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October 12, 2021
Bad faith insurance claims often arise following an insurer’s breach of their duty to defend or untimely reservation of rights assertion.
Bad faith insurance claims arise from unlawful insurer practices and behaviors. Insurance litigation for bad faith insurance claims may arise from numerous unlawful behaviors; however, this article discusses three common grounds that give rise to insurance bad faith.
Three common practices that give rise to an insurance bad faith claim include an insurer’s breach of their duty to defend, an insurer untimely asserting their reservation of rights and an insurer incurring bad faith liability for settling a claim in derogation of insured’s collateral rights.
Duty to defend, is the insurer’s obligation to provide an insured with a defense to claims assumed under the insurance policy. The duty to defend is known to be a broad obligation where a carrier has an obligation to defend suits even if the claim is groundless, false of fraudulent. An insurer has one primary interest, which is to provide a defense per the promises considered in the insurance policy and to preform those promises with good faith and fair dealings. Smoot v. State Farm Mut. Auto. Ins. Co., 299 F.2d 525, 530 (5th Cir. 1962)
The duty to defend arises whenever a claim, potential claim or dispute contains any allegation that could rationally fall under the assumed protection in a purchased insurance policy. If a claim or dispute may rationally fall under the presumed protections of an insurance policy, then an insurer has an obligation to come forward and defend the claim or dispute. Avondale Industries, Inc. v. Travelers Indem, 887 F.2d 1200 (2d Cir. 1989)
In short, so long as the insured party, notifies their insurer of a claim, dispute or potential claim that may arguable be considered an assumed protection under the insurance policy, that insurer has an obligation and duty to defend the dispute, even if the claim is baseless.
An insurer, generally speaking, has a quasi-contractual duty to defend an entire action if at least one claim or one alleged cause of action is potentially covered under the insurance coverage. However, in instances where a carrier feels they are defending a claim that may not be covered under a policy, they may reserve their right to reimbursement for defense costs, this is known as a reservation of rights. Buss v. Superior Court, 16 Cal. 4th 35, 65 Cal. Rptr. 2d 366, 939 P.2d 766 (1997)
In order for a carrier to properly assert a reservation of rights, the right to reimbursement must be addressed in the underlying insurance liability policy, and the insurer must assert a reservation of rights in a timely manner. If an insurer unreasonably delays in asserting their reservation of rights, it constitutes a waiver. The intention behind a timely assertion of the right to reimbursement, is to allow an insured to make a determination and seek the opportunity to accept the insurer’s defense, or alternatively, defend in some other manner. If a reservation of right is untimely and asserted after significant defense costs have been incurred, the insured is prejudiced by the delay. Stonewall Ins. Co. v. City of Palos Verdes Estates (1996) 46 Cal. App. 4th 1810, 1839, 54 Cal. Rptr. 2d 176
An insurer owes a fiduciary duty to their insured, including the duty not to contravene on insured’s rights. Insured’s rights contain the right to pursue collateral claims against third parties. If an insurer knows that an insured intends to pursue a collateral claim against a third party, and that insurer takes actions that derogates the rights of the insured to pursue their collateral claims, the insurer is subject to liability. Insurance carriers must operate with good faith and fair dealings, and when an insurer’s actions harm their insured’s rights, they are breaching their fiduciary duty. Barney v. Aetna Cas. & Sur. Co. (1986) 185 Cal. App. 3d 966, 975–981, 230 Cal. Rptr. 215; Rothtrock v. Ohio Farmers Ins. Co. (1965) 233 Cal. App. 2d 616, 43 Cal. Rptr. 716.
Three real estate developers formed a limited partnership and developed a 12-unit condominium project in San Diego, California. All three developers, as well as the partnership, were insured under the same insurance policy. In 1991, the homeowner association of the 12-unit condominium, filed a construction defect lawsuit against the developers and other defendants. The developers promptly tendered the defense of the construction defect claim to their insurance carrier. The insurer provided a defense to the partners from April 1992 to January 1994 after which time they withdrew their defense asserting that there was no potential coverage under the policy. Following the carrier’s withdrawal, the homeowner association secured a default judgment that ultimately forced all three developers into bankruptcy.
Following this incident, the developers filed an insurance bad faith claim against the insurance carrier. Among the several causes of action in the insurance litigation, the insured developers alleged breach of contract, breach of their duty to defend, untimely assertion of their reservation of rights and failure to operate with good faith and faith dealing. The subsequent bad faith cause of action which the developers filed against the insurer arose from the insurance carrier’s behavior in the first litigation. Specifically, in the construction defect lawsuit, the homeowner association had participated in bad faith litigation tactics (i.e., hiding evidence, submitting fraudulent documents etc…) and the insurance carrier failed to advise the developers of the potential claim. Further, by permitting the homeowner association to proceed with a default judgement the developers’ right to assert a counter claim was unlawful extinguished.
Following a prolonged jury trial, the jurors reached a unanimous verdict in favor of the developers awarding the, $27,000,000 in compensatory damages. The jury found that the insurance carrier operated in bad faith in refusing to defend the developers and infringing on their right to file a counter claim.
Case: Pershing Park Villas Homeowners Association, Harry R. Bigham, Timothy R. Penkala and Joseph R. John vs. United Pacific Insurance Company and Reliance Insurance Company; Case No: 95CV1918 – United States District Court, Southern District, San Diego (1998)
If an insurance company is found to have acted in bad faith, they may be liable for: Compensatory Damages, Punitive Damages, and Attorney Fees. Our previous articles discussing compensatory damages and punitive damages are linked below: