Chapter Nineteen

• Jurisdiction: New York

Chapter Nineteen

Discovery in Coverage and Bad-Faith Litigation

Richard J. Cohen, Esq. Aaron J. Aisen, Esq. Adam R. Durst, Esq.*

* The authors wish to thank all those who worked on previous versions of this chapter, including Kimberlee L. Danieu, Esq. and Daniel W. Gerber, Esq.

I. Paper Discovery—What are the Battlegrounds?

Unlike many other types of litigation, insurance coverage and bad-faith litigation is very document-intensive because such claims are almost entirely dependent on documentary evidence. This is not to say that these claims necessarily involve voluminous documentation, but the importance of relevant documents is paramount.

In these kinds of cases, the plaintiff’s discovery goals are to establish:

(1) Failure to investigate unreasonable coverage decision or delay;

(2) Failure to settle within policy limits;

(3) Failure to keep insured informed of compromise offer;

(4) Failure to advise insured of status;

(5) Failure to advise insured of right to separate counsel;

(6) Failure to properly assess underlying plaintiff’s probability of success on merits and magnitude of damage;

(7) Failure to adopt and implement reasonable underwriting, training and claims handling standards; and/or

(8) Failure to treat multiple insureds equally.

Rule 26(b)(1) of the Federal Rules of Civil Procedure (FRCP) provides as follows:

(b) Discovery Scope and Limits.

(1) Scope in General. Unless otherwise limited by court order, the scope of discovery is as follows: Parties may obtain discovery regarding any non-privileged matter that is relevant to any party’s claim or defense and proportional to the needs of the case, considering the importance of the issues at stake in the action, the amount in controversy, the parties’ relative access to relevant information, the parties’ resources, the importance of the discovery in resolving the issues, and whether the burden or expense of the proposed discovery outweighs its likely benefit. Information within this scope of discovery need not be admissible in evidence to be discoverable.

In this regard, policyholder’s counsel should seek items that may provide evidence as to how insurance companies understand and intend to apply the policy language they draft.

The claim file maintained by the insurer or its adjusters usually contains primary evidence of the reasons a claim is denied. Thus, this file is often essential for showing whether an insurance company has a legitimate or arguable basis for denying a claim, and for proving or disproving that an insurer committed bad faith in the manner in which a claim is handled, including any alleged delay in paying a legitimate claim.

Further, in order to obtain punitive damages, a plaintiff must show that the insurer acted with willfulness, maliciousness, abusiveness or recklessness.²⁴²⁴ This is typically the most difficult element of the bad-faith claim to prove and may be established by correspondence or comments contained in a claim file relating to the insurer’s attitude toward the insured or his claim.

Finally, other elements of coverage claims may also depend on documentary evidence such as the underwriting file, procedure handbooks and manuals, coverage opinion files and financial documents. Considering the importance of the documentary evidence in coverage and bad-faith cases, thorough and sometimes imaginative discovery techniques warrant close attention when engaged in any insurance litigation.

A. True and Complete Copy of the Insurance Policy

A general prerequisite in insurance litigation is obtaining an accurate and complete copy of the insurance policy. Although courts have developed special rules when dealing with insurance, a coverage issue is essentially a matter of contract law. Likewise, to state the obvious, reviewing an accurate copy of an insurance policy is also a prerequisite to an insurance company denying a claim of defense based on coverage issues. Liability coverage is essentially determined from the four corners of the policy and the complaint against an insured.²⁴²⁵ An exception to this general rule is the requirement that no extrinsic facts be considered where a complaint does not implicate coverage, but the insurer knows extrinsic facts that would bring the claim within coverage.²⁴²⁶

Probably the most relevant copy of a policy is the original policy issued to the insured at the commencement of the policy term. While businesses usually keep original insurance policies on hand as valuable business assets that are frequently used and relied on, individuals commonly lose or misplace their policies and may rely on the insurer to maintain accurate copies.

Insurance companies also maintain copies of policies for differing periods of time, depending on document retention policies. To maintain uniformity and to save storage space, insurance companies usually maintain policy “forms” that are applicable to all insureds for a certain type of coverage, subject to additional endorsements that change coverage provisions under certain circumstances. The policy form is not usually kept in the insured’s underwriting file, which typically includes only policy declaration pages and insured-specific endorsements. Thus, when obtaining a policy from an insurer, it usually takes time for the insurer to obtain the underwriting file and then obtain the appropriate forms from a computer database or other suppliers of printed forms. Sometimes commercial policies can be very complex, and when there is a dispute about coverage, it is advisable to have the accuracy and completeness of the policy certified by those maintaining it. In fact, it is always advisable to obtain certified copies of policies, even when dealing with a seemingly simple policy. It is not uncommon to see inaccurate or incomplete policies create problems in coverage litigation.²⁴²⁷ In Petr-All Petroleum Corp. v. Fireman’s Insurance Co., the court held that where there was no endorsement setting forth an absolute pollution exclusion listed on the liability declaration page, and the policy submitted contained no such endorsement, the policy would retain its prior “sudden and accidental” pollution exclusion.²⁴²⁸

Insureds are entitled to obtain copies of their policies when they request them. After litigation has commenced, interested parties can obtain copies of insurance policies as a matter of course under the FRCP. Civil Practice Law & Rules 3101(f) (CPLR) provides:

A party may obtain discovery of the existence and contents of any insurance agreement under which any person carrying on an insurance business may be liable to satisfy part or all of a judgment which may be entered in the action or to indemnify or reimburse for payments made to satisfy the judgment. Information concerning the insurance agreement is not by reason of disclosure admissible in evidence at trial. For purpose of this subdivision, an application for insurance shall not be treated as part of an insurance agreement.

Federal Rule 26(a)(l)(A) requires the production of insurance policies as part of the parties’ pre-discovery disclosures as a matter of course:

(a) Required Disclosures. (1) Initial Disclosures. Except as exempted by Rule 26(a)(1)(B) as otherwise stipulated or ordered by the court, a party must, without awaiting a discovery request, provide to other parties: . . .

(iv) for inspection and copying as under Rule 34, any insurance agreement under which an insurance business may be liable to satisfy all or part of a possible judgment in the action or to indemnify or reimburse for payments made to satisfy the judgment.

B. The Underwriting and Agent Files

Other important sources of documentary evidence in insurance litigation include the insurer’s underwriting file and the separate file kept by the agent.²⁴²⁹ Sometimes overlooked by insurer and insured alike, these files often contain important information about a policy’s coverage, representations and understandings about coverage that may not appear on the face of the policy, and the manner in which an insurer has handled and/or interpreted a particular policy and its provisions.²⁴³⁰ Among the relevant information contained in an underwriting file are: (1) a history of negotiations for coverage; (2) a history of past policies and changes in coverage; (3) representations made by an insured on policy applications; and (4) representations made by an insurer that do not appear in the final policy. A version of the policy along with correspondence showing representations and understandings about coverage is also usually maintained by the agent who sold the policy. Obviously, this file may contain a copy of the policy, but it will also contain correspondence regarding policy changes, payment history and other communications between the agent and the insured that could provide relevant information about coverage.

C. Claims Files

The claims file generally contains the core documents to any coverage claim. The information contained in these files should, if possible, be thoroughly examined. It should be the chief target of discovery efforts by plaintiffs attempting to turn a simple coverage claim into a bad-faith action. Likewise, the claim file should be carefully protected by the insurer both during its creation and during litigation. By far, most of the reported decisions dealing with bad-faith discovery focus on the claim file.²⁴³¹

A typical claim file contains documentation about an insured’s submission of a claim; memoranda, notes and comments by adjustors; investigative documents such as medical bills, medical records and other damages information; recorded or written statements by witnesses; adjustors’ reports; and sometimes, attorney correspondence. It usually contains an original or copy of all of the documents relevant to an insurer’s handling of a claim. It may also contain information revealing an insurance company’s policies and procedures about handling a claim as well as the company’s...