Avoiding "bad faith" in settlement: what are the developments?

• Author: Wall, Dennis J.

By itself, "bad faith" is a term without meaning. It must be put in context, otherwise it often receives only the meaning each person gives it. In order to be able to advise clients and argue before courts and regulatory agencies, lawyers handling "bad faith" matters should be aware of the term's different meanings. This article discusses "bad faith" in one specialized context - the settlement of claims under liability or third-party insurance policies.

"BAD FAITH" INGREDIENTS

A recent Florida case on insurer bad faith declared: "The legal standard governing an insurer's settlement conduct is one of reasonableness. D. Wall, Litigation and Prevention of Insurer Bad Faith [subsection] 9.03 ([first edition]) 1985)"(1) The court affirmed a summary judgment for the carrier.

So-called bad-faith claims under both first-party coverages and liability or third-party coverages have increased dramatically. In general terms, the number of bad-faith claims in first-party cases is greater, but a judgment or settlement in a given third-party case usually will involve a much larger amount of money. Of the 1,800 cases cited in the second edition of the author's book, through July 1995, the largest exposure to bad-faith damages on individual claims was clearly in third-party cases, although punitive damage assessments in individual first-party cases are sometimes as large.(2)

Avoiding claims of bad faith in third-party cases entails wrestling with questions in three areas. The courts in most jurisdictions treat these three areas separately, but they are by no means always demarked by black-and-white distinctions. Overlapping points abound.

The three areas of liability insurer bad faith are

* settlement,

* wrongful refusal to defend, and

* conduct of the insured's defense.

This article focuses on claims in the first of these three areas - bad faith in settlement.

Regardless of which test they follow, most courts in most cases examine whether a liability insurer has fulfilled its duty of good faith and fair dealing in settlement by comparing (1) the amount of the policy limits, (2) the likelihood that the insured would be found liable, and (3) the amount or range of damages reasonably likely if the claim was not settled.

Putting these three considerations together, courts search for an answer as to whether the insured's liability was probable and damages were great, meaning that damages were reasonably in excess of policy limits and the insured's liability was more probable than not. An affirmative answer ordinarily means that a court will say that the liability insurer should have acted to settle the case.

Standards to measure the insured's settlement conduct have been stated in various ways by various courts. Perhaps the most popular standard requires liability insurers to be diligent in negotiating settlement and to give at least equal consideration to their insured's interests as to their own when deciding whether and how to settle.(3) Another standard of conduct measures whether a liability insurer's settlement activity was the same as it would have been if only the insurer were responsible to satisfy the claim - in other words, whether it appears that the liability insurer acted as though it had issued a liability policy without limits, particularly where liability is probable and damage are great.(4)

Regardless of the particular standard of settlement conduct a court may follow, in almost all jurisdictions the courts have agree that liability for extracontractual or bad-faith damages because of alleged bad faith and unfair dealing in settlement by a liability insurer depends on what the liability insurer knew and when it knew it. As a result, cases usually turn on questions of fact.(5)

THINGS TO DO

1. Investigate

   Investigation of the claim against the insure is clearly essential to maintaining a good faith claims file. Investigation and evaluation tie together. A reasonable investigation must lead to a reasonable evaluation. Otherwise, there is no reason for conducting the investigation. Together, they will provide the basis for a finding of good faith and fair dealing, or for the imposition of extracontractual damages for bad faith in settlement.(6)

   The investigation must be a reasonable one. Liability for a suit of extracontractual damages amounting to one and a half times the liability insurer's policy limits was assessed where the evidence was sufficient to support the trial court's finding that the liability insurer should have made a settlement offer but did not.(7)

2. Evaluate

   As stated, liability and evaluation go hand-in-glove. Both must be reasonable. There must not only be a reasonable investigation, but the insurer will be responsible in extracontractual damages for ignoring the conclusions apparent from any reasonable evaluation based on its investigation.(8)

   A liability insurer was held responsible for extracontractual damages totaling two and a half times its policy limits in a case that had these ingredients, among others: (1) The claims representative wrote to defense counsel that defense counsel would note from "reviewing our file" that this is a case of clear liability. (2) Defense counsel, acting under his own ethical obligations to the insured as his client, advised the insured that his own evaluation of the case was that this would be "an extremely dangerous case to try."...