UNIVERSITY OF PUGET SOUND LAW REVIEWVolume 15, No. 1FALL 1991
NOTES
The Need for Revisiting the Imposition of Bad Faith Liability: Industrial Indemnity Co. v. Kallevig
J. Benson Porter, Jr. (fn*)
I. Introduction
Numerous values are promoted under the American legal system. While business growth is encouraged by various state and federal laws,(fn1) the legal system also recognizes and promotes an individual's freedom from negligent and intentional harms.(fn2) At times, however, these two separate values can clash in cases such as bad faith litigation between insureds and their insurance companies. Bad faith litigation arises when an insurance company denies payment of a claim submitted by an insured, and the insured pursues judicial relief on grounds that the insurer's denial is not appropriately based.(fn3) In Washington, the relationship between an insurance company and its insured is governed by common, statutory, and administrative law.(fn4) The Washington Supreme Court recently considered these laws as they apply to bad faith litigation in Industrial Indemnity Co. v. Kallevig.(fn5)
Before the Kallevig decision can be placed into context and analyzed, one must consider the development of bad faith litigation in Washington. The body of law governing bad faith litigation in Washington developed primarily over the past twenty-five years. While previously requiring the business of insurance be actuated in good faith,(fn6) the Washington State Legislature repealed the insurance exemption from the Consumer Protection Act (CPA) to ensure sufficient reimbursement to the insured and to deter unjustified claim denials.(fn7) In 1970, Washington courts followed this trend by explicitly recognizing that a fiduciary relationship exists between an insurer and its insured.(fn8) At the same time, while recognizing and promoting an insured's ability to recover when an unjustified claim denial occurs,(fn9) the courts have attempted to develop a bad faith standard that allows insurers some flexibility in protecting their own interests.(fn10) Under this standard, Washington courts review an insurance company's actions and surrounding circumstances to determine whether the insurer was reasonably justified in denying a claim.(fn11)
The Washington Supreme Court in Kallevig employed this reasonable justification standard for determining whether an insurer acted in bad faith by denying a claim. While this standard is consistent with prior case law,(fn12) a subsequent appellate court decision applied an arguably less onerous bad faith standard in Gingrich v. Unigard Security Insurance Co.(fn13) The standard applied by the Gingrich court required consideration of whether an insurer's actions were unreasonable, frivolous, or untenable.(fn14) Because this standard is less onerous than the reasonable justification standard of Kallevig, insurers may attempt to avoid the Kallevig standard and its underlying public interest considerations by recharacterizing claim denials in a manner more closely analogous to the denial in Gingrich.
In addition to applying a reasonable justification standard, the Kallevig court held that a single violation of the insurance commissioner's regulations delineating unfair business practices was sufficient to impose CPA liability upon the insurer. This holding, however, disregards the frequency provision within the regulations. In order to constitute unfair claims settlement practices, the frequency provision requires violation of the regulations with such frequency as to indicate a general business practice.(fn15)
Because of the potential uncertainty created by two inconsistent bad faith standards articulated in Kallevig and Gingrich, and the failure to recognize a regulatory frequency provision, this Note posits two recommendations. First, in order to harmonize the bad faith standards applied in Kallevig and Gingrich, the Kallevig reasonable justification standard should be applied in situations involving questions similar to those confronted by the Gingrich court. Second, this Note contends that the Kallevig court's analysis imposing liability under the CPA was defective because it failed to take proper account of the frequency requirement within the unfair trade practices regulations. By ignoring the frequency provision, the Kallevig decision allows inconsistent treatment of similar factual situations depending on whether the decision is being made by an agency or judicial body. As such, the legislature should review the appropriateness of a frequency requirement for determining unfair business practices. If its review establishes the appropriateness of this requirement, the legislature should amend the unfair business practices statute to prevent a single violation of the unfair trade practices regulations from serving as the basis for CPA liability.
To provide a basis for analyzing the Kallevig decision, this Note will first review the development of the bad faith standard employed in Washington. The Note will then discuss the facts in Kallevig and consider the imposition of the bad faith standards employed by the Kallevig and Gingrich courts. Lastly, the court's analysis for the imposition of CPA liability will be reviewed and critiqued.
II. The Development of Bad Faith Liability of Insurers
Bad faith liability is a general categorization for liability imposed upon an insurer when the insurer has acted in bad faith. These actions include inadequate investigation, unfounded settlement delay, or wrongful cancellation.(fn16) The consideration of bad faith liability can be separated into two distinct areas: (1) the formulation of the standard used to measure an insurance company's conduct and (2) the mechanism employed to enforce compliance with this standard.
In Washington, the first recognition of an insurer's bad faith liability to an insured was in Tyler v. Grange Insurance Association.(fn17) In considering the refusal to settle a claim within an insurance policy's limits, the Tyler court recognized an insurer's contractual right to defend and settle a claim. The court noted, however, that an insurer owed a duty of good faith arising from a fiduciary relationship between an insurer and insured.(fn18) Since the recognition of this fiduciary duty in Tyler, several decisions have expanded and clarified the duty owed to an insured by an insurance company.(fn19) For example, while Tyler addressed an insurer's duty to settle a claim within policy limits,(fn20) the Washington Supreme Court later considered the insurer's duty to pay an insured's claim.(fn21) In this context, the court held that insurers had a broad obligation of fair dealing; therefore, a specific showing of dishonesty, misrepresentation, deceit, or fraud was not required to impose penalties under the CPA.(fn22)
On the other hand, rather than describe an insurer's duty as a broad obligation of fair dealing, some Washington courts have formulated this duty differently. For example, bad faith action can be shown by a frivolous and unfounded denial of policy benefits, while the denial of benefits due to a debatable question of coverage is insufficient for a bad faith claim.(fn23) Another court stated that the insured must prove the insurance company did not act fairly, honestly, and objectively, or the insurer acted without reasonable justification in refusing the claim.(fn24) Most recently, the Kallevig court considered whether the insurer was reasonably justified in denying a claim.
Along with developing a standard for measuring an insurance company's conduct, courts have considered which mechanism should be used to enforce compliance with this standard. The appellate court in Tyler recognized a duty sounding in tort in order to encourage the insurer to consider the insured's interests when settling a claim.(fn25) The Washington Supreme Court, however, has not expressly recognized an insurer's duty to an insured in bad faith actions as giving rise to a tort.(fn26) Instead, Washington and a minority of other states have enacted a statutory framework through which an insured can recover under the CPA.(fn27) By using a statutory framework to impose liability in bad faith actions, the Washington State Legislature created a system that attempts to balance compensating an injured insured with enabling the insurer to protect its interests.(fn28) The Washington Supreme Court recently applied this statutory framework for bad faith actions in Kallevig.
III. The Decision in Kallevig
A. The Facts of the Case
On January 27, 1986, the Peach Tree Restaurant was destroyed by fire.(fn29) The restaurant, owned by David and Judith Kallevig, was insured by Industrial Indemnity Company of the Northwest, Inc.(fn30) Following a claim under the restaurant's policy, Industrial Indemnity brought an action for declaratory judgment alleging that David Kallevig intentionally caused the fire. The Kallevigs, in turn, counterclaimed for damages under contract and CPA theories.
On the evening of the fire, two employees closed the restaurant and turned off the electrical switches in the food preparation area. Shortly thereafter, David Kallevig arrived at the restaurant, counted the money, and placed the money into a floor safe. The fire was reported to the Yakima Fire Department approximately one-half hour after Kallevig left.(fn31)
At trial...
