Overcoming attorney-client privilege and work product protection in bad-faith cases: bald assertions of bad faith should not be accepted by courts as a warrant to plaintiffs to rummage through claims files.

• Author: Jebo, James R.

IN THE 1970s, a sequence of California decisions created a new tort--one for bad faith denial of an insurance claim. (1)

In the beginning, insurance policies were treated like any other type of contract. Relying on the common law rule announced in 1854 by the Exchequer Chamber, Hadley v. Baxendale, (2) courts limited damages to those contemplated by the parties at the time the contract was formed. (3) The business of insurance, however, is much different from other commercial pursuits. Individuals and companies obtain insurance to hedge against risks and potential losses they often are not economically able to suffer. Insurance companies have an unequal bargaining power. They are able to pass litigation costs off to insureds in the form of higher premiums, while an uninsured person or company is not able to do that. Insureds must in most cases accept adhesion contracts, with little or no power to bargain over details. Insurance policies, moreover, are extremely complicated documents, containing countless warranties and exceptions to coverage that often are not fully understood by the insured.

The tort of bad-faith denial of claims originated because of the peculiar nature of insurance contracts and an appreciation that the principles of contract law are inadequate to protect policyholders. (4) Simply put, states that have adopted this tort require insurance companies to act in good faith, and fairly deal with their insureds. (5)

Although about 45 American states have adopted the bad-faith tort for first-party claims, the type of bad-faith claim on which this article concentrates, the law is relatively new and in a state of flux. One area often litigated is the insured's right to inspect the insurer's claims file during discovery. Plaintiffs argue that it is the only way to prove bad faith, while defendants contend that information is protected by the attorney-client privilege or the work product doctrine, or both. A 2001 decision by the Ohio Supreme Court, Boone v. Vanliner Insurance Co., (6) has brought this issue into sharp focus. The court held that in a bad-faith case, all claims file materials created before the claim was denied are discoverable. The unique part of the decision was that the court found that materials showing an insurer's lack of good faith are unworthy of protection.

The mere allegation of bad faith on the part of the insurer, however, should not result in a blanket exception to the attorney-client privilege and the work product doctrine. Several cases, including Vanliner, have held that any information or documentation collected or produced before a claim is denied was prepared in the normal course of business and thus is not eligible for discovery immunity. This is an overgeneralized inference that ignores the principles behind the work product doctrine. To balance the competing interests, courts should require a factual showing of bad faith, not a mere allegation--that is, there must be specific facts and examples pleaded on which a reasonable judge could infer that there was a question of insurer bad faith.

BAD FAITH AND PRIVILEGES

1. A Bit of History

   In the mid to late 1800s, states began regulating the insurance industry in response to its growth and widespread corruption. (7) In 1944, the U.S. Supreme Court held in United States v. Southeastern Underwriters Ass'n that insurance transactions were commerce and thus subject to federal regulation. (8) In response, Congress in 1945 enacted the McCarran-Ferguson Act, 15 U.S.C. [section] 1101 et seq., which provides that federal laws such as the Sherman and Clayton acts and the Federal Trade Commission Act, apply only to insurance transactions in areas overlooked by state law. Thus, states are given a great deal of discretion in the field of insurance law, and this can lead to widely divergent opinions.

   Like other contracts, insurance policies carry an implied duty of good faith and fair dealing originating from common law. (9) Both the Uniform Commercial Code and the Restatement of Contracts explicitly direct contracting parties to act in good faith. While legal scholars argue over the definition of "good faith" and its negative, "bad faith," a widely accepted belief is that good faith requires an insurer to place the insured's interests above its own. When denying a claim, the insurer's decision must be based on honest, intelligent and realistic grounds, after adequately investigating the circumstances. (10)

   While contract law requires an insurer to act in good faith, many states allow insureds to use tort law to sue for denial of claims. This greatly increases not only the kind of remedies available but also, and more important, the amount of damages. In breach of contract claims, courts generally do not allow damages beyond what is contemplated in the insurance policy, but tort claims embrace actual as well as punitive damages.

   There are several countervailing issues at work concerning bad-faith claims. On the one hand, bad-faith tort claims and the resulting punitive damages work to keep insurers accountable. On the other hand, insurers need to investigate and deny claims not only to operate as a business but also to combat fraud without fearing punitive damages. (11)

2. Attorney-client Privilege

   The attorney-client privilege--the oldest of privileges for confidential communications--bars disclosure of information containing confidential communications between the attorney and client. Section 68 of the Restatement (Third) of the Law Governing Lawyers states that the privilege may be invoked with respect to a communication made between privileged persons, in confidence, for the purpose of obtaining or providing legal assistance for the client.

   Couch defines the privilege as applying only if:

   (1) the asserted holder of the privilege is or sought to become a client; (2) the person to whom the communication was made (a) is a member of the bar of a court, or his subordinate and (b) in connection with this communication is acting as a lawyer; (3) the communication relates to a fact of which the attorney was informed (a) by his client (b) without the presence of strangers (c) for the purpose of securing primarily either (i) an opinion of law or (ii) legal services or (iii) assistance in some legal proceeding, and not (d) for the purpose of committing a crime or tort; and (4) the privilege has been (a) claimed and (b) not waived by the client. (12) A problematic issue exists when a corporation is the client, as is often the case in insurance litigation. Corporations are legal fictions, but they are entitled to claim the privilege, and their in-house counsel may be the attorney for this purpose. (13) The issue has two main questions: Who is the client? For whom was the attorney performing legal services at the time of the communication?

   The first question was considered by the U.S. Supreme Court in 1981 in Upjohn Co. v. United States. (14) Prior to that case, the lower courts had held that only the controlling officers of a corporation could be regarded as the client. Upjohn stated that low and mid-level employees also may have information that should be protected under the attorney-client privilege. The Court even refused to reject the privilege concerning communications with former employees. This ruling is important for insurance companies in claiming the privilege for knowledge held by claims adjusters and other lower-level employees.

   The second issue raises the question of whether material produced by an attorney was in preparation for litigation or in the normal operation of the business. Several courts have held that in the insurance context, if an attorney acts as a claims adjuster or claims investigator and is not offering legitimate legal assistance, the attorney-client privilege does not apply. (15)

   Another common source of litigation in bad faith claims is whether there has been a waiver of the attorney-client privilege. A client can waive the privilege voluntarily by disclosing the confidential information. Disputes arise in insurance cases when the insurer makes an allegation or takes a position in the litigation, then uses the attorney-client privilege as a shield to discovery of the underlying facts by the opposing party. (16) This is referred to as the "sword and shield" idea.

   Wigmore comments:

   There is always also the objective consideration that when [an attorney's] conduct touches a certain point of disclosure, fairness requires that his privilege shall cease whether he intended that result or not. He cannot be allowed, after disclosing as much as he pleases, to withhold the remainder. (17) C. Work Product Doctrine

   The work product doctrine had its origin in Hickman v. Taylor, (18) in which the U.S. Supreme Court held that there is certain information that should not be discoverable unless there is a compelling need. Work product is defined as materials prepared in anticipation of litigation or for trial. The Court based its ruling on the belief that an attorney must have a certain degree of privacy and must feel secure in properly preparing for a case. This preparation often includes memoranda, correspondence and other tangible and intangible items that reflect the attorney's mental impressions of the case. In a concurring opinion, Justices Jackson and Frankfurter noted...