The term "bad faith" is an unfortunate misnomer that is probably responsible for more confusion than understanding among the bench and bar. Under the current State of Minnesota insurance law, the insurer's "bad faith" or "good faith" is often completely irrelevant to the action. Indeed, in Minnesota, an insurer in a "first-party action" cannot be liable for "bad faith" even if its objective was to maliciously deny a claim it knew to be legitimate and meritorious.2
The following discussion will focus not on determining the difference between "good faith" and "bad faith," but instead, on whether and when insurance companies in "third-party actions" may be liable for damages beyond the policy coverage (i.e. extra-contractual damages). It will also cover the theories and damages available under a "third-party claim," where a liability insurer (i.e. an automobile or homeowners liability policy) refuses to pay amounts within its policy limit to an injured third party, and the insured is left exposed to a judgment in excess of his insurance coverage.
II. THIRD-PARTY CLAIMS
"Third-party claims" typically arise out of a situation where a liability insurer refuses to pay sums in settlement within policy limits to a third party who was injured because of the fault of the insured. After the insurance company refuses to settle, the third-party claimant obtains a judgment against the insured over and above the policy limits, leaving the insured with personal liability. If the insured has assets, they are obviously subject to attachment. Even for the insured with no assets, they face the prospect of an excess judgment hanging over their heads affecting their credit and possibly even driving them into bankruptcy.
The following discussion will show that Minnesota law has long recognized that where an insurance company acts in "bad faith" in denying settlement offers within its policy limits (and keeping in mind that this "bad faith" may have little to do with the insurer's motives), the insurance company is deemed liable to the full extent of the excess judgment against its insured.
The following will also show that the underlying premise of bad faith law is really quite simple--without the threat of a "bad faith" claim, a liability insurer has no reason or incentive to consider the fiduciary duty owed to its insured when resolving the conflict between its own interests (to pay as little as possible) and that of its insured (to be protected from the personal exposure that would result from a verdict in excess of their liability coverage). Without the threat of its own exposure beyond its limit of liability coverage, an insurance company might as well take the risk of going to trial and hope for a low verdict, even if this decision put its insured's personal assets in jeopardy.
B. Minnesota Law
Minnesota first recognized an insured's right of action against his own company because of an excess judgment in Mendota Electric Company v. New York Indemnity Company, 169 Minn. 377, 211 N.W. 317 (1926). In reversing the trial court's sustaining of a demurrer to the complaint, the court stated the grounds for the action based upon a refusal to settle.
- Good faith and fair dealings are correlative obligations, and the insurer owes to the insured some duties in the matters of the settlement of claims covered by the policy; and, where the insured is clearly liable and the insurer refuses to make a settlement, thus protecting the insured from a possible judgment for damages in excess of the amount of the insurance, their refusal must be made in good faith and upon reasonable grounds for the belief that the amount required to effect a settlement is excessive. 169 Minn. at 380, 211 N.W. at 318.
- It takes something more than mere mistake to constitute bad faith, particularly with respect to the action of an insurer under a policy of public liability who is not absolutely bound to make a settlement. The right to control negotiations for a settlement must, of course, be subordinate to the purpose of the contract, which is to indemnify the insured within the contract limit. But it takes something more than error of judgment to create liability. Mendota Electric Company v. New York Indemnity Company, 175 Minn. 181, 184, 221 N.W. 61 (1928).
Two years later, the Minnesota Supreme Court decided Boerger v. American General Insurance Company of Minnesota, 257 Minn. 72, 100 N.W.2d 133 (1959), where the next of kin of a deceased cab passenger sued the cab owner for the wrongful death. In the course of settlement negotiations, the plaintiff offered to settle for $12,000.00. The insured had underlying limits of $10,000.00 and a $2,000.00 promissory note from the taxicab owner, and the personal attorney for the taxicab owner demanded the company accept the offer. The company refused, which resulted in an excess verdict. After a verdict of $17,500.00, the taxicab owner recovered the excess verdict of $5,500.00 from the insurer, which was upheld on appeal. In affirming the award, the court stated:
- We are of the opinion that the insurance company could have validly declined the offer of settlement if good faith existed on either of one of two grounds. First, if it in good faith believed that its insured was not liable. Second, even if liability of its insured was certain, if it believed in good faith that a settlement at the proposed figure which it was required to contribute was greater than the amount the jury could award in damages . . . Statements by the insurance company's counsel and claims manager clearly indicated that they were of the opinion that its insured would be held liable. 257 Minn. at 75, 100 N.W.2d at 135.
- While the insurance company, in determining whether to accept or reject an offer of compromise, may properly give consideration to its own interests, it must, in good faith, give at least equal consideration to the interests of the insured and if it fails to do so, it acts in bad faith. 257 Minn. at 77, 100 N.W.2d at 136. (emphasis added)
The Minnesota Supreme Court has also recognized the potential conflict of interest existing for defense counsel who is retained by and reports to the insurance company, yet also represents the insured. Where an unsophisticated insured relies upon his company-paid attorney, a potential conflict may arise where that attorney is presented with a policy limits demand. Obviously, the potential for any excess, personal liability on behalf of the insured can be avoided by accepting the offer - yet defense counsel also faces the requirement that he or she advise the insurance company regarding whether it should make payment of the full policy limit. In Lange v. Fidelity and Casualty Company of New York, 290 Minn. 61, 185 N.W.2d 881 (1971), the court upheld an award of $4,000.00 for an excess judgment, noting that the insurer had no tactical or economic justification for refusing the settlement, and stating that an insurer must view the negotiations for settlement as if there were no limit upon the policy, and further requiring that the insurer advise the insured of its potential exposure in a manner in which the insured would be advised if he had retained private counsel. Thus, from the language of Lange, it can be seen that the insurance company is liable not only for its own failure to consider the interests of its insured, but it also may be liable for its attorney's conflict of interest in failing to give full advice as a result.
Lange was also significant because it involved an insolvent insured. Previous decisions had indicated that where there was no possibility of recovering the excess amount from the insured, there could be no bad faith, Dumas v. Hartford Accident Indemnity Company, 92 N.H. 140, 26 A.2d 361 (1942), and Norwood v. Travelers Insurance Company, 204 Minn. 595, 284 N.W. 785 (1939). Such decisions had been justifiably criticized as encouraging neglect of an insurer's responsibilities toward poor insureds. In Lange, the court held that payment of the excess judgment or even the possibility of payment by the insured was not a prerequisite to the action, thus overruling Dumas and Norwood.
C. Short v. Dairyland Insurance Co.
The current leading Minnesota decision on bad faith is Short v. Dairyland, 334 N.W.2d 384 (Minn. 1983), a case handled by this author. This decision represents a clear expression of the duties of an insurer to protect its insured, and the financial consequences to the carrier that disregards those duties. Short is a particularly fascinating case, not only because it is a classic example of an insurance company disregarding in every possible way the interests of its insured, but also because it conclusively demonstrates that an insurance company cannot save itself from bad faith by ultimately trying to pay its limits after it has already refused the plaintiff's demand for these limits.
Short also sends a strong message to insurance companies that they cannot protect themselves from bad faith liability by putting their insured into bankruptcy (which they did in Short by the very same insurance defense lawyer who defended the insured in the wrongful death case), as the bad faith action is an asset that may be pursued by the bankruptcy trustee.
Short arose out of an automobile accident on February 23, 1976, where a drunk driver, who also had not taken his "anti-blackout" medication, crossed the centerline and killed Donald Morin, a 40-year old husband and father of five minor children who was earning approximately $30,000 annually. Kearney had only $25,000 of liability coverage through Dairyland Insurance Company, and it was immediately apparent from the circumstances of the accident that he was solely at fault, and that the damages to Mr. Morin's family vastly exceeded these $25,000 limits.
However, the insurance adjuster assigned to the case by Dairyland, despite having authority to pay the full $25,000 limits to Mr. Morin's family, tried to use the then new no-fault law as leverage (or perhaps more aptly, as a club) to force the Morin family to take less than the full limits, claiming to the Morins' attorney that if the case was sued, the no-fault carrier would be subrogated to the extent of the $10,000 it paid in no-fault survivor's benefits. When this adjuster, Linda Lunzer, tried to negotiate a "discount" off of these $25,000 limits, Mrs. Morin's attorneys put the matter in suit. Ms. Lunzer then told the Morin's attorney that she would pay the $25,000, but she would have to put both Mrs. Morin and her no-fault carrier on the same $25,000 check because of this subrogation interest, but that Dairyland would settle with Mrs. Morin for $24,000 without placing State Farm on the check (despite the fact that State Farm's subrogation interest was at least $10,000). Once again, Dairyland was trying to use the no-fault statute to try to obtain $1,000 discount off of its policy.
Mrs. Morin's attorneys made a final attempt to settle the case for $25,000 a year and a half later, which was once again rejected by Dairyland. In December of 1977, Dairyland tried to pay its policy limits into court, which plaintiff opposed and which was denied by the trial court. Shortly before trial in November, 1978, Dairyland finally made an unequivocal offer of these $25,000 limits to the plaintiff (shortly after it had retained a law firm specifically with regard to the anticipated excess verdict and bad faith case), but this offer was rejected and the case proceeded to trial. A verdict of $745,000 was rendered against Kearney, and his attorney retained by Dairyland then put him into bankruptcy, even though Mrs. Morin's attorneys advised him that they would agree not to pursue this excess verdict in return for an assignment of his claim against Dairyland.
Dairyland's obvious intent in putting Kearney into bankruptcy was to eliminate the bad faith case, but the trustee in bankruptcy, Brian Short, recognized it as a substantial asset of the bankruptcy estate, and retained Mrs. Morin's attorneys to handle the bad faith case. Dairyland's essential defense in the case was that Mrs. Morin's attorneys, in demanding the policy limits only a month after the accident, and then commencing suit only two days later, had not given Dairyland a "reasonable time" to respond to the demand for settlement. When the Short v. Dairyland case was called for trial in June of 1982, Dairyland moved for summary judgment, contending that this absence of a reasonable time to "consider" the offer defeated plaintiff's claim as a matter of law. Plaintiff made a cross-motion for summary judgment on the basis that the undisputed facts established bad faith as a matter of law.
Hennepin County District Court Judge Jonathan Lebedoff granted plaintiff's motion for summary judgment, awarding damages of the full policy limits plus interest at the statutory rate. Because Judge Lebedoff's Memorandum was adopted in its entirety as the opinion of the Supreme Court, it is instructive to examine the grounds for the decision.
The introduction to Judge Lebedoff's opinion is reflective of an increasing trend in the analysis of bad faith questions. While earlier cases like Mendota Electric Company v. New York Indemnity Company, supra, and Larson v. Anchor Casualty Company, supra. focused upon the rights of the insurer, the Short decision began with emphasis upon the rights of the insured.
- The primary right of a purchaser of a contract of insurance is the right to payment when a loss signals the insurer's liability within the limits of the policy of insurance. . . Usually, however, the insurer contractually acquires control of the negotiations and settlement, thus oftentimes creating conflicting interests on the part of the insurer. On the one hand, the insurer owes a fiduciary duty to the insured to represent his or her best interests, and to defend and indemnify. On the other hand, the insurer's interested in settlement at the lowest possible figure. It is important, however, and must be remembered, that the insurer's right to control the negotiations for settlement must be subordinated to the purpose of the insurance contract - to defend and indemnify the insured within the limits of the insurance contract. 334 N.W.2d at 387. (Emphasis added)
With respect to Dairyland's central contention that the time period given it to settle was "unreasonable," the opinion flatly dismissed that defense:
- Dairyland complains that it was under no absolute duty to accept the settlement demand of March 31, and that it was entitled to 'explore' the possibility of settlement for less than the full policy limits. While this may be true, such 'exploration' might lead to a finding of bad faith, and in the instant case, that it was this court has found. To characterize Dairyland's brazen attempts to obtain a discount as 'exploring' the possibility of settlement for less than the full policy limits is specious and overlooks Dairyland's primary responsibility - its insured. Not only did Dairyland attempt to obtain a discount, but it also attempted to coerce Morin's attorney into submission by raising the specter of State Farm's subrogation rights should Morin seek to submit her claim to the jurisdiction of the courts. If such actions do not constitute lack of 'good faith', this Court is unable to imagine why. Lunzer's reference to State Farm's subrogation rights should the matter be placed into suit could be nothing more than an attempt to gain leverage and a discount from the policy limits--all in dereliction of its fiduciary duty to Kearney. 334 N.W.2d at 388-89.
D. Measure of Damages, Foss v. State Farm
In a recent unpublished but critically important decision (in which this author submitted an Amicus Curia brief on behalf of the Minnesota Trial Lawyers Association), the Minnesota Court of Appeals reversed a decision of the trial court that, had it stood, would have wreaked havoc on bad faith law in Minnesota. In Foss v. State Farm Mutual Automobile Insurance Company, 1996 WL 653942 (Minn. Ct. App. 1996), rev. denied January 7, 1997, a jury in a personal injury action found the defendant driver, Robert William Foss, negligent and liable for damages in an amount that exceeded the $100,000 liability limits of his State Farm automobile policy by $154,478.58. Foss thereafter assigned his bad faith claim to the injured plaintiff in the underlying action, but because State Farm claimed that the attorney it retained to defend Foss, Lee LaBore, was not its agent, Foss also sued (in his own name) LaBore for malpractice.
In the subsequent bad faith action against State Farm, the jury found that State Farm acted in bad faith and that its bad faith was a direct cause of damage to Foss. However, instead of correctly ruling that the measure of bad faith damages in Minnesota is, as a matter of law, the amount of the excess verdict, the trial court instead (over the plaintiff's strong objections) submitted to the jury the special verdict fact question of what sum of money would "adequately compensate" Mr. Foss for his "personal exposure" (emphasis added). The jury, which was aware that Foss had assigned his bad faith claim to the injured plaintiff in the underlying action, naturally answered the question of his "personal exposure" with the finding of zero. The trial court also denied Foss'
post-trial motions seeking a determination that the jury's finding of causal bad faith made State Farm liable for the amount of the excess verdict as a matter of law.
The trial court's ruling that the jury should determine damages in a bad faith case was contrary to settled Minnesota law, and was reversed in a short (and rather curt) unpublished opinion. (Attached at A-23)
While the law thus stands as it always has, it is worth examining this issue here to ensure that the policy purposes underlying this established principle are understood, as is its status as the overwhelming majority rule, in order to help persuade any reluctant judges to not repeat the mistake of the Foss trial court.
The fundamental harm that always occurs in a bad faith case is that an insured is now exposed to very precise and measurable damages, namely the excess verdict that occurred when the insurer put its own interest's first. Consequently, in Strand v. Travelers Ins. Co., 300 Minn. 311, 219 N.W.2d 622 (1974), the Supreme Court, in a per curiam opinion, held that "the proper measure of damages was the full amount of the difference between the policy limit and the verdict in the initial action. . . " 300 Minn. 311, 219 N.W.2d at 622. In Short, supra, where the insurer failed to settle the underlying action against its insured within his $25,000 policy limits and a $745,000 verdict was reached, the Supreme Court held that "the amount of damages is the excess amount over and above the $25,000 policy limits." 334 N.W.2d at 389.
Short and Strand are in accord with the majority rule on the measure of damages in a third party bad faith case. The majority of jurisdictions that have directly addressed this issue have long determined that, at the very least, in an action for breach of an insurer's duty to settle, an insured can recover the difference between the total amount of the judgment and the amount of the policy limits. "The normal recovery, where the insurer's actionable bad faith or negligence is established and an excess judgment is recovered, is the amount for which the insured becomes charged in excess of his [or her] policy coverage." 44 Am.Jur.2d Insurance Â§ 1532 (1969), in Accord 40 A.L.R.2d 168, 178-81 Â§ 4 (1955).
The only limitation that courts have placed upon an insured's right to recover the full excess verdict against him is what some courts have called the "Payment Rule" or "Michigan Rule." Under this rule, the insured's ability to pay this excess verdict limits the damages in the bad faith action to the amount of the insured's assets not exempt from legal process. Frankenmuth Mut. Ins. Co. v. Keeley, 447 N.W.2d 691, 707-09 (Mich.1989) (Frankenmuth I) (Levin, J., dissenting) (dissent adopted as majority in Frankenmuth Mut. Ins. Co. v. Keeley, 461 N.W.2d (1990) (Frankenmuth II).
As noted above, the Minnesota Supreme Court in Lange, where the insured was insolvent and unable to pay the excess verdict, overruled the prior Minnesota decision that appeared to follow the premise of the Michigan Rule, Norwood v. Travelers Insurance Company, 204 Minn. 595, 284 N.W. 785 (1939), stating:
- Because we believe that a judgment-proof insured does indeed suffer injury when a claimant obtains a judgment against him in excess of liability insurance policy limits, we now overrule language in the Norwood case to the contrary and hold, as most states hold, that an insured may bring an action against his insurer for "bad faith" refusal to settle whether or not the insured has paid, or can pay, that part of the judgment which exceeds the policy limits. A judgment-proof insured suffers injury from a judgment against him in excess of policy limits because such a judgment will potentially impair his credit, place a cloud on the title to his exempt estate, impair his ability to successfully apply for loans, and may eventually require him to go through bankruptcy. Further, if the rule were that a judgment-proof insured suffers no injury from an excess judgment, an insurer's responsiveness to its well-established duty to give equal consideration to an insolvent insured's interests would tend to become meaningless. Id. at 885. (emphasis added)
The Indiana court's justification for adopting the judgment rule was to prevent bad faith practices in the insurance industry. Id. at 385. The court also relied on Indiana law imposing upon insurance companies a duty to deal in good faith with their insureds, and that absent a duty of good faith, the insurer might only consider its own monetary interests when settling claims, ignoring the risk of an excess verdict on the insured. Id. at 386 (citations omitted). Just as in a multitude of Minnesota decisions, the Indiana court concluded that the judgment rule furthers the duty of good faith "by forcing an insurer to act in the insured's best interests regardless of his financial status." Id. at 386.
In another example, applying Wisconsin law, the Seventh Circuit Court of Appeals rejected an insurance company's argument that, upon a finding of bad faith, the question of damages was a factual issue which must be decided by the jury. Moutsopoulos v. American Mutual. Ins. Co., 607 F.2d 1185, 1187 (7th Cir. 1979). The Seventh Circuit held that "once an insurer is liable for exercising bad faith toward its insured, the insured's assignee is entitled as a matter of law to damages equal to the excess judgment." Id. (citing Howard v. State Farm Mutual Auto. Ins. Co., 236 N.W.2d 643 (Wisc.1975)).
In yet another recent case, the Maryland Court of Appeals held that "[p]resent Maryland law, and the majority rule, is that the measure of damages in a bad faith failure to settle case is the amount by which the judgment rendered in the underlying action exceeds the amount of insurance coverage." Medical Mutual v. Evans, 622 A.2d 103 (Md. 1993) (emphasis added).
The Evans court quoted State Farm Mut. Auto Ins. Co. v. Schlossberg, 570 A.2d 328, at 336 (Md. Ct. App.1991), cert. denied, 577 A.2d 50 (1991), which stated:
- [T]he proper method of assessing damages . . . is the difference between the insurance coverage and the jury verdict in the underlying case . . . Since liability has been decided . . . and since the damages to be awarded in this case are a fixed sum determined by mathematical computation, there is no fact issue for a jury to decide. (emphasis added)
Finally, it must be remembered that in Minnesota's leading bad faith case of Short v. Dairyland, 334 N.W.2d 384 (Minn. 1983), the insured was bankrupt.
E. Procedural Prerequisites for a Bad Faith Claim
Plaintiff's counsel must always be aware of the prerequisites of a bad faith action so as to utilize it as an effective negotiating tool. The first and most important requirement is that a demand be made, clearly setting forth the client's position, the facts justifying the settlement demand, any applicable law, and a time limit within which the company must respond. In addition, the demand should include a reason for the time limit, which is most frequently that after a given time, additional expenses will be incurred. At the end of this article is an example of an appropriate bad faith letter.
In addition, upon recovery of an excess judgment after the insurance company's refusal of a good faith demand, plaintiff's counsel must decide how to proceed regarding the judgment. At the present, there is no Minnesota decision recognizing a direct cause of action by the third-party claimant against the insurer, although other jurisdictions have recognized such a direct suit. Thompson v. Commercial Union Insurance Company of New York, 250 So. 2d 259 (Fla. 1971). Thus, it is necessary for the plaintiff to obtain an assignment of the insured's cause of action. (For an example of an assignment to be utilized on such a cause of action, see the materials appended to this decision.)
In Lange, the Minnesota Supreme Court recognized the validity of an insured assigning his cause of action, ruling that on an involuntary assignment to a receiver:
- The vast majority of states permit an insured to assign his cause of action against the carrier to the injured claimant, even if there is no express statutory authority permitting such assignment. If, as we believe and defendant concedes, a voluntary assignment is permissible, it would be wholly inconsistent to hold that, upon the insured's refusal, assignment could not be made involuntarily where authorized by statutes governing proceeding supplementary to the execution of a judgment. 185 N.W.2d at 886-87.
An additional alternative for a plaintiff faced with an uncooperative insured is to proceed by garnishment. This procedure does have the advantage of not releasing the defendant insured, yet allowing the plaintiff to take control of the litigation. Illustrative of this approach is the case of Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982). Garnishment has in fact been used in a few decisions which are reported. See, Shaw v. Botens, 403 F.2d 150 (3rd Cir. 1968); Gilley v. Farmer, 207 Ka. 536, 485 P.2d 1284 (1971), Rutter v. King. 57 Mich. Ap. 152, 226 N.W.2d 79 (1974).
However, use of the device of garnishment does not obviate the necessity for the cooperation of the insured if the claim of bad faith is to be predicated upon a failure to advise the insured of a potential conflict of interest, or of an offer. Although many bad faith cases can be proved simply by examination of the insurance company's file, the insured's cooperation will usually be essential to recovery.
At the end of these materials, the reader will find a copy of the complaint in Short v. Dairyland. Also attached is the Demand for Production of Documents and sample Interrogatories used in the Short case. It is also essential that the entire claims files of the defendant, including all memoranda prepared by anyone connected with the insurer, including the attorneys for the insured, be obtained, reviewed, and indexed in preparation for trial.
F. NORTHFIELD INSURANCE AND THE REQUIREMENT OF "CLEAR LIABILITY
In a very recent (and very disturbing) decision, Northfield Ins. Co. v. St.Paul Suplus Lines Ins. Co., 545 N.W.2d 57 (Minn Ct. App. 1996, rev. denied June 19, 1996, the Minnesota Court of Appeals appeared to improperly limit a liability insurance company's bad faith exposure to cases where the insured was "clearly liable." This decision (involving a complicated injury case) arose out of a multi-million dollar judgment, where the insurance company had rejected a settlement offer of $50,000 (without even communicating the offer as required). Nevertheless, the Court held that unless there was "clear liability" on the insured (which there was not), there could be no bad faith for this excess verdict. This decision seems to ignore the many separate and distinct obligations an insurance company has to its insured, and hopefully new decisions will limit the application of this case. For now, however, this decision must be dealt with in handling a bad faith claim.
As a final note on the topic of bad faith, it is important to remember that not only insureds are protected by bad faith law, for on the other side of every bad faith case is an injured plaintiff also victimized by the insurance company that failed to properly pay a claim. As explained in Lange, the public's interests are also served by compelling insurers to act in good faith:
- Furthermore, we did not say in Peterson [v. American Family Mutual Ins.], nor did we intend to imply, that the contractual relationship between a liability insurance carrier and the insured in no way involves the public interest in the payment of just claims to parties injured in motor vehicle accidents. That public interest is embodied in our Safety Responsibility Act, Minn.St. c.170. Under our statutory scheme, a liability insurance policy is not a mere indemnity policy protecting only the insured. 185 N.W.2d at 886.
1 This article was adapted from materials presented by Michael L. Weiner at a seminar sponsored by the Minnesota Institute of Legal Education, on April 8. 1997, in Minneapolis, Minnesota.
2 Unlike many other jurisdictions, Minnesota does not recognize "first party" bad faith claims wherein the insured, covered by a policy providing benefits (such as health or medical insurance or disability coverage) directly to the insured, has a right to seek extra-contractual damages for their insurer's breach of contract. See Haagenson v. National Farmers Union Property and Casualty Co., 277 N.W.2d 648 (Minn. 1979), and Pillsbury Co. v. National Union Fire Insurance Co. of Pittsburgh, Pennsylvania, 425 N.W.2d 244 (Minn. Ct. App. 1988).
3 In adopting the "judgment rule", the court rejected the "payment rule" which dictates that an insurer may be held liable for a judgment in excess of policy limits only if part or all of the judgment has been paid by the insured. The rationale behind the payment rule is that where an insured does not pay any money in satisfaction of an excess judgment, the insured is not harmed and therefore should not be entitled to damages. Id. at 385.