bad faith assignment

What is “Assignment” of a Bad Faith Claim?

When an insurance company fails to settle a claim within its insured’s policy limits (despite a reasonable likelihood that a verdict will exceed those policy limits), the insurance company may be exposed to a claim for bad faith. 

Under the law, an insurance company has a duty to give fair consideration to the rights of its insured when considering a settlement offer. 

Let’s say an insurance company fails to consider its policyholder’s rights in deciding whether to accept a reasonable settlement offer. As a result, the policyholder’s assets are exposed to a judgment in excess of their insurance protection. In this situation, the policyholder may have a bad faith claim against the insurance company.  

For example, a driver of a vehicle who is insured with a policy limit of $100,000 causes an accident that results in over $300,000 in damages to the other driver.  The injured driver wants to settle the case for the $100,000 limit, but the at-fault driver’s insurance company refuses to accept the offer without a reasonable basis for doing so.

The case then proceeds to trial and results in a verdict far exceeding the amount of the coverage available, jeopardizing the policyholder’s personal assets.  In that situation, the policyholder is personally on the hook for $200,000 when their insurance company should have ensured they paid nothing out of pocket. 

If there is a reasonable likelihood of an excess verdict, like when the injured claimant’s medical bills exceed the policy limit, and the insurer still fails to settle the claim, the insurance company has breached its duty of good faith to its policyholder. 

In this situation, the policyholder has the right to bring a cause of action against the insurer, not the injured driver, for the amount of the excess verdict. The policyholder had a contractual relationship with the insurer, and the policyholder is obligated to compensate the injured victim.  Technically, it is the insured who was wronged through their relationship with the insurer.  Thus, the bad faith claim belongs to the insured. 

How does the injured victim get compensated?

Only a small minority of states allow the injured third-party to bring a bad faith action directly against the insurance company. However, in many jurisdictions, including Illinois, the policyholder can transfer, or “assign,” their right to pursue the bad faith claim against the insurer to the injured victim. 

Often, the policyholder will trade their rights to prosecute the bad faith claim, in exchange for an agreement not to execute the judgment against the policyholder’s assets.   Essentially, they trade their case against the insurance company for relief from the judgment.  The assignment of a bad faith claim can be accomplished by a voluntary agreement or may be compelled by an order of the court. 

What happens when an insurance company refuses to defend its policyholder?

Sometimes, an insurance company may refuse to defend its insured in a third-party claim by an injured party.  Insurers may claim that there is no coverage for an occurrence for whatever reason, and because there is no covered event, there is no duty to defend the insured. 

Some courts find that, where an insurer improperly refuses to represent its insured, the insured may settle the claim on their own, directly with the injured claimant, and then seek reimbursement from the insurance company. [i]  

This is often true, even if the policy precludes settlements made without the insurance company’s consent. [ii]   Often where this is the rule, an insured can agree to have a judgment entered against them for a certain amount, and then assign the bad faith claim connected to that judgment to the injured victim. 

In summary, even though a third-party claimant will most likely be unable to pursue a claim for bad faith directly against the offending insurance company, compensation for the injured victim can often be awarded via assignment of the insured’s bad faith claim. 

[i] See, e.g. Ansonia Assoc. Ltd. P’ship v. Pub. Serv. Mut. Ins. Co., 693 N.Y.S.2d 386, 389 (1998)

[ii] See Id.

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Pennsylvania Supreme Court Allows Assignment of Statutory Bad Faith Claims

Last week, the Pennsylvania Supreme Court held in Allstate v. Wolfe that an insured may assign its statutory bad faith cause of action to an injured plaintiff and judgment creditor. The case arose when Wolfe was struck by a driver insured by Allstate. Wolfe made settlement demands, which were rejected, before proceeding to trial where he was awarded both compensatory and punitive damages. In exchange for an agreement not to execute the judgment, the defendant assigned his rights to any claims under the Allstate policy to Wolfe. Wolfe then sued Allstate, asserting the bad faith refusal to settle under both common law contract theory and statutory bad faith pursuant to 42 Pa. C.S. § 8371 (which permits the award of punitive damages). Allstate removed the case to federal court and argued that Wolfe lacked standing to pursue the statutory bad faith claim.

The distinction between the “bad faith” contractual refusal to settle and the tort of statutory bad faith became the focal point, with Allstate asserting that unlike contract claims, tort claims are not assignable under Pennsylvania law. The trial court disagreed, finding that Wolfe had standing, and a jury decided that Allstate committed bad faith. Allstate appealed to the Third Circuit, which found state and federal decisions on the issue conflicting and petitioned the Pennsylvania Supreme Court to provide clarity.

Allstate argued that permitting the assignment of statutory bad faith claims would “foster mischief by encouraging plaintiffs to pursue unreasonable settlement demands and advance bad-faith claims which otherwise never would have been initiated.” It generally asserted that assignment would upset the equilibrium between insurer and insured and do nothing to further protect an insured that the common law contractual remedy for the refusal to settle did not already provide. Wolfe countered that an insurer that refused to settle in good faith had nothing to fear and that assignment would further deter bad faith conduct, which was the goal of Pennsylvania’s bad faith statute.

In ruling that a bad faith claim under 42 Pa. C.S. § 8371 may be assigned, the Pennsylvania Supreme Court looked to the legislative intent behind the statute. It noted that the General Assembly was aware when the statute was enacted in 1990 that the assignment of contractual “bad faith” claims was permitted, yet remained silent as to the assignability of what the court viewed as a “supplementation of remedies.” While finding Allstate’s arguments “quite reasonable,” in the end the Court “simply d[id] not believe the General Assembly contemplated that the supplementation of the redress available for bad faith…would result either in a curtailment of assignments of pre-existing causes of action in connection with settlements or the splitting of actions.” The Court noted that if its belief was mistaken, the Pennsylvania General Assembly could correct it. In other words, until the legislature amends the statute to preclude the assignment of bad faith claims, it is now clear they are assignable and enforceable by a non-insured against an insurer, creating an additional factor to be considered by insurers evaluating settlement demands when Pennsylvania law applies.

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Assignment of Rights Allows for Bad Faith Action

As I mentioned last week in Bad Faith Asserted by Excess Insurer , there are certain circumstances in which an individual or entity other than the policyholder can assert a bad faith claim against an insurance company. This situation recently arose before the Washington Court of Appeals in Unigard Ins. Co. v. Mutual of Enumclaw Ins. Co. , 250 P.3d 121 (April 4, 2011) in an appeal regarding prejudgment interest, jury instructions and clean up costs.

The underlying case arose from Charles Engelmann’s purchase of property in 1979. The property had formerly been used as a dry cleaning facility. Mr. Engelmann later sold the property to Newmarket I, a general partnership. Years later, the Washington State Department of Ecology notified Newmarket that it might be liable for the release of hazardous substances at the property under the Model Toxics Control Act, Chapter RCW 70.105D. Based on the prospect of state enforcement, Newmarket entered into a voluntary clean-up program. An investigation of the property revealed soil and groundwater contamination. Newmarket incurred clean-up costs.

Newmarket then sued Mr. Engelmann and other former owners of the property for contribution. Mr. Engelmann tried to tender his defense to Mutual of Enumclaw Insurance Company (“Mutual”), the carrier of his homeowner’s policy during the time that he owned the property. Mutual denied coverage and refused to defend.

Left to deal with the claims on his own, Engelmann entered into a settlement agreement with Newmarket. He agreed to pay Newmarket $20,000 and to assign Newmarket all his rights against Mutual of Enumclaw. In return, Newmarket released Engelmann from all claims except to the extent they could be satisfied through the assignment of rights. Engelmann did not admit liability. The agreement expressly stated that the settling parties denied liability “for any and all claims related to the Site, the Facility and the Contribution Action.” Newmarket designated the rights it had obtained from Engelmann to its own insurer, Unigard Insurance Company. Unigard sued Mutual of Enumclaw for breach of contract, bad faith, and violation of the Consumer Protection Act. The parties each moved for partial summary judgment on the issue of liability. The trial court granted Unigard’s motion.

The properly executed assignment of rights enabled Newmarket to file a bad faith claim against an insurer that was not its own.

Please consider that the decision above is specific to the state of Washington. Other jurisdictions may rule otherwise.

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Since the Kentucky Supreme Court issued its opinion in Associated Ins. Serv., Inc. v. Garcia, 1 it has been abundantly clear that an insured tortfeasor may assign a claim against its insurance carrier to an injured third-party by means of a consent judgment and agreement to forbear execution in order to protect itself from liability. In fact, the Court in Garcia specifically endorsed the use of such assignments as a means to “provide a remedy to the injured party as well as the tortfeasor who has been negligently denied adequate insurance coverage.”2 In the unavoidable subsequent action against the insurance carrier, the injured third-party would merely have the burden of offering prima facie evidence that the amount of the fixed judgment was reasonable before making its arguments with regard to coverage.3 Practically speaking, the insured tortfeasor could clearly meet its prima facie burden by notifying its insurance carrier of its intent to resolve the claim with the injured party and giving the insurance carrier one more chance to resolve the claim and eliminate risk.

More recently, in Indiana Ins. Co. v. Demetre, 4 the Kentucky Supreme Court provided putative insureds and thirdparty claimants with perhaps a greater remedy against insurance carriers which may have improperly denied coverage. In Demetre, Indiana Insurance Company’s insured, Mr. James Demetre, was sued by a tenant for physical injuries which were allegedly the result of environmental factors arising from the condition of a piece of real property. There was no dispute that Mr. Demetre had informed Indiana Insurance’s agent of the condition of the property, but there was a significant question as to whether the underwriters at Indiana Insurance were informed of the risk or intended to underwrite that risk. In response to the suit, Indiana Insurance provided Demetre with a defense in conjunction with a reservation of rights. Four months after the initial suit was filed, Indiana Insurance filed a declaratory judgment action seeking a determination as to coverage. In response, Demetre filed a first-party bad faith case against Indiana Insurance alleging breach of contract, violation of Kentucky’s Consumer Protection Act and violation of Kentucky’s Unfair Claims Settlement Practices Act. After more than two years of litigation, Indiana Insurance elected to settle the third-party claims for $165,000, and the declaratory judgment action was dismissed. Presumably, Indiana Insurance had eliminated all risk and foreclosed any possibility of liability against Demetre. Demetre, however, was not satisfied. After spending more than two years of his life in litigation and spending nearly $400,000.00 of in his own money in legal fees, Demetre continued to pursue his bad faith case against Indiana Insurance. Upon hearing the evidence at trial, the jurors awarded Mr. Demetre $3,425,000 in damages ($925,000 in emotional distress damages and $2,500,000 in punitive damages) as a result of Indiana Insurance’s lack of a reasonable basis to delay a coverage determination; misrepresentation of facts or policy provisions; failing to respond in a reasonably prompt manner to Demetre’s claim; failing to settle the third-party’s claim in good faith; failing to provide a prompt, fair and equitable settlement after liability had become clear; engaging in false and deceptive practices prohibited by the Kentucky Consumer Protection Act and for its violation of the covenant of good faith and fair dealing implied in the subject policy.5 In other words, Indiana Insurance got hit for $3.45 million dollars because it failed to deny or accept the claim at the outset of litigation.

Does an insurer open itself up to a bad faith claim like Mr. Demetre’s by resolving a claim upon which it had previously denied coverage once it receives notice of the potential entry of a consent judgment? Does a putative insured have an obligation to inform its carrier of the assignment of a bad faith claim? Could a jury have returned the same verdict to an injured third-party who had accepted assignment of Demetre’s bad faith claim? For now, those questions remain unanswered in Kentucky, but one thing is clear. It is critically important for carriers with coverage questions in Kentucky to engage counsel to provide definitive coverage opinions at the outset of a claim.

__________________________________________

1 307 S.W.3d 58, 64 (Ky. 2010), as modifi ed (Feb. 3, 2010), as modifi ed (Mar. 19, 2010).

2 527 S.W.3d 12.

3 Id. at 68.

4 27 S.W.3d 12 (Ky. 2017).

5 Id. at 33.

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The lid is off the policy . . .But what’s next?

Winning and collecting from an insurer a judgment that exceeds the policy limits.

You’ve sent your letter-perfect policy-limit demand, providing the other party’s insurer with a clear and unequivocal opportunity to settle within their policy limits. The demand was sent at a time when the other party’s liability was reasonably clear and any judgment was likely to exceed the amount of the demand. ( Johansen v. California State Auto. Ass’n Inter-Ins. Bureau (1975) 15 Cal.3d 9, 16; CACI 2334.) And it provided the insurer with whatever information and documents (medical records, police reports, witness statements) were available at the time. Finally, it gave the insurer a reasonable time for acceptance – the longer the insurer had to investigate, the less time it needed to respond to the demand. ( Coe v. State Farm Mut. Auto. Ins. Co. (1977) 66 Cal.App.3d 981, 994; Kelley v. British Commercial Ins. Co. (1963) 221 Cal.App.2d 554.)

But the insurer rejected the policy limit demand, or it failed to respond in a timely fashion. When an insurer “fails to accept a reasonable settlement offer within policy limits,” it “will be held liable in tort for the entire judgment against the insured, even if that amount exceeds the policy limits.” ( Rappaport-Scott v. Interinsurance Exch. (2007) 146 Cal.App.4th 831, 836.) The “lid” is off the insurance policy. But how do you obtain and eventually recover an excess judgment? There are a number of important steps. One of the most critical is to obtain an assignment of rights from the insured – one assigning all of their assignable rights against the insurer to your client. After that, the options depend on one crucial detail – whether the insurer is providing a defense to their insured.

Obtain an assignment from the insured

An assignment is one of the only ways for the third-party claimant to proceed directly against the insurer to recover an excess judgment. In essence, an assignment of rights in exchange for a covenant not to execute “frees the insured from monetary liability and, in turn, allows the plaintiff to step into the shoes of the insured and bring suit against the insurance company for whatever claims the insured might have had.” ( Executive Risk Indem., Inc. v. Jones (2009) 171 Cal.App.4th 319, 325.)

The assignment can be entered into at any time after expiration of the time to accept the offer within policy limits – even before judgment. This is true regardless of whether the insurer is defending or not. The failure to accept the reasonable settlement demand constitutes a change in the relationship between insurer and insured: “[w]hen the insurer breaches its obligation of good faith settlement, it exposes its policyholder to the sharp thrust of personal liability . At that point, there is an acute change in the relationship between policyholder and insurer.” ( Critz v. Farmers Ins. (1964) 230 Cal.App.2d 788, 801 (emphasis added).) Although the insured must still cooperate in defense of the action (by appearing to testify and telling the truth), “he need not indulge in financial masochism,” nor “bare his breast to the continued danger of personal liability.” ( Id. at 801.) As recognized by the California Supreme Court, “an insured breaches no duty to the insurance company when he assigns his rights against the company to the injured plaintiff for a covenant not to execute.” ( Samson v. Transamerica (1981) 30 Cal.3d 220, 241.)

The major caveat

There is one major caveat to obtaining an assignment from the insured. In California, an insured can assign to a third-party claimant all assignable claims and causes of action against an insurer, except claims for emotional distress and punitive damages, which are not assignable as a matter of law, and are retained by the insured. ( Murphy v. Allstate Ins. Co . (1976) 17 Cal.3d 937, 942.). When entering into an assignment agreement, it is important that both the third-party claimant (the assignee) and the insured (the assignor) have an understanding about whether the non-assigned claims for emotional distress and/or punitive damages will be pursued. This is to avoid an improper “splitting” of the bad-faith cause of action.

If an insured intends to pursue non-assigned claims for emotional distress and punitive damages, they must be brought in a joinder action along with the third party claimant’s prosecution of the assigned claims. If the assigned and non-assigned claims are pursued in separate actions, it would constitute an improper “splitting” of a cause of action and neither action could proceed. ( Purcell v. Colonial Insurance Company (1971) 20 Cal.App.3d 807; Cain v. State Farm Mutual Automobile Insurance Company (1975) 47 Cal.App.3d 783.) Because of the rule established in Purcell and Cain , the assignment agreement should specifically address whether and how the non-assigned claims will be pursued. The assignment agreement should expressly state that the non-assigned claims will not be pursued, or if pursued, will be done in a joinder action to avoid an improper “splitting” of a cause of action.

Finally, some additional items to bear in mind when obtaining an assignment of rights in exchange for a covenant not to execute: (1) obtain the assignment before trial/judgment – insureds may be less cooperative after being subjected to cross-examination or after a large judgment has been rendered against them; (2) include an assignment by the insured of any Brandt attorney’s fees incurred to recover or obtain policy benefits; (3) be mindful that an assignment is not a “settlement agreement” or a “release agreement” and should not include language to that effect – it is merely an assignment in exchange for a covenant not to execute on any eventual judgment; and (4) before granting a covenant not to execute on any excess judgment, investigate the insured’s financial status to make sure there are no other assets to satisfy the judgment.

Control of the defense

When the insurer defends the action against its insured, the insurer retains the right to control the defense and settlement of that action. For the purposes of evaluating an insurer’s duty to accept a reasonable settlement demand, it makes no difference whether the insurer is defending the insured in the third-party claimant’s action. The California Supreme Court has held insurers liable for an excess judgment, without regard to policy limits, in either context. (See Johansen v. California St. Auto. Assn. Inter-Ins. Bur ., 15 Cal.3d 9, (where the insurer was defending but refused to settle within policy limits), and Samson v. Transamerica Ins. Co ., 30 Cal.3d 220, (where the insurer refused to either defend or settle).) The difference lies in the options available to the claimant and insured after the insurer’s failure to settle. When an insurer provides a defense, those options are much more limited.

Even where an insurer failed to accept a reasonable opportunity to settle within policy limits, so long as it continues to provide a defense to its insured, the insurer retains the right to control settlement and defense of the action. Thus, the insured has no right to settle directly with the injured party, no right to enter into a stipulated judgment, and no right to attempt to sabotage the insurer’s defense. ( Hamilton v. Maryland Casualty Co. (2002) 27 Cal.4th 718, 726.) “[N]either the adequacy of the representation nor the effectiveness of the defense are relevant to the question whether the [insured] can enter into a binding settlement without the insurer’s consent.” ( Safeco Ins. Co. v. Superior Court ( McKinney ) (1999) 71 Cal.App.4th 782, 789.)

In essence, this means that if the insurer is providing a defense, the third-party claimant must proceed to trial and obtain an excess judgment against the insured. The primary step for the third-party claimant to take then is to acquire the assignment of rights from the insured and prosecute the lawsuit. With the assignment in hand, the third-party claimant can proceed directly against the insurer upon the rendering of an excess judgment.

If the insurer refuses to provide a defense

If the insurer refuses to provide a defense, additional options are available. “An insurance company ‘bears a duty to defend its insured whenever it ascertains facts which give rise to the potential of liability under the policy.’ Wrongful failure to provide coverage or defend a claim is a breach of contract.” ( Pruyn v. Agric. Ins. Co. (1995) 36 Cal.App.4th 500, 514-15, as modified on denial of reh’g (July 27, 1995), quoting Isaacson v. California Ins. Guarantee Assn . (1988) 44 Cal.3d 775, 791.) By breaching its contractual duty to defend the insured, the insurer forfeits its right to control the settlement and defense of the action. The insured, in addition to assigning his or her rights to the third-party claimant, has additional options for resolving the action brought against them, such as: (1) an uncontested trial, which is binding on the insurer; (2) a default judgment, also binding on the insurer; and (3) a stipulated judgment, which is subject to attack by the insurer in the subsequent bad-faith action.

• Undergoing an uncontested trial

In Samson v. Transamerica , (1981) 30 Cal.3d 220, one of the insured’s carriers, State Farm, agreed to defend the insured, while the other, Transamerica, denied a defense. Consequently, the insured and State Farm collectively entered into an agreement with the Samsons, the underlying plaintiffs, before the action went to trial. The agreement provided that, in exchange for State Farm’s payment of its $100,000 policy limit and the insured’s assignment of any rights against Transamerica, the Samsons would sign a covenant not to execute any judgment ultimately obtained against the insured. Moreover, the insured agreed to cooperate with the plaintiffs in the action against him. This agreement was reached without the knowledge of Transamerica.

At trial, the insured did not contest liability or damages, presented no defenses, and did not cross-examine witnesses. Although Transamerica had been informed of the pendency of the action, it was not informed of the trial date. The trial court ultimately awarded the Samsons $725,000. Thereafter, the Samsons, as judgment creditors and assignees, sued Transamerica.

The Samson court was called upon to “decide whether this insurance company is bound to pay the entire judgment entered against its insured in an action to which it was not a party, because it refused to defend its insured and rejected a settlement offer.” ( Id. at 224.) Transamerica argued that “even if coverage is found Transamerica should have an opportunity to litigate the amount of damage,” and that it should only be liable up to its $300,000 policy limit. ( Id. at 236.)

But Samson found that “an insurer who fails to accept a reasonable settlement offer within policy limits because it believes the policy does not provide coverage assumes the risk that it will be held liable for all damages resulting from such refusal, including damages in excess of applicable policy limits.” ( Id. at 237.) Thus, the insurer was bound by the judgment, despite it being an uncontested trial. Similarly, in National Union Fire Ins. Co. v. Lynette C. (1994) 27 Cal.App.4th 1434, 1449, the court observed that a judgment entered by a court after an uncontested trial was an “independent adjudication of the facts based on an evidentiary showing” because “[the parties] did not resolve the issues of liability and damages in the [underlying] action. A court did.” ( Ibid .)

The case law is clear that once an insurer refuses to defend in an underlying action, and refuses to intervene by filing a motion to vacate the judgment in the underlying action, it cannot later collaterally attack the evidence of damages which were introduced and proven in the underlying action. The controlling case is Clemmer v. Hartford Ins. Co. (1978) 22 Cal.3d 865, 885-886, a decision by the California Supreme Court. In Clemmer , the Court held that an insurer has standing to seek to set aside a judgment entered against its insured that it may be held responsible to pay. Clemmer further held that when an insurer declines to exercise this option, it is later precluded from re-litigating the issue of damages. ( Id . at 888.)

The Clemmer Court noted that since the insurer had ample notice of the adverse judgment; it had six months to file a motion in the underlying action to set aside the judgment, and that its failure to do so precluded it from raising its defense in a collateral attack on the judgment. The Clemmer court explained that the insurer had standing to seek to move to set aside the judgment, but failed to do so. ( Id . at 886.) The Court explained that because the insurer “chose to remain silent, resting on its claim of noncoverage” and “[h]aving failed to pursue remedies thus available to it, it cannot now claim prejudice or lack of opportunity to litigate damages.” ( Id . at 886).

Based on the foregoing, in order to preclude a later attempt to collaterally attack the judgment, the recommended course is to have an independent adjudication of the underlying action and then give notice of the judgment to the insurer. This can be accomplished either through the uncontested trial, or the default judgment below. Both will be binding on the insurer.

Obtaining a default judgment

This route for obtaining an excess judgment was specifically approved in Amato v. Mercury Casualty Co. (1997) 53 Cal.App.4th 825. In Amato , the insured (Amato) tendered to his insurer, Mercury, but Mercury refused to defend. The plaintiff in that action offered to settle for the $15,000 policy limit, a demand that was also rejected by Mercury. The insured couldn’t afford to defend himself, so the plaintiff obtained a default judgment against Amato for $165,750. Mercury, similar to the example above in Clemmer , failed to do anything to set aside the default.

Amato considered that “[a] default judgment for personal injury results only after the court conducts a hearing to consider the plaintiff’s evidence and to award such damages as that evidence shows to be just.” ( Id. at 838, citing Code Civ. Proc., § 585, subd. (b).) Thus, the judgment that resulted involved “significant independent adjudicatory action by the court, thus mitigating the risk of a fraudulent or collusive settlement between an insured and the claimant. Final judgments entered under ... these circumstances are binding on the insurer which has wrongfully abandoned its insured and may be enforced directly under Insurance Code section 11580.” ( Amato, 53 Cal.App.4th at 838, quoting Pruyn, supra, 36 Cal.App.4th at 517, 523.)

Under Amato , the insurer who breaches the duty to defend, where the insured suffers a default judgment because they are unable to defend themselves, will be liable for the default judgment “which is a proximate result of its wrongful refusal to defend.” ( Amato, at 829.) The “insured is not required . . . to conduct a ‘trial within a trial’ in order to recover the amount of the default judgment.” ( Ibid. ) The court in Xebec Development Partners Ltd. v. National Union Fire Ins. Co . (1993) 12 Cal.App.4th 501, made the same point, observing that the prove-up proceeding that is necessary to obtain a default judgment provides the requisite independent adjudication necessary to bind an insurer. ( Id ., 12 Cal.App.4th at 541, 544.)

Thus, when an insurer refuses to defend, a default judgment will be binding on the insurer in the subsequent bad-faith action as a consequential damage where the insured could not afford to defend the action.

Stipulated judgment subject to attack by insurer

A stipulated judgment can be subject to attack by the insurer − it only provides an evidentiary presumption in favor of the excess judgment and is not binding. When a “liability insurer wrongfully denies coverage or refuses to provide a defense, then the insured is free to negotiate the best possible settlement . . . including a stipulated judgment accompanied by a covenant not to execute.” ( Pruyn, supra, at 509.) But when that agreement purports to fix the amount of damages suffered by the third-party claimant by way of a stipulated judgment or settlement, it calls into question whether the settlement properly represents the amount of damages sustained, or whether it was collusive. ( Id., at 518.) The concern arises in this situation because it is in the insured’s interest to agree to damages in any amount as long as the agreement provides that the insured will not be personally responsible for payment. ( Ibid .)

Pruyn specifically addressed whether a stipulated judgment between the insured and the third-party claimant would be binding on the insurer. The claimant argued that it should be binding because the stipulated judgment was found to constitute a “good-faith” settlement under Code of Civil Procedure section 877.6. But Pruyn surveyed the law and determined that the rule that a final judgment entered against an insured would be binding on the insurer did not apply when there was a stipulated judgment that had only been subject to approval under section 877.6.

Pruyn held that a stipulated judgment approved as a good-faith settlement would not be treated as the equivalent of a judgment entered after a default hearing or an uncontested trial. Instead, the insurer would be given an opportunity that is generally not available when there is a judgment entered after an adjudicatory proceeding – the opportunity to attack the amount of the settlement as the product of fraud and collusion. ( Pruyn, at 526.)

But note that the settlement “will raise an evidentiary presumption in favor of the insured (or the insured’s assignee) with respect to the existence and amount of the insured’s liability.” ( Id. at 509.) The effect of the presumption – and of the settlement – is to “shift the burden of proof to the insurer” to affirmatively show that the settlement was unreasonable or the product of fraud or collusion. ( Ibid. )

As the previous decisions demonstrate, the underlying judgment is binding on the insurers when there was an independent adjudication of liability and damages. ( Pruyn , 36 Cal.App.4th at 527; Amato, 53 Cal.App.4th at 838.). But where the adjudication is made by the parties, the judgment is only entitled to a rebuttable presumption. Accordingly, while a stipulated judgment is permissible when an insurer has refused to both defend and settle, the better practice is to proceed to judgment with an independent judicial adjudication.

The CCP 638 reference hearing

A preferable alternative that will be binding on the insurer when it refuses to defend? Undergoing a California Code of Civil Procedure section 638 reference hearing.

To be enforceable against an insurer, a ‘judgment need not be based on a contested or adversarial trial, but may rest upon a default hearing following a settlement or an uncontested trial where the insured settled with the claimant and thereafter provided no defense.

( Garamendi v. Golden Eagle Ins. Co. (2004) 116 Cal.App.4th 694, 739-740.)

These circumstances necessarily involve significant independent adjudicatory action by the court thus mitigating the risk of fraudulent or collusive settlement between an insured and the claimant. Final judgments entered under either of these circumstances are binding on the insurer which has wrongfully abandoned its insured…

( Id. at 740.)

One way to proceed with the “significant independent adjudicatory action” is to have, as part of the assignment, an agreement among all parties to appoint a referee pursuant to California Code of Civil Procedure section 638 (herein CCP 638). Under that section, “a referee may be appointed upon the agreement of the parties . . . (a) to hear and determine any or all of the issues in an action or proceeding, whether of fact or of law, and to report a statement of decision.” In addition, “[a] statement of decision reported by a referee under a voluntary general reference [CCP 638] is the equivalent of a statement of decision rendered by a superior court . . . .” ( Central Valley General Hosp. v. Smith (2008) 162 Cal.App.4th 501, 513.)

Functionally, the way to proceed is to have the parties, as part of the assignment agreement, agree to undergo a CCP 638 reference by the referee of their choice (preferably a retired judicial officer), who will be appointed to determine all issues in the matter, including facts, law, liability, and damages. With the executed assignment agreement in hand, the parties jointly file a stipulation with the Superior Court to appoint the CCP 638 referee on the same terms as the assignment agreement and to determine all issues in the case. Once the referee is ap- pointed, the parties can select a mutually agreeable date for the CCP 638 reference hearing, preferably at a neutral site, or the referee’s office. The insurer should be invited to attend, in writing. Following the hearing, the referee will render a statement of decision, which can be confirmed by the Superior Court, with judgment entered pursuant to the terms of that decision.

This judgment, because it involved significant independent adjudicatory action by the court and its designated referee, will be binding on the insurer to the same extent as an uncontested trial or default judgment. This procedure provides greater autonomy, quicker resolution, and an independent statement of decision that establishes the facts, decision, law, and damages in the underlying action.

Final tips after failure to settle

An important consideration for the follow-up bad-faith action against the insurer is the matter of the plaintiff. With an assignment of rights, the third-party claimant can directly proceed against the insurer for the entire excess judgment, but cannot claim emotional distress or punitive damages without also including the insured as a plaintiff. And, as above, both the third-party claimant and the insured would have to proceed as plaintiffs against the insurer in the same action . It calls for a decision – does the insured, the tortfeasor in the underlying case, make a sympathetic and believable plaintiff? And are the emotional distress damages and punitive exposure sufficient to justify their inclusion and the added complexity? It calls for a case-by-case determination.

An alternative to the assignment of rights agreement is an assignment of proceeds agreement. There, the insured prosecutes the entirety of the bad-faith action against the insurer, and agrees to assign the proceeds of that action to the third-party claimant. But this raises issues of its own – including settlement control, consent to settle, how proceeds are shared, and the control of the litigation. Both approaches have their benefits and drawbacks.

But the importance of an assignment cannot be overstated – it is the only way for a third-party claimant to proceed directly against the insurer for the excess judgment. That is not to say the third-party claimant lacks options though. Insurance Code section 11580(b)(2) provides that “whenever judgment is secured against the insured . . . in an action based upon bodily injury, death, or property damage, then an action may be brought against the insurer on the policy and subject to its terms and limitations, by such judgment creditor to recover on the judgment.”

The import of Insurance Code section 11580 is that an adjudicated claimant becomes a third-party beneficiary under the policy. They can then file an action to collect the judgment that is “on the policy” – i.e., the amount of the judgment within the policy limits. This can be initiated even without an assignment. Should the insurer refuse to pay the judgment on the policy, an action against the insurer for bad faith failure to pay can be directly brought by the third-party claimant. But to collect any “excess” judgment over the amount “on the policy,” the third-party claimant must have an assignment from the insured. ( Murphy v. Allstate (1976) 17 Cal.3d 937; Hand v. Farmers (1994) 23 Cal.App.4th 1847.)

Finally, regardless of the route taken to obtain the excess judgment, be it CCP 638 reference, uncontested trial, or default judgment, be certain to take the necessary steps to work up the case. Hire the proper experts, obtain the necessary testimony, and collect the relevant evidence and workup to maximize the value of the underlying case. The excess judgment is the foundation for the future bad-faith case. Notably, the judgment provides presumptive proof of the value of the claim. “The size of the judgment recovered in the personal injury action, although not conclusive, furnishes an inference that the value of the claim is the equivalent of the amount of the judgment and that acceptance of an offer within those limits was the most reasonable method of dealing with the claim.” ( Crisci v. Security Ins. Co. of New Haven (1967) 66 Cal.2d 425, 430.)

Perfecting an excess judgment and working to recover the entire amount from the insurer takes practice, but generally follows the same series of steps. After the insurer has rejected a reasonable opportunity to settle within policy limits, begin discussions for an assignment in exchange for a covenant not to execute. With the assignment in hand, the determining factor is then whether the insurer is defending the underlying action. If so, prosecute your case and strive for an excess judgment. If not, engage in one of the options above that requires substantial judicial intervention and management – a default judgment, uncontested trial, or preferably, a CCP 638 reference – and obtain an excess judgment. At that point, with an assignment and excess judgment in hand, you’re ready to proceed with an action against the insurer to recover the entire amount of the excess judgment.

Ricardo Echeverria

Ricardo Echeverria is a trial attorney with Shernoff Bidart Echeverria LLP, where he handles both insurance bad-faith and catastrophic personal-injury cases.  He is currently the incoming President of CAALA and was named the 2010 CAALA Trial Lawyer of the Year, the 2011 Jennifer Brooks Lawyer of the Year by the Western San Bernardino County Bar Association, and a 2012 Outstanding Trial Lawyer by the Consumer Attorneys of San Diego. He was also a finalist for the CAOC Consumer Attorney of the Year Award in both 2007 and 2009, and is also a member of ABOTA and the American College of Trial Lawyers.

Matthew Clark

Matthew Clark is a partner with the Irvine-based law firm of Bentley & More LLP, where he handles complex, law-and-motion, and appellate matters in fields ranging from insurance bad faith, to catastrophic personal injury and public-entity liability. He was recognized as a Rising Star by Super Lawyers magazine in 2015, 2016, and 2017 and attended the University of Michigan and Notre Dame Law School.

Copyright © 2024 by the author. For reprint permission, contact the publisher: Advocate Magazine

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Pennsylvania Decides Again that Assignments of Bad Faith to Restorers are Valid

Pennsylvania federal court held that bad faith claims could be assigned to a third party, such as a restoration company, who alleged injury from the insurer’s conduct in adjusting the claim. .

State Farm Fire and Casualty Company (“State Farm”) insured 1133 Columbia LLC’s property (“Columbia”). Royal Water Damage Restoration (“Royal Water”) performed mitigation, remediation, and drying services after a water line burst, damaging the property. Columbia subsequently assigned its rights under the State Farm policy to Royal Water, which sued State Farm for breach of contract and statutory bad faith in the Philadelphia County Court of Common Pleas. State Farm moved to dismiss the bad faith claim, arguing that the bad faith claim could not be assigned. The Court denied the motion, allowing Royal Water to pursue the claim for bad faith and breach of contract against State Farm.

Columbia suffered a water line break, sustaining a loss to multiple units. Columbia submitted a timely claim to State Farm, which sent an adjuster to evaluate damages. Royal Water restored the property between December 2020 and February 2021. State Farm initially agreed with the scope of Royal Water’s work, and Royal Water billed State Farm $165,012.32 for its services.

After prior approval of the scope, State Farm sent Royal Water’s invoices to a Third Party vendor for an audit. The third-party was late to the project; thus, it only saw the completed site. Royal Water alleges the vendor’s “estimate for drying goals” was “an arbitrary number of days” and not “based on objective calculations as required by the Institute of Inspection Cleaning and Restoration Certification standards . . . .” (“IICRC”). Although Royal Water told State Farm three times that the third-party estimate did not comply with IICRC standards, State Farm paid Royal Water based on the estimate. 

Royal Water alleges that it has not been reimbursed approximately $45,000 for the reasonable expenses it incurred for its services because State Farm underestimated the extent of the damage. In addition, Royal Water alleges it is Columbia’s “creditor” because of “State Farm’s wrongful refusal to pay reasonable expenses” for Royal Water’s services. However, Royal Water did not allege there is an outstanding judgment for any unpaid amount. State Farm argues that Columbia’s assignment was invalid because Royal Water does not have an outstanding judgment.

Assignment of an Insurance Bad Faith Claim

Columbia “assigned any and all of its rights, benefits and causes of action” under its State Farm policy to Royal Water “to the extent [the restoration company] provided services” at the property. State Farm argued that case precedent in Pennsylvania required both the assignee being injured and the assignee is a judgment creditor (Allstate Prop. & Cas. Ins. Co. v. Wolfe (2014) 629 Pa. 444, 446 [105 A.3d 1181, 1182].) . The court held that State Farm’s interpretation of Wolfe is inconsistent with the broader reasoning behind it.

“Allowing Royal Water to stand in Columbia’s shoes serves “the salutary purposes of encouraging good faith settlement negotiations, and punishing insurance carrier abuse”

When the bad faith statute was enacted, the Supreme Court had allowed assignments of bad faith claims “for almost twenty-five years.” It did not believe the legislature intended to change the practice because, as drafted, the statute does not explicitly bar assignments. Allowing insureds to assign their bad faith claims serves the statute’s “aim of deterrence.” It does not encourage plaintiffs to “pursue unreasonable settlement demands” or claims that otherwise never would have been pursued. 

The court goes on to state that even if Wolfe limited assignments to “injured” third parties, Royal Water has plausibly alleged it “has actually sustained injury” from State Farm’s conduct and is not “an uninterested party to the insurance claim” pursuing litigation just “to create an economic benefit to it.” The Pennsylvania Federal Court then held that: Royal Water seeks to recover from State Farm’s refusal to pay “expenses it incurred for its services at the insured premises relative to the covered loss. “Allowing Royal Water to stand in Columbia’s shoes serves “the salutary purposes of encouraging good faith settlement negotiations, and punishing insurance carrier abuse.” Wolfe , 105 A.3d at 1186

Don’t Be Afraid to Question the Insurance Company’s Decisions

Carriers need an objectively reasonable justification for denial of claims decisions or they face liability for insurance bad faith.

Put your questions in writing and demand that the insurance company put its position in writing as well. The adjuster may justify their claims handling in one way on the phone but it’s a different matter when they have to reduce their decision to writing. Remember, once an insurer puts its position in writing if you end up having to sue the insurer for bad faith they will have a hard time changing their position.  If you don’t “get it in writing” you might be surprised how the adjuster’s version of what was said to you changes when they are under oath in a deposition or in court.

If the policyholder or assignee believes the insurance company is acting unreasonably and unfairly, then it is probably time to seek the advice of an experienced insurance bad faith lawyer. 

Watch and learn more about insurance bad faith below.

Ready to learn about Assignments of Insurance Rights and Benefits?

The Book on the Assignment of Benefits, 2nd ed. by Ed Cross, contains forms for every State, a letter to place the carrier on notice, along with a training guide explaining the ins and outs of executing and enforcing an assignment.

There is no greater way to empower a restorer to recover fair market value for restoration service than with a properly-drafted Assignment of Insurance Rights. Assignments allow restorers to cause insurance companies to pay a reasonable price for restoration service, and to pay a second time if the insurer sends the restorer’s money to the policyholder. 

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IF A BAD FAITH CLAIM EXISTS, CAN THE DEFENDANT ASSIGN HIS RIGHTS WITH THE INSURER TO THE PLAINTIFF AND AVOID LIABILITY?

Sometimes the black letter law passed by the legislature is unclear. The legislature can’t anticipate every possible fact scenario when they pass a law, so it lay to the courts to interpret the law and give guidance to what it means. This interpretation is called case law. When the court decides a certain meeting to the law it essentially answers a legal question. Lawyers and other courts then can rely on that ruling when they have a similar issue in their case. The following case answers the question above.

Glenn v. Fleming, 799 P.2d 79 (Kan. 1990).

This case addresses the following issue:

If an insurance company (“insurer”) cannot reach a settlement agreement with a plaintiff because of bad faith, can the defendant assign his rights with the insurer to the plaintiff and avoid liability?

This case explored the issue of whether a defendant can assign his rights with the insurer to the plaintiff and avoid liability if the insurer could not reach a settlement agreement because of bad faith. In exploring this issue, the court concluded that an assignment/covenant not to sue may be utilized if the judgment was reasonable in amount and entered into in good faith. Id. at 93.

In this case, the defendant drove his pickup truck to a nearby business to purchase propane gas. Id. at 81. The plaintiff, an employee of the business, filled the propane tank on the vehicle. Id. After the tank was filled, a vapor fire suddenly occurred. Id. The plaintiff was severely injured and required extensive hospitalization and treatment. Id. As a result of the injury, the plaintiff filed a personal injury action against the defendant. Id. The defendant’s insurance company was Aetna and the policy limits for this accident were $25,000. Id. at 82. Both plaintiff and defendant had very little recollection on what occurred prior to the explosion; however, both were insistent that the other was responsible for the explosion. Id. Therefore, the plaintiff offered to settle the case and dismiss the defendant from suit for a payment of $25,000. Id. The defendant’s attorney passed this onto Aetna who rejected the offer and counter offered at $5,500. Id. In response, the plaintiff rejected the counteroffer. Id. After the defendant’s attorney saw how severely burned the plaintiff was, he contacted Aetna. Id. at 83. Thereafter, Aetna offered the plaintiff $25,000 and the plaintiff rejected the offer, informing Aetna that it was too late and that Aetna previously had acted in bad faith. Id. Much back and forth went on between the plaintiff and Aetna and no settlement was agreed upon. Id. Therefore, the case went to trial and the jury found the plaintiff to be 30% at fault and the defendant to be at 70% at fault. Id. at 84. The total verdict for the plaintiff was $1,500,000, which was reduced to $1,050,000 after the court took into consideration the plaintiff’s 30% fault. Id.

After the jury returned a verdict, the defendant found himself in a bit of predicament as a result of Aetna not being able to settle with the plaintiff. Id. So, the defendant signed a covenant not to execute with the plaintiff. Id. In this covenant, the defendant assigned all of his contractual rights with Aetna under his policy to the plaintiff. Id. In return, the plaintiff agreed not to execute upon any property of the defendant, either real or personal. Id. In essence, the defendant thought, “It is not my fault Aetna acted in bad faith and could not reach a settlement agreement with the plaintiff. Therefore, I am going to give all of my rights with Aetna to the plaintiff and let the plaintiff go after them instead of me.” Id. at 92.

The question then became whether the defendant could do this. Id. According to the court, the assignment/covenant not to sue may be utilized if the judgment was reasonable in amount and entered into in good faith. Id. at 93. Additionally, the court specified that a defendant was only able to assign his rights to a plaintiff if the insurance company negligently refused to settle or acted in bad faith. Id. at 91. Further, the court noted that it was the responsibility of the plaintiff to prove to the jury that the insurance company exercised bad faith in refusing to settle within the policy limits. Id. at 93. In sum, the court found that the plaintiff proved the insurance company acted in bad faith and the agreement between the plaintiff and defendant was reasonable and entered in good faith. Id.

California Court of Appeals Pushes Back on Bad Faith “Set Up”

Steven L. Miracle

Given the potential for the award of punitive damages and attorney’s fees, third-party claimants and their counsel have a clear incentive to exert pressure on an insurance company to make critical settlement decisions shortly after a loss. Typically a policy limits demand, third-party claimants and their counsel seek to settle their claims within a specified (and often condensed) timeframe in the hopes of depriving insurers of the necessary information to make informed settlement decisions. When an insurer is unable or unwilling to pay the limits on the proposed terms, the third-party claimants and their counsel will later attempt to take an assignment of the insureds’ “bad faith” claim predicated on the insurer’s failure to settle the claim within the policy limits, thereby exposing the insureds to personal liability. This is generally referred to as a bad faith “setup.” 

This is not a new concept. In 1985, Justice Kaus of the California Supreme Court observed that “attorneys who handle policy claims against insurance companies are no longer interested in collecting on those claims, but spend their wits and energies trying to maneuver the insurers into committing acts which the insured can later trot out as bad faith.”  White v. Western Title Ins. Co. , 710 P.2d 309, 328 n.2 (Cal.) (Kaus, J., concurring and dissenting). The Tenth Circuit Court of Appeals has recognized similar concerns over “manufactured” bad faith claims, noting that “[c]ourts should exercise caution ‘when the gravamen of the complaint is not that the insurer has refused a settlement offer, but that it has delayed in accepting one.’ This caution ‘arises from the desire to avoid creating the incentive to manufacture bad faith claims by shortening the length of the settlement offer while starving the insurer of the information needed to make a fair appraisal of the case.”  Wade v. EMASCO Ins. Co ., 483 F.3d 657, 669 (2007). Nonetheless, third-party claimants and their counsel continue to employ this strategy to varying degrees of success. Indeed, in some jurisdictions, evidence of the “set up” is not admissible in a bad faith action. 

However, a recent decision by the California Court of Appeals shows that this strategy has its limits. On August 23, 2022, the court handed down a decision in  Palma v. Mercury Ins. Co.  The case involved a car-on-moped collision that left the moped operator dead. Within a month of the accident, counsel for the moped operator’s estate sent a settlement demand to Mercury Insurance Company (“Mercury”), which insured Frank McKenzie, the car driver, seeking the “full policy limits,” which included $15,000 in bodily injury liability coverage and $10,000 in property damage coverage. The demand letter threatened that the estate “will determinatively prove our client’s medical expenses, and recovery will be well in excess of your insured’s policy limits.” The offer was to remain open for 14 days and was conditioned on McKenzie providing a declaration indicating he had no other insurance to cover the accident and Mercury providing an “appropriate release.” 

In response, Mercury hired an attorney and instructed him to accept the offer. Within a week of the letter, counsel faxed a letter to the estate’s counsel indicating Mercury would be tendering its $15,000 policy limits to the estate and the deceased’s heirs. In addition, he enclosed an affidavit of heirs so their names could be included in the release. Counsel for the estate did not respond.

A few days later, Mercury’s retained counsel contacted McKenzie to discuss the settlement offer. McKenzie agreed to the settlement and signed a declaration stating he had no other insurance to cover the accident. Mercury’s counsel advised Mercury that he would overnight the settlement check with the release and McKenzie’s declaration to the estate’s counsel. He then advised the estate’s counsel that Mercury had accepted the offer and enclosed the check and the release. However, he inadvertently failed to enclose McKenzie’s declaration. Counsel asked the estate’s counsel to advise whether there were any changes to the release before the 14-day window expired. The estate’s counsel never responded. A month later, Mercury’s counsel mailed a check for the value of the damaged moped.

A few months later, Mercury’s counsel inquired as to the status of the release. The estate’s counsel responded that there was no settlement because the demand was for all available policy limits, including the $10,000 property damage limits. Over the next several months, Mercury continued reiterating its offer of the $15,000 bodily injury limits. Ultimately, the estate’s counsel responded that Mercury had committed bad faith by failing to accept a reasonable policy limits demand. And, for the first time, the estate’s counsel claimed Mercury failed to deliver McKenzie’s declaration timely. As a result, the estate’s counsel stated the firm would be filing a lawsuit that would drive McKenzie into bankruptcy, “destroy” his credit and embarrass McKenize and his family through post-judgment collection proceedings. Mercury’s counsel immediately sent McKenzie’s declaration and advised that he did not read the demand letter, including the property damage limits. 

Almost a year after the accident, the estate’s counsel filed suit, which included a wrongful death action brought by the deceased’s family members. The matter was tried by a jury, and the court ultimately entered judgment against McKenize on the wrongful death action in the amount of $3 million. McKenzie then assigned his rights against Mercury to the plaintiffs, who sued Mercury for bad faith. 

On appeal, the Court of Appeals affirmed summary judgment in favor of Mercury. Mercury had argued that only the estate had made a settlement demand (which did not include the wrongful death claims), the offer was unreasonable because it demanded the property damage limits for a moped worth less than those limits and, alternatively, that its failure to accept the settlement offer was the result of negligence, not bad faith. The Court of Appeals agreed with Mercury on all these points, holding that no reasonable jury could conclude Mercury had acted in bad faith.  

The Court of Appeals, seemingly incensed by the Plaintiffs’ and their counsel’s conduct, did not stop there. The court explained that “[i]f anyone acted in bad faith, it was Plaintiffs” and their counsel. In the court’s view, the issue of McKenzie’s declaration “could have been resolved with a single phone call” and did not justify their commencement of legal proceedings against McKenzie, knowing it would “destroy” his credit and embarrass him and his family members. 

Although the California Court of Appeals reached the correct decision in  Palma , the bad faith “setup” remains an important strategy for third-party claimants and their counsel. Therefore, insurers with a time-sensitive demand for policy limits must respond quickly, either tendering the limits (if appropriate) or specifically identifying the information needed to complete an investigation and attempting to negotiate the deadline. Our seasoned counsel at Meissner Tierney Fisher & Nichols S.C. are well-suited to help insurers navigate these challenging circumstances. If we can be of assistance, please contact us at 414-273-1300.

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UP authored amicus in this important case of first impression supporting the rights of policyholders and their judgment creditors to recover a judgment in excess of the policy limits in contract actions against the insurance company for breach of the duty to defend, where the…

• Assignment of Bad Faith Claims

On certified question from the U.S. Court of Appeals for the Third Circuit, the Pennsylvania Supreme Court confronted the issue of whether statutory bad faith claims may be assigned to an injured third party when the insured settles its claim and/or chooses not to pursue…

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Assignment of Benefits and Insurance Bad Faith Law: 50-State Reference Guide

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The RIA sees widespread ignorance of the law of assignments and underutilization of assignments as a significant threat to the health of the restoration industry and the availability of high-quality restoration services to consumers. Accordingly, the RIA has compiled this collection of excerpts of cases and statutes that address certain aspects of the enforceability of assignments for each state, and insurance bad faith. It is not a complete statement of the relevant law, and as laws change, the legal principles may be reversed or become outdated. However, this material will provide a good starting point for restorers, working closely with their lawyers, to formulate an assignment strategy that fits their businesses.

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Guide for Causes of Action for Bad Faith Claims

UNFAIR CLAIMS SETTLEMENT PRACTICES ACT KY. REV. STAT. ANN. §§ 304.12-230 (1984/1988).

Kentucky case law establishes there is no claim for bad faith in the absence of coverage.  Absent a contractual obligation, there simply is no bad faith cause of action, either at common law or by statute. Davidson v. Am. Freightways, Inc. , 25 S.W.3d 94, 100 (Ky. 2000). “[I]n the absence of a contractual obligation in an insurance policy for coverage, there can be no claim for bad faith.” Kentucky Nat’l Ins. Co. v. Shaffer , 155 S.W.3d 738, 742 (Ky. Ct. App. 2005), Motorists Mutual v. Glass , 996 S.W.2d 437 (Ky. 1999) deals with first- and third-party claims, discusses the history of both, and places all prior bad-faith cases in the perspective of that history.

• Can insureds sue for bad faith (i.e., first party bad faith)? Yes. Motorists Mutual v. Glass , 996 S.W.2d 437 (Ky. 1999). Bad Faith Update Six Essential Cases, Mike Breen. 66 KY Bench & B 6 (March 2002) and Duty of Liability Insurer to Compromise Litigation, 26 KY, L.J. 100, Jan. 1938. ‍
• Can third parties sue for bad faith (i.e., third party bad faith)? Yes. State Farm v. Reeder , 763 S.W.3d 116 (Ky. 1988).  KRS 446.070 provides a claim to any person injured by the violation of another Kentucky statute. Through this statute, third parties can sue for violations of KRS 304.12-230, Kentucky’s Unfair Claims Settlement Practices Act (UCSPA), which is nearly identical to the Model Act.

FIRST PARTY BAD FAITH:

• Are there statutory grounds for the bad faith cause of action? If so, identify the source (i.e., an Unfair Claims Practices Act, or some other consumer protection statute) and its main provisions.  Yes, under KRS 304.12-230, the Kentucky Unfair Claims Settlement Practices Act (“UCSPA”), which lists 15 unfair acts.

Claimants may also have a claim for violation of Kentucky’s Consumer Protection Act, KRS 367.110 et seq. The purchase of a policy is a service intended to be covered by the Act— Stevens v. Motorists Mut. Ins. Co. , 759 S.W.2d 819 (Ky. 1988)—but the failure to settle a claim is not, in and of itself, an unfair act contemplated by the Act. State Farm Fire & Casualty Ins. Co. v. Aulick , 781 S.W.2d 531 (Ky. App. 1989).

• Is there a common law/judicially created bad faith cause of action (i.e., the implied covenant of good faith)? If so, identify the major case(s) and language of the standards applicable to bad faith cases.  Yes, the claim arises under the implied covenant of good faith inherent in every contract. Grundy v. Manchester Ins. & Indem. Co. , 425 S.W.2d 735, 737 (Ky. 1968). Wittmer v. Jones, 864 S.W.2d 885, 890 (Ky. 1993):

Whether a bad-faith claim arises under common law or under the UCSPA, the claimant must prove three elements to prevail: (1) the insurer must be obligated to pay the claim under the terms of the policy; (2) the insurer must lack a reasonable basis in law or fact for denying the claim; and (3) it must be shown that the insurer either knew there was no reasonable basis for denying the claim or acted with reckless disregard for whether such a basis existed. Id.  Technical violations of the UCSPA do not form the basis of a claim. There must also be “evidence sufficient to warrant punitive damages.” Id. That means the claimant must show that the insurer acted with an “evil motive,” or “reckless indifference to the rights of others.” Id.   See also, Motorists Mut. v. Glass, supra 996 S.W.2d at 452: “[M]ere delay in payment does not amount to outrageous conduct absent some affirmative act of harassment or deception.”  

Duty to settle: Although the insurer has a duty to its insured to settle claims within its policy limits when it can reasonably do so, that duty does not arise until a claimant makes a demand within the policy limits. There is no affirmative duty on the carrier to “seek out the claimant and offer settlement in order to avoid a charge of bad faith.” Davis v. Home Indem. Co. , 659 S.W.2d 185, 189 (Ky. 1983).  

Duty to defend: Under Cincinnati Ins. v. Vance , 730 S.W.2d 521 (Ky. 1987), an insurer may deny coverage and refuse to provide a defense. But if that denial is found to be wrongful in subsequent coverage litigation, the insurer becomes responsible for the entire amount of any verdict rendered against the insured without regard to policy limits.

The insurer may also be bound by any settlement agreement reached between the claimant and the insured, although it is not necessarily bound by the agreed-upon damages.

Since Vance most insurers defend under a reservation of rights unless their coverage position appears airtight. However, an insured is not required to accept a defense under reservation of rights. Medical Protective Co. v. Davis , 581 S.W.3d 25 (Ky. 1979).

Both insurers and individual adjusters have been sued for violations of the UCSPA. But Kentucky has never ruled on whether individual adjusters may be sued for common-law bad faith. Because of Kentucky’s stringent summary-judgment standard, many plaintiffs who sue out-of-state insurers will join adjusters who reside in Kentucky to destroy diversity.

Note, in the Eastern and Western federal districts regarding fraudulent joinder for defeating diversity jurisdiction. Under Sixth Circuit law, a defendant is fraudulently joined if there is no reasonable basis to predict that the state law would impose liability under the facts pleaded in the complaint. Alexander v. Elec. Data Sys. Corp. , 13 F.3d 940, 949 (6th Cir. 1994). For representative cases see Lisk v. Laroque , 2008 U.S. Dist. LEXIS 4030 (W.D.Ky. 2008)(finding fraudulent joinder); Malone v. Cook , 2005 U.S. Dist LEXIS 24962 (W.D.Ky. 2005)(finding fraudulent joinder); Gibson v. Am. Mining Ins. Co. , 2008 U.S. Dist. LEXIS 82205 (E.D.Ky. 2008)(rejecting fraudulent joinder argument).

Update: In Western Leasing, Inc. v. Acordia of Kentucky, Inc. , 2010 Ky. App. LEXIS 81 (May 7, 2010), the court upheld the dismissal of an UCSPA claim against Acordia, who was the plaintiff’s agent for procuring insurance the plaintiff. The UCSPA was intended to regulate the conduct of insurance companies. The statute regulates the conduct only of persons who enter into contracts of insurance. Brokers do not actually enter into such contracts; they procure such contracts on behalf of their principals.  A motion asking the Kentucky Supreme Court for discretionary review of Western Leasing is pending as of this writing.  

Self-insured entities are not subject to claims for bad faith. Davidson v. American Freightways, Inc. , 25 S.W.3d 94 (Ky. 2000).

Workers’ compensation carriers are not subject to statutory claims under the UCSPA or the Consumer Protection Act; workers are limited to the remedies available under the Workers’ Compensation Act, KRS Chapter 342.

Bifurcation—Trial courts are required to bifurcate bad-faith claims, trying them after the underlying claim is resolved, and only if it is resolved in favor of the claimant. Wittmer. In practice, some courts schedule the bad-faith case to follow the underlying case immediately, if necessary. Most will set the bad-faith case much later.

Bifurcation of Discovery— Wittmer does not speak to whether trial courts should hold discovery in abeyance pending the resolution of the underlying claims. The practice varies from jurisdiction to jurisdiction—and in those jurisdictions having more than one trial judge, from judge to judge. Some judges are convinced that allowing discovery to proceed while the underlying case is unresolved prejudices the insured (in a first-party case) and the insurer (in first- and third-party cases.)  

• What are the applicable statutes of limitation? There has been no case in Kentucky yet that has determined the proper statute of limitations of a first-party bad-faith claim. There are three possibilities, none shorter than five years: KRS 413.120(5) sets a five-year limit upon claims arising from the violation of another statute, if the other statute does not contain an internal limitation. To the extent a bad-faith claim is based on a violation of the UCSPA this statute could apply. KRS 413.120(12) sets a five-year limitation on actions for fraud. Because the UCSPA makes certain misrepresentations by insurers actionable, bad-faith cases in Kentucky are sometimes phrased in the language of fraud. Under KRS 413.130(3), actions for fraud do not accrue until they are discovered, but in no case may such actions be brought more than 10 years after the alleged fraud. 413.090(2) sets a 15-year limitation on actions arising on a written contract. ‍
• What defenses are available to the bad faith cause of action (e.g.., the "genuine dispute of fact" doctrine; "wrong but reasonable")?  An insurer is always “entitled to challenge a claim and litigate it if the claim is debatable on the law or the facts.” Wittmer, 784 S.W.2d at 890. This is usually referred to as the “reasonable-basis” defense. Whether the insurer had a reasonable basis in law or in fact to deny a claim is generally a jury question. However, “where the is a legitimate first-impression coverage question for purposes of Kentucky law and recognized authorities support the insurer’s position . . . the insured’s claim is fairly debatable as a matter of law.” Empire Fire & Marine Insurance Company v. Simpsonville Wrecker Service, Inc. , 880 S.W.2d 886 (Ky.App. 1994). ‍
• What are the recoverable damages for the bad faith cause of action?  Consequential damages flowing from the breach of contract. Damages for mental suffering and anguish. Attorneys’ fees (KRS 304.12-235). Interest (KRS 304.12-235). Punitive damages. The trial judge must determine that sufficient evidence exists to warrant a punitive damages instruction before allowing a bad-faith claim to go to the jury. Thus, the same evidence that permits a finding of bad faith also supports an award of punitive damages; that is, evidence that the insurer acted with “evil motive” or a “reckless disregard to the rights of others.” Wittmer , 784 S.W.2d at 890.

THIRD-PARTY BAD FAITH:

• Are there statutory grounds for the bad faith cause of action? If so, identify the source (i.e., an Unfair Claims Practices Act, or some other consumer protection statute) and its main provisions.  Third parties have only a statutory claim for violation of the UCSPA. They may not bring claims for common-law bad faith, because they are not parties to the contract that contains the duty of good faith. Grundy v. Manchester Ins. & Indem. Co. , 425 S.W.2d 735, 737 (Ky. 1968).  Nor may they bring claims for violation of the Consumer Protection Act, because as third parties they are not the consumer who purchased the policy, and so have no standing. Anderson v. National Sec. Fire & Casualty Co. , 870 S.W.3d 432 (Ky.App. 1993).

Statutory bad-faith claims are subject to the same Wittmer elements set forth above. A claimant must show (1) that the insurer owed the claim; (2) that the insurer refused to pay the claim; and (3) that the refusal was without a reasonable basis, or with reckless disregard as to whether such a basis existed.  

Third parties may also bring bad-faith claims via assignment. Grundy v. Manchester Ins. & Indem. Co. , 425 S.W.2d 735, 737 (Ky. 1968). The insured may assign its claim after suffering an excess verdict, or before any verdict is rendered, if the insurer refuses to defend.

• Is there a common law/judicially created bad faith cause of action (i.e., the implied covenant of good faith)? If so, identify the major case(s) and language of the standards applicable to bad faith cases. Third parties have only a statutory claim for violation of the UCSPA. They may not bring claims for common-law bad faith, because they are not parties to the contract that contains the duty of good faith. Grundy v. Manchester Ins. & Indem. Co. , 425 S.W.2d 735, 737 (Ky. 1968).

Chartwell Law represents the interests of insurers and employers, as such, we continue to continue to monitor the legal landscape. If you have any questions about issues associated with right of action for bad faith claims, our attorneys are available to help. Please contact your Chartwell Law attorney.

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