Expert Commentary

Looking at the Tort of Bad Faith

A tort is a civil wrong from which one person can receive damages from another for injuries. Nearly 60 years ago, the California Supreme Court created a new tort in US jurisprudence when it decided Comunale v. Traders & General Ins. Co., 50 Cal. 2d 654, 328 P.2d 198 (1958). The tort was called the "tort of bad faith."


Claims Management
November 2017

In Comunale, insureds were allowed to recover against insurers in both tort and contract. By so doing, the California Supreme Court changed everything. It held:

Although a wrongful refusal to settle has generally been treated as a tort (see Keeton, Liability Insurance and Responsibility for Settlement, 67 Harv. L. Rev. 1136, 1138; Anno., 131 A.L.R. 1499, 1500), it is the rule that where a case sounds both in contract and tort, the plaintiff will ordinarily have freedom of election between an action of tort and one of contract. (Eads v. Marks, 39 Cal. 2d 807, 811 [249 P.2d 257].) An exception to this rule is made in suits for personal injury caused by negligence, where the tort character of the action is considered to prevail (Huysman v. Kirsch, 6 Cal. 2d 302, 306 [57 P.2d 908]; Krebenios v. Lindauer, 175 Cal. 431 [166 P. 17]), but no such exception is applied in cases, like the present one, which relate to financial damage (cf. County of Santa Clara v. Hayes Co., 43 Cal. 2d 615, 619 [275 P.2d 456]; Jones v. Kelly, 208 Cal. 251, 255 [280 P. 942]).

The court allowed the insured to receive, in addition to the contract damages that the insured was entitled to receive under the common law applied for the years before Comunale was decided, damages for emotional distress and punitive damages to punish the insurer for what the court concluded was its wrongful acts. Thus, the tort of bad faith was created because an insurer failed to treat an insured fairly, and the court felt that traditional contract damages were insufficient to properly compensate the insured whose claim was denied.

Insureds, lawyers for insureds, regulators, and many courts across the United States cheered the action of the California Supreme Court, and most states adopted the tort.

As a Result of Comunale

After the creation of the tort of bad faith, if an insurer and insured disagreed on the application of the policy to the factual situation, damages were no longer limited to contract damages, as in other commercial relationships. If the court found that the insurer was wrong, it could be required to pay the contract amount and damages for emotional distress, pain, suffering, punishment damages, attorney's fees, and any other damages the insured and the court considered appropriate. It was hoped that the tort of bad faith would have a salutary effect on the insurance industry and force insurers to treat their insureds fairly.

However, when insignificant claims deemed wrongfully denied resulted in $5 million verdicts, "fairness" found a new definition. Juries, unaware of the reason for and operation of insurance, decided that insurers that did not pay claims were evil and punished them, often feeling sorry for the insureds. This happened even when the insurer's conduct was correct and proper under the terms of its contract. The massive judgments were publicized, and many insurers decided fighting insureds in court was too risky and expensive. If an insured sued for bad faith, regardless of how correct the position of the insurer on the contract, the insurer would often choose to pay to settle.

Most of the massive verdicts were reversed or reduced on appeal. The bad actors raised their premium and lost little business. Other insurers, faced with the massive verdicts, allowed fear to control reason and paid claims that were improper or fraudulent. The extra cost was passed on to all insurance consumers, not to the insurers who acted improperly. The bad actors, in fact, profited. They continued their wrongful acts and paid the few insureds that sued.

Honest and professional insurers paid fraud perpetrators and claims the policy never intended to cover for fear of being painted with the same brush as the bad actors. Those who exercised good faith were punished, and those who dealt with insureds in bad faith profited. The tort of bad faith, designed to help the innocent, resulted in punishing the honest and professional insurers, rewarding the insurers who acted in bad faith with profit. Also, because of the fear of punishment with bad faith suits, insurers allowed many frauds to succeed rather than face potential tort damages. Contract terms and conditions that were clear and unambiguous were ignored to avoid litigation.

Where the Tort of Bad Faith Is Now

In the nearly 60 years of application across the United States, the tort of bad faith has not, in my opinion, had a salutary effect on the insurance business or the people and businesses who are insured. Insurance costs more than is reasonable or necessary so that sufficient funds exist to pay claims and tort damages from those insureds who believed they were wronged.

Suits relating to claims presented for the 1994 Northridge earthquake in California are still pending, seeking tort and punitive damages for failure to pay what the insureds believe they were owed. In Louisiana and Mississippi, multiple millions were paid to settle claims that flood damage was covered as a result of Hurricane Katrina, although the policies excluded flood and the plaintiff insureds failed to buy flood insurance.

The tort of bad faith is like the mythical vampire—it hides in the dark. The truth about the tort of bad faith is that it will die only if it is put into the light of day. It does not solve the problem anticipated. Rather, it makes a few lawyers very rich; a few insureds receive indemnity for which they did not bargain and makes the cost of insurance prohibitive to those who wish only to receive the benefits of the contract.

"Fair" Requires Equal Application of the Law to All Parties

In California, and in most states that allow a breach of an insurance contract to support a tort cause of action, the application of the law is only allowed to go in one direction. Insurance litigants are not equal. An insured can obtain tort damages for bad faith breach of the insurance contract, but an insurer may not receive tort damages for bad faith breach of an insurance contract.

The inequality of treatment of insurers and insureds resulted in a distinction between tort and contract liabilities that convinced the Montana Supreme Court to reject comparative bad faith as a defense in a bad faith action against an insurer because "the [insurer's] tort cannot be offset comparatively by the [insureds'] contract breach." It characterized the differing legal concepts as "apples and oranges" (Stephens v. Safeco Ins. Co. of America, 852 P.2d 565, 568-569 (Mont. 1993)). In addition, a different court rejected a comparative bad faith defense for an insured's misperformance of its contractual duties in a bad faith action against the insurer for refusal to defend (First Bank v. Fidelity and Deposit Ins., 928 P.2d 298, 306-309 (Okla. 1996)).

In California, the decision in Agricultural Ins. Co. v. Superior Court, 70 Cal. App. 4th 385 (1999) agreed. Agricultural involved a bad faith action arising out of an insurance claim for earthquake damage. After the insurer paid the claim in part, controversies arose, ultimately leading to the insured's suit for breach of contract and bad faith. The trial court stayed the action to allow the insurer to complete its investigation. The insurer did, and then cross-complained, contending that the insured's claim was in significant part falsified. Making a false claim is a ground usually sufficient to allow the insurer to declare the policy void and deny all payments.

The insurer pleaded various contract theories, and also the tort theories of fraud and what was called "reverse bad faith," (i.e., tortious breach of the covenant of good faith and fair dealing by the insured). The insured demurred to the tort theories, and the trial court sustained the demurrers without leave to amend. The decision made the following amazing conclusion:

Although there is an implied covenant of good faith and fair dealing in every contract, although each party is bound by it, and although this principle applies to insurance contracts (see, e.g., Liberty Mut. Ins. Co. v. Altfillisch Constr. Co., 70 Cal. App. 3d 789, 797 (1977)), the potential liability for breach is different for insurers and insureds. In summary, an insured may be held liable in contract for breaching the covenant, but cannot be held liable in tort.

This goes against the 14th Amendment to the US Constitution, which provides in part:

No State shall make or enforce any law which shall abridge the privileges or immunities of citizens of the United States; nor shall any State deprive any person of life, liberty, or property, without due process of law; nor deny to any person within its jurisdiction the equal protection of the laws.

If the law allows an insured to sue for tort damages as a result of a breach of the covenant of good faith, fair dealing equal protection should allow an insurer to sue the insured for tort damages as a result of the breach of the same covenant. Our system of constitutional law does not allow one litigant to be more equal than others. Insurers are clearly not as equal as their insureds with regard to the tort of bad faith. Even when there is clear evidence that the insured breached the covenant of good faith and fair dealing, the insurer is only entitled to contract damages while the insured, whose insurer acted in breach of the covenant, can be awarded tort and punitive damages.

Although the courts may not think so, the insured's breach of the covenant of good faith and fair dealing should also be separately actionable as a contract claim. Some forms of misconduct by an insured will void coverage under the insurance policy. However, the court in Agricultural believed that contract remedies "adequately serve to protect an insurer from the insured's misconduct without creating the logical inconsistencies and troublesome complexities of a defense of comparative bad faith."

In so doing, the California court ignores the logical inconsistencies and troublesome complexities of the tort of bad faith when it finds an insurer breached the covenant. What is tortious conduct by an insurer should be tortious conduct by an insured. Damages available to the insured should be available to the insurer.

Conclusion

In my opinion, it is time to put a stake in the heart of the tort of bad faith. Insureds who are wronged by their insurer should limit their recovery to contract damages. If the tort of bad faith must exist, it must be applied equally. The abuse of the tort of bad faith has become so extreme that the tort must be eliminated or, otherwise, made fair.

If there is a tort of bad faith—as the courts seem to believe—the 14th Amendment to the US Constitution requires equal protection. An insurer who is wronged by its insured should have the same right to tort damages and punitive damages for breach of the covenant as can the insured. There should be no call for comparative bad faith but only that any party to a contract of insurance treated in bad faith by the other should be entitled to recover the same damages, both contract and tort damages.

I think the tort of bad faith has served its purpose. It should be killed with a stake through its heart, covered in garlic and doused with holy water, and then buried and never allowed to rise again.

© 2017 Barry Zalma, Esq., CFE


Opinions expressed in Expert Commentary articles are those of the author and are not necessarily held by the author's employer or IRMI. Expert Commentary articles and other IRMI Online content do not purport to provide legal, accounting, or other professional advice or opinion. If such advice is needed, consult with your attorney, accountant, or other qualified adviser.

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