Bad Faith Article Published in NJ Defense Association Newsletter
Former Middlesex County Superior Court Judge C. Judson Hamlin, Of Counsel to PMOH, and PMOH Partner Elizabeth "Betsy" Flanagan have authored a guide to litigators on the issue of bad faith alleged against insurance companies. The New Jersey Defense Association prominently displayed the article, "Bad Faith Litigation: A New Jersey Roadmap," in its most recent December edition. The work analyzes the various facets of a bad faith claim based on New Jersey jurisprudence and comments on the many issues to be addressed by trial courts in the near future. Judge Hamlin and Mrs. Flanagan identify and discuss the issues affecting bad faith litigation including: the elements of such a claim, the appropriate fact-finder, the burden of proof and discovery.
Bad Faith Litigation: A New Jersey Roadmap
New Jersey Courts once again face issues arising from bad faith litigation
By: Honorable C. Judson Hamlin and Elizabeth Callaghan Flanagan, Esq.
Thirty six years ago the Supreme Court of New Jersey recognized that insurance companies have an affirmative duty to act in good faith in representing their insureds. Rova Farms Resort, Inc. v. Investors Ins. Co. of America, 65 N.J. 474 (1974). Without articulating the specific duties and obligations to be imposed on both an insurance carrier and its insured or the manner of determining the discharge of their respective obligations, the Court left open challenging procedural and substantive questions. These issues have remained unanswered - until now.
The recent unreported Appellate Division opinion in Wood v. New Jersey Mfrs. Ins. Co., 2010 N.J. Super. Unpub. LEXIS 1803 (App. Div. July 28, 2010), by a particularly able Appellate part placed those questions squarely in play for the trial court on remand. This article will attempt to identify those issues, their underlying policy considerations and resulting practical implications. The authors do not endorse any particular resolution of these issues and note the paucity of relevant reported decisions. Interested parties in bad faith litigation are understandably hesitant to try these cases because of significant financial exposure, the likelihood of prolonged and costly litigation and the possibilities of an adverse precedential decision.
Immediately following the landmark Rova Farms decision, legal pundits predicted an onslaught of bad faith litigation and heralded the birth of a new cottage industry for the plaintiffs' bar. In fact, although the specter of bad faith litigation continues to loom like Damocles' sword throughout the insurance industry, trial of such cases is rare, particularly in New Jersey. Consequently, there is little guidance to be found in reported cases as to how to proceed to trial of bad faith actions. This article will explore some of the issues raised on the road to trial of a bad faith action.
I. Historical Overview
Prior to the decision in Rova Farms, New Jersey courts leaned towards an approach to bad faith similar to the iconic Justice Potter Stewart's "I know it when I see it" assessment of pornography. Jacobellis v. Ohio, 378 U.S. 184, 197 (1964). In Radio Taxi v. Lincoln Mut. Ins. Co., 31 N.J. 299 (1960), the Court wrestled with the allegation of bad faith and recognized that insurance contracts impose an implied covenant of good faith and fair dealing on insurers. In applying this standard, the Court determined that the insurer had not acted in bad faith because the insured could not establish that its insurer had been "unduly venturesome at the expense of the insured." Id. at 313.
Similarly, in Bowers v. Camden Fire Ins. Assoc., 51 N.J. 62 (1968), the Court recognized the insurer's general duty to act in good faith:
Good faith is a broad concept. Whether it was adhered to by the carrier must depend upon the circumstances of the particular case. A decision not to settle must be a thoroughly honest, intelligent and objective one. It must be a realistic one when tested by the necessarily assumed expertise of the company.
Id at 71.
In Bowers the Court held that the insurer acted in bad faith for not settling for policy limits prior to appeal of an excess jury verdict. The Bowers court also agreed with the concept that an insurer should decide whether to settle "as if no policy limit were applicable to the claim." Id. at 72.
In Pickett v. Lloyd's, 131 N.J. 457 (1993), the Court articulated the "fairly debatable" standard. Although this case involved a first-party claim against an insurer, its rationale was adopted in other cases involving third-party claims. Under the fairly debatable standard, an insurer must have "[known] or recklessly disregarded the fact that no valid reasons supported the delay." Id. at 481. In Rova Farms, the Court, in employing tort and contract principles, did not enunciate a fairly debatable standard and imposed an affirmative obligation on the insurer to act in good faith to settle litigation against its insureds. The recent case of Taddei v. State Farm, 401 N.J. Super. 449 (App. Div. 2008) (cert. granted 2010) makes clear that "the Rova Farms model simply does not apply in the first party coverage context." Id. at 459.
Although the Rova Farms case was tried to a judge, few bad faith cases since 1974 have gone to trial in New Jersey. This is undoubtedly because few insurers want to risk expanding further the potential breadth of this decision. However, proper analysis of Rova Farms and developing case law should serve to clarify, narrow and define its application.
II. Rova Farms
The underlying case in Rova Farms involved a plaintiff who dove head first from a platform into a lake, hit his head in shallow water, and became a quadriplegic. The jury in the underlying action found the insured resort owner to be negligent and awarded the plaintiff $225,000. The insured's policy limit was $50,000. Thereafter, the insured paid the excess portion of the verdict and filed suit against its insurer for bad faith.
Evidence introduced at trial of the bad faith case revealed that the insurer's claims committee had determined that due to plaintiff's alleged contributory negligence the case was one of "severe damages-weak liability." During the trial, and even while an appeal of the jury verdict was pending, the insurer clung to its "weak liability" theory and refused several opportunities to pursue settlement for policy limits. In so doing, the insurer ignored the advice of its counsel as well as separate counsel retained by its insured.
In affirming the trial court's decision that the insurer had acted in bad faith, the Court explained that "... an insurer, having contractually restricted the independent negotiating power of its insured, has a positive fiduciary duty to take the initiative and attempt to negotiate a settlement within the policy coverage." Id. at 496. It also provided some guidance as to the factors to be considered during the trial of a bad faith case:
While the view of the carrier or its attorney as to liability is one important factor, a good faith evaluation requires more. It includes consideration of the anticipated range of a verdict, should it be adverse: the strengths and weaknesses of all of the evidence to be presented on either side so far as known; the history of the particular geographic area in cases of similar nature; and the relative appearance, persuasiveness and likely appeal of the claimant, the insured and the witnesses at trial.
Id. at 490.
The Court further explained that, "...the question is not whether the carrier, its attorney, or the insured considers a defendant liable but what the jury would be justified in finding from the evidence available and adduced." Id. at 490. The Rova Farms decision is consistent with N.J.S.A. 17:29-B4(9)(f) which prohibits unfair insurance practices including, "[n]ot attempting in good faith to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear."
Although the Rova Farms case was precedent setting for its clarification of the affirmative duties of insurers with respect to settlement, many questions were raised by this decision. Thus, after Rova Farms, it was reasonable to think that New Jersey appellate courts would tackle other bad faith cases and provide guidance to insurers and attorneys who practice in this area.
Recently, in the unreported Wood case, the Appellate Division reversed a trial court's summary judgment decision in which the Court found that the carrier had acted in bad faith when it refused to offer its policy limits in settlement of third-party litigation against its insured. Plaintiff, a mail carrier, alleged that she sustained serious injury when she was attacked by a dog housed on the insured's premises. Similar to Rova Farms, the plaintiff in the underlying case received a verdict well in excess of policy limits. However, unlike Rova Farms, damages in the Wood case were as much an issue as liability. Also, in Wood, the defendant insured assigned her bad faith claim to the tort plaintiff in settlement of the excess judgment against her, an increasingly common practice.
In remanding the case for a bench or jury trial, the Appellate Division relied heavily on Rova Farms and emphasized the fact-sensitive nature of a bad faith claim. Significantly, as in Rova Farms, it refused to impose a strict liability theory or per se rule as to bad faith of the insurer. Rather, the Court indicated that the insurer was entitled to show that its decisions were made in good faith. Consistent with recent history, the Wood case is apt to settle. However, in the event that this or any other bad faith case proceeds to trial, there are unresolved pre-trial and trial issues which attorneys and trial judges will confront. In an effort to limit the scope of this article, the discussion of these issues is confined to bad faith claims brought by insureds or their assignees stemming from third-party tort claims against insureds.
A. Existing Practices
In the absence of a specific judicially approved roadmap, practicing attorneys and sophisticated insurers have developed a sometimes ambiguous modus vivendi so as to avoid dispositive judicial precedent.
In most cases an injured tort plaintiff retains counsel who, upon learning of coverage limits, concludes that the client's liability and damage proofs may result in a verdict in excess of the tortfeasor's coverage. Counsel thereupon (usually pre suit) makes a demand on the insurer for the full amount of the coverage. At that point the insurer, in the exercise of its fiduciary duty, conducts a good faith and timely investigation of the underlying cause of action and may decline to enter into negotiations or may make an offer of less than its full coverage. As a side note, if an insurer delays or fails to make a timely and good faith investigation it may later be foreclosed from arguing an otherwise valid basis for a disclaimer. Griggs v. Bertram, 88 N.J. 347 (1982).
In some cases an insurer may conclude that given the liability and damages and the limit of its coverage, it is appropriate to pay the limits to plaintiff in return for a full release. In the absence of a complete release, the insurer may decide to pay the policy limits to the Clerk of Court thus discharging its contractual obligation to the insured and also avoiding all future claims for bad faith and attendant penalties.
In the absence of those pretrial, practical alternatives, litigation then ensues which brings us to the issues to be dealt with on the Wood remand. For purposes of this discussion we assume: court filed litigation, a demand usually formalized by an offer of judgment pursuant to R. 4:58; a refusal by the insured's carrier to pay the sum; and, a trial verdict in excess of the demand and coverage. The authors further assume that the carrier gave the insured timely notice of possible exposure in excess of policy limits and the insured's right to retain personal counsel. After return of the excess verdict it is customary (especially when the tortfeasor has little or no personal assets) for the plaintiff to obtain an assignment of the insured's direct rights to proceed against the carrier alleging bad faith and breach of its fiduciary duty to its insured. That raises the issues outlined below.
B. When does a bad faith claim arise?
A bad faith claim in a third-party action potentially develops when a third-party plaintiff obtains an excess recovery against an insured and an insurer has previously rejected settlement offers or failed to pursue reasonable opportunities to settle within policy limits. In reaching its decision in Rova Farms, the Court cited numerous instances in which the insurer rejected or ignored settlement opportunities after the commencement of litigation. This focus on the insurer's decisions regarding settlement is consistent with the Court's expressed concern for the insured who has contractually given up its rights, including the defense and settlement of the action.
Far less clear is the situation, discussed infra, wherein the insurer is confronted with a pre-litigation demand by a third-party's attorney to post policy limits. Does an insurer face bad faith claims for its failure to settle before threatened litigation is actually filed? Rova Farms does not address this issue and no New Jersey case law is on point. To further confuse this issue, an analysis of case law from other jurisdictions reveals opposing views. We think the better view is that Rova Farms obligations in third-party actions cannot be triggered until the underlying lawsuit is filed.
Once the underlying lawsuit is filed, a carrier cannot avoid a bad faith claim simply by offering its limits immediately prior to trial. In this regard, other jurisdictions are helpful:
The insurer could be encouraged to gamble with the insured's money in the hope of saving some of its own. When it becomes apparent that the gamble has failed, and that the case will be tried, the insurer could avoid liability for excess simply by offering its policy limits in judgment. Such is not the law.
Howard v. State Farm Mut. Auto. Liab. Ins. Co., 70 Wis.2d 985, 995, 236 N.W. 2d 643 (Wis. 1975).
C. Preliminary Issues
In a third-party action, the cause of action for bad faith normally does not ripen until an excess verdict is obtained. It is now usual practice for an insured who is exposed to an excess liability verdict to assign potential bad faith claims to the plaintiff in the underlying case in settlement of the case against the insured defendant. These pretrial assignments raise potential conflicts, including the impact of such agreements on the insured's duty to cooperate with its insurer in defending the underlying case.
An argument can be made that pretrial agreements between plaintiffs and insureds to assign bad faith claims in exchange for agreements to not pursue excess judgments against the insured violate the duty to cooperate clause found in most insurance contracts and public policy. Alternatively, if the fiduciary duty of good faith is owed to the insured, an insurer can then argue that the agreement protecting an insured against enforcement of an excess judgment would almost by definition preclude a filing of bad faith claims.
As a practical mater, if the assignment has already been made pretrial, should the bad faith claim be tried in tandem with the underlying action? In Taddei v. State Farm, infra, the New Jersey Supreme Court currently is reviewing a decision in which the entire controversy doctrine was held to bar a plaintiff insured in a first-party action from filing a bad faith action against its insurer after trial of its underlying case against the insurer.
D. Who is the fact finder?
The Wood court enigmatically remanded the fact finding issue for "plenary trial." Plenary trial by judge or jury? The plaintiff's bar will press for a jury trial pitting an individual policy holder against an impersonal and profitable insurance company. The defense bar will seek to avoid a jury trial. Clearly this issue will be the first and paramount issue to be determined by the court on remand.The Rova Farms case was decided by a trial judge and his decision ultimately was affirmed by the Supreme Court. In the earlier Bowers case, a jury decided the bad faith action filed by an insured. In Wood, the Appellate Division identified but did not decide the issue regarding the proper trier of fact. "The question essentially turns on whether such a bad faith claim is essentially one of law or equity." Wood at 41. This issue also may depend on whether the plaintiff is an assignee or an insured. If an assignee, the plaintiff may have no claim against the insurer in tort, or breach of fiduciary duty. In such a case, the plaintiff receives an assignment of the contractual rights between the insurer and insured. In a breach of contract, bad faith action with an assignee as plaintiff, it would seem that a bench trial would be appropriate.
In reaching its decision in Rova Farms, the Court stated that "a wrongful failure to settle, wherein the insurer has breached the fiduciary obligation imposed by virtue of its policy, sounds in both tort and contract." Rova Farms at 505. Although a bad faith claim sounds in both contract and tort, it essentially is equitable in nature. Wood at 41, 42, citing 500 Columbia Tpk. Assocs. V. Haselman, 275 N.J. Super. 166, 171 (App. Div. 1994). Such a claim is premised on the idea that it would be unfair to require an insured to pay an excess verdict if its insurer breached its fiduciary duty when it could have settled the case within policy limits. Stated differently, if an insurer elects to roll the dice, the insured who has been "contractually restricted" and doesn't knowingly participate in the risk, should not pay the price for an ill conceived gamble. Thus, we think it likely that a court will lean to resolving this issue in the context of a bench trial because our courts have recognized that it is rooted in equitable principles.
III. Burden of Proof
As in all trials, the trial court will be required to determine who has the burden of proof and what will be the required level of proof. Whether rightly or wrongly the courts have refused to adopt a per se rule that would only require a showing of a demand and offer of judgment within policy limits and a return of verdict in excess thereof. That being the case we think it likely that a plaintiff would be required to demonstrate by competent evidence a timely (post suit filing) demand, as evidenced by an offer of judgment, a refusal to settle and a verdict in excess of coverage and a subsequent refusal by the carrier to pay the returned judgment. The specific factual circumstances in Wood including recommendations by the carrier's retained counsel and its claims representatives and conflicting experts' reports on damages would be particularly cogent.
In Rova Farms, as in Radio Taxi, the Court refused to impose a strict liability standard for bad faith actions. Id. at 490. Therefore, trial of a bad faith action would require that an insured/assignee plaintiff first come forward to establish a prima facie case of bad faith. This prima facie showing must do more than establish that there was the opportunity to settle, a rejection or failure to pursue that opportunity to settle and an excess verdict. The plaintiff must make some additional showing that the insurer breached its affirmative good faith duty to the insured.
Once the plaintiff has established a prima facie case for bad faith, the burden would shift to the defendant insurer to demonstrate that it acted in good faith. In support of this position, the insurer would be required to explain the fundamental reasons for its decision not to settle. The interesting question that will arise is as to the degree to which the carriers will reveal their inner claims evaluation process in attempting to rebut the plaintiff's assertion. Clearly the more opaque the carrier's proofs are, as to the decision making process, the less likely it will be that they would be able to prevail. Additionally, the insurer may be required to demonstrate that it communicated its decisions to its insured.
IV. Standard of Proof
The preponderance of credible evidence test generally is the standard of proof employed to decide both breach of contract and tort actions. Insurers may argue that due to the implication of some sort of fraudulent conduct on its part, perhaps a failure to settle for impermissible commercial purposes, the clear and convincing standard might be appropriate. However, the preponderance standard is consistent with the Rova Farms designation of bad faith as a hybrid of tort and contract principles and should be the standard of proof applied to such actions.
V. Discovery
Discovery demands will provide a particularly fertile battleground for the competing interests. It is imperative to keep in mind that the court long ago recognized that as to an action by a policy holder and his/her insurance company, having undertaken to represent the insured's interest (in addition to their own), the carrier cannot claim privilege to refuse material discovery demands by its insured or his/her assignee. Judge Baime directly decided that issue 29 years ago. Longo v. Am. Policyholders Ins. Co., 181 N.J. Super. 87 (Law Div. 1981).
Once the burden and standards of proof have been established, the scope of discovery becomes clearer. Plaintiffs should be entitled to request all relevant information relating to the insurer's decisions regarding settlement offers or its failure to pursue settlement opportunities. This discovery would include depositions of claims personnel and attorneys, production of internal insurer and claims committee documents, including electronic records, emails, billing and payment records and interrogatories. The authors make no observations on the possible materiality of discovery of a carrier which is extraneous to the specific claim in dispute. Requests for Admissions could prove particularly useful in bad faith actions. Plaintiffs probably will seek to make the attorney for the carrier's insured in the underlying tort action a witness in the bad faith case.
Due to the nature of a bad faith case, discovery motions relating to attorney-client privilege and work product issues may be extensive. Additionally, in camera inspections of sensitive insurance company documents may be required. For example, the trial court may need to review insurer's assessments of both plaintiff's and its own experts and attorneys, case valuations and corporate policies. When appropriate, the Court may require protective orders for documents of particular sensitivity.
VI. Expert Testimony
In some bad faith cases, particularly where the damage and/or liability component of the underlying action requires expert testimony, expert testimony relating to the insurer's decision might be helpful to the Court in determining whether an insurer breached its fiduciary duty to its insured or violated the contractual obligation of good faith. Parties should decide whether to retain experts early in the discovery phase of the case.
VII. Damages
If bad faith is established, the Court may award plaintiff the excess verdict differential, plus post-judgment interest. The Court in Kotzian v. Barr, 81 N.J. 360 (1979) denied pre-judgment interest against an insurer but left open the question of whether pre-judgment interest might apply after a finding of bad faith. It indicated that "[t]his is not to say that the insurance contract is so sacrosanct that misconduct or bad faith on the part of the carrier would protect it against a claim of prejudgment interest over its policy limits..." Kotzian at 367.
Plaintiff may also seek punitive damages. However, the award of such damages in a bad faith case probably would violate public policy particularly where an insured's assignee is the plaintiff and already has obtained an award of damages in the underlying tort action. Additionally, any decision to allow punitive damages for proof of egregious bad faith probably would require that plaintiff establish its case through clear and convincing evidence.
We refrain from commenting on possible claims for counsel fees in connection with the bad faith claim. It is assumed the rules of court and statutory provisions adequately address those issues.
VIII. Closing Notes
Any experienced counsel can easily project the multiplicity of issues to be addressed on remand. The challenge to counsel and the remand court will be substantial. We undertake here only to offer some lynchpins to begin the discussion. A full exploration of the many issues that arise in this type of bad faith litigation in this and comparable jurisdictions warrant a more exhaustive treatment which the authors are now pursuing.
Honorable C. Judson Hamlin
Elizabeth Callaghan Flanagan, Esq.
*The authors would like to acknowledge Seton Hall law student, Michelle M. O'Brien, for her valuable research and general assistance in the preparation of this article.