California Supreme Court Creates New Penalty For First Party Bad Faith Claims Handling

The California Supreme Court in its recent decision in Zhang v. Superior Court, 2013 Cal. LEXIS 6520  (August 1, 2013), considered whether alleged bad faith in handling a first party claim could support a cause of action against an insurer under the California Unfair Competition Law (“UCL”) even though the alleged conduct violates section 790.03 of the Unfair Insurance Practices Act (“UIPA”).

Yanting Zhang sued California Capital Insurance Company (“CCIC”) for breach of contract, bad faith, and violation of the UCL, arising from the handling of a claim for fire loss at a commercial property owned by Zhang.  The UCL cause of action alleged that CCIC falsely advertised a promise to provide timely coverage in the event of a compensable loss, when CCIC had no intention of paying the true value of fire loss claims.  CCIC demurred to that cause of action on the grounds that a UCL claim cannot be supported by a violation of conduct prohibited by the UIPA.  The trial court granted the demurrer and Zhang filed a petition for writ of mandate to the Court of Appeal which reversed the trial court decision.  The Supreme Court granted review.

The opinion in Zhang is the latest in a line of decisions by California appellate courts growing out of Moradi-Shalal v. Fireman’s Fund Ins. Cos. (1988) 46 Cal.3d 287, in which the Supreme Court held that there was no private right of action for violation of an insurer’s duties under the UIPA.  The decision in Moradi-Shalal ended years of third party bad faith litigation in California.  The court in Moradi-Shalal held that the UIPA only authorized administrative enforcement by the California Insurance Commissioner for violations of the UIPA, but such did not affect actions based on traditional common law theories of private recovery against insurers.  Those were said to include claims for “fraud, infliction of emotional distress, and (as to the insured) either breach of contract or breach of the implied covenant of good faith and fair dealing.”

In Manufacturers Life Ins. Co. v. Superior Court (1995) 10 Cal.4^th 257, the Supreme Court held that Moradi-Shalal did not preclude first party UCL actions based on grounds independent from the UIPA, even if the conduct also violates the UIPA.  In that case, the court allowed an action under the UCL by an insurance agent against insurers for violations of the California anti-trust statutes, known as the Cartwright Act.  The plaintiff agent had alleged an insurance industry conspiracy against it in retaliation for disclosure of the true cost of settlement annuities.  Manufacturers Life was followed by State Farm Fire & Cas. Co. v. Superior Court (1996) 45 Cal.App.4^th 1093, in which the Court of Appeal held an insured was entitled to pursue a UCL claim against its first party insurer (in a Northridge Earthquake related claim) based on fraud and common law bad faith claims handling.  A split in California law resulted when another district court of appeal disagreed with the State Farm decision, holding in Textron Financial Corp. v. Nat. Union Fire Ins. Co. (2004) 118 Cal.App.4^th1061, that a common law first party bad faith claim could not support a UCL cause of action where the alleged bad faith conduct was the type proscribed in the UIPA.

The Supreme Court in Zhang resolved the split in California authority by disapproving Textronand agreeing with State Farm.  The majority decision, signed by five of the seven Supreme Court justices, held that a common law first party bad faith claims handling action could qualify as any of the three statutory forms of unfair competition: the conduct was said to be (1) unlawful (under the common law), (2) unfair to the insured, and (3) may qualify as fraudulent business practices.  The court noted that the concerns raised in Moradi-Shalal (primarily proliferation in litigation) would not arise because “UCL remedies are limited in scope, generally extending only to injunctive relief and restitution.”  Therefore, a UCL claim did not duplicate bad faith claims which are for damages.  The court said that its rejection of Textrondid not affect its prior decisions in third party insurance claims cases.  As to the insured’s cause of action in the case before it, the court said that the UCL cause of action was supported by both the allegations of false advertising and of common law bad faith claims handling.

Justice Wenegar wrote a separate concurring decision, joined by Justice Liu, to say that the majority decision did not go far enough.  She argued that since the UIPA did not directly prohibit a private right of action, but merely did not allow one, a UCL claim could be based on its violation (raising the specter of possible third party claims).  The majority of the court disagreed with Justice Wenegar in Footnote 8, saying that her conclusion was directly contrary to the court’s holdings in Maufacturers Life and Moradi-Shalal.

Missouri Federal Court Rejects Bad Faith Claim

In its recent decision in Hullverson v. Liberty Ins. Underwriters, 2013 U.S. Dist. LEXIS 101640 (E.D. Mo. July 22, 2013), the United States District Court for the Eastern District of Mississippi had occasion to consider the issue of whether Missouri law permits an insured to assert a bad faith claim sounding in tort based on an insurer’s breach of the duty to defend.

Liberty International Underwriters insured the Hullverson law firm under a professional liability policy.  The firm and several individual attorneys were sued in connection with various activities relating to the firm’s advertising.  Liberty denied coverage for the suit, prompting Hullverson to commence a declaratory judgment action against Liberty.  In addition to asserting causes of action for declaratory judgment and breach of contract, Hullverson’s complaint stated a cause of action for vexatious refusal to pay in violation of Missouri Revised Statutes §§ 375.296 and 375.420, and a cause of action for bad faith failure to defend and indemnify.

Liberty moved to dismiss Hullverson’s bad faith cause of action, arguing that Missouri’s vexatious refusal to pay statutes preempt such a cause of action.  The court agreed that as a general proposition, a bad faith cause of action for breach of duty to defend is not permissible under Missouri law.  The seminal decision on the issue, observed the court, is Overcast v. Billings Mut. Ins. Co., 11 S.W.3d 62 (Mo. 2000), in which the Missouri Supreme Court held that “an insurance company's denial of coverage itself is actionable only as a breach of contract and, where appropriate, a claim for vexatious refusal to pay.”  These decisions, explained the Hullverson court, make clear that absent wrongful conduct independent of the denial of the duty to defend, an insured cannot recast a breach of contract claim as a tort claim.   With this general rule in mind, the court concluded that Hullverson failed to alleged the requisite independent conduct that would permit a bad faith claim:

Plaintiffs have failed to plead or argue any conduct in Count IV that is distinct from conduct alleged in Counts I, II, and III. The bad faith claim is not wholly independent of their breach of contract and vexatious refusal claims. This is not they type of independent tort claim contemplated by Overcast. Plaintiffs have merely stated a claim for bad faith based almost wholly on Liberty's refusal to pay their insurance claim. Missouri courts have consistently interpreted the holding in Overcast to preclude these types of claims.

As such, the court agreed that Hullverson was limited to its claim for vexatious refusal to pay, and that its bad faith claim must be dismissed.

California Court Holds Insurer’s Settlement Decisions Not In Bad Faith

In its recent decision in ACE Capital v. Eplanning, Inc., 2013 U.S. Dist. LEXIS 32613 (E.D. Cal. March 8, 2013), the United States District Court for the Eastern District of California had occasion to consider California rules concerning settlement of competing claims to limited insurance proceeds, particularly in a situation where some of the claims are not covered.

Underwriters insured Eplanning under a $5 million claims made and reported professional liability policy.  A number of claims were made and reported during the policy period, the total of which far exceeded the policy’s limit of liability.  While Underwriters initially undertook the defense of Eplanning and settled some of the underlying claims, it eventually interpleaded the remainder of the policy proceeds - just in excess of $300,000 - into the court to be allocated among the various remaining claimants.  At issue in the interpleader was whether Underwriters’ conduct was in bad faith, pursuant to Schwartz v. State Farm, 88 Cal.App.4th 1329 (2001), for not having commenced its interpleader earlier.  This bad faith claim, however, was asserted by underlying plaintiffs who had brought four individual suits not covered under the policy since their claims were first made after the policy’s expiration.   These plaintiffs, as the assignees of the insured, argued that an insurer can still act in bad faith, even where no policy benefits are ultimately due, “where there are numerous covered claims asserted against the policy” and where there is a potential for coverage.  Thus, plaintiffs argued that Underwriters committed bad faith in its settlement of other claims, and that this bad faith cause of action was assignable notwithstanding the fact that plaintiffs’ underlying suits were not otherwise covered under the policy.

The court disagreed, noting that given the claims made and reported nature of Underwriters’ policy, and given the fact that the four suits brought by underlying plaintiffs were commenced after the policy’s expiration, there never was a potential that these particular claims would be covered under the policy.   The court concluded that the decision in Schwartz only extended to claims for which insurers can have a coverage obligation and where this coverage obligation is breached.  Thus, Underwriters were not required to consider plaintiffs’ four suits in making its decisions concerning settlement and interpleader.  The court agreed that Underwriters could have no bad faith exposure to underlying plaintiffs given the correctness of Underwriters’ disclaimer of coverage.  As the court explained, “an insurer cannot be held liable on a bad faith claim for doing what is expressly permitted in the agreement.”

Massachusetts High Court Awards $22 Million In Bad Faith Damages

In its recent decision in Rhodes v. AIG Domestic Claims, et al., 2012 Mass. LEXIS 28 (Mass. Feb. 10, 2012), the Supreme Judicial Court of Massachusetts, Massachusetts’ highest court, addressed how damages are to be awarded under Massachusetts’ General Law 93A, § 9 (Massachusetts’ consumer protection statute) for an insurer’s failure to effectuate a prompt, fair and equitable settlement with a claimant, both prior to and following a verdict in an underlying lawsuit.

The underlying matter in Rhodes involved an accident between a tractor-trailer leased and operated by the insured, GAF, and a passenger vehicle, causing catastrophic injuries to plaintiff and rendering her a paraplegic.  GAF had $2 million in primary coverage through Zurich and $50 million in excess umbrella coverage through National Union.  AIG Domestic Claims (“AIGDC”) was the entity tasked with handling the claim on behalf of National Union.  Following an initial investigation, GAF’s third-party administrator advised Zurich and AIGDC in writing that liability was clear.  After suit was filed, the same third-party administrator estimated the value of the case to be between $5 million and $10 million.  A year later, after the driver of the truck plead guilty to a criminal charge relating to his operation of the vehicle, plaintiff made a settlement demand of $18.5 million, which was later reduced to $16.5 million.

Zurich tendered its $2 million limit to AIGDC.  Six months prior to trial, AIGDC attended a meeting with defense counsel at which time it was advised that the average settlement value for comparable cases was $6.6 million and the average jury verdict was $9.6 million.  Notwithstanding, just weeks later, an initial settlement offer was made to plaintiffs in the amount of $2 million, representing the value of the Zurich policy.  The Rhodes court noted that following this initial settlement offer, AIGDC engaged in delay tactics to avoid mediating the case until just one month prior to trial.  At the mediation, AIGDC offered $2.75 million, and later offered $3.5 million after plaintiffs countered at $15 million.  The court noted that the AIGDC representative attended the mediation with authority to settle up to $3.75 million, but elected not to make such an offer, even as the damages analysis changed for the worse at the mediation.  Instead, the AIGDC representative left the mediation one hour after making his offer of $3.5 million.  The matter ultimately went to trial, on damages alone (GAF had stipulated to liability), and the jury returned with a verdict, which when combined with interest, totaled $11.3 million. 

GAF immediately moved for a new trial and for an appeal.  Shortly thereafter, plaintiffs sent demand letters to Zurich and AIGDC pursuant to G.L. c. 93A, alleging that the insurers had failed to effect a prompt and equitable settlement.  This statute authorizes an individual to prosecute an action for unfair business practices, including violation of c. 176D, which is Massachusetts’ unfair insurance practices statute.  C. 176D, § 3(9)(f) defines unfair claim settlement practices to include “[f]ailing to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear.”  AIGDC responded to plaintiffs’ demand letter one month later by offering to settle both the underlying matter and the c. 93A claim for $7 million, which included Zurich’s $2 million.  Zurich separately responded to the plaintiffs by paying an amount just in excess of $2 million.  Plaintiffs and AIGDC thereafter settled the underlying negligence claim for $8.965 million, but with plaintiffs maintaining their right to prosecute their c. 93A claim. 

In a subsequent bench trial on the issue, a Massachusetts trial court found that AIGDC willfully and knowingly breached its duty to make a fair and reasonable offer prior to trial once liability and damages became reasonably clear, but that the evidence established that plaintiffs would not have accepted any such offer, and as such, damages were not available under c. 93A for AIGDC’s preverdict conduct.  The court went on, however, to find that AIGDC engaged in postverdict misconduct by failing to effectuate a prompt and fair settlement after the verdict was returned.  The court specifically found that AIGDC’s offer of $7 million was “not only unreasonable, but insulting.”  The judge awarded plaintiffs loss of use damages for this violation in the amount of $448,250, calculated as the lost interest on the $8.965 million settlement from the date the matter should have settled to the date that it actually did settle.

The case was appealed to the Massachusetts Appeals Court, which held that plaintiffs should have been awarded damages for AIGDC’s preverdict conduct.  On further appellate review, the Massachusetts Supreme Judicial Court (“SJC”) agreed that plaintiffs established a violation of c. 93A with respect to AIGDC’s pretrial conduct by showing that they suffered a loss due to AIGDC’s failure to make a timely, reasonable offer.  Moreover, the SJC held that the lower court erred in considering whether plaintiffs would have accepted such an offer, since such is not a relevant consideration in finding a violation of the statute.  Notwithstanding, the SJC held that it was not necessary to determine plaintiffs’ damages as a result of AIGDC’s pretrial conduct, since plaintiffs could not recover twice for AIGDC’s failure to effectuate a prompt and reasonable settlement.  As such, the SJC focused solely on what damages were available to plaintiffs as a result of AIGDC’s postverdict conduct.

Toward this end, the SJC looked to the language of c. 93A § 9(3), which states that in the event of a violation, the “recovery shall be in the amount of actual damages or twenty-five dollars, whichever is greater; up to three but not less than two time such amount if the court finds that the use of employment of the act or practice was a willful or knowing violation … .”  This language, reasoned the SJC, dictated that the damages available to plaintiffs were the actual value of the verdict, multiplied by no less than two since the lower court concluded that AIGDC’s conduct was willful and knowing.  In other words, the lower court’s “loss of use” analysis, which awarded damages based on lost interest, was not an appropriate methodology for calculating c. 93A damages.  Instead, the SJC concluded that plaintiffs should have been awarded $22 million, representing the underlying $11 million verdict multiplied by two.

In reaching its holding, the SJC rejected AIGDC’s arguments that damages under c. 93A should not be awarded since plaintiffs’ underlying tort injuries did not arise out of AIGDC’s claims handling conduct.  In particular, the SJC rejected AIGDC’s arguments that the statute only applies in the first-party insurance context, or that the judgment against GAF did not arise out of the same transaction or occurrence as the c. 93A claim.  The latter argument, explained the SJC, was a matter of form over substance and not relevant to recovery under the statute.  The SJC further rejected AIGDC’s contention that the multiplied damages aspect of c. 93A was “grossly excessive” and thus violative of the Fourteenth Amendment.  Such an argument, explained the court, ignored the fact that AIGDC’s conduct in failing to effect a prompt settlement despite the clear evidence of liability and damages was “sufficiently reprehensible” and that in any event, the ratio between compensatory damages and punitive damages was not excessive.  The SJC, in passing, acknowledged that “$22 million in c. 93A damages is an enormous sum,” but that “the language and history of … c. 93A leave no option but to calculate the double damages award against AIGDC based on the amount of the underlying tort judgment.”

New York Court Addresses Impact of Allowing Insured to Default

The recent decision by New York’s Appellate Division, First Department, in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., 2012 N.Y. App. Div. LEXIS 16 (Jan. 3, 2012) illustrates the dangers under New York law in denying a duty to defend, and allowing an insured to default, when coverage is questionable.

The underlying matter in K2 involved a convoluted factual scenario, complicated by the insured’s default.  Plaintiffs, K2, were a group of limited liability companies that made a series of loans to non-party Goldan, LLC.  Goldan’s principal was Jeffrey Daniels.  Mr. Daniels also happened to be an attorney, and in this capacity, he represented K2 in connection with the loan to Goldan.  How or why K2 agreed to be represented by Mr. Daniels despite the apparently obvious conflict of interest was not explained by the court.  After the loans were made, Goldan became insolvent and defaulted on the loans, whereupon K2 learned that Mr. Daniels had failed to properly secure the loans with mortgages and had failed to obtain title insurance. 

K2 subsequently brought a malpractice action against Mr. Daniels and demanded $450,000 to settle their claims, which was within the $2 million limit of liability on Mr. Daniels’ legal malpractice policy issued by American Guarantee.  American Guarantee nevertheless denied coverage to Mr. Daniels based on two policy exclusions: one applicable to claims based upon or arising out of the insured’s capacity as an officer or director of a business enterprise and the other applicable to acts or omissions of the insured for any business enterprise in which the insured had a controlling interest.  American Guarantee’s argument, therefore, was that the exclusions applied because Mr. Daniels represented K2 in connection with loans made to a company in which he was a principal.  Mr. Daniels failed to appear in K2’s lawsuit, resulting in a default judgment in the amount of $688,716.  Following entry of the judgment, Mr. Daniels assigned his rights under the policy to K2, including bad faith claims.  K2 thereafter brought a direct action against American Guarantee.

The court explained that having allowed its insured to default, American Guarantee could litigate the application of the exclusions, but could not otherwise challenge the underlying or damages determination, citing to Lang v. Hanover Ins. Co., 787 N.Y.S.2d 211 (N.Y. 2004) and Rucaj v. Progressive Ins. Co., 797 N.Y.S.2d 79 (N.Y. 1^st Dep’t 2005).  The court nevertheless concluded that the exclusions relied on by American Guarantee did not apply since K2’s suit related to Mr. Daniels’ capacity as their own lawyer rather than his capacity as a director or officer of Goldan.  The court noted that by having failed to defend its insured, American Guarantee “cannot at this juncture assert defenses that would have defeated the legal malpractice claims (for example, that Daniels was not performing legal services for plaintiffs but instead was representing Goldan) or would have established the applicability of the exclusions … .”  In other words, the court suggested that there were facts that would have either refuted K2’s malpractice claim, or that could have supported application of the policy exclusions, but by having allowed its insured to default, American Gurantee could not rely on or seek to discover such facts, and instead was limited to the allegations in the complaint in support of its policy exclusions.

In passing, the court rejected K2’s claim for bad faith, holding that under Pavia v. State Farm Mut. Auto Ins. Co., 82 N.Y.2d 445 (N.Y. 1993), K2 failed to demonstrate American Guarantee’s “gross disregard” of its insured’s interests under the policy.

California Court Holds “Genuine Dispute Rule” Not Proper Basis for Motion to Dismiss

In its recent decision titled Essex Marina City Club, L.P. v. Continental Casualty Co., 2011 U.S. Dist. LEXIS 97382 (N.D. Cal. Aug. 30, 2011), the United States District Court for the Northern District of California addressed an insurer’s argument that California’s “genuine dispute rule” warranted dismissal of an insured’s bad faith claim.

The insured, Essex Marina, had sought a defense and indemnification under a professional liability policy issued by Continental for an underlying lawsuit.  At issue in the Essex Marina’s lawsuit was Continental’s handling of the claim following the initial tender.  The matter passed hands through five different claims adjusters and was the subject of numerous requests for information from Continental to Essex Marina, prompting the court to characterize Continental’s conduct as a game of “hot potato.”  In all, it took Continental over two years before it finally denied coverage to Essex Marina during which time Essex Marina allegedly incurred hundreds of thousands of dollars in attorneys’ fees in the underlying litigation.  

Essex Marina later sued for a declaration of coverage as well as for bad faith on the basis that Continental “consciously and unreasonably … failed to make a timely ruling on its claim [and] failed to properly investigate its claim.”  Citing to Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009), Continental moved to dismiss the bad faith cause of action on the basis that it was not a plausible claim.  Continental argued, among other things, that such a claim was negated by California’s “genuine dispute rule,” which “operates as an exception to the general rule that an unreasonable delay in payment of benefits due under an insurance policy gives rise to tort liability.”  The court held that while there may have been a genuine dispute as to the validity of Essex Marina’s bad faith claim, “this is an intensely factual issue not suitable for resolution on a Rule 12(b)(6) motion.”