CHAPTER 6

• Jurisdiction: United States

CHAPTER 6

Duties of the Insured and the Insurer

A. The Implied Covenant of Good Faith and Fair Dealing

Insurance is considered a business of the utmost good faith. The principle of utmost good faith (uberrima fides), as first stated in the British House of Lords by Lord Mansfield in 1766, is that the duty of good faith rests upon both the insured and the insurer. See Carter v. Boehm, 3 Burr 1905 (1766), in Chapter 1.

It is still the law in England and was adopted by California and other states. Imposing a duty to deal with each other in good faith in all insurance transactions requires that the duty exists during the negotiation for the contract and throughout the term of the contract. The breach of the implied covenant of good faith originally resulted in the imposition of contract damages, not tort damages.

The courts of many states created a tort called “bad faith conduct of insurance contract requirements” or the “tort of bad faith.”

The duty imposed by the contract of insurance is defined as follows:

In every insurance contract there is an implied covenant of good faith and fair dealing that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.¹

Many states have accepted a form of the tort of bad faith including: Noble v. National Am. Life Ins. Co. 624 P.2d 866 (Ariz. 1981); Escambia Treating Co. v. Aetna Cas. & Sur. Co. 421 F. Supp. 1367 (N.D. Fla. 1976) (applying Florida law); Grand Sheet Metal Products Co. v. Prot. Mut. Ins. Co., 375 A.2d 428 (Conn. Super. 1977); Ledingham v. Blue Cross Plan for Hosp. Care of Hosp. Serv. Corp., 330 N.E.2d 540 (Ill. 1976), reversed on other grounds 356 N.E.2d 7 (Ill. 1976); Vernon Fire & Cas. Ins. Co. v. Sharp, 349 N.E.2d 173 (Ind. 1976); Amsden v. Grinnell Mut. Reinsurance Co., 203 N.W.2d 252 (Iowa 1972); Robertsen v. State Farm Mut. Auto Ins. Co., 464 F. Supp. 876 (D.S.C. 1979) (applying South Carolina law); Farmers Ins. Exch. v. Schropp, 567 P.2d 1359 (Kan. 1977); Phillips v. Aetna Life Ins. Co., 473 F. Supp. 984 (D. Vt. 1979) (applying Vermont law); Arnold v. Nat’l Cnty. Mut. Fire Ins. Co., 725 S.W. 2d 165 (Tex. 1987), and others in Kansas, Mississippi, Montana, Nevada, New Mexico, North Dakota, Ohio, Oklahoma, Wisconsin, and Connecticut.

In California, the courts began the transformation of the breach of the doctrine of good faith and fair dealing from a contract to a tort remedy, primarily through six cases spanning a 21-year period.

B. Tort of Bad Faith

As you read the decision that follows consider:

Ÿ Was there a wrong for which no remedy existed?

Ÿ Was the contract remedy, available since the inception of British Common Law, no longer adequate?

Ÿ Did the California Supreme Court create a new remedy?

Ÿ If so, why did the court create the remedy?

Ÿ If not, what was the basis for the conclusion reached by the Supreme Court?

Ÿ Did the insurer have a means of avoiding this case?

Ÿ What did the insurer do that was so egregious that brought about the result?

Ÿ How did the court justify concluding that the breach of a contract allowed the recovery of tort damages?

Ÿ Did the insured have the ability to choose between a tort or contract claim?

Ÿ Can the insured collect both contract and tort damages?

As you read the case, consider the bases the court adopted as a reason for the creation of a tort of bad faith and why the conduct of the insurer caused the court to change the law.

Comunale v. Traders & Gen. Ins. Co.
50 Cal. 2d 654, 328 P.2d 198 (1958)

Mr. and Mrs. Comunale were struck in a marked pedestrian crosswalk by a truck driven by Percy Sloan. Mr. Comunale was seriously injured, and his wife suffered minor injuries. Sloan was insured by defendant Traders and General Insurance Company under a policy that contained limits of liability in the sum of $10,000 for each person injured and $20,000 for each accident. He notified Traders of the accident and was told that the policy did not provide coverage because he was driving a truck that did not belong to him. When the Comunales filed suit against Sloan, Traders refused to defend the action, and Sloan employed competent counsel to represent him. On the second day of the trial Sloan informed Traders that the Comunales would compromise the case for $4,000, that he did not have enough money to effect the settlement, and that it was highly probable the jury would return a verdict in excess of the policy limits. Traders was obligated to defend any personal injury suit covered by the policy, but it was given the right to make such settlement as it might deem expedient. Sloan demanded that Traders assume the defense and settlement of the case. Traders refused, and the trial proceeded to judgment in favor of Mr. Comunale for $25,000 and Mrs. Comunale for $1,250.

Sloan did not pay the judgment, and the Comunales sued Traders under a provision in the policy that permitted an injured party to maintain an action after obtaining judgment against the insured. (See Ins. Code, §11580, subd. (b)(2).) In that suit judgment was rendered in favor of Mr. Comunale for $10,000 and in favor of Mrs. Comunale for $1,250. This judgment was satisfied by Traders after it was affirmed in Comunale v. Traders & Gen. Ins. Co., 253 P.2d 495 (Cal. Ct. App. 1953).

Comunale obtained an assignment of all of Sloan’s rights against Traders and then commenced the present action to recover from Traders the portion of his judgment against Sloan which was in excess of the policy limits. The jury returned a verdict in Comunale’s favor, but the trial court entered a judgment for Traders notwithstanding the verdict.

The following questions are presented on Comunale’s appeal from the judgment:

1. Did Sloan have a cause of action against Traders for the amount of the judgment in excess of the policy limits?

2. Was Sloan’s cause of action against Traders assignable?

3. Was the cause of action barred by the statute of limitations?

Liability in Excess of the Policy Limits

In determining whether Traders is liable for the portion of the judgment against Sloan in excess of the policy limits, we must take into consideration the fact that Traders not only wrongfully refused to defend the action against Sloan but also refused to accept an offer of settlement within the policy limits. It is not claimed the settlement offer was unreasonable in view of the extent of the injuries and the probability that Sloan would be found liable, and Traders’ only reason for refusing to settle was its claim that the accident was not covered by the policy. Because of its wrongful denial of coverage, Traders failed to consider Sloan’s interest in having the suit against him compromised by a settlement within the policy limits.

There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement. (Brown v. Superior Court in & for Los Angeles Cnty., 34 Cal. 2d 559, 564 (1949).) This principle is applicable to policies of insurance. (Hilker v. W. Auto. Ins. Co., 231 N.W. 257, 258 (1930) (aff’d on rehg., 235 N.W. 413) (1931).) In the Hilker case it is pointed out that the rights of the insured “go deeper than the mere surface of the contract written for him by defendant” and that implied obligations are imposed “based upon those principles of fair [50 Cal2d Page 659] dealing which enter into every contract.” (231 N.W. at p. 258.) It is common knowledge that a large percentage of the claims covered by insurance are settled without litigation and that this is one of the usual methods by which the insured receives protection. (See Douglas v. U.S. Fid. & Guar. Co., 127 A. 708, 712; Hilker v. W. Auto. Ins. Co., supra.) Under these circumstances the implied obligation of good faith and fair dealing requires the insurer to settle in an appropriate case although the express terms of the policy do not impose such a duty.

The insurer, in deciding whether a claim should be compromised, must take into account the interest of the insured and give it at least as much consideration as it does to its own interest. (See Ivy v. Pac. Auto. Ins. Co., 156 Cal. App. 2d 652, 659 [320 P.2d 140] (1958).) When there is great risk of a recovery beyond the policy limits so that the most reasonable manner of disposing of the claim is a settlement which can be made within those limits, a consideration in good faith of the insured’s interest requires the insurer to settle the claim. Its unwarranted refusal to do so constitutes a breach of the implied covenant of good faith and fair dealing.

There is an important difference between the liability of an insurer who performs its obligations and that of an insurer who breaches its contract. The policy limits restrict only the amount the insurer may have to pay in the performance of the contract as compensation to a third person for personal injuries caused by the insured; they do not restrict the damages recoverable by the insured for a breach of contract by the insurer.

The decisive factor in fixing the extent of Traders’ liability is not the refusal to defend; it is the refusal to accept an offer of settlement within the policy limits. Where there is no opportunity to compromise the claim and the only wrongful act of the insurer is the refusal to defend, the liability of the insurer is ordinarily limited to the amount of the policy plus attorneys’ fees and costs. (Mannheimer Bros. v. Kansas Cas. & Sur. Co., 184 N.W. 189, 191 (Minn. 1921).) In such a case it is reasoned that, if the insured has employed competent counsel to represent him, there is no ground for concluding that the judgment would have been for a lesser sum had the defense been conducted by insurer’s counsel, and therefore it cannot be said that the detriment [50 Cal2d Page 660] suffered by the insured as the result of a judgment in excess of the policy limits was proximately caused by the insurer’s refusal to defend. (Cf. Lane v....