REBUTTAL: Reverse Bad Faith Does Not Exist
This responds to a guest article that appeared on June 23, 2015, in Law360 titled: "Reverse Bad Faith: Does It Exist and Can It Be Useful?"
There is no such thing as reverse bad faith and only a Victor Frankenstein jurist could stitch together such a beast.
Imagine a policyholder is sued and tenders the lawsuit to his insurer. The insurer accepts the defense under a reservation of rights and during the defense, the insurer determines that the policyholder isn't going to be a good witness. The insurer tells the policyholder that it thinks the policyholder is not doing well in depositions and that the insurer thinks the poor showing may be "bad faith" on the part of the policyholder. During mediation in the underlying claim, the insurer demands that the policyholder pay a significant part of any settlement under the threat — if coverage litigation ensues — of a counterclaim against the policyholder for "reverse bad faith," along with the threat of consequential damages, attorneys' fees in the coverage action and punitive damages. Most policyholders couldn't risk the fight, but the insurance industry can. If the insurer loses, on to the next claim. If the policyholder loses, perhaps on to financial ruin and its attendant emotional damage.
In any event, there is a well-established means for an insurer to obtain relief from what the RBF article advocates as "a plausible [new] remedy": all third-party insurance policies contain many "conditions" and insurers commonly claim that breach of those conditions excuses any further performance on their part. Typical conditions of this nature are the notice clause, which requires prompt notice of any claim to the insurer and (in occurrence-based policies) allows the insurer to seek avoidance of its defense and indemnity duties if it can show "actual prejudice" from the delay (Campbell v. Allstate Insurance Co. (1963) 60 Cal. 2d 303, 308), the cooperation clause, which requires the insured "to cooperate with us in the investigation, settlement or defense of the suit" (ISO Form CG 00 01 12 07, Sec. IV, 2.3(c)), under which "the insurer's performance is excused if its ability to provide a defense is substantially prejudiced" (Rockwell International Corp. v. Superior Court (1994) 26 Cal. App. 4th 1255, 1263) and the no voluntary payments clause, which relieves the insurer of its duties where the insured has made payments on account of the claim, in non-emergency conditions and without the insurer's consent (Jamestown Builders Inc. v. General Star Indemity Co. (1999) 77 Cal. App. 4th 341, 350). These defenses protect insurers from insureds who actually undermine the insurer's ability to defend claims and strike the proper balance between the parties in view of the "prophylactic" purposes of insurance (Buss v. Superior Court (1997) 16 Cal. 4th 35, 49.) Thus, the proposed introduction of a tort claim by insurers against policyholders that do not act to their insurer's liking would seriously skew the well-honed present balance of rights and duties between the parties.
Thirty years ago, a court started to bring life something like what the RBF article proposes: an entirely new form of comparative fault the insurer could interpose as a defense to a policyholder bad faith lawsuit called "comparative bad faith." California Casualty General Insurance Co. v. Superior Court, 173 Cal. App. 3d 274, 283 (1985).
Fifteen years ago, the California Supreme Court put reverse bad faith on the pyre when it disapproved of California Casualty, stating that the California Casualty court's extension of tort comparative fault principles to an insured's breach of the covenant of good faith and fair dealing " ... misleadingly equates an insured's contractual breach of the reciprocal covenant of good faith and fair dealing with an insurer's tortious breach of the covenant. The holding [of California Casualty] is confusing and inconsistent insofar as it acknowledges an insured's breach of the covenant is not actionable in tort, but nonetheless can give rise to tort consequences because the insurer may assert it as a defense in a bad faith action to lessen the responsibility for its own tortious conduct." Kransco International Insurance Co. v. American Empire Surplus Lines Insurance Co., 23 Cal. 4th 390, 406-407 (2000).
The Kransco court thus rejected "tort consequences" to the policyholder. Yet, the entire RBF article tries to conjure exactly such tort consequences even though state and federal courts also disapprove of them, as did the Kransco court. As Justice Baxter wrote in Kransco:
Nor has California Casualty been accepted or treated as controlling authority in sister state jurisdictions or the federal courts. We have noted that the Oklahoma Supreme Court in First Bank, supra, 928 P.2d at page 308, expressly rejected the rationale and holding of California Casualty and that the Montana Supreme Court in Stephens v. Safeco Insurance Co. of America, supra, 852 P.2d at pages 568-569, likewise refused to recognize a comparative bad faith defense. (Ante, at p. 403.) Similarly, in Johnson v. Farm Bureau Mutual Insurance Co. (Iowa 1995) 533 N.W.2d 203, 207-208, the Iowa Supreme Court refused to recognize the analogous tort of reverse bad faith. Appellate courts in Texas, Oregon and Florida and district courts in the Virgin Islands and Hawaii, have likewise all refused to recognize an affirmative defense of comparative bad faith. (See Southland Lloyd's Insurance Co. v. Tomberlain (Tex.Ct.App. 1996) 919 S.W.2d 822, 832, fn. 5; Stumpf v. Continental Casualty Co. (1990) 102 Or.App. 302 [794 P.2d 1228]; Nationwide Property & Casualty Insurance Co. v. King (Fla.Dist.Ct.App. 1990) 568 So.2d 990, 990-991; In re Tutu Water Wells Contamination Litigation (D.V.I. 1999) 78 F.Supp.2d 436, 454-455; Wailua Associates v. Aetna Casualty and Surety Co. (D. Hawaii 1998) 183 F.R.D. 550, 559-560.)
To the extent it is inconsistent with the conclusions reached herein, California Casualty General Insurance Co. v. Superior Court, supra, 173 Cal. App. 3d 274, is disapproved." (emphasis supplied).
The RBF article, at every turn, contradicts not just the weight of settled law, but all settled law. It doesn't matter that Hadley v. Baxendale stated in 1854 that under certain circumstances special damages not foreseen when the contract was made can be recovered if circumstances were or should have been known to the defendant when the contract was made. Hadley v. Baxendale is a contract case and actually limits recoverable damages, which makes it hard to see the relevance of the RBF article's discussion of that classic decision. The authorities cited above all reject the notion that the insurance industry can seek such "tort consequences." Nor do the other cases cited in the RBF article help to vivify the dead concept of reverse bad faith.
Much of the RBF article is devoted to New York law. The article stresses Bi-Economy Marketing Inc. v. Harleysville Insurance Co. of N.Y., 10 N.Y.3d 187 (2008), which held that where fire destroyed the insured's business and the property insurer was slow in paying the damages, this amounted to bad faith claims handling and that therefore the insured could properly seek consequential damages for the collapse of its business, as the insurer should have been aware that any breach of its obligations to investigate in good faith and pay covered claims promptly would result in payment of damages to the insured for the loss of its business as a result of the breach. There is exactly nothing remarkable in that conclusion, nor any support for the RBF article's premise.
Other New York cases cited in the RBF article are trial and intermediate appellate cases, some unpublished, that go the same way:
Savino: Insurance Co is subject to special, ie., consequential damages.
Rodriguez: same (punitive damages claim removed).
Grinshpun: consequential damages allowed in bad faith claim against the insurance company.
The RBF article claims that Endurance American Specialty Insurance Co. v. Lance-Kashian & Co., CV F 10-1284 (E. D. Cal.) seems to offer hope of "reverse bad faith" claims. The case involved a motion to dismiss. The insurer sued for declaratory relief that it was not liable for independent counsel (Cumis) fees because, among other things, the rates were too high. The court dismissed the claim of tortious bad faith (contra to the RBF article's point) but held that there could be breach of contract, including the duty of good faith and fair dealing, if the policyholder failed to cooperate in the defense of the third party claim. This was a ruling on the pleadings, citing Kransco extensively. Nothing at all that suggests an insurer would have a bad faith tort claim — Judge Lawrence O'Neil dismissed the tort claim!
The RBF article also cites Kaiser Foundation Hospitals v. North Star Reinsurance Corp., 90 Cal. App. 3d 786 (1979). In Kaiser, an insurer claimed that Kaiser and another insurer had conspired to assign a large number of claims — evidently for continuous injuries — to specific policy years to exhaust the primary and hit the plaintiff excess insurer early. The court overruled a demurrer. The case is of no consequence inasmuch as certainly any party to any contract has a duty of good faith and fair dealing to the other parties, but, again, its violation of that universal condition is a breach of contract, not a tort.
The RBF article tries to alter the universally existing, socially appropriate distinction between insurance companies' improper conduct and policyholders' breaches of their obligations. That is a very bad idea and those courts that have been approached about it have universally rejected it.