INTRODUCTION: Exploring New Options
With bad faith actions1 on the rise, insurers have looked to a variety of legal options in defending themselves. Many of these options recognize that the bad faith conduct of the insured must also be considered when evaluating the alleged bad faith conduct of the insurance company. These defenses often incorporate comparative fault type arguments, and look to justify or explain the conduct of the insurance company. However, while these arguments have been successful in some courts2, they may not provide an adequate remedy for insurers who must dedicate resources and incur costs in defending themselves against bad faith actions. Accordingly, in recent years insurers faced with bad faith claims have explored other options, including the doctrine of reverse bad faith.3
THE BAD FAITH SUIT
Depending on the state, a bad faith suit may be brought against an insurer by either the insured or a third party entitled to recover from the insured's policy.4
In both cases, the party bringing the bad faith action (the "claimant") typically asserts that the insurer improperly handled their insurance claim and, in doing so, either: 1) breached its common law duty of good faith and fair dealing; or 2) violated a statutorily created duty owed to the claimant. Since these allegations are directed at independent duties that attach to the insurance relationship itself, the party bringing the bad faith action is not limited to the policy limits provided by the insurance contract. Rather, the claimant may recover extra-contractual damages above the limits provided.
The exposure of insurers to potential extra-contractual damages has been the driving force behind the increase in bad faith suits. Simply put, bad faith claims are often more financially rewarding for a claimant and her attorney than simply collecting on the underlying insurance claim. Accordingly, it has become commonplace for plaintiffs' attorneys to focus their time and energy on maneuvering insurance companies into committing acts that the attorney will later characterize as being made in bad faith.
CONSIDERING THE CLAIMANT'S CONDUCT IN BAD FAITH SUITS
In response, insurance companies have experimented with various legal defenses in an effort to ensure that the claimant's conduct is taken into consideration. While some of these defenses have proven effective on a few occasions, many courts have not been willing to consider the claimant's conduct. Recognizing this, insurance companies are now exploring the potential of affirmative causes of action against claimants. Most recently, insurers have looked to the doctrine of reverse bad faith.
REVERSE BAD FAITH DEFINED
Reverse bad faith, if recognized, would provide the insurer with an independent cause of action against the claimant, and, potentially, would allow insurers to collect compensatory, and possibly punitive, damages based on the bad faith conduct of the claimant.
Unlike comparative fault-type defenses, which attempt to minimize the liability of the insurer by focusing attention on the claimant's acts of bad faith, the doctrine of reverse bad faith would allow an insurer to bring suit against the claimant for her wrongful conduct. The benefits of a reverse bad faith suit are two-fold. First, the conduct of the claimant is squarely placed before the Court for consideration. Second, an insurer may potentially recover damages which result from having to investigate and defend the claimant's bad faith or contract claim.
In order for an insurer to rely on this doctrine and the independent cause of action it would provide, the insurer would have to establish that:
2) The claimant acted in bad faith -- (i.e., breached a duty to act in good faith);
3) The actions of, or failure to act by, the claimant interfered with the adjustment, investigation, defense or settlement of a claim; and
4) The insurance company was prejudiced or damaged as a result of the claimant's bad faith conduct.
CLAIMANT'S CONDUCT THAT MAY CONSTITUTE "BAD FAITH"
Assuming that the jurisdiction in question recognizes that the claimant has a duty to act in good faith towards the insurer in relation to her claim5, the next consideration for the insurer is whether the claimant acted in bad faith.
Since there is no bright-line test to determine whether a claimant is acting in bad faith, the following types of conduct should be scrutinized:
Lack of cooperation;
Late or inadequate notice of claim;
Misrepresentation in application;6
Submission of fraudulent or fabricated claims;
Concealment or misrepresentation of material facts in connection with a claim;
Impairment of the insurer's subrogation rights;
Attempts by the claimant to set up the insurer; and/or
Assertion of frivolous bad faith claims.
If it is determined that the claimant is acting in bad faith, the insurer must show it was prejudiced by the claimant's acts, and damaged as a result. This may entail making the argument that additional monies and resources were expended as a result of the claimant's acts, and therefore, the insurer was damaged. If a claimant's conduct is particularly reprehensible, an insurer could potentially seek punitive damages, although there is no current case law supporting such awards.
LACK OF ACCEPTANCE OF CONCEPT OF REVERSE BAD FAITH WITH COURTS
While attractive in some respects, this theory has been met with limited success in the courts. In fact, there are very few cases addressing the theory, and there has been no appellate acceptance of the cause of action.7
The lack of judicial recognition and acceptance of the cause of action for reverse bad faith has been driven, in large part, by: 1) the lack of precedent from other courts; 2) the fundamental difference in position, power, and control traditionally believed to exist between large insurance companies and individual consumers; and 3) the availability of other remedies.
Recognizing the courts' reluctance to recognize this cause of action thus far, and the lack of any indication that this theory is likely to gain widespread judicial recognition, insurance companies can and should focus on those defenses that are currently available to defend against bad faith suits arising out of policy claims. However, insurers may find it appropriate to pursue this cause of action when problems exist with the available alternatives8, when the available alternatives will not make the insurer whole, or when the claimants' conduct is especially egregious.
INSURER'S ALTERNATIVES IF REVERSE BAD FAITH REJECTED
To the extent insurers decide to pursue the reverse bad faith cause of action, and it is not accepted or successful in the courts, it should be remembered that there are alternatives. Some of the alternatives include:
2) Asserting the claimant's conduct as the basis of a comparative bad faith defense where available;
3) Initiating fraud claims when the claimant's conduct warrants it; and
4) Asserting the claimant's conduct through available affirmative defenses, including such policy defenses as late notice, failure to cooperate, misrepresentation, and failure to mitigate losses.
Reverse bad faith, while an appealing alternative in theory, is an action which has met with limited success in the courts. However, insurers may find it appropriate to utilize the theory of reverse bad faith in certain cases. In the event the theory is not accepted or successful, insurance companies are wise to consider the available alternatives which focus on the conduct of the claimant.
CASE REFERENCE FOOTNOTES
A) Snap-On Tools Corp. v. First State Insurance Co., No. 87 CV-981 (Wis. Cir. Ct., Kenosha Co. 1991) rev'd 175 Wis. 2d 622, 502 N.W.2d 282 (Wis Ct. App., March 31, 1993)(Wisconsin Court of Appeals reversed on other grounds a Wisconsin trial court award on insurer's reverse bad faith counterclaim).
B) Tolkes & Sons, Inc. v. Midwestern Indemnity Co., 65 Ohio St.3d 621, 605 N.E.2d 936 (Ohio 1992)(Ohio Supreme Court refused to recognize tort action of reverse bad faith, citing the availability of a fraud action).
C) Mercedez-Benz of North America v. Hartford Accident and Indemnity Co., Nos. 89-56011, 89-56012 (9th Cir., filed June 2, 1992)(Ninth Circuit U.S. Court of Appeals refused to recognize tort action of reverse bad faith).
D) First Lehigh Bank v. North River Insurance Co. v. Joseph J. Peischl, Jr., et al., No. 88-7746 (E.D. Pa., December 1, 1989)(U.S. District Court refused to recognize tort action of reverse bad faith).
E) Johnson v. Farm Bureau Mutual Insurance Co., 533 N.W.2d 203 (Iowa 1995)(Iowa Supreme Court declined to recognize tort action of reverse bad faith).
F) Joseph Garvey v. National Grange Mutual Life Insurance Co., No. 95-19 (E.D. Pa., June 14, 1996) (U.S. District Court allowed reverse bad faith claim to be considered by jury who found on behalf of insurer but awarded no damages).
G) Thomas A. Schulz, et al. v. Liberty Mutual Insurance Co., No. 92-10312-MLW (D. Mass., September 26, 1996)(U.S. District Court refused to recognize tort action of reverse bad faith).
1 Bad faith actions arise from the alleged failure of an insurance company to handle, administer or settle a claim under a policy in "good faith."
2 See California Casualty General Insurance Co. v. Superior Court, 173 Cal.App.3d 274, 218 Cal.Rptr. 817 (4th Dist. 1985) (recognizing defense of comparative bad faith).
3 The doctrine of reverse bad faith can be asserted in a number of ways, including being asserted as a defense to a policy claim, as a counterclaim to a bad faith action, or as an independent cause of action.
4 Regardless of the party asserting the bad faith claim, the nature of the claim and the defense available to the insurer remain very similar.
5 The doctrine of reverse bad faith may have a greater chance of being accepted in states which already recognize that the duty to act in good faith in relation to an insurance claim is a two-way street. See, e.g., Transit Cas. Co. v. Sprink Corp., 94 Cal.App.3d 124, 156 Cal.Rptr. 360 (1979) ("duty of good faith between insured and insurer is a reciprocal one").
6 Applications should be scrutinized when the insured is the claimant.
7 See Case Reference Footnotes at conclusion of article for listing of reverse bad faith cases considered to date.
8 For example, an insurer may have statute of limitations concerns, or face problems in proving specific elements of other causes of action.