5.4.1 Advice of Counse

• Jurisdiction: Arizona

A bad faith claim based solely on an insurance company's denial of coverage will fail on the merits if the final determination of non-coverage is ultimately made.^[294]

In Manterola v. Farmers Insurance Excange,^[295] the court observed: "Although the pertinent Arizona decisions clearly have rejected the notion that a contractual breach or even policy coverage is a necessary element for all bad faith claims, none of the cases suggest that a carrier may be held liable for bad faith denial of coverage in the face of a final judicial determination there was no coverage."^[296] Where the insurance company's coverage denial is the predicate basis for the bad faith case, without additional bad faith claims being asserted unrelated to coverage, the determination of bad faith will ultimately have to await the outcome of a Declaratory Judgment Action deciding coverage.^[297] Where a coverage denial is the basis for the bad faith claim, the plaintiff's ability to prove one element of the bad faith denial of coverage claim?unreasonableness?depends on the outcome of the coverage determination. Thus, only after the coverage question has been fully litigated and has resulted in a final determination of coverage can the claimant prove that the insurance company's denial of coverage had been unreasonable which is a necessary element of that particular claim.^[298]

Advice of Counsel^[299]

An insurance company may defend itself against allegations of bad faith and malicious claim handling by providing evidence that it relied upon the advice of competent counsel.^[300] The so-called advice-of-counsel^[301] defense^[302] provides that when an insurer's actions are in conformity with advice given by its counsel, the insurer's actions are made in good faith. Thus, state of mind, an essential element that an aggrieved policyholder must demonstrate in establishing insurer bad faith, is nullified.^[303] Conversely, the rejection of counsel's advice^[304] or the failure to seek legal advice when prudent claim handling dictates doing so may be evidence of bad faith.^[305]

Jurisdictions are split over the acceptance of the advice-of-counsel defense.^[306] Whether the advice-of-counsel defense is available may depend upon a particular jurisdiction's legal standard regarding the tort of bad faith. A definitive standard of bad faith is difficult to formulate because the elements of the test change as the context changes.^[307] Where the insurer's state of mind is the focus of the bad faith claim of unreasonableness, the advice-of-counsel defense may be applicable.^[308] In those jurisdictions where the tort requires proof of the insurance company's actual intent to harm, the advice-of-counsel defense may undermine and diminish the required mental state necessary to establish bad faith. It must be established that the company knew or should have known that its conduct created an unreasonable risk of harm to the insured.^[309] Where the alleged bad faith is based on the insurance company's conduct, the advice of counsel may become irrelevant because the insurance company's conduct should be evaluated against industry standards for claims handling and claims processing.^[310]

Commentators have different views regarding the necessary elements that give rise to the advice-of-counsel defense. One commentator^[311] has delineated four necessary elements of the defense: "(1) the insurer sought counsel's advice in good faith; (2) the insurer disclosed all pertinent information to its attorney; (3) the insurer acted on the advice in good faith; and (4) the attorney was competent in the particular area of law and disinterested in the matter."^[312]

Although these proposed elements may be jointly sufficient to establish the absence of bad faith, other commentators postulate that fewer elements are necessary:

For example, it is not necessary that the insurer seek counsel's advice in good faith. The insurer might seek counsel's advice in bad faith and come into a state of good faith by having been jolted by counsel's vivid, perceptive, and well-reasoned opinion letter. It also is not necessary that the insurer disclose all pertinent information to its attorney. The insurer may not have all of the pertinent information, and might commission the lawyer to complete the investigation. Moreover, if the opinion letter came to the correct conclusion, even though missing pertinent information, if the insurer acted on the letter appropriately, and if the failure to disclose all of the pertinent information was nothing more than negligent, the opinion letter should still immunize the insurer from bad faith.^[313]

Professor Quinn has identified criteria associated with the hiring of counsel to analyze coverage questions:^[314] (1) reasonable judgment must be exercised by the insurer in selecting experienced and competent coverage counsel; (2) sufficient facts and information must be provided for coverage counsel to render an appropriate opinion; (3) coverage counsel reasonably appears to have researched, investigated, and analyzed the issues; (4) coverage counsel communicates the opinion in a reasonable way; that is, coverage counsel's analysis shows that objective consideration has been given to the facts and issues, any alternatives, the law, how to present arguments, and so forth; (5) the insurer thoughtfully considered the coverage opinion; and (6) the insurer largely follows the advice of counsel.^[315] Furthermore, reliance on the advice of counsel must be reasonable.^[316] This requires, in part, that the insurance company provide counsel with sufficient factual and other available, relevant information necessary to offer an accurate opinion or advice.^[317] Where an insurance company knows or has reason to know that the advice of its counsel is incorrect, it will not be able to avoid bad faith liability exposure by claiming reliance.^[318] Finally, the advice must be timely. An insurance company cannot bootstrap an incorrect coverage decision by later consulting with counsel. ^[319]

The nature of the communication must be examined. Where the attorney is hired to perform claims adjusting or to act in a capacity other than as a lawyer, the communications may not be privileged.^[320] Some courts look to the "dominant purpose" of the communication to determine whether the attorney-client privilege exists for communications between the insurance company and the attorney.^[321] The dominant purpose of the transaction must be to transmit information in the course of the attorney's professional employment.^[322] "The relevant question is not whether [the attorney] was retained to conduct an investigation, but rather, whether this investigation was related to the rendition of legal services."^[323] Therefore, the parties must intend the communication to be confidential.^[324]

The scope of the waiver that occurs when the advice-of-counsel defense is raised is unclear.^[325] Once the insurance company interposes the advice-of-counsel defense regarding a particular claim, the correspondence between the attorney and the insurance company is placed...