Legislative Approaches to Bad Faith Litigation-New Appleman Insurance Bad Faith Litigation-Chapter 10

Legislative Approaches to Bad Faith Litigation-New Appleman Insurance Bad Faith Litigation-Chapter 10

    By William T. Barker, Partner, SNR Denton

Chapter 10 reviews the role of statutes in insurance bad faith litigation.  Such litigation has been primarily a creature of the common law.  But state insurance regulators also developed model statutes prohibiting various unfair claim practices and subjecting them to regulatory sanctions; those models were widely adopted, either as legislation or as regulations.  In addition to urging adoption and expansion of common-law causes of action, counsel for plaintiffs advocated recognition of implied causes of action under those statutes and regulations.  Most jurisdictions have rejected such causes of action and even some of the decisions recognizing those causes of action have been overruled, either by judicial decision or by statute.  On the other hand, a number of states have created express causes of action, either for some or all violations of the general unfair claims practices statutes or for various specifically defined unlawful practices.

Section 10.02 reviews the development of insurance regulation in the United States and the unusual commitment of most regulation to state law, now codified in the McCarran-Ferguson Act and in state statutes adopted pursuant to that Act.  One notable source for state statutes is the National Association of Insurance Commissioners, which propounds a variety of model laws, notably including a Model Unfair Claims Practices Act, some version of which has been adopted in most states.  That Model Act and its predecessors are discussed in § 10.03.

Section 10.04 examines causes of action under state unfair claim settlement practices statutes.  The cause of action for insurance bad faith has been primarily a creature of the common law.  But counsel for plaintiffs also saw an opportunity in state unfair claim practices statutes and regulations based on the NAIC models.  In addition to urging adoption and expansion of common-law causes of action, they advocated recognition of implied causes of action under those statutes and regulations.  (Defense lawyers, of course, resisted implied causes of action and urged that express causes of action be narrowly construed.)  Additionally, some states have adopted statutes not based on the NAIC models.

Section 10.04[1] examines statutes and regulations based on the NAIC models.  In jurisdictions recognizing a common law cause of action, an implied statutory cause of action adds little to the rights of an insured.  But third-party claimants might gain significant rights denied by the common law if they could assert a cause of action for “[n]ot attempting in good faith to effectuate prompt, fair, and equitable settlement of claims submitted in which liability has become reasonably clear.”  Thus, debate about the propriety of recognizing an implied statutory cause of action often focused on the reasons for allowing or not allowing such actions by third-party claimants.  Few states recognized an implied cause of action, and some of those that did have retreated, either by judicial decision or legislation.

States that have declined to recognize an implied cause of action have concluded that the statute is essentially regulatory, with purely administrative remedies, and not intended to confer private rights, especially not on third parties (a subject addressed in more detail in chapter 2).  Courts recognizing such a cause of action have relied on what they considered the strong public policy of that statute.

The prohibitions of the NAIC models were originally directed only to conduct “committed or performed with such frequency as to indicate a general business practice.”  Many state statutes still include that limitation.  In 1990, the NAIC broadened the Model Act to also prohibit violations “committed flagrantly and in conscious disregard” of the act or its implementing rules.  Whether in response to the NAIC amendment or otherwise, some states have broadened the scope of their statutes or interpreted those statutes to reach conduct other than general business practices.

Where causes of action are recognized under statutes similar to the NAIC models, it is often necessary for the underlying claim to be resolved before an unfair claim practices suit can be brought.  Unfair settlement practices claims by third-party claimants present special considerations that generally require that they be deferred until the resolution of the third party’s claim against the insured.  Evidence of insurance is inadmissible to prove liability and most jurisdictions also preclude joinder of the insurer or mention of insurance in the action against the insured, lest the jury be prejudiced.  Moreover, unless the trial against the insurer is postponed until the liability of the insured is first determined, the defense of the insured may be seriously hampered by discovery initiated by the injured claimant against the insurer.  And determination of the damages, if any, from the insurer’s failure to attempt settlement is best done after conclusion of the action against the insured.  Settlement of the underlying claim may or may not be sufficient to permit an unfair practices suit to be brought.

Absent rights flowing from a statute, third-party claimants ordinarily have few rights of their own regarding insurer refusal to settle and must rely primarily on assignments of the rights of the insureds they have sued.  And the insurer generally will not be liable to the insured unless it exposed the insured to excess or noncovered liability by mishandling the defense or failing to settle when it should have done so.  When a third-party claimant has a statutory right to have the insurer attempt settlement when liability has become reasonably clear, the most obvious consequence is that the claimant can assert a breach of this duty even if the insured was never exposed to any excess or noncovered liability.  It has even been held that an insurer’s failure to settle with the claimant is not excused by the insured’s refusal to give contractually required consent, though that holding seems unsound.  There is no clear law on the measure of damages for a claimant when an insurer has failed to make reasonable efforts to settle and the insured is potentially exposed to an excess judgment.

Section 10.04[2] examines selected state statutes.  For example, Connecticut has a statute following the NAIC models, but privately actionable by way of a consumer protection statute.

Section 10.04[2][b] analyzes the Florida Civil Remedy Act, which makes actionable certain violations of a statute based on the NAIC models, and itself prohibits certain practices.  To pursue claim under the Civil Remedy Act, plaintiffs must file civil remedy notices with the Department of Insurance and allow 60 days for the insurer to cure the violation.  A statutory action is premature until the underlying claim has been finally resolved.  In contrast to the law elsewhere, it is not a sufficient defense to a first party bad faith action that the underlying claim was fairly debatable.

Section 10.04[2][c] examines Kentucky’s common law and applicable statutes, the Kentucky Consumer Protection Act (“KCPA”) and the Kentucky Unfair Claim Settlement Practices Act (“KUCSPA”).  The latter substantially follows the NAIC Model in defining unfair practices.  It provides no express cause of action, but one has been implied.  The KCPA grants a private cause of action to “[a]ny person who purchases or leases goods or services primarily for personal, family or household purposes and thereby suffers any ascertainable loss of money or property, real or personal, as a result of the use or employment by another person of a method, act or practice declared unlawful” by the KCPA.  An insured can sue for an insurer’s failure to settle that exposes the insured to an unreasonable risk of an excess judgment    For other types of claims the insured must prove coverage, lack of a reasonable basis to deny or delay payment, and the insurer’s knowledge or reckless disregard of that lack.  Before the cause of action exists in the first place, there must be evidence sufficient to warrant punitive damages.  While the insurer is entitled to contest claims that are fairly debatable, it must debate them fairly.

Section 10.04[2][d] examines Louisiana’s various statutes authorizing recovery of penalties or damages for insurance claim handling.  A general unfair trade practices statute, largely based on the NAIC models, is not privately actionable.  Louisiana also has a number of statutes providing for penalties for unjustified delay in payment of insurance benefits, one of which also provides for award of damages; one penalizes undue delay in initiating adjustment of a loss.  In most cases, denial or delay of payment is not unjustified if there is any reasonable cause or excuse.  Third-party claimants have only limited rights under these statutes.

Section 10.04[2][e] examines Maryland’s relatively new bad faith statute.  That statute permits recovery of damages and attorneys’ fees where the insurer has failed to act in good faith.  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.”  The only case interpreting the statute is a federal case holding that the fact that the claim was fairly debatable did not preclude a finding of bad faith.  That holding is strongly criticized.

Section 10.04[2][f] examines the Massachusetts statutes permitting recovery for unfair claim practices.  A privately actionable general consumer protection statute prohibits “[u]nfair methods of competition and unfair or deceptive acts or practices in the conduct of any trade or commerce.”  Businesses can sue under this statute, but their rights are narrower than those of consumers.  Depending on which section of the statute is invoked, it may be necessary to make a pre-suit demand.  In response to a demand (or to a suit, if no demand is required), the recipient or defendant can tender a settlement that, if the court finds it reasonable, will limit the relief available to the plaintiff.  Attorneys’ fees are recoverable.  For willful violations, the court must add double the amount of damages and may add up to treble that amount. Technical violations that cause no harm are not actionable.  Both insureds and third-party claimants can complain about failure to settle.  But no statutory duty to do so arises until both liability and the amount of damages are “reasonably clear.”  Liability is “reasonably clear” when “’a reasonable person, with knowledge of the relevant facts and law, would probably have concluded, with good reason, that the insurer was liable to the plaintiff.’”  First-party claims must be investigated and, when liability is reasonably clear, settled.

Section 10.04[2][g] examines the Montana statutes prohibiting unfair insurance claim practices.  The Unfair Trade Practices Act (“UTPA”) is not privately actionable by an insured or claimant except as provided by Mont. Code § 33-18-242.  Certain practices are actionable, but “[a]n insurer may not be held liable under this section if the insurer had a reasonable basis in law or in fact for contesting the claim or the amount of the claim, whichever is in issue.”  At common law, that principle normally means that the insurer need not fear a bad faith action if it has a reasonable prospect of defeating the claim and there ordinarily can be no bad faith liability if the insurer is not actually liable for contract benefits.  But the Montana Supreme Court does not read the statute that way.  An insurer can be liable for refusing to settle a third-party claim for which liability was “reasonably clear,” even if the insurer succeeded in defeating that claim in the underlying action.  Attorneys’ fees are not recoverable.  Both insureds and third-party claimants can complain about failure to settle, but “[a] third-party claimant may not file an action under this section until after the underlying claim has been settled or a judgment entered in favor of the claimant on the underlying claim.”

Section 10.04[2][h] examines Pennsylvania’s bad faith statute, which provides for recovery punitive damages, penalty interest, and attorneys’ fees.  While the statute makes no express provision for compensatory damages for consequential harms, such damages are sometimes recoverable under the common law for breach of the duty to settle  With respect to first-party claims, "To prove bad faith, a plaintiff must show by clear and convincing evidence that the insurer (1) did not have a reasonable basis for denying benefits under the policy and (2) knew or recklessly disregarded its lack of a reasonable basis in denying the claim.”  In the absence of coverage, there is no bad faith claim.  First-party standards apply to uninsured/underinsured motorist claims.

Section 10.04[2][i] examines Texas statutes authorizing suits for unfair claim practices.  Texas has long recognized a common-law cause of action when an insured suffers an excess judgment due to the insurer’s negligent rejection of a within-limits settlement opportunity.  More recently, it recognized a common-law cause of action for failure, without a reasonable basis, to provide first-party benefits.  These common-law remedies have now been supplemented by (largely parallel) statutory causes of action that provide more extensive remedies and, so, may effectively supplant the common-law causes of action. 

In an action under the Insurance Code, a prevailing plaintiff may recover actual damages and attorneys’ fees; if the trier of fact finds “that the defendant knowingly committed the act complained of, the trier of fact may award an amount not to exceed three times the amount of actual damages.”  With minor exceptions, a plaintiff suing under the Insurance Code must first give the defendant notice of the complaint and of the damages claimed.  A person receiving a notice may make a settlement offer within 60 days.  If such an offer is rejected and the plaintiff fails to recover a larger amount, any recovery of attorneys’ fees is limited to those incurred before the offer.

Consumers may also sue under the Deceptive Trade Practices Act (“DTPA”).  A prevailing consumer may recover economic damages found by the trier of fact.  “If the trier of fact finds that the conduct of the defendant was committed knowingly, the consumer may also recover damages for mental anguish, as found by the trier of fact, and the trier of fact may award not more than three times the amount of economic damages.”  If the trier of fact finds the conduct was committed intentionally, up to three times the mental anguish damages may also be awarded.  A prevailing consumer is also entitled to an award of attorneys’ fees.  Claims under the DTPA are subject to requirements of notice and offer of settlement similar to those under the Insurance Code.

Texas has a prompt payment statute, governing first-party claims and authorizing penalty interest at 18% per annum, together with reasonable attorneys’ fees, where an insurer that is liable for a claim fails to comply with the requirements of the statute.  These remedies are cumulative to any others provided by law.  For purposes of this statute, a first-party claim may include an insured’s claim for provision of a defense under a liability insurance policy.

Section 10.04[2][j] examines Washington statutes authorizing recovery for bad faith.  Washington recognizes common law tort actions for unreasonable failure to protect an insured from exposure to liability in excess of policy limits. Washington also has several statutory provisions that may directly or indirectly provide grounds of liability for unfair claim practices.  Rather than enacting an unfair practices act, Washington has authorized the Commissioner to define unfair or deceptive acts or practices in the business of insurance.  The Commissioner has exercised this authority by promulgating regulations.   Among the defined practices are various unfair claim settlement practices, including many based on the NAIC model act.  There is no direct private action for violation of the regulations, but causes of action are available under the Consumer Protection Act, which permits recovery of both damages and attorneys’ fees, plus a discretionary amount up to treble damages, but capped at $25,000.  A denial of coverage does not constitute an unfair or deceptive act or practice as long as it is based on reasonable conduct of the insurer.

Washington also now has a specific statute directed to unreasonable denial of coverage or benefits to first-party claimants, enacted by referendum in 2007.  It authorizes recovery of actual damages plus attorneys’ fees and litigation costs, including expert witness fees.  The superior court has discretion to increase the award to treble the actual damages.  Before filing any suit under this statute, the claimant must give notice to the insurer and the Commissioner of the basis for the cause of action and allow the insurer twenty days to resolve the basis for the claim.

Section 10.04[2][k] examines the interaction of West Virginia statutes with its unique common law “Hayseeds rule.  The West Virginia Unfair Trade Practices Act (“UTPA”) largely follows the NAIC model, and includes a subsection on unfair claim settlement practices, forbidding them when committed or performed with such frequency as to indicate a general business practice.  The West Virginia Supreme Court held that this statute supported an implied cause of action.  More recently, the legislature has precluded any private cause of action by a third-party claimant.  The case law under the UTPA is intertwined with development of a unique West Virginia common law rule, adopted in Hayseeds, Inc. v. State Farm Fire & Casualty. Under that rule, a policyholder who “substantially prevails” in litigation to obtain first-party insurance benefits may be entitled, without proving any bad faith, to recover attorneys fees, damages for net economic loss from delayed payment, and an award for aggravation and inconvenience.

The requirements for recovering punitive damages are ostensibly strict:

punitive damages for failure to settle a [first-party claim] shall not be awarded against an insurance company unless the policyholder can establish a high threshold of actual malice in the settlement process. By "actual malice" we mean that the company actually knew that the policyholder's claim was proper, but willfully, maliciously and intentionally denied the claim.

But the court’s application of that standard is less protective of insurers than the words would suggest.

The West Virginia court has extended the basic Hayseeds rule: an insurer must “promptly conduct a reasonable investigation of the policyholder's loss based upon all available information. On the basis of that investigation, if liability to the policyholder has become reasonably clear, the insurance carrier must make a prompt, fair and equitable settlement offer.”  Failure to do so may be taken into account in determining whether the insured has substantially prevailed.  More generally, the entire settlement negotiations must be considered.

While a policyholder who “substantially prevails” on a claim for benefits can recover under Hayseeds without any need to show bad faith, an insured who did not substantially prevail in a coverage action can still pursue a UTPA action.  Among the practices prohibited by the UTPA (if part of a general business practice of violation) are “refusing to pay claims without conducting a reasonable investigation based upon all available information” and “not attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear.”  Because a plaintiff must show that the defendant had a general business practice of violating the UTPA, discovery regarding other claims is proper.  But a court should not compel discovery that is oppressive and unduly burdensome; a demand for nationwide discovery regarding other claims has been limited to West Virginia claims.  Punitive damages may be recovered for violation of the UTPA.  But to recover punitive damages, the plaintiff must show that the insurer “knew [the] claim was proper and willfully, maliciously, and intentionally delayed payment in order to attempt to obtain a less than just settlement.”

Section 10.05 considers the relevance of unfair claim settlement practices statutes to common-law causes of action.  Plaintiffs seek to draw an analogy to the role of statutes in the law of negligence.  Negligence law involves determinations of what constitute reasonable precautions to take against risks of bodily injury, property damage, or other interests protected against negligent invasion.  Bad faith law arguably involves determinations about what constitutes reasonable conduct in the handling of insurance claims.  To the extent that a statute or regulation indicates what is reasonable, it might establish a standard of conduct or at least provide evidence of what conduct might be required.  In general, the cases have not held violations of unfair claim practices statutes or regulations to be bad faith per se.  But some cases hold that such statutes or their violation may be considered in one way or another.

Section 10.06 examines statutes authorizing recovery of attorneys’ fees, interest and/or penalties on insurance claims.  Where some statute allows recovery of damages for bad faith, that statute commonly allows recovery of attorneys’ fees as well.  And where either a statute or the common law allows recovery of damages for bad faith, the fees incurred to obtain contract benefits that were denied in bad faith may be recoverable as an element of damages.  Some states have statutes allowing insureds to recover attorneys’ fees as a matter of course when they prevail in a suit regarding coverage (either generally or with regard to particular kinds of coverage, such as no-fault auto insurance).  Other statutes provide for attorneys’ fees and/or interest at a penalty rate if there is substantial delay in payment, without any showing that the delay was undue.  And some states provide for recovery of attorneys’ fees, penalties and/or penalty interest where the insurer’s conduct would be characterized as bad faith in a jurisdiction allowing recovery for bad faith.  In general, the standards under such statutes are similar to those for first-party bad faith, in jurisdictions recognizing that cause of action.  Statutes of the types described usually do not provide any rights to third-party claimants.  Under some statutes, it is significant whether and when the insured or claimant made a demand.

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.  He is a co-author (with Ronald D. Kent) of New Appleman Insurance Bad Faith Litigation, Second Edition and author or co-author of chapters of New Appleman on Liability Insurance, Second Edition; has published over 100 articles, and speaks frequently on insurance and litigation subjects.  He has been described as the leading lawyer-commentator on the connections between procedure and insurance.  See Charles Silver & Kent Syverud, The Professional Responsibilities of Insurance Defense Lawyers, 45 Duke L.J. 255, 257 n.4 (1995).  He is a member of the Editorial Board of New Appleman on Insurance Law and New Appleman Insurance Law Practice Guide.  Mr. Barker is a member of the American Law Institute.

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