Chapter 5 - § 5.2 • COMMON LAW BAD FAITH
| Jurisdiction | Colorado |
There is significant confusion over common law bad faith claims available under Colorado law. This section begins with a short summary of the two different common law bad faith claims, then discusses each one in more depth.
A claim for common law bad faith breach of an insurance contract can arise in two different contexts: first-party and third-party.
"First-party bad faith cases involve an insurance company refusing to make or delaying payments owed directly to its insured under a first-party policy such as life, health, disability, property or fire."15 For example, a property insurer's bad faith denial of a claim for damage to a roof damaged by hail could subject the insurer to damages in excess of what the insured can recover under the insurance policy. The original claim is made by the insured against the insurer for benefits payable directly to the insured under a first-party insurance policy. Therefore, the insurer's denial exposes the insured to being personally liable for the monetary obligations underlying the insured's claim — here, the cost of repairing the damaged roof.16
"Third-party bad faith arises when an insurance company acts unreasonably in investigating, defending, or settling a claim brought by a third person against its insured under a liability policy."17 Third-party bad faith is recognized because, by virtue of the liability insurance contract, an insurer retains the absolute right to control the defense of actions brought against the insured, and the insured is prevented from interfering with the insurer's investigation, defense, and settlement of the claim against the insured.18 These special features of a liability insurance policy impose a quasi-fiduciary duty on the insurer.19 Importantly, the insurance company's duty of good faith and fair dealing extends only to its insured, not to the third-party.20
§ 5.2.1—An Introduction to the Unfair Competition — Deceptive Practices Act
Colorado has adopted an Unfair Competition — Deceptive Practices Act (UCDPA),21 the purpose of which is to regulate trade practices in the business of insurance. It prohibits unfair or deceptive trade practices in the insurance industry and establishes standards concerning misrepresentation, unfair discrimination, unfair claim settlement practices, and other improper practices by insurers.22
In 2008, the Colorado legislature amended the UCDPA to add §§ 1115 and 1116, creating a private right of action under which insureds can bring statutory first-party bad faith claims against insurers for unreasonably delaying or denying payment of a claim for benefits owed to or on behalf of any first-party claimant.23 Passage of §§ 1115 and 1116 significantly changed Colorado's first-party bad faith landscape by authorizing additional damages of two times the covered benefit amount, plus the insured's attorney fees incurred in bringing the statutory bad faith action.24 As a result, first-party bad faith actions against insurers have become much more feasible, since insureds no longer risk paying as much in attorney fees as they might recoup from their insurer if they prevail. Statutory bad faith claims are discussed in detail in § 5.3.
§ 5.2.2—First-Party Bad Faith Claims
The elements of a first-party bad faith claim are:
1) The plaintiff insured had injuries, damages, or losses;
2) The insurer acted unreasonably;
3) The insurer knew that its conduct or position was unreasonable or recklessly disregarded the fact that its conduct or position was unreasonable; and
4) The insurer's unreasonable conduct or position was a cause of the insured's injuries, damages, or losses.25
"An insurer's liability for bad faith breach of insurance contract depends on whether its conduct was appropriate under the circumstances."26 Unreasonable conduct means "the failure to do an act that a reasonably careful insurance company would do, or the doing of an act that a reasonably careful insurance company would not do, under the same or similar circumstances, to protect the persons insured from injuries[,] damages[, or] losses."27 Unreasonable position means "a position taken by an insurance company with respect to a claim being made on one of its policies that a reasonably careful insurance company would not take under the same or similar circumstances."28
A first-party claimant must also prove that the insurer either knowingly or recklessly disregarded the validity of the insured's claim.29 Reckless disregard occurs when an insurer "acts [or] takes a position with knowledge of facts that indicate that its conduct [or] position lacks a reasonable basis or when it is deliberately indifferent to information concerning the claim."30 "This standard of care 'reflects a reasonable balance between the right of an insurance carrier to reject a non-compensable claim submitted by its insured and the obligation of such carrier to investigate and ultimately approve a valid claim.'"31
What is "appropriate" defies precise definition, but the UCDPA sets out some basic principles. It states the general rule that in a civil action against an insurance company, the jury may be instructed that the insurer owes its insured a duty of good faith and fair dealing,32 and that the duty is breached if the insurer delays or denies payment without a reasonable basis for its action.33 Under a first-party insurance policy, the reasonableness of an insurer's delay34 or denial is determined based on whether the insurer knew its actions were unreasonable or the insurer recklessly disregarded that fact.35 Juries may be instructed that certain willful conduct is prohibited by statute, and that they may consider any such conduct in determining whether the defendant acted unreasonably in delaying or denying payment.36 C.R.S. § 10-3-1104(1)(h) provides that committing or performing any of the listed practices, either in willful violation of the Act or with such frequency as to indicate a tendency to engage in a general business practice, constitutes an unfair claim settlement practice. An "unfair claim settlement practice" is included among what the Act deems "unfair methods of competition and unfair or deceptive acts or practices in the business of insurance."37 "In determining whether an insurer's delay or denial was reasonable, the jury may be instructed that willful conduct of the kind set forth in section 10-3-1104(1)(h)(I) to (1)(h)(XIV) is prohibited and may be considered if the delay or denial and the claimed injury, damage, or loss was caused or contributed to by such prohibited conduct."38 However, the Act does not create a private cause of action,39 and the Act "may be used as valid, but not conclusive, evidence of industry standards."40 Thus, courts have held it was reversible error to give a jury instruction setting forth the statutory definition of misrepresentation in insurance applications41 and stating that a violation of the statute constituted negligence.42
The courts have identified a number of other considerations for evaluating good faith and reasonableness:
• Standards of conduct in the insurance industry may determine reasonableness in denying a claim.43
• The insurer need not prevail on the issue of coverage for there to be a "reasonable basis"44 for denying a claim.
• An insurer's resort to a judicial forum is not necessarily bad faith or unfair dealing, regardless of the outcome.45
• Mere disagreement over the terms of the contract is insufficient to state a claim for bad faith.46
• The fact that there is "colorable" evidence supporting the insurer's action does not alone defeat a bad faith claim.47
• Actions an insurer takes in reasonable reliance on existing law cannot constitute bad faith because such conduct is not unreasonable.48
In 2003, the Colorado Court of Appeals rejected an insurer's contention that the reasonableness of its conduct should be determined by reference to the "lack of substantial justification" standard contained in Colorado's Frivolous, Groundless or Vexatious Actions Act.49 The court concluded that doing so would unduly "limit the calculus" of what is "unreasonable" in the insurance bad faith context.50
The insured bears the burden of proving the insurer's knowledge or reckless disregard of the fact that a valid claim has been submitted.51 An insurer acts with reckless disregard of whether its conduct is unreasonable when it acts or takes a position with knowledge of facts indicating that its conduct or position lacks a reasonable basis, or when it is deliberately indifferent to information about the claim.52 Reliance on professional advice is persuasive evidence that the insurer did not act unreasonably.53 Notably, an insurer's invocation and completion of an appraisal process will not immunize it from a lawsuit alleging, or potential liability for, common law bad faith.54
After an insurer has decided to pay its insured the available limits under a policy, it cannot compel the insured to undergo an independent medical exam (also referred to as a defense medical exam) in the insured's subsequent action for common law bad faith, because the results of the exam can no longer provide the insurer with information relevant to its coverage decision.55
§ 5.2.3—Third-Party Bad Faith Claims
The elements of a third-party bad faith claim are:
1) The insured had injuries, damages, or losses;
2) The insurer acted unreasonably; and
3) The insurer's unreasonable conduct or position was a cause of the insured's injuries, damages, or losses.56
Third-party bad faith occurs when an insurance company acts unreasonably in investigating, defending, or settling a claim brought by a third person against its insured under a liability policy.57 Both case law and the UCDPA provide that the determination of whether a delay or denial was reasonable is based on whether the delay or denial was negligent.58 The basis for such claims is that when defending third-party claims, an insurance company stands in a...
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