Sentinel. The Bad Faith

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1 Contacts: Matthew M. Haar Joseph C. Monahan Amy L. Piccola Matthew J. Antonelli A.J. Kornblith Patrick F. Nugent Meghan Talbot Author: Simeon Poles Insurance Practice Standing guard on developments in the law of insurance bad faith around the country CONTENTS Supreme Court of Louisiana: Bad Faith Failure to Settle Does Not Require Firm Offer and Insurer s Potential Liability Extends to Misrepresentations and Failures to Disclose Facts Unrelated to pages 1-2 Middle District of Pennsylvania Denies Multiple Challenges to Privileged Documents Redacted by Insurer in Bad Faith Claim Related to Uninsured Motorist pages 3-4 Sixth Circuit Court of Appeals Rules That Kentucky Supreme Court Would Not Recognize Reverse Bad Faith Claim pages 4-5 Supreme Court of Louisiana: Bad Faith Failure to Settle Does Not Require Firm Offer and Insurer s Potential Liability Extends to Misrepresentations and Failures to Disclose Facts Unrelated to Kelly v. State Farm Fire & Cas. Co., No CQ-1921 (La. May 5, 2015). Answering certified questions from the Fifth Circuit Court of Appeals, the Supreme Court of Louisiana finds an insurer can be liable for (1) bad faith failure to settle where no firm settlement offer was received, and (2) misrepresenting or failing to disclose facts that are not related to coverage. In November 2005, Danny Kelly was injured in an automobile accident with Henry Thomas, an insured of State Farm. Kelly suffered a fractured femur in the accident and spent six days in the hospital, incurring $26,803 in medical expenses. In January 2006, Kelly s attorney mailed a letter to State Farm enclosing Kelly s medical records and stating that he would recommend that his client release State Farm and Thomas from liability in exchange for payment of the policy limits; State Farm did not immediately respond. In March 2006, State Farm offered to settle the case for the policy limits of $25,000. Kelly s attorney rejected the offer and filed suit against Thomas. Later that day, State Farm sent Thomas a letter telling him that he had potential liability exposure and suggesting that he retain independent counsel. State Farm did not specifically inform Thomas of Kelly s medical expenses, its communications with Kelly s attorney, or its policy limits offer. At trial, Kelly secured a verdict against Thomas for $176,464 plus interest. State Farm then tendered its policy limits of $25,000. Thomas and Kelly subsequently entered a compromise agreement in which Thomas assigned his rights to Kelly to pursue a bad faith claim against State Farm, and Kelly agreed not to enforce the judgment against Thomas s personal assets. Delaware Maryland Massachusetts New Jersey New York Pennsylvania Washington, DC

2 Kelly sued State Farm in Louisiana state court and the insurer removed the case to federal district court. The district court addressed two issues: 1) whether State Farm had a duty to notify its insured of Kelly s initial letter; and 2) whether State Farm s failure to accept Kelly s January 2006 settlement offer constituted bad faith. State Farm moved for summary judgment on both claims. The district court granted summary judgment on the first claim, finding that State Farm had no duty to notify Thomas of the January 2006 letter because the letter did not constitute a settlement offer. As to the second claim, the district court denied summary judgment because, at trial, Kelly might be able to prove that State Farm acted in bad faith by failing to settle his claim. Upon State Farm s motion for reconsideration, the district court revised its opinion and granted summary judgment in full based on State Farm s argument that the court s determination that the letter was not a settlement offer necessarily precluded liability on the failure to settle claim. Kelly appealed to the Fifth Circuit, which heard the matter in a three-judge panel. Initially, the court affirmed dismissal of the failure to settle claim and reversed dismissal of the claim that State Farm had a duty to inform its insured of the initial letter. Upon petitions for rehearing by both parties, the Fifth Circuit withdrew its opinion and, noting an absence of controlling precedent under Louisiana law, certified two questions to the Louisiana Supreme Court. Specifically, the Louisiana Supreme Court was asked to determine: 1) whether an insurer can be found liable for a bad faith failure to settle a claim when the insurer never receives a firm settlement offer; and 2) whether an insurer is liable for misrepresenting or failing to disclose facts that are not related to the insurance policy s coverage. The Court, after noting that bad faith failure to settle is a recognized cause of action in Louisiana, narrowed the issue presented by the first question to whether an insurer s affirmative duty to make a reasonable effort to settle claims is triggered only by receipt of a firm settlement offer. The Court noted that Louisiana s bad faith statute contained no reference to a firm settlement offer and determined that imposing such a requirement would exceed its powers of statutory interpretation. The Court also addressed two practical considerations of making a finding of bad faith contingent upon receipt and rejection of a firm settlement offer. First, the Court found that insureds do not control whether an offer is made and, consequently, an insurer s obligation to act in good faith is triggered by knowledge gathered during its investigation of the claim. Second, the Court rejected State Farm s assertion that insurers will be uncertain of whether they are acting in bad faith absent a requirement that they receive a firm offer to settle. Accordingly, the Court found that an insurer could be found liable for bad faith failure to settle under Louisiana law in the absence of a firm settlement offer. The Court then turned to the question of whether an insurer can be liable for misrepresenting or failing to disclose information unrelated to insurance coverage. Noting a split between state appellate courts on the question, the Court determined that resolution of the question turned on the function of the word or in Louisiana s bad faith statute, which prohibits [m] isrepresenting pertinent facts or insurance policy provisions relating to any coverages at issue. According to the Court, when viewed in the context of the statute as a whole, this prohibition is meant to address communications from insurers that either state untruths or fail to state the truth. According to the rules of statutory interpretation enshrined in Louisiana law, the Court was required to read the or as purely disjunctive, meaning that an insurer can be liable for misrepresenting either: 1) pertinent facts, or 2) insurance policy provisions relating to any coverages at issue. After receiving the Supreme Court s opinion, the Court of Appeals vacated the judgment of the District Court and remanded the case to the district court for further proceedings consistent with the Supreme Court s analysis. 2

3 Middle District of Pennsylvania Denies Multiple Challenges to Privileged Documents Redacted by Insurer in Bad Faith Claim Related to Uninsured Motorist Lane v. State Farm Mut. Auto. Ins., No. 3:14-CV (M.D. Pa. May 18, 2015). Insured not entitled to compel production of un-redacted documents revealing pre- and post-complaint communications protected by work product and attorney client privilege. On August 31, 2011, James Lane was injured in an automobile accident. Lane s State Farm automobile insurance policy carried uninsured/underinsured motorist coverage of $100,000. A month after he submitted his claim to State Farm, Lane s damages were assessed at an inquest in the Supreme Court of New York, Orange County. Despite having notice of the proceeding, State Farm did not attend the inquest. Lane received a judgment in the amount of $200,000. State Farm asked for and received numerous medical authorizations to obtain Lane s records and eventually examined Lane under oath, but did nothing else to resolve the claim. In March 2013, Lane demanded that State Farm settle the UM claim for $100,000; State Farm countered with an offer of $27,000. Unsatisfied, Lane filed suit in Pike County, Pa., alleging that State Farm acted in bad faith by refusing to settle his claim. State Farm removed the action to federal court for the Middle District of Pennsylvania. Lane filed a motion to compel production of various documents from State Farm related to State Farm s claims handling and reserve process. Lane s motion presented three issues for resolution by the court: 1) whether post-complaint mental impressions of State Farm employees constitute work-product; 2) whether the procedures for setting reserves and the reserve history of the claim are irrelevant, confidential, and/or privileged; and 3) whether the portions of State Farm s evaluation of the claim containing mental impressions of defense counsel are protected by attorney-client privilege. In its privilege log, State Farm noted that it redacted portions of its claims log, which were created after Lane filed suit. State Farm contended that those entries were created in anticipation of litigation and contained mental impressions of counsel, and thus were not discoverable. In his motion, Lane argued that the mental impressions contained in those two pages of redacted claims log entries were necessarily relevant to a bad faith claim and that State Farm s continuing evaluation of his UM claim entitled him to discovery of records and materials post-dating the litigation. The Court rejected Lane s arguments for three reasons: 1) Lane failed to put forward plausible justifications as to how post-complaint mental impressions could be relevant to the facts of his claim; 2) courts of the Third Circuit have held that the mere existence of a bad faith claim does not make otherwise privileged information per se discoverable; and 3) Lane was unable to demonstrate the substantial need required for production of the two pages in question under the Federal Rules of Civil Procedure. The Court relied upon similar reasoning in dismissing Lane s arguments that he was entitled to receive un-redacted copies of documents containing pre-complaint attorney communications and work product. Lane argued that he was entitled to receive the documents because attorney communications may be discoverable when they are put at issue in the litigation, but failed to provide an explanation as to how this general principle applied to his motion. The Court noted that State Farm never asserted an advice of counsel defense and declared that if a mere relationship to a lawsuit was all that was required to make documents discoverable, the privilege would essentially [be] obliterate[d]. Finally, the Court addressed the discoverability of State Farm s reserve history for Lane s claim. Lane submitted a document request seeking both copies of the reserve history and changes thereto, as well as the insurer s methods and criteria for setting reserves. State Farm objected to production on 3

4 the grounds that the reserve history was irrelevant and its methods for setting reserves were privileged. Lane argued that because his claim centered on a dispute with State Farm as to the appropriate value of the claim, he should be entitled to receive information related to the reserve history and pro- cedures. The Court disagreed, finding that Lane presented an insufficient basis to overcome his burden of proving that the reserve materials were relevant or discoverable. Therefore, the court denied Lane s motion to compel discovery in total. Sixth Circuit Court of Appeals Rules That Kentucky Supreme Court Would Not Recognize Reverse Bad Faith Claim State Auto Prop. and Cas. Ins. Co. v. Hargis, No (6th Cir. May 6, 2015). Sixth Circuit Court of Appeals denies motion for certification of questions to the Kentucky Supreme Court regarding viability of reverse bad faith claims on basis that insurer provided insufficient evidence to conclude Court would adopt the claim under Kentucky law. On December 9, 2007, Lori Hargis s home burned to the ground under suspicious circumstances. After the fire, Hargis submitted an insurance claim for $866,000 and collected more than $425,000 from State Auto. State Auto subsequently alleged that Hargis violated provisions of the policy regarding intentional loss and concealment or fraud by setting or conspiring to set the fire, and by falsifying the amount of property losses she suffered. State Auto filed suit in Kentucky state court to void the policy. Hargis removed the case to federal district court and filed counterclaims against State Auto for breach of contract and bad faith under Kentucky common law, the Kentucky Consumer Protection Act ( KCPA ), and the Kentucky Unfair Claims Settlement Practices Act ( KUCSPA ). State Auto survived Hargis s summary judgment motion on the breach of contract claim when it demonstrated the existence of a genuine issue of material fact regarding its arson defense by presenting circumstantial evidence of Hargis s motive and opportunity to commit the crime. The case never went to trial. Under the weight of the insurer s mounting evidence, Hargis was forced to admit she had solicited a friend to commit the arson in order to collect money on the insurance claim. Both Hargis and her co-conspirator were indicted in January 2011 for conspiracy to use fire to commit wire fraud in violation of 18 U.S.C. 844(h) and (m), a charge to which Hargis pleaded guilty. State Auto moved for summary judgment on Hargis s bad faith claims, and the district court granted the motion on the basis that State Auto s refusal to pay was at least debatable in light of Hargis s subsequent indictment. The insurer also amended its complaint to include claims for insurance fraud and reverse bad faith, and moved for summary judgment on all other pending claims. Hargis s sole opposition was to summary judgment on the reverse bad faith claim. The district court denied summary judgment on the reverse bad faith claim because State Auto provided no case law showing that such claims were recognized in any jurisdiction. State Auto appealed the ruling and then requested that the district court certify to the Kentucky Supreme Court the question of whether a reverse bad faith claim would sound in tort under Kentucky law. After the district court refused to certify the question because the claim was no longer pending before it, State Auto repeated its request to the Sixth Circuit Court of Appeals. State Auto argued that the Kentucky Supreme Court would adopt the claim of reverse bad faith because it had previously shown a willingness to expand on and create new claims under Kentucky law. However, the Sixth Circuit observed that such expansions occurred in light of the state Supreme Court s consideration of how other courts have addressed the issue. Unable to present supporting case law from other jurisdictions, State Auto argued in the alternative that 4

5 the implied covenant of good faith and fair dealing imposes contractual obligations on both the insurer and the insured. In light of those obligations, State Auto argued it was unjust for the law to require the insurer to observe the covenant without requiring the insured to do so as well. Moreover, State Auto complained that reverse bad faith claims were a necessary tool to prevent insureds from lodging costly bad faith claims against the insurer with comparatively little or no risk for themselves. In response, the court examined Kentucky law on the implied covenant of good faith and fair dealing, noting that Kentucky law only recognizes a tort claim for breach of the covenant where the insured and the insurer were in a special relationship and distinct elements are present, such as: unequal bargaining power, vulnerability, and trust between the parties; nonprofit motivations for contracting (e.g., peace of mind, security); and inadequacy of standard contract damages. The court found that such reasoning cut against State Auto s argument that the mutuality of the implied contractual obligation alone would lead the Kentucky Supreme Court to adopt a common law tort for reverse bad faith. Next, the court examined the state s bad faith jurisprudence and observed that the Kentucky Supreme Court recognized first-party tort claims for bad faith because of the presence of the special relationship between an insurer and its insured and the kind of distinct elements that are recognized as giving rise to an independent tort claim for bad faith. However, while the Kentucky Supreme Court expanded bad faith jurisprudence to include first-party claims, it declined to provide reciprocal rights or remedies to insurers under the KUCSPA. Accordingly, the Sixth Circuit found that the Kentucky Supreme Court s refusal to make the protections of the KUCSPA reciprocal indicated a willingness to conclude in a related context that insureds are in need of protection that insurers are not. The court then surveyed the reasoning of other states courts in declining to adopt the common law tort claim of reverse bad faith. Courts in other jurisdictions generally have refused to adopt the claim because: (1) insurers have other remedies available to combat fraud on the part of the insured; (2) insurers are in a more secure and advantageous position relative to the insured; and (3) the parties relationship does not impose upon the insured the same fiduciary duties borne by the insurer. Only the Oklahoma Supreme Court reserved the possibility that malfeasance by the insured could sound in tort and merit adoption of the claim. Finally, the Sixth Circuit rejected State Auto s argument regarding the unjust nature of allowing Hargis to escape the consequences of her intentionally fraudulent conduct, noting that Hargis had been subjected to a civil judgment for damages, incarceration, and restitution. As the court observed, her conviction made it easier for State Auto to prevail on its claims of insurance fraud and breach of contract. Therefore, the court predicted that the Kentucky Supreme Court would not adopt a common law tort claim for reverse bad faith by an insured, and denied State Auto s motion for certification. This publication has been prepared by the for information purposes only. The provision and receipt of the information in this publication (a) should not be considered legal advice, (b) does not create a lawyer-client relationship, and (c) should not be acted on without seeking professional counsel who have been informed of the specific facts. Under the rules of certain jurisdictions, this communication may constitute Attorney Advertising Saul Ewing LLP, a Delaware Limited Liability Partnership. ALL RIGHTS RESERVED. Baltimore, MD 500 East Pratt St. Charles O. Monk, II Boston, MA 131 Dartmouth St. Richard D. Gass Chesterbrook, PA 1200 Liberty Ridge Dr. Michael S. Burg Nathaniel Metz Harrisburg, PA 2 North Second St. Joel C. Hopkins Newark, NJ One Riverfront Plaza Stephen B. Genzer New York, NY 555 Fifth Ave Philadelphia, PA 1500 Market St. Bruce D. Armon Pittsburgh, PA One PPG Place David R. Berk Charles Kelly Princeton, NJ 650 College Rd. E Marc A. Citron Washington, DC 1919 Pennsylvania Ave, NW Mark L. Gruhin Andrew F. Palmieri Wilmington, DE 222 Delaware Ave. William E. Manning Wendie C. Stabler