exceeding the policy limit), expenses and litigation costs, an increased rate of prejudgment interest (10% instead of 6%), and (in administrative proceedings only) penalties of up to $125,000 for each violation. The statute provides that "[g]ood faith means an informed judgment based on honesty and diligence supported by evidence the insurer knew or should have known at the time the insurer made a decision on a claim."
In Ceclila Schwaber Trust Two v. Hartford Accident & Indemnity Co., the insured sought benefits for snow and ice damage to a warehouse roof in 2003 and for bad faith in adjusting the claim. Initially, Hartford denied the claim on the ground that the damage resulted from long-term water damage. It later agreed that about 5% of the damage was covered but concluded that the remainder of the loss was attributable to faulty workmanship, maintenance, and wear and tear. The property was then sold at a discount in the amount of the estimated cost of replacing the roof, and suit was filed. The court found material issues of fact on coverage, precluding summary judgment for either party.
Hartford then moved for summary judgment on the bad faith claim, arguing that the existence of factual issues meant that the claim was fairly debatable and that, under bad faith law almost everywhere outside Maryland, that precludes a finding of bad faith. The court recognized that other jurisdictions generally hold that an insurer when a claim is fairly debatable, then "'the insurer is entitled to debate it' and will not be subject to liability for acting in bad faith.'" But the court found no indication that the Maryland General Assembly intended this narrow construction of the Statute. In its view, the statutory definition:
focuses on the actions taken by the insurer in forming a judgment as to coverage, as well as what the insurer knew or should have known at the time it denied coverage to its insured. In the cases cited above, the fairly debatable standard was created by courts simultaneously with the creation of a common law cause of action for bad faith; there was no controlling statute. In this case, however, the cause of action arises pursuant to a statute, and the court must follow the statutory language. Moreover, the action here is for failure to act in "good faith," as opposed to an action for "bad faith." Maryland courts have indicated that the two are not the same.
In analyzing this holding, this commentary begins by reviewing the reasons why the "fairly debatable" rule is a bedrock doctrine of bad faith law elsewhere. As the commentary explains:
The purposes underlying the bad faith tort dictate the substantive standard of liability. That standard specifies what facts must be proven. The law of bad faith represents a balance between two competing interests: "the right of an insurer to reject an invalid claim and the duty of the carrier to investigate and pay compensable claims." [Citation omitted.] The tort is recognized to protect the insured's right to payment. But the insurer's right to challenge validity limits the circumstances in which liability may be imposed for non-payment, even if the claim ultimately proves meritorious. Both interests must be considered in defining the substantive legal standard.
Insureds who have suffered losses are especially vulnerable to abusive practices where an insurer exploits the insured's need for funds by bargaining for a reduced payment, even if there is no real question that benefits are due. Bad faith law seeks to control this abuse by providing enhanced liability for an insurer which refused a payment it knew or (had it properly investigated) should have known was due.
But countervailing concerns limit the basis on which liability can be imposed. As the commentary explains:
An insurer's right to contest questionable claims is more than an ordinary contractual right: it serves an important public interest. Insurance rates are based on insurers' predictions of the claims they will be required to pay. If erroneous denial of a claim can result in expensive tort remedies, insurers may feel compelled to pay questionable claims rather than risk such liability. This is a particular concern with possibly fraudulent claims, where any impropriety of the claim will have been assiduously concealed and may only be detectable by expensive investigation and resort to circumstantial evidence. Such payments, or the expectation of having to make them, would tend to inflate costs for those wishing only coverage for the risks specified in the contract.
Accordingly, almost all jurisdictions recognizing extracontractual liability for bad faith hold that an insurer may safely deny a claim, without exposing itself to bad faith liability, so long as the insured's entitlement to the benefits withheld is fairly debatable.
This commentary examines the language of the statute and relevant Maryland case law to conclude that, contrary to Ceclila Schwaber Trust Two, this rule ought to be applied under the Maryland statute. [Portions of this commentary are drawn from William T. Barker & Ronald D. Kent, The New Appleman Insurance Bad Faith Litigation (2009).]
William T. Barker is a partner in the Chicago office of SNR Denton with a nationwide practice representing insurers in complex litigation, including matters relating to coverage, claims handling, sales practices, risk classification and selection, agent relationships, and regulatory matters.
Kirk R. Ruthenberg is a senior litigation partner who has practiced law at SNR Denton for over 27 years, headed the firm's Litigation Practice in the Washington, D.C. office for nearly two decades, and now devotes full time to his litigation practice.
Kenneth J. Pfaehler is a partner in the Washington, D.C. office of SNR Denton. Mr. Pfaehler's practice centers on complex litigation matters. He has extensive experience in litigating cases involving insurance coverage and insurance bad faith.
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