How to Recognize an Attempted Bad Faith Set Up
Bad faith insurance claims are successful when a plaintiff can prove that the insurance company wrongfully denied an insurance claim and deprived the insured of the benefits of the contract of insurance without good cause. Bad faith insurance suits can arise in the context of any insurance policy.
California created the tort of bad faith by court decision. Florida, on the other hand, like many states created by legislation liability for insurers who act in bad faith in denying insurance claims. Since most states allow suit for the tort of bad faith it often seems that every claim that is rejected – whether correctly or wrongfully – results in a suit alleging breach of contract and the tort of bad faith.
In light of the substantial damage awards attendant to bad faith claims, plaintiffs’ attorneys have great incentive to try to maneuver insurance companies into committing acts that may constitute bad faith. They may, and fairly often do, attempt such “set-ups” by creating a situation where the insurer refuses to settle a tort claim within policy limits within a limited period of time. The plaintiff’s purpose, of course, is to recover substantial extra-contractual damages, including attorneys’ fees, where permitted. In short, since a bad faith verdict can be vastly more lucrative than simply collecting on a “within policy limits” claim, the temptation for a lawyer to take advantage of a young, inexperienced or inadequate insurance adjuster, overcomes any sense of morality or the need to obtain a settlement that is in the best interests of the lawyers’ clients.
With bad faith claims viewed as the gateway to recovering attorney fees and damages well in excess of policy limits, insurers and policyholders counsel need to be well versed in addressing scenarios in which an insurer’s allegedly flawed investigation, settlement practices, and/or noncompliance with statutory claims handling requirements open the door to extracontractual disputes.
While bad faith claims start with establishing some form of unreasonable conduct by the insurer, something more than negligence, a mistake, or poor judgment is required to present a meritorious bad faith claim. This holds true whether the bad faith claim rests on the insurer’s alleged breach of the implied covenant of good faith and fair dealing, its fiduciary or quasi-fiduciary obligations owed to its insured, or its violation of unfair insurance practices or claims handling statutes.
Some fact situations that can easily result in a bad faith suit include:
- Low policy limit and high exposure claims;
- Failure to settle a liability claim within limits when liability of the insured is clear.
- Lost opportunities to settle within limits;
- Failure to apprise insured of material litigation or settlement developments;
- Flawed investigation unduly focused on developing grounds to deny claim;
- Competing claims for policy limits;
- Mishandled control of defense, including disregard of conflicting interests and/or insured’s entitlement to independent counsel;
- Failing to timely apprise insured of coverage limitations;
- Overlooked traps in demand letters;
- Insufficient attention to efforts to establish bad faith claim in problematic jurisdictions;
- Material violation of statutory claims handling requirements; and/or
- Problematic claims file entries.
As a result, the bad faith set-up became common. The bad-faith set-up is not a new tactic. In 1985, Justice Kaus of the California Supreme Court observed:
It seems to me that attorneys who handle policy claims against insurance companies are no longer interested in collecting on those claims, but spend their wits and energies trying to maneuver the insurers into committing acts which the insured can later trot out as bad faith. [White v. W. Title Ins. Co., 710 P.2d 309, 328 n.2 (Cal. 1985) (Kaus, J., concurring and dissenting)]
In J.B. Aguerre, Inc. v. American Guarantee & Liability Ins. Co. (1997) 59 Cal.App.4th 6, 68 Cal.Rptr.2d 837, the Court of Appeal affirmed a judgment of dismissal on demurrer, holding a liability insurer did not act unreasonably as matter of law in refusing to meet the plaintiff’s $2 million settlement demand, despite the alleged risk of exposing the insured to uncovered punitive liability. The insured’s alleged fear of his punitive exposure coerced him to contribute to a settlement out of duress. Justice Neal observed as follows:
What we have here, at bottom, is an effort by [the insured] to concoct a bad faith claim out of whole cloth with the ‘ingenious assistance of counsel.’ [The insured] has attempted to position itself to pursue a high stakes, bad faith case, seeking punitive damages, from which it hopes to emerge not only with the [underlying] claim disposed of at no cost to [the insured], but a profit as well in the form of damages recovered from [the insurer]. [¶] Bad faith litigation is not a game, where insureds are free to manufacture claims for recovery. Every judgment against an insurer potentially increases the amounts that other citizens must pay for their insurance premiums. Id. at pp.17-18, 68 Cal.Rptr.2d 837.)
Bad faith set-ups most frequently originate in the third-party context. When an insurer is defending an insured against a tort claim and there are insufficient limits available to compensate the insured party. In this context, the set-up involves attempts to cause an insurance company to reject a policy limits settlement offer. Third-party claimants and their counsel have come up with various ways in which to present their offers to reduce the chance that the insurer will actually accept the offer within the stated time period.
The plaintiff’s goal, of course, is to obtain a sizeable excess verdict. If successful, the next step in the strategy is for claimant’s counsel to enter into an agreement with the insured whereby claimant gives a covenant not to execute on the judgment in exchange for an assignment of the claim based on bad faith failure to settle. The most common form of a bad faith set-up is to make a settlement demand – typically policy limits – with an unreasonable time demand.
A claimant may make a settlement demand with an unrealistic time limitation before the insurance company has full access to the information bearing on liability and damages. The insurance company often declines to meet the demand, explaining that it needs further information. This position is then portrayed as a failure to settle, and will then be used against the insurance company as evidence of unreasonable conduct in the settlement of the case.
In a particular case, an insured’s demand letter imposed such unreasonable conditions that the Ninth Circuit concluded that the insurer did not act in bad faith in not immediately meeting the demand. [Charyulu v. California Cas. Indem. Exch., 523 F. App’x 478, 480 (9th Cir. 2013)]
In assessing bad faith, the reasonableness of the conduct of the insurer’s counsel must be measured against the corresponding actions of the plaintiff’s counsel. Granting summary judgment, one district court may properly look to another district court’s determination that a particular demand letter was unreasonable and a legally insufficient predicate for an insurance bad faith claim as a matter of law. [AAA Nevada Ins. Co. v. Vinh Chau, 808 F. Supp. 2d 1282, 1288 (D. Nev. 2010), aff’d in part, dismissed in part sub nom.]
In AAA Nevada Ins. Co. v. Chau, 463 F. App’x 627 (9th Cir. 2011) the Ninth Circuit granted summary judgment because, on the undisputed facts, the insureds’ counsel’s “demand letter was itself unreasonable and appears to be nothing more than an attempt to set up a potential bad faith claim.
© 2021 – Barry Zalma
Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost
equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 52 years in the insurance business. He is available at http://www.zalma.com and firstname.lastname@example.org.
Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.
Over the last 53 years Barry Zalma has dedicated his life to insurance, insurance claims and the need to defeat insurance fraud. He has created the following library of books and other materials to make it possible for insurers and their claims staff to become insurance claims professionals.
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