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Eastern District Judge McHugh found no coverage due in this case.  Addressing bad faith, he then states:

Plaintiff cannot succeed on her claim of bad faith under 42 Pa. C.S.A. § 8371. “[T]o recover in a bad faith action, the plaintiff must present clear and convincing evidence (1) that the insurer did not have a reasonable basis for denying benefits under the policy and (2) that the insurer knew of or recklessly disregarded its lack of a reasonable basis.” Rancosky v. Washington Nat’l Ins. Co., 642 Pa. 153, 170 A.3d 364, 365 (2017). Because I have found that the insurer here was not obligated to cover the Plaintiff for the disputed claims, by definition the insurer had a reasonable basis to deny the benefits. See USX Corp. v. Liberty Mutual Ins. Co., 444 F.3d 192, 202 (3d Cir. 2006).

Date of Decision:  March 2, 2022

Walker v. Foremost Ins. Co. Grand Rapids, Michigan, U.S. District Court Eastern District of Pennsylvania No. CV 20-4966, 2022 WL 612716 (E.D. Pa. Mar. 2, 2022)(McHugh, J.)

Note:  Judge McHugh’s opinion was recently criticized on the theory that statutory bad faith claims should be treated as entirely distinct from coverage/breach of contract claims, at least in first party property damage matters.  Under this theory, even if there is a legally correct basis to deny a claim (which a court upholds), and no benefits are due, the bad faith claim can potentially proceed.

This ultimately goes to the issue of whether a statutory bad  faith claim can exist if no benefit is due under the policy; whether that policy involves an obligation to cover property damages in a first party case, or a duty to defend and indemnify third party liability claims.

As has been discussed many times over the years on this Blog, e.g., in this linked summary and in the 2014 article found within this summary, in 2007, the Pennsylvania Supreme Court indicated in Toy v. Metropolitan Life that cognizable statutory bad faith claims, whether first or third party, require denial of a benefit (i.e., denial of the insured’s direct damage claim or the refusal to defend or indemnify against a third party claim).  If that reading is correct, and no benefit is due under a policy, section 8371 does not provide a remedy for poor claim handling standing alone (as distinguished, e.g., from poor claim handling that leads to a delay in payment due under the policy).  In those circumstances, if an insurer acts poorly during the claims handling process, the only redress would be to raise the problematic conduct with the insurance commissioner.

The Third Circuit’s 2007 Gallatin Fuels decision, which was issued a few weeks after Toy but did not cite Toy, gives an unusual example of this independent bad faith theory.  In that case, the policy was not in effect, but the insurer mistakenly believed it was in effect. The court found the insurer’s poor conduct in handling the claim — under the non-existent policy —  amounted to bad faith.  While there were no breach of contract damages available since there was no policy in effect, the court found the insured could still seek attorney’s fees, and then seek punitive damages based on those attorney’s fees as the primary damages (rather than unpaid benefits as the basis for the punitives).  The court recognized this sort of claim as encompassed by section 8371.

Under that standard, it appears that the insurer’s subjective belief controls, rather than an objective measure of reasonableness, which is typically used to measure the first element of statutory bad faith.

Another variation on the independent bad faith theory exists when the insurer expressly denies coverage based on an exclusion or policy limitation, that exclusion or limitation does not ultimately preclude coverage, but the insurer later effectively asserts an alternative, valid, exclusion or limitation to deny coverage.  (Typically, insurers reserve rights to raise other exclusions or limitations in denial or reservation of rights letters, thus avoiding waiver or estoppel arguments should additional positions be raised in the future.)

Objectively, in the above example, there was never any coverage due since the applicable exclusion always barred coverage. Because the insurer didn’t originally realize the applicable exclusion prevented coverage, and asserted another exclusion that had no proper application, however, should there be subjective bad faith because of the insurer’s actual state of mind, as opposed to the objective fact that no coverage was ever due?

The independent bad faith theory in these cases hinges on the idea that the insurer’s own mistake caused the insured to pursue a coverage claim and/or a bad faith claim, incurring legal fees as damages, even though no coverage damages were due at the end of the day.  This argument would appear to be based on the theory that there is an estoppel exception to the statutory requirement that if no benefit is due, then there is no cognizable bad faith claim.

(We use the word mistake, instead of language indicating intentionality or recklessness.  An insurer seeking to deny coverage would not intentionally fail to rely upon a valid and enforceable exclusion upon which to base its denial. Thus, in these hypotheticals, the failure to rely on such an exclusion is very likely a mistake on the insurer’s part.  Any bad faith in these circumstances apparently would have to include recklessly or intentionally asserting a separate, ineffective, exclusion.  There is no question in the law that negligence cannot be the basis for statutory bad faith.)

Such a theory, if ever accepted, would raise interesting issues.  For example, estoppel requires justifiable or reasonable reliance on the conduct of another.  What if the insured or its counsel did understand early on that the applicable exclusion would bar coverage, but remained silent in the face of the insurer’s adjuster or counsel failing to understand the exclusion’s applicability and unknowingly omitting it as a basis to deny coverage.

Can an insured assert estoppel if it knew that there was a policy exclusion that would very likely bar coverage if the carrier caught on and eventually asserted that exclusion?

Does an insured assume the risk of litigating a coverage or bad faith claim if it knows there is an as yet unasserted exclusion that would objectively result in a coverage denial if ever raised?

An insurer can not knowingly omit consideration of, and reference to, policy language in hopes that the insured would not catch on that coverage is due under that policy language.  Can an insured pursue coverage or bad faith litigation if it has actual knowledge coverage is not due under an applicable policy exclusion or limitation, even if the insurer has not raised it?

Could discovery be taken regarding the insured’s knowledge on the viability of the originally unasserted applicable exclusion, or as to any risk assessment the insured made that the insurer would eventually raise that exclusion to deny coverage?  How would the attorney-client privilege or work product doctrine apply in such situations?

Would an insured or its counsel have an affirmative obligation not to pursue a bad faith claim if (1)  they knew no coverage was due under an express policy exclusion or limitation; and (2) it was only through the insurer’s subjective failure to grasp that exclusion’s applicability that it had not asserted the exclusion, which would very likely have precluded coverage in the first instance had it been asserted?

What if the insured is uniquely in possession of information which, if known to the insurer, would cause the insurer to assert an exclusion that it would otherwise not know applied.  Do the insured and/or the insured’s counsel have any obligation not to pursue coverage or bad faith claims under those circumstances, if the facts solely known to them would objectively preclude coverage under a policy exclusion or limitation?  Would there be any 42 Pa.C.S. § 4117(g) implications?

We also note that some other earlier Pennsylvania cases discuss the viability of bad faith claims even when coverage was not due; however, this was in the context of the coverage claim being time-barred, e.g., by a contractual time limitation on bringing claims.  As one district court observed, the cases in which the bad faith claim remains actionable where coverage may not be due are those cases where the “contract claim is barred by technical defenses, settled, or otherwise not litigated.” Schindler v. Berkshire Life Ins. Co., No. 98-5049, 1999 U.S. Dist. LEXIS 10414 (E.D. Pa. Jul. 9, 1999).

Other pre-Toy cases purportedly giving a wide birth to independent bad faith claims are distinguished in Toy as actually going to the issue of what evidence may support a cognizable bad faith claim, rather than providing an independent basis for defining a cognizable bad faith claim (Condio, Zimmerman, O’Donnell).  As stated in Toy:

In this area, the term “bad faith” refers not only to the claim an insured brings against his insurer under the bad faith statute, but also, to the conduct an insured asserts his insurer exhibited and establishes that it is liable. These matters although related, are nonetheless, separate and distinct. We write to the former. The concurrence appears to write to the latter.  In every one of the cases the concurrence cites … to describe our view of § 8371 as unduly restrictive and inconsistent with the Superior Court’s perspective, the insured brought an action under § 8371, alleging that his insurer failed to satisfy his first party claim in the proper manner. The question before the court in each of those cases was not whether the insured alleged a cognizable claim under the bad faith statute. Rather, it was whether the evidence offered at trial by the insured as to the insurer’s behavior was sufficient to prove the bad faith claim and/or admissible in a § 8371 action.

Our 2014 article addressing these nuances and issues can be found here.

Undoubtedly, there are other issues and perspectives arising from the notion that bad faith claims can proceed where an insurer has no coverage obligation. The questions and issues raised above are meant to provide some food for thought and reflection by judges, lawyers, insurers, and insureds on some of these potential issues and hypothetical perspectives.