1. Claims of Failure to Settle
Suits may be based upon the insurer’s failure to settle a third party’s claim against the insured within policy limits, thus exposing the insured to liability in excess of those limits. There is an implied covenant of good faith and fair dealing in every insurance contract. Smith v. American Family Mut. Ins. Co., 294 N.W.2d 751 (N.D. 1980). This obligates the insurer to avoid conduct that would deprive the insured of the contract’s protection for which he/she/it bargained. Thus, the insurer is impliedly obligated to accept “reasonable” settlement offers (because to do otherwise would deprive the insured of the bargained for protection).
“Reasonable” settlements are those which are reasonably evaluated as likely to prevent a substantial likelihood of a judgment that is both (1) against the insured and also (2) in excess of the policy limits. In instances of such substantial likelihood, the insurer owes a duty to the insured to settle within the policy limits. The failure to settle within policy limits in such cases [where both (1) and also (2) exist] subjects the insurer to liability for all damages proximately resulting from the wrongful conduct, whether they could have been anticipated or not. Thus, the insurer would be liable for the entire judgment, plus other compensatory damages resulting from its refusal to settle (including damages for emotional distress and mental suffering in a suit by the insured) and even for punitive damages (if there is an additional showing of “oppression, fraud or malice”, or “recklessness”). See, Riske v. Truck Insurance Exchange, 351 F.Supp. 76 (D.N.D. 1972) (applying Minnesota law) for an example of this two part test.
These types of suits may be brought either by the insured or by the third party claimant (through an assignment from the insured or through execution after judgment on the insured’s assets, which includes the claims the insured has against others).
b. Standards for Deciding Bad Faith
(Failure to Settle)
The standards for judging whether the insurer acted reasonably in refusing to settle a claim against the insured party depend in part on the ground upon which the insured based its decision not to settle. If the refusal is based on a denial of coverage (i.e., there is a coverage dispute with its insured) and the insurer is later determined to be wrong, the insurer acts at its own risk. In most cases, the courts do not allow the defense that the denial of an offer to settle was based on a good faith belief there was no coverage. If there is found to be coverage, an action by its insured for failure to settle within policy limits becomes almost absolute liability for the insurer. (Thus, there is a powerful incentive to an insurer to initiate and complete a declaratory judgment action to determine coverage before the underlying claim against the insured is tried in court.)
In contrast, where the insurer’s refusal to settle is based on its evaluation of the demand (i.e., the insurer takes the position that it probably can obtain a defense verdict or that the plaintiff’s verdict probably will be lower than the demand) the insurer is judged by the “prudent insurer standard.” See, Riske v. Truck Insurance Exchange, 351 F.Supp. 76 (D.N.D. 1972). The test is whether a prudent insurer would have accepted the settlement offer if the insurer alone were liable for the entire judgment. This test is phased many ways by the courts. The most frequent wording is that the insurer in deciding to pay its own money must give equal (or greater) consideration to the interest of the insured not to lose any money (and to have the protection purchased) when contrasted to the interest of the insurer not to lose money.
c. Elements of Bad Faith Action
(Failure to Settle)
In a failure to settle case, to recover on the theory of a breach of the implied “good faith” covenant, the plaintiff (the insured or third party claimant) must plead and prove the following elements:
(1) That there is coverage;
(2) That the carrier had a reasonable opportunity to settle within policy limits;
(3) That the carrier refused to settle within policy limits;
(4) That the refusal to settle within limits was unreasonable (this element usually is not needed by the plaintiff, if the refusal was based on an insurer’s denial of any coverage);
(5) That an excess judgment was returned against the insured; and
(6) That the excess judgment against the insured was assigned to the third party (this element is needed only for an action by a third party).
d. Factors Determining Unreasonableness
The insurer is obligated to consider the interest of the insured, as well as its own interest, in evaluating settlement offers. Whether the insurer acted reasonably is determined in part by the following:
(1) The likelihood that there will be a verdict against the insured (i.e., the strength of the claimant’s case on liability);
(2) The likelihood that the verdict, if adverse, will be for a sum greater than the insurance coverage (i.e., the financial risk to which the insured is exposed in the event of a verdict for the plaintiff);
(3) The insurer’s failure to properly investigate to ascertain evidence that may be used at trial by the claimant against the insured;
(4) The insurer’s rejection of advice from its own lawyers or claims investigators;
(5) The insurer’s failure (including appointed counsel’s failure to inform the insured of potential damages, adverse testimony, and the potential for adverse verdict; or to inform the insured of all negotiations and all compromise offers, (to enable the insured to consider “adding to the pot” to effectuate settlement or getting his/her own attorneys). Cf., Warren v. American Family Mut. Ins. Co., 361 N.W.2d 724 (Wisc. 1984);
(6) Any attempt by the insurer to coerce the insured to contribute to the settlement without the insurer paying all the settlement;
(7) The fault of the insured in causing the insurer’s rejection of the proposed compromise settlement by misleading it as to material facts. Each party’s duty is dependent upon the agreement reached between the insurer and the insured and their legitimate expectations which arise from the contract of insurance. The insurance carrier has a reasonable expectation that its insured will furnish it with all the necessary information it requests to handle the claim. Thus, if the insured fails to deliver the information, or misleads the insurer, any damage that follows as a result of the insured’s failure to act is attributable to the insured himself.
(8) The court’s acceptance of the legal doctrine of comparative bad faith of the insured. The viability of the affirmative defense of comparative bad faith is uncertain. However, some cases outside the Dakotas hold that an insured also has a duty of fair dealing. The South Dakota case of Wolff v. Royal Ins. Co., 472 N.W.2d 233 (S.D. 1991) also seems to recognize such a duty. If the insured breaches his implied duty of good faith and fair dealing, then the insurer-defendant has at least a partial defense to a bad faith action
e. Insurer’s Response To Settlement Offers Under Limits
The claimant’s attorney may write a letter outlining the merits of the claimant’s case and offering to settle for less than the policy limits. The insurer must then notify its policyholder that the claim is in excess of the policy limits, that an offer to settle within the policy limits has been made, and that the policyholder may engage counsel to advise him/her/it and to assist the counsel appointed by the insurer to defend.
If the policyholder engages a lawyer, then the plaintiffs’ attorney calls that defense attorney on the telephone, tells that personal attorney what has transpired, and pretty soon the insurer receives a similar demand from the insured’s personal attorney with an explicit threat of an excess suit and a suit for bad faith in refusing to settle. By this time, the poor insurance company is really sweating, as well it may.
If liability is controverted and damages are severe, the insurer is not allowed to gamble with the insured’s personal assets, merely because the insurer has a limited “upside” amount of coverage, and it prefers to gamble unreasonably upon the law of averages. Nevertheless, if the insurer acts reasonably, the insurer is not compelled to either make excessive settlements or suffer unlimited liability where its insured was too cheap to buy other than a minimum limit policy.
The insurance company should, if it is on its toes, always forward a reply communication to the plaintiff’s counsel (and to its insured) setting forth the reasons why the settlement is declined. The reason to set out “reasons” for declining to settle within policy limits is to allow the jury to see that before the insurer was sued for bad faith it did the job of a reasonable insurer.
To avoid “bad faith” charges an insurer should respond to each settlement demand, even if it perceives the offer as uncertain, defective, or unreasonable. Simply ignoring an incomplete, defective, or unreasonable demand may constitute a breach of the insurer’s duty to use good faith efforts to settle and protect the insured.
In the face of a below limits demand, the insurer should always:
(1) make a timely response to the demand,
(2) point out the specific reasons why the demand is incomplete, or cannot be presently acted upon, or is unreasonable in time limits,
(3) point out why the demand is excessive or unreasonable in amount, and
(4) manifest a willingness to negotiate further.
A delayed attempt to accept a previous reasonable settlement demand will not “cure” the insurer’s previous bad faith conduct in unreasonably refusing an offer. If the demand is reasonable and the insurer does not accept within the time limits stated (if those time limits are reasonable), then: a breach of the implied covenant automatically has occurred, and the injured claimant is relieved of any further duty to continue negotiations. Critz v. Farmers Ins. Group, 230 Cal.App.2d 788 (1965). Thus, it is risky for an insurer to allow a claimant’s settlement demand to expire, without some response. (At least make a request for further time within which to respond.)
However, accomplishing settlement for the amount demanded, even belatedly, may minimize the insurer’s liability by cutting off liability for emotional distress damages and economic loss after the date of settlement.
f. Proper Parties – Excess Liability Case
(1) Parties Plaintiff
(a) Named insureds and additional non-named insureds.
(b) An assignee of an insured or a judgment creditor who has seized the rights of the insured by execution on the judgment.
(c) Third party claimants who were intended beneficiaries of the insurance contract. These are usually only claimants against insureds who have liability policies required by public law or who have contracts which have as their object the financial protection of persons who may be injured. A third party claimant usually may not sue under a theory of breach of an implied covenant of fair dealing because the duty to reasonably settle is intended to protect the insured and not the third party. However, a third party claimant may maintain the insured’s cause of action against the insurer as an assignee of the insured or on execution of the insured’s assets, per item (b) above.
(2) Parties Defendant
(a) Both the primary and excess carriers may be sued for failure to accept a reasonable offer within policy limits.
(b) There is no implied covenant action by an insured against a reinsurer since there is no privity of contract between the insured and reinsurer. However, the insured or a third party claimant may sue a reinsurer as an assignee of the primary insurer’s rights.
(c) Since a breach of an implied contractual covenant action lies only against a party to the insurance contract, the action for breach of contract does not lie against the insurer’s agents (e.g. adjusters, investigators, claims managers, house counsel, etc.). However, agents and employees may be held personally liable on other independent tort theories, e.g., their negligence in investigation of the claim.
2. Claims of Failure to Defend
Suits may be based upon the insurer’s failure to defend a third party’s claim against the insured. Because the duty to defend inures to the benefit of the insured, not to the injured party, the actions are really part of what an insurer calls “first party coverage” claims. However, duty-to-defend cases are generally analyzed by the courts as “third party” cases because they arise out of a third party’s liability claim against the insured.
There is an express agreement in most liability insurance contracts to defend the insured. This expressly obligates the insurer to defend actions brought against its insured. In addition, in every insurance contract there is an implied covenant to deal fairly with the insured. This obligates the insurer to use good faith to keep the express promise and furnish the defense. Breach of the implied promise furnishes the basis for a tort claim of bad faith against the insurer.
b. Approaches To Coverage Disputes
The insurer has four basic alternatives when faced with a claim against the insured when there is a coverage question. The insurer may:
(a) refuse to furnish a defense,
(b) reserve rights, and furnish the insured with insurer-appointed counsel and a defense,
(c) reserve rights and pay the insured to defend the claim with his/her own counsel, or
(d) accept a defense of the third party suit and waive objections to the lack of coverage.
Options (a) and (d) are usually poor choices for the insurer. Option (c) may be required by the courts in some instances. Option (b) is usually the best choice for the insurer.
To maintain a “bad faith” tort action against the insurer for wrongful refusal to defend, the insured must plead and prove:
(1) Existence of a duty to defend;
(2) Notice and opportunity to defend;
(3) Refusal to defend; and
(4) Damages resulting from the “bad faith” refusal to defend.
d. Damages For Refusal To Defend
Breach of the insurer’s duty to defend the insured in a third party lawsuit subjects the insurer to liability for whatever litigation expenses – attorney fees and other defense costs – the insured incurred in defending the lawsuit, as well as to liability for emotional distress damages. In extreme cases where the refusal to defend and denial of coverage are coupled with conduct constituting “oppression, fraud or malice”, or “recklessness” punitive damages may be awarded.
The basic case in North Dakota is Smith v. American Family Mut. Ins. Co., 294 N.W.2d 751 (N.D. 1980). It was held there that a failure to defend the insured was a tortious breach of the implied covenant of fair dealing, as well as a contract breach of the contract obligation to defend. (Cf., Bender v. Time Insurance Company, 286 N.W.2d 489 (N.D. 1980), holding that the tort claim for breach of implied covenant of good faith can exist even if the contract breach claim is barred.) In Smith, the North Dakota court concluded that tort damages could be awarded (including damages for emotional distress without physical manifestation) from the mere fact of failure to defend.
Although the breach of the implied covenant of good faith is called “bad faith”, it is not every “bad faith” refusal to defend that justifies punitive damages. To justify punitive damages, there must be an unreasonable or reckless refusal to defend in addition to the mere “bad faith” from breach of the “good faith” duty to defend. Smith expressly adopted the reasoning of Corwin – Chrysler – Plymouth Inc. v. Westchester Fire Ins. Co., 279 N.W.2d 638. (N.D. 1979), as being applicable to refusals to defend. Corwin states, at 645:
“Yet a finding of bad faith alone does not entitle the insured to punitive damages; oppression, fraud or malice, actual or implied must also be found.”
Unfortunately for the insurer, in North Dakota implied malice is merely “recklessness of the rights of others”, and a jury usually is eager to find an insurer who does not defend, when there is a contract to defend, is guilty of recklessness of the rights of others.