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Comparative Bad Faith

  • Background
  • Illinois Law Regarding Insurer Bad Faith
  • Cramer v. Insurance Exchange Agency
  • Kransco v. American Empire Surplus Lines Insurance Company
  • "An Insurer's Duty and the Insured's Duty of Good Faith Differ"
  • Dissenting Opinion
  • Conclusion

Inherent in every policy of insurance is an implied duty of good faith and fair dealing between the parties to the contract. Although the duty of good faith is a "two-way street," it is often argued, and perhaps more often true than not, that courts construe the insurer's burden in a manner greater than that of the insured. Notwithstanding, the duty of good faith is absolutely necessary to ensure that the parties do not try to take unfair advantage of each other or to do anything that will undermine the other party's right to receive the benefit of the contract.

The tort of "bad faith," was not actually recognized in the state of Illinois until 1975 in the case of Ledingham v. Blue Cross, 29 Ill.App.3d 339, 330 N.E.2d 540 (5th Dist. 1975). Since that time, there has been confusion and disagreement in the Illinois courts regarding how the statute pertaining to insurer misconduct, 215 ILCS 5/155 (Section 155), should be reconciled with separate allegations of wrongful conduct by an insurer, such as, malicious prosecution, breach of privacy etc.

Some courts have held that Section 155 does not insulate an insurer from other potential tort actions, and that a plaintiff may pursue an action alleging bad faith, as well as, seek punitive damages. Other courts have held that Section 155 insulates an insurer from all other tort actions, regardless of the specific legal theory asserted, if the complaint alleges nothing more than unreasonable and vexatious conduct. Still, other courts have rejected the court's ruling in Ledingham and have rebuffed the tort of bad faith entirely.

As the doctrine of bad faith continues to evolve, it is interesting to examine how this evolutionary process may be moving in dissimilar directions in the states of Illinois and California. Thus, the Illinois Supreme Court recently issued a ruling which arguably broadens the exposure for extra-contractual suits against insurers. While, in California, efforts are being made to limit the insurer's exposure by allowing them the right to assert, when appropriate, an affirmative defense of "comparative bad faith."

As a matter of background, the pertinent Illinois law regarding insurer bad faith, i.e., 215 ILCS 5/155, provides as follows:

In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other cost, plus an amount not to exceed any one of the following amounts:

(a) 25% of the amount which the court or jury finds such party is entitled to recover against the company, exclusive of all costs;

(b) $25,000;

(c) the excess of the amount which the court or jury finds such party is entitled to recover, exclusive of costs, over the amount, if any, which the company offered to pay in settlement of the claim prior to the action . . .

In Cramer v. Insurance Exchange Agency, 174 Ill.2d 513, 221 Ill.Dec. 473, 675 N.E.2d 897 (1996), the Illinois Supreme Court recently attempted to clarify the law regarding insurer bad faith. Unfortunately for insurers, the court's "clarification" may broaden their exposure for extra-contractual suits and awards.

The facts in Cramer are straightforward. The insured purchased a homeowner's insurance policy from the insurer covering his personal property, and the policy was to run for one year from October 25, 1991 to October 25, 1992. The insured's residence was burglarized shortly after the policy's inception. The underlying dispute arises from the insurer's attempted cancellation of the policy. Thus, the insurer argues that it canceled the policy before the burglary occurred. The insured contends that he never received a notice of cancellation and that any purported cancellation is common law fraud. Id. at 516, 517, 221 Ill.Dec. 475, 675 N.E.2d at 899, 900.

The trial court certified two questions for interlocutory appeal: (1) whether Section 155 of the Illinois Insurance Code insulates an insurer from a cause of action for fraud; and (2) whether the policy provision which states that "no action can be brought unless the policy provisions have been complied with and the action is started within one year after the date of loss" is applicable to a cause of action for fraud against an insurer.

The Supreme Court concluded that Section 155 does not insulate an insurer from suits which allege separate and independent torts such as fraud. The court further concluded that well-established torts like common law fraud require the proof of elements that are different from bad faith, and that such torts provide for damages that are different from those provided for in Section 155. Accordingly, it was the court's view that Section 155 was not intended to insulate an insurer from these types of allegations and suits.

Therefore, where a plaintiff can properly allege and prove the elements of a separate tort for insurer misconduct, they will be allowed to pursue that cause of action against the insurer. However, the Supreme Court also concluded that a mere allegation of "bad faith", i.e., a charge which simply complains of unreasonable and vexatious conduct by an insurer, without more, is not a separate and independent tort that will be recognized in Illinois. Thus, unlike common-law fraud, conduct amounting to "bad faith" does not rise to the level of a well-established tort and is merely the type of conduct that Section 155 was intended to address.

The court aptly noted that the recognition of an independent tort of "bad faith" would encourage plaintiffs to sue in tort, rather than in breach of contract, in order to avoid the policy's suit limitation clauses and to avoid the limitation for the maximum recoverable amount as prescribed in Section 155. In other words:

"When the legislature has provided a remedy for a heretofore unremedied evil, the courts should not allow an end-run around the limits imposed by that statute by creating a common-law action that remedies the same basic evil." Id. at 527, 221 Ill.Dec. At 480, 675 N.E.2d at 904, citing UNR Industries, Inc. v. Continental Ins. Co., 607 F.Supp. 855, 864 (E. Dist. 1984).

Arguably, the court's decision in Cramer v. Insurance Exchange will have a double-edged sword effect. Previously, the lower courts were split on whether Section 155 should entirely insulate an insurer from all other tort actions, regardless of the specific legal theory asserted. Now it is clear that when a plaintiff can properly allege and prove the elements of a separate and independent tort for insurer misconduct, they will be allowed to pursue that cause of action against the insurer.

On the other hand, to the extent that Section 155 provides a limitation on recovery, insurers should be insulated from extra-contractual tort actions that merely allege "bad faith", i.e., unreasonable and vexatious misconduct.

In contrast to the Illinois Supreme Court's view point on bad faith as expressed in Cramer, California courts are examining the issue of "comparative bad faith", i.e., an offset of bad faith damages assessed against the insurer based upon the extent of bad faith conduct displayed by the insured.

In Kransco v. American Empire Surplus Lines Ins. Co. 63 Cal.Rptr.2d 532 (Court of Appeals, 1st Dist. 1997), 35-year-old Michael Hubert jumped head-first onto his neighbor's backyard water slide toy and broke his neck, instantly rendering him a quadriplegic in June 1987. Hubert brought suit against Kransco, the manufacturer of the Slip 'N Slide toy. Kransco was defended by its insurer, American Empire Surplus Lines Insurance Company (AES), which had also agreed to indemnify the company for damages up to $1 million. Kransco also had several layers of excess insurance coverage with other carriers amounting to $5 million of total coverage. Id. at 535.

Hubert offered to settle his suit against Kransco for $750,000 during the trial, almost a million dollars less than his pretrial demand. AES rejected the offer and unsuccessfully tried to settle the case for $450,000. The jury returned a verdict in favor of Hubert and against Kransco in an amount exceeding $12.3 million, including $10 million in punitive damages. Id.

Subsequently, Kransco filed a separate suit against AES alleging bad faith based upon their failure to accept Hubert's offer to settle his claim within the policy limits despite a substantial risk of a verdict greatly in excess of those limits. In an affirmative defense, AES charged that Kransco was largely to blame for the Hubert verdict because it angered the jury by falsely disclaiming knowledge, during the pretrial discovery in the case, of a previous crippling injury and a death resulting from its Slip 'N Slide toy.

The jury returned a verdict against AES in the amount of $14 million. However, the jury also found that Kransco, itself, had breached a duty of good faith and fair dealing, or failed to exercise ordinary care in the handling of Hubert's claim before the verdict, and attributed fault for the Hubert verdict at 90 percent to Kransco and only 10 percent to AES. Id. at 535, 536.

The trial court, upon Kransco's motion for judgment notwithstanding the verdict, found the doctrine of "comparative bad faith" wholly inapplicable, reversed the jury's verdict and entered judgment in favor of Kransco for the full amount of damages as calculated by the jury, plus prejudgment interest and costs. AES appealed seeking, in part, reinstatement of the jury's verdict on fault allocation. On appeal, AES did not deny its bad faith but argued that the insured's "comparative bad faith" and comparative negligence as a litigant in the underlying action should reduce the insurer's liability. Id.

The California First District Court of Appeals disregarded AES's claim that Kransco's misrepresentation that it knew of no previous injuries resulting from the Slip 'N Slide caused the jury's high punitive damage award. In affirming the trial court's ruling, the appellate court held that the insured's misrepresentation in the underlying case cannot be compared to an insurer's bad faith failure to settle within policy limits. Id. at 537, 538.

Thus, according to the court, an insurer's duty and the insured's duty of good faith differ, i.e., an insurer's breach of the covenant of good faith is governed by tort principles, but an insured's breach of the covenant of good faith is not a tort but is merely a breach of contract, and contractual breaches do not implicate fault and are generally excluded from comparative fault allocations.

In an apparent effort to appease the insurance industry, the court stated that its rejection of comparative bad faith does not leave insurers without redress for an insured's misconduct. Thus, an insured's misconduct may allow the insurer to deny liability for the submitted claim.

In a strong dissent of the court's opinion, a fellow justice of the court commented that comparative bad faith avoids the potential injustice of a crude all-or-nothing concept and equitably apportions damages according to the relative culpability of the parties. Thus, the insured should have the expectation of coverage and a defense, but not to the extent that his own breach of the policy provisions has caused or exacerbated the loss. See Id. at 547-555.

The dissenting justice further opined that when an insured's breach of the duty of good faith and fair dealing contributes to an insurer's failure or delay in the investigation and payment of a claim, it should constitute, at least, a partial defense to an insured's later suit against the insurer for bad faith. Id.

To date, no state Supreme Court has fully embraced the doctrine of "comparative bad faith," and the weight of authority is seemingly against it. Neither, it seems, has the full effect of the Cramer decision been determined in the state of Illinois. However, it is seemingly inevitable and only a matter of time before the states' Supreme Courts begin to closely exam the equity of these contrasting doctrines.

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