Asymmetrical Combat: Bad Faith Liability in Insurance Recovery Cases

• Publication year: 2022

William G. Passannante ^*

Abstract: Policyholder counsel see claims that an insurer violated its duty of good faith and fair dealing is an essential tool in leveling the playing field in policyholder-insurer disputes, especially in high-stakes litigation. Insurance companies write the policies, employ lobbyists, exchange information with each other, and, of course, have more experience handling claims. So, the author writes, bad faith allegations bring more balance to the relationship and provide a disincentive to "the profitable breach of the insurance promise." He discusses above-policy limits risks for insurers, as well as attorneys' fees, interest on unpaid claims, punitive damages, and more.

Bad faith insurance litigation presents high-stakes risks for insurance companies in the unbalanced battle between insurance companies and their policyholders. The asymmetric nature of the insurance claims process—insurance companies draft the insurance policies, lobby legislatures as an industry repeat litigant, exchange superior information among themselves, and have more experience with claims than any policyholder—means that policyholders need a counterbalance. Insurance company liability for bad faith and related above-policy limits liabilities can act as that counterbalance.

Insurance company bad faith and related doctrines prove useful because of the claims-handling calculus used to attempt to avoid coverage for a claim. Without more an insurance company denying a claim faces what it did at the outset—the amount of the covered claim. Insurance companies thus engage in the profitable breach ¹ of the insurance promise.

Most purchasers of the insurance product would think of their insurance company as a fiduciary or trustee from whom one can

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expect scrupulous candor. ² At claims time many policyholders do not receive what they expect. Still, hornbook contract law tells policyholders that every insurance policy contains within it a duty of good faith and fair dealing. ³ Enforcing that duty of good faith and fair dealing helps level the insurance claim playing field.

Some Examples of Above-Policy Limits Exposure for Insurance Companies

If instead, the policyholder shows the insurance company its exposure to (1) policyholder attorney's fees, (2) interest on the unpaid claim, (3) damages for bad faith behavior, and (4) punitive or exemplary damages—often tort-related—on account of wrongful behavior, the profitable opportunistic breach no longer appears profitable.

Bad faith liability of insurance companies has a role to play in making the insurance transaction fairer to policyholders. ⁴

Policyholder Attorney's Fees

Insurance companies may view denying your insurance claim as a profitable opportunistic breach, but most states treat insurance claims differently by permitting recovery of attorney's fees. Most understand that insurance is different. ⁵ A majority of states may force the insurance company to pay your legal fees to force them to honor the policy they sold. If informal efforts to resolve the dispute with your insurance company have been unsuccessful, litigation may be the next step.

By engaging in this "opportunistic breach," the insurance company may deny coverage wrongfully, continue to collect and invest premiums during its well-financed coverage litigation, and the only penalty it risks is paying the policyholder the same coverage it owed all along. As the Colorado Supreme Court stated:

Contract damages "offer no motivation whatsoever for the insurer not to breach. If the only damages an insurer will have to pay upon a judgment of breach are the amounts that it would have owed under the policy plus interest, it has

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every interest in retaining the money, earning the higher rates of interest on the outside market, and hoping eventually to force the insured into a settlement for less than the policy amount." ⁶

There are a number of rationales for an award of attorney fees to policyholders in insurance coverage disputes. These rationales generally are founded upon: the nature of the insurance promise (for example, the nature of an insurance company's duty to defend its policyholder); the theory of consequential damages; the language of particular insurance policy provisions; public policy considerations; or specific statutory provisions.

Where the policyholder establishes the duty to defend in a declaratory judgment action, the insurance company should bear the consequences of its wrongful action and reimburse the policyholder for its attorney fees and costs in the declaratory judgment action. For example, ⁷ under Texas law, "an insurer who has breached the duty to defend is liable for damages including the attorneys' fees incurred in pursuing an insurance coverage action." ⁸

New York courts have recognized that fees may be recoverable as consequential damages when the policyholder brings a breach of contract action against the insurance company. ⁹

Other courts have found that attorney fees constitute an element of the policyholder's damages for the insurance company's bad faith refusal to pay a claim. For example, in Taylor v. State Farm Fire & Casualty Co., 981 P.2d 1253, 1258 (Okla. 1999) (emphasis in original), the Supreme Court of Oklahoma held that:

[W]hen an action is pressed for bad-faith refusal to settle—first recognized as a distinct tort in Christian v. American Assur. Co.—the plaintiff may seek damages (a) for the loss payable under the policy together with (b) those other items of recovery that are consistent with harm flowing from insurer's bad-faith breach of its implied-in-law duty to settle.

Courts in a number of jurisdictions look to statutes to award attorney fees. Some statutes are drafted broadly, such as in New Hampshire, where N.H. Rev. Stat. Ann. § 491:22-b (2022), states:

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In any action to determine coverage of an insurance policy pursuant to [Section] 491:22, if the insured prevails in such action, he shall receive court costs and reasonable attorneys' fees from the insurer.

One commentator has criticized the refusal of courts to award attorney fees in declaratory judgment actions absent bad conduct as unfair to the policyholder, as follows:

After all, the insurer had contracted to defend the insured, and it failed to do so. It guessed wrong as to its duty, and should be compelled to bear the consequences thereof. If the rule laid down by these courts should be followed by other authorities, it would actually amount to permitting the insurer to do by indirection that which it could not do directly. That is, the insured has a contract right to have actions against him defended by the insurer, at its expense. If the insurer can force him into a declaratory judgment proceeding and, even though it loses in such action, compel him to bear the expense of such litigation, the insured is actually no better off financially than if he had never had the contract right mentioned above. Other courts have refused to impose such a burden upon the insured. ¹⁰

The award of policyholder attorney's fees is one way to begin to make the insurance relationship fairer by improving balance in available remedies.

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