c. Elements of Bad Faith Action

(Failure to Settle)

In a failure to settle case, to recover on the theory of a breach of the implied "good faith" covenant, the plaintiff (the insured or third party claimant) must plead and prove the following elements:

	(1) That there is coverage;
	(2) That the carrier had a reasonable opportunity to settle within policy limits;
	(3) That the carrier refused to settle within policy limits;
	(4) That the refusal to settle within limits was unreasonable (this element usually is not needed by the plaintiff, if the refusal was based on an insurer's denial of any coverage);
	(5) That an excess judgment was returned against the insured; and
	(6) That the excess judgment against the insured was assigned to the third party (this element is needed only for an action by a third party).

The insurer is obligated to consider the interest of the insured, as well as its own interest, in evaluating settlement offers. Whether the insurer acted reasonably is determined in part by the following:

(1) The likelihood that there will be a verdict against the insured (i.e., the strength of the claimant's case on liability);

(2) The likelihood that the verdict, if adverse, will be for a sum greater than the insurance coverage (i.e., the financial risk to which the insured is exposed in the event of a verdict for the plaintiff);

(3) The insurer's failure to properly investigate to ascertain evidence that may be used at trial by the claimant against the insured;

(4) The insurer's rejection of advice from its own lawyers or claims investigators;

(5) The insurer's failure (including appointed counsel's failure to inform the insured of potential damages, adverse testimony, and the potential for adverse verdict; or to inform the insured of all negotiations and all compromise offers, (to enable the insured to consider "adding to the pot" to effectuate settlement or getting his/her own attorneys). Cf., Warren v. American Family Mut. Ins. Co., 361 N.W.2d 724 (Wisc. 1984);

(6) Any attempt by the insurer to coerce the insured to contribute to the settlement without the insurer paying all the settlement;

(7) The fault of the insured in causing the insurer's rejection of the proposed compromise settlement by misleading it as to material facts. Each party's duty is dependent upon the agreement reached between the insurer and the insured and their legitimate expectations which arise from the contract of insurance. The insurance carrier has a reasonable expectation that its insured will furnish it with all the necessary information it requests to handle the claim. Thus, if the insured fails to deliver the information, or misleads the insurer, any damage that follows as a result of the insured's failure to act is attributable to the insured himself.

(8) The court's acceptance of the legal doctrine of comparative bad faith of the insured. The viability of the affirmative defense of comparative bad faith is uncertain. However, some cases outside the Dakotas hold that an insured also has a duty of fair dealing. The South Dakota case of Wolff v. Royal Ins. Co., 472 N.W.2d 233 (S.D. 1991) also seems to recognize such a duty. If the insured breaches his implied duty of good faith and fair dealing, then the insurer-defendant has at least a partial defense to a bad faith action

e. Insurer's Response To Settlement Offers Under Limits

The claimant's attorney may write a letter outlining the merits of the claimant's case and offering to settle for less than the policy limits. The insurer must then notify its policyholder that the claim is in excess of the policy limits, that an offer to settle within the policy limits has been made, and that the policyholder may engage counsel to advise him/her/it and to assist the counsel appointed by the insurer to defend.

If the policyholder engages a lawyer, then the plaintiffs' attorney calls that defense attorney on the telephone, tells that personal attorney what has transpired, and pretty soon the insurer receives a similar demand from the insured's personal attorney with an explicit threat of an excess suit and a suit for bad faith in refusing to settle. By this time, the poor insurance company is really sweating, as well it may.

If liability is controverted and damages are severe, the insurer is not allowed to gamble with the insured's personal assets, merely because the insurer has a limited "upside" amount of coverage, and it prefers to gamble unreasonably upon the law of averages. Nevertheless, if the insurer acts reasonably, the insurer is not compelled to either make excessive settlements or suffer unlimited liability where its insured was too cheap to buy other than a minimum limit policy.

The insurance company should, if it is on its toes, always forward a reply communication to the plaintiff's counsel (and to its insured) setting forth the reasons why the settlement is declined. The reason to set out "reasons" for declining to settle within policy limits is to allow the jury to see that before the insurer was sued for bad faith it did the job of a reasonable insurer.

To avoid "bad faith" charges an insurer should respond to each settlement demand, even if it perceives the offer as uncertain, defective, or unreasonable. Simply ignoring an incomplete, defective, or unreasonable demand may constitute a breach of the insurer's duty to use good faith efforts to settle and protect the insured.

In the face of a below limits demand, the insurer should always:

	(1) make a timely response to the demand,
	(2) point out the specific reasons why the demand is incomplete, or cannot be presently acted upon, or is unreasonable in time limits,
	(3) point out why the demand is excessive or unreasonable in amount, and
	(4) manifest a willingness to negotiate further.

However, accomplishing settlement for the amount demanded, even belatedly, may minimize the insurer's liability by cutting off liability for emotional distress damages and economic loss after the date of settlement.

f. Proper Parties - Excess Liability Case

(1) Parties Plaintiff

(a) Named insureds and additional non-named insureds.

(b) An assignee of an insured or a judgment creditor who has seized the rights of the insured by execution on the judgment.

(c) Third party claimants who were intended beneficiaries of the insurance contract. These are usually only claimants against insureds who have liability policies required by public law or who have contracts which have as their object the financial protection of persons who may be injured. A third party claimant usually may not sue under a theory of breach of an implied covenant of fair dealing because the duty to reasonably settle is intended to protect the insured and not the third party. However, a third party claimant may maintain the insured's cause of action against the insurer as an assignee of the insured or on execution of the insured's assets, per item (b) above.

(2) Parties Defendant

(a) Both the primary and excess carriers may be sued for failure to accept a reasonable offer within policy limits.

(b) There is no implied covenant action by an insured against a reinsurer since there is no privity of contract between the insured and reinsurer. However, the insured or a third party claimant may sue a reinsurer as an assignee of the primary insurer's rights.

(c) Since a breach of an implied contractual covenant action lies only against a party to the insurance contract, the action for breach of contract does not lie against the insurer's agents (e.g. adjusters, investigators, claims managers, house counsel, etc.). However, agents and employees may be held personally liable on other independent tort theories, e.g., their negligence in investigation of the claim.

2. Claims of Failure to Defend

a. Generally

Suits may be based upon the insurer's failure to defend a third party's claim against the insured. Because the duty to defend inures to the benefit of the insured, not to the injured party, the actions are really part of what an insurer calls "first party coverage" claims. However, duty-to-defend cases are generally analyzed by the courts as "third party" cases because they arise out of a third party's liability claim against the insured.

There is an express agreement in most liability insurance contracts to defend the insured. This expressly obligates the insurer to defend actions brought against its insured. In addition, in every insurance contract there is an implied covenant to deal fairly with the insured. This obligates the insurer to use good faith to keep the express promise and furnish the defense. Breach of the implied promise furnishes the basis for a tort claim of bad faith against the insurer.

b. Approaches To Coverage Disputes

The insurer has four basic alternatives when faced with a claim against the insured when there is a coverage question. The insurer may:

	(a) refuse to furnish a defense,
	(b) reserve rights, and furnish the insured with insurer-appointed counsel and a defense,
	(c) reserve rights and pay the insured to defend the claim with his/her own counsel, or
	(d) accept a defense of the third party suit and waive objections to the lack of coverage.

c. Elements

To maintain a "bad faith" tort action against the insurer for wrongful refusal to defend, the insured must plead and prove:

	(1) Existence of a duty to defend;
	(2) Notice and opportunity to defend;
	(3) Refusal to defend; and
	(4) Damages resulting from the "bad faith" refusal to defend.

Breach of the insurer's duty to defend the insured in a third party lawsuit subjects the insurer to liability for whatever litigation expenses - attorney fees and other defense costs - the insured incurred in defending the lawsuit, as well as to liability for emotional distress damages. In extreme cases where the refusal to defend and denial of coverage are coupled with conduct constituting "oppression, fraud or malice", or "recklessness" punitive damages may be awarded.

The basic case in North Dakota is Smith v. American Family Mut. Ins. Co., 294 N.W.2d 751 (N.D. 1980). It was held there that a failure to defend the insured was a tortious breach of the implied covenant of fair dealing, as well as a contract breach of the contract obligation to defend. (Cf., Bender v. Time Insurance Company, 286 N.W.2d 489 (N.D. 1980), holding that the tort claim for breach of implied covenant of good faith can exist even if the contract breach claim is barred.) In Smith, the North Dakota court concluded that tort damages could be awarded (including damages for emotional distress without physical manifestation) from the mere fact of failure to defend.

Although the breach of the implied covenant of good faith is called "bad faith", it is not every "bad faith" refusal to defend that justifies punitive damages. To justify punitive damages, there must be an unreasonable or reckless refusal to defend in addition to the mere "bad faith" from breach of the "good faith" duty to defend. Smith expressly adopted the reasoning of Corwin - Chrysler - Plymouth Inc. v. Westchester Fire Ins. Co., 279 N.W.2d 638. (N.D. 1979), as being applicable to refusals to defend. Corwin states, at 645:

"Yet a finding of bad faith alone does not entitle the insured to punitive damages; oppression, fraud or malice, actual or implied must also be found."

Unfortunately for the insurer, in North Dakota implied malice is merely "recklessness of the rights of others", and a jury usually is eager to find an insurer who does not defend, when there is a contract to defend, is guilty of recklessness of the rights of others.

B. - INITIAL CONSIDERATIONS FOR THE INSURER

Q. Where Should Your Best Attorney Be? [(a) Asserting the insurer's position of no coverage through a declaratory judgment action, or (b) Defending the underlying claim, or (c) Where the best chance of defense is?]

    A. Where the best chance of defense is.

Q. Should Different Claims Persons Handle Coverage and Defense?

    A. It is not legally necessary, but it helps to have the person making the initial decisions on proper settlement amounts for the claim against the insured not be the same person who makes initial determination of whether the insurer will decline coverage or what will be paid for settlement of the coverage dispute. Such a division of initial responsibility helps defend against a claim that the final decision by the insurer was unreasonable. (This assumes the person making the initial decision made the same determination the company ultimately made.)

Q. Should (Must) you Pay the Insured's Personal Attorney?

(1) To defend the underlying claim?

    A. Generally, no, if you furnish counsel to defend the claim. However, if you are defending under a reservation of rights, there are some situations where the insured can decline the counsel you appoint and choose another, which you must pay.

(2) To defend a declaratory action?

    A. No, not initially. However, if you lose the declaratory judgment action you will usually be required to pay the insured's legal fees to secure the determination of coverage.

C. RESERVING RIGHTS AND DECLARATORY ACTIONS

1. Denial of Coverage by Insurer

a. Risks in Denying Coverage Without Specific Reasons

An insurance company seeking to decline coverage or liability must do so within a reasonable time following tender of defense. If the company delays its decision so long that the insured's rights are prejudiced, the company may be estopped from denying coverage.

If the insurer takes control of the action without notice to the insured that the insurer does not consider itself liable under the policy, the insurer usually is estopped from denying liability on the policy. Prejudice to the insured will be conclusively presumed when the insurer exercises complete control over the defense without a reservation of rights.

If the company elects to deny coverage, it should list in a denial letter all reasons then available for the denial. The courts are split on the questions of whether failure to list a ground for denial of coverage will later estop the company from relying upon that ground.

b. Risks in Denying Coverage Without Defending Insured

Where the company had denied a defense, the insured can defend on his own and sue the insurer afterwards for damages.

When the insurer refuses to defend, it generally loses both policy defenses such, as breach of cooperation by the insured, failure to give notice, etc., and also a substantial part of the right to question the propriety of any settlement made by the insured.

A settlement by the insured with the claimant is not a violation of the insured's duty to cooperate with the insurer - if the insurer refused to defend or refused to settle reasonably. Once the insurer abandons the insured, the insured can make such settlement as he/she deems provident.

The settlement by the insured in such a situation, assuming coverage, is enforceable against the insurer if it is reasonable and prudent and if it is not the product of fraud and/or collusion. The insurer is limited to a determination whether the amount of the settlement is reasonable and prudent.

2. Non-Waiver Agreements

Two options are available to the company that wants to furnish a defense but reserve the right to later deny coverage: (1) a non-waiver agreement; or (2) a reservation of rights letter.

A non-waiver agreement is a contract between the insurer and the insured in which the insured agrees that the company can reserve all of its rights under the policy including the right to deny coverage later for any reason. In exchange for this agreement, the insurer agrees to defend the action without cost to the insured.

3. Non-Waiver Agreements Compared to Reservation of Rights

Non-waiver agreements appear to be falling out of favor. If there is coverage, the policy obligates the company to provide a defense; the company has no right to insist that the insured (that has coverage) enter into a non-waiver agreement prior to providing the defense, it is required by contract to provide. Indeed, requesting a non-waiver agreement may be evidence of bad faith by the insurer.

If the company attempts to secure a non-waiver agreement and the insured refuses to consent, the insured's refusal to enter into a non-waiver agreement is a form of saying "If you [the insurer] defend, then you will waive your rights; I will not give the company the option of defending and reserving rights." In short, the insured's refusal to sign a non-waiver agreement may preclude the company from defending with a reservation of its rights. The insured has put the insurer into a situation where if it proceeds to defend the insured, the court may say the company has waived the policy defenses.

A reservation of rights letter and a non-waiver agreement provide precisely the same protection to the company. Under both, the company has the right later to deny coverage on announced policy defenses. A reservation of rights letter is better than a non-waiver agreement. It gives the company control of the conditions under which it is defending, without needing the consent of the insured to be effective.

4. Reservation of Rights Letter

A reservation of rights letter is a unilateral declaration from the company to the insured that the company is furnishing a defense of the tendered lawsuit but reserves its right to later deny coverage on certain specified grounds. Without a reservation of rights letter prior to accepting the defense, or within a reasonable time thereafter, the company may be estopped from denying coverage. With the reservation of rights letter, the company is protected from waiver of its rights.

A reservation of rights letter is not sufficient if it only states that the company reserves its right to later deny coverage. The purpose of a reservation of rights letter is to enable insureds to make intelligent decisions. Therefore, the company must delineate with specificity every reason for denial of coverage of which it is then aware, in its reservation of rights letter.

5. Control of Defense Where Insurer has Reserved Rights

The insurer has control of the defense, and with control goes responsibility. Therefore, an insurer who undertakes to defend its insured is held to the standard of the fiduciary care the attorney whom it appoints to conduct the defense of the insured is obligated to furnish the insured. Whether or not the insurer has reserved rights in furnishing an attorney to defend, in the event the attorney does anything to violate that fiduciary duty, the insurer is liable for that violation.

The courts are split on the question of whether a reservation of rights, in and of itself, creates a sufficient conflict of interest, between insurer and insured, to permit the insured to control the defense, to reject appointed counsel and to choose independent counsel (thereby transforming the insurer's duty to defend into a duty to reimburse the insured for the fees of counsel chosen by the insured). Cf., Prahm v. Rupp Const. Co., 277 N.W.2d 389 (Minn. 1979); Roser v. USF&G, 585 F.2d 932 (8th Cir. 1978). The supposed prevailing rule is that a reservation of rights does give the insured the right to control the defense and to choose independent counsel. On the other side, the supposed minority view relies upon the ethical integrity of counsel to assure that the issue of coverage does not interfere with the defense of the underlying action. Cf., Tews Funeral Home Inc. v. Ohio Cas. Ins. Co., 832 F.2d 1037 (7th Cir. 1987). These courts keep the contractual right to control the defense with the insurer, even though there has been a reservation of rights. The North Dakota court has not yet spoken on the question.

The South Dakota court, in a statement not necessary for the case, has said that an insurer does not have the right to retain control of the defense and at the same time disclaim coverage. However, the insured's failure to object impliedly consents to the insurer's control of the defense. Connolly v. Standard Cas. Co., 73 N.W.2d 119 (S.D. 1955).

The Federal Eighth Circuit Court (which is the federal appeals court for federal courts in the Dakotas) has held that continued control of the defense after a reservation of rights is bad faith by the insurer if the insured has requested control of the defense through an attorney chosen by the insured. Kansas Bankers Surety Company v. Lynass, 920 F.2d 546 (8th Cir. 1990). Therefore, where the insured requests the defense be conducted and controlled by the insured's personal attorney, an insurer which has reserved rights should recognize that expert legal advice should be sought by the insurer.

6. Declaratory Judgment Actions

In the context of a coverage dispute, a declaratory judgment action is an action seeking a judicial declaration of the rights of the parties to an insurance contract and other interested parties. If the insurer prevails in the declaratory judgment action and establishes that it provides no coverage for the underlying action, it avoids all indemnity to its insured for the underlying action. If the insurer wins the declaratory action, whether the insured is liable for defense costs the insurer has spent in the underlying action is not entirely free from doubt.

Under North Dakota law, if the insurer loses the declaratory judgment action, it will be liable for the insured's costs and attorney fees in the declaratory judgment action.

If the insured loses the declaratory judgment action, the insurer under some cases outside North Dakota is still liable for the insured's costs and attorney fees in the declaratory judgment action. Such a result seems unlikely in North Dakota.

HOW TO AVOID BAD FAITH IN FAILURE TO SETTLE EXCESS DAMAGES CLAIMS AGAINST THE INSURED ---- TWELVE SUGGESTIONS TO INSURERS

(1) Investigate well! Investigate the facts to limit the damages claimed. Investigate the facts and the "soundness" of facts that show no liability.

(2) Early in the investigation, get the insured's version into recorded form. (It is surprising that near trial an insured, wanting a settlement, changes history to shade his fault a little worse than he/she told you at first.) Get a receipt from the insured, in 30 days after you took the statement, that you sent the insured a copy of the statement. Keep the actual recording, and the receipt for the transcribed copy.

(3) Inform the insured of the excess possibility and that the insured can hire additional counsel at the insured's expense. At the same time, ask the insured if the insured believes the plaintiff should get paid the amount demanded. Document the insured's response.

(4) Before the claimant makes a demand, offer to the claimant something to settle the claims against the insured. (Establish the "psychological reasonable range.")

(5) Respond promptly to all offers to negotiate or settle to the claimant. Keep the insured informed of all offers made.

(6) Put all communications to the claimant or the insured regarding settlement negotiations into writing. Remember those communications may be in evidence someday when someone is trying to show you were unreasonable.

(7) Give equal (or more) consideration to the right of the insured to have protection compared to the right of the insurer not to pay excessive amounts.

(8) Put into some written response something like:

"We certainly want to be fair, but we cannot with fairness to all the policyholders pay excessive amounts to settle claims. Excessive settlements result in all policy owners having to pay higher premiums in the future."

(9) In a letter rejecting a settlement under settlement limits, give the reasons for denial. Make a paper record that the amount of the proposed settlement is unreasonable, and that considering the interest of the insured the offer still is an unreasonable settlement amount.

(10) Do not let a deadline by plaintiff for final cut-off for all negotiations expire without having offered the limit of authority that your file shows you have. The plaintiff may never engage in settlement negotiations again.

(11) As it gets close to trial, ask the insured if the insured has any ideas for a better defense. Document the response in writing to the insured. (Be ready to add the item the insured suggests as an aid to better defense if it is at all reasonable.)

(12) Always be open to conducting further negotiations or looking at the decision regarding amounts or responsibilities of settlement. The standard closing paragraph, in letters to either the claimant or the insured regarding settlement, always should be something like the following.

"If you think we have overlooked something or you have new information, please let us know, so we can negotiate further, or see if a different conclusion can properly be made."

A CHECKLIST FOR INSURER OF WHAT NOT TO PUT IN THE LIABILITY CLAIM FILE WHEN THERE IS A COVERAGE DISPUTE WITH THE INSURED.

This is also a checklist for claimant's attorney as to what to look for in the insurer's files.

Ideally for the insurance company, if there is a coverage dispute with the insured, there are four separate files:

	1. The file of the writing agent,
	2. The underwriting file on the insured,
	3. The (liability) claim file regarding the liability claim against the insured and the defense of the insured, and
	4. The (coverage) claim file regarding the dispute between the insurer and the insured on coverage.

	a. The insurer's personnel's conclusions on coverage
	b. Correspondence and documents to/from the insurer about coverage
	c. Internal documents about coverage

	a. Your personal observations about the insured or the claimant except those that discuss how the jury will regard the insured or the claimant on the underlying claim.
	b. Underwriting manuals or coverage materials or claims procedural manuals.
	c. Anything that does not relate to what can be shown in court in defending the insured, or to what the claimant can prove against your insured.

Dear Attorney Nasty:

Thank you for your letter of November 15, 1991, with reference to the pending suits you have brought in Sagamon County against Mrs. Anthony. You have demanded $999,999 (one dollar less than the insurance coverage of Mrs. Anthony) for your client.

As you are doubtless aware, we undertook an investigation immediately upon being informed of the accident, to give protection under the policy to our insured, Mrs. Anthony. Without going into extensive detail concerning all the defense investigation, our investigation revealed the following.

A.J. Brown is a traveling salesman who was somewhat acquainted with your client Mrs. Rainey. Upon the date in question he had picked up Mrs. Rainey and with her had driven to a nearby community where they made the rounds of several taverns. There is definite evidence that both of them had been drinking.

Our insured, Mrs. Anthony, is a careful driver. We have every reason to believe that she was driving carefully. We would certainly rely on her previous statement given to aid an attorney retained to defend her, and to accept the other evidence which indicates she was driving in a reasonable manner.

Even if the jury should find negligence on the part of our insured, it would be difficult to find Mr. Brown to be in the exercise of due care. He was rounding a curve at the time the accident occurred and had no visibility of the road ahead. Yet, Brown made no effort to decrease his speed or to take other steps for his safety. Had his headlights been burning, the accident probably would never have occurred; and, had he not been drinking, the same is probably true.

As to Mrs. Rainey's injuries, we are informed that the fractured ankle is completely healed and the knee is responding well to treatment. She was not employed, and consequently did not lose any earnings. Mr. Brown is now back at work and apparently made an excellent recovery from the injuries he received.

As you know, we have occasion to see many hundreds of accident claims. The situation presented is not a new one. Our experience has been that under circumstances similar to this, the jury is prone either (A) to return a verdict for the defendant or (B) to return a small verdict as a compromise between liability and the injuries, or (C) return a verdict in sums much less than you seem to expect. Although no one can guarantee what a jury will do, there is a low chance that a verdict would be returned that would be in excess of the coverage of Mrs. Anthony.

You have asked that we respond in ten days after your demand letter. That time limit seems unreasonable to us, in view of the long time that you have been working with this case to this date before we were informed of the claim, that our investigation is still ongoing, and that discovery in this case has not been completed. However, even though your time limit for negotiations seems unreasonable, we are making our best response to you in the time limit you have set.

We are disappointed that you seem inflexible about the amount you would recommend to your client for settlement. If indeed your client is willing only to accept the amount that you have demanded, it appears that your client is not willing to negotiate in good faith to see if differences in opinion can be resolved.

It is our feeling we would not be rendering the proper service to our insured, Mrs. Anthony, by making the large and excessive payment demanded in your letter. That would certainly constitute a judgment by us that she was wholly at fault and would appear upon her claim record when she applies for insurance in the future. Nor could we, as a trustee for all policyholders, use their funds for excessive payments such as you have demanded. We certainly want to be fair, but we cannot with fairness to policyholders pay excessive amounts to settle claims. Excessive settlements result in all policyholders having to pay higher premiums in the future.

We will continue to give service to Mrs. Anthony under all of the circumstances of this case. We are sending a copy of this letter to Mrs. Anthony (as well as to James Counsel whom we have hired to defend her). By copy of this letter to Mrs. Anthony, I am asking Mrs. Anthony to send to me directly any comments she has, and let us know if she wishes in any way to personally contribute to our response or offers we make to settle the claims.

Mr. James Counsel has been furnished settlement authority by us and has been asked by us to negotiate with you. He will make a reasonable settlement offer to you, and you may negotiate directly with him. We want you and him to discuss the probability that the verdict will be in favor of the defense, and the expected (low) range of verdict in this case or any other factors that bear upon what would be a reasonable settlement amount in this case.

Mr. James Counsel has been retained by us solely to furnish a defense to Mrs. Anthony and to conduct direct settlement negotiations as a part of that defense. He is not retained to engage in any matters involving insurance coverage or Mrs. Anthony's desires regarding any actions Mrs. Anthony might wish the company to take. If Mrs. Anthony wants a different or further response to your demand for $999,999, Mrs. Anthony should contact me directly. My address is shown on this letter.

If you have additional information that has not been brought to our attention, or if you feel we have overlooked anything, please tell us or Mr. James Counsel. We would be happy to discuss this further and see if our decision can be changed. Furthermore if you do want to negotiate in good faith we are always open to negotiations for the benefit of all concerned, to see if an amicable and reasonable settlement can be made.

Yours very truly,

BLANK INSURANCE COMPANY

By

cc: Mrs. Anthony & James Counsel, Esq.