JUNE 2015 Contacts: Matthew M. Haar 717.257.7508 [email protected] Joseph C. Monahan 215.972.7826 Practice [email protected] Amy L. Piccola 215.972.8405 [email protected] Matthew J. Antonelli 202.295.6608 The Bad Faith [email protected] A.J. Kornblith 202.295.6619 [email protected] Patrick F. Nugent 215.972.7134 [email protected] Meghan Talbot 215.972.1970 [email protected] Author: Standing guard on developments in the of insurance bad faith around the country Simeon Poles Sentinel CONTENTS Supreme Court of Louisiana: Bad Faith Failure Supreme Court of Louisiana: Bad Faith to Settle Does Not Require Firm Offer and Failure to Settle Does Insurer’s Potential Liability Extends to Not Require Firm Offer and Insurer’s Potential Misrepresentations and Failures to Disclose Liability Extends to Misrepresentations and Facts Unrelated to Coverage Failures to Disclose Kelly v. State Farm Fire & Cas. Co., No. 2014-CQ-1921 (La. May 5, 2015). Facts Unrelated to Coverage Answering certified questions from the Fifth Circuit Court of Appeals, the Supreme Court of Louisiana finds an pages 1 - 2 insurer can be liable for (1) bad faith failure to settle where no firm settlement offer was received, and (2) misrep- Middle District of resenting or failing to disclose facts that are not related to coverage. Pennsylvania Denies Multiple Challenges to In November 2005, Danny Kelly was injured in an automobile accident with Henry Thomas, an insured of State Privileged Documents Farm. Kelly suffered a fractured femur in the accident and spent six days in the hospital, incurring $26,803 in Redacted by Insurer in medical expenses. Bad Faith Claim Related to Uninsured Motorist In January 2006, Kelly’s attorney mailed a letter to State Farm enclosing Kelly’s medical records and stating Coverage that he would recommend that his client release State Farm and Thomas from liability in exchange for payment pages 3 - 4 of the policy limits; State Farm did not immediately respond. In March 2006, State Farm offered to settle the case for the policy limits of $25,000. Kelly’s attorney rejected the offer and filed suit against Thomas. Later Sixth Circuit Court of that day, State Farm sent Thomas a letter telling him that he had potential liability exposure and suggesting that Appeals Rules That he retain independent counsel. State Farm did not specifically inform Thomas of Kelly’s medical expenses, its Kentucky Supreme communications with Kelly’s attorney, or its policy limits offer. Court Would Not Recognize “Reverse At trial, Kelly secured a verdict against Thomas for $176,464 plus interest. State Farm then tendered its policy Bad Faith” Claim limits of $25,000. Thomas and Kelly subsequently entered a compromise agreement in which Thomas as- pages 4 - 5 signed his rights to Kelly to pursue a bad faith claim against State Farm, and Kelly agreed not to enforce the judgment against Thomas’s personal assets.

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Kelly sued State Farm in Louisiana state court and the insurer triggered only by receipt of a firm settlement offer.” The Court removed the case to federal district court. The district court noted that Louisiana’s bad faith statute contained no reference addressed two issues: 1) whether State Farm had a duty to to a firm settlement offer and determined that imposing such notify its insured of Kelly’s initial letter; and 2) whether State a requirement would exceed its powers of statutory interpreta- Farm’s failure to accept Kelly’s January 2006 settlement offer tion. The Court also addressed two “practical considerations” constituted bad faith. of making a finding of bad faith contingent upon receipt and rejection of a firm settlement offer. First, the Court found that State Farm moved for summary judgment on both claims. The insureds do not control whether an offer is made and, conse- district court granted summary judgment on the first claim, quently, an insurer’s obligation to act in is triggered finding that State Farm had no duty to notify Thomas of the by knowledge gathered during its investigation of the claim. January 2006 letter because the letter did not constitute a Second, the Court rejected State Farm’s assertion that insur- settlement offer. As to the second claim, the district court de- ers will be uncertain of whether they are acting in bad faith nied summary judgment because, at trial, Kelly might be able absent a requirement that they receive a firm offer to settle. to prove that State Farm acted in bad faith by failing to settle Accordingly, the Court found that an insurer could be found his claim. Upon State Farm’s motion for reconsideration, the liable for bad faith failure to settle under Louisiana law in the district court revised its opinion and granted summary judg- absence of a firm settlement offer. ment in full based on State Farm’s argument that the court’s determination that the letter was not a settlement offer neces- The Court then turned to the question of whether an insurer sarily precluded liability on the failure to settle claim. can be liable for misrepresenting or failing to disclose informa- tion unrelated to insurance coverage. Noting a split between Kelly appealed to the Fifth Circuit, which heard the matter in state appellate courts on the question, the Court determined a three-judge panel. Initially, the court affirmed dismissal of that resolution of the question turned on the function of the the failure to settle claim and reversed dismissal of the claim word “or” in Louisiana’s bad faith statute, which prohibits “[m] that State Farm had a duty to inform its insured of the initial isrepresenting pertinent facts or provisions letter. Upon petitions for rehearing by both parties, the Fifth relating to any coverages at issue.” According to the Court, Circuit withdrew its opinion and, noting an absence of control- when viewed in the context of the statute as a whole, this ling precedent under Louisiana law, certified two questions prohibition is meant to address communications from insurers to the Louisiana Supreme Court. Specifically, the Louisiana that either state untruths or fail to state the truth. According Supreme Court was asked to determine: 1) whether an insurer to the rules of statutory interpretation enshrined in Louisiana can be found liable for a bad faith failure to settle a claim law, the Court was required to read the “or” as purely disjunc- when the insurer never receives a firm settlement offer; and tive, meaning that an insurer can be liable for misrepresenting 2) whether an insurer is liable for misrepresenting or failing either: 1) “pertinent facts,” or 2) “insurance policy provisions to disclose facts that are not related to the insurance policy’s relating to any coverages at issue.” coverage. After receiving the Supreme Court’s opinion, the Court of Ap- The Court, after noting that bad faith failure to settle is a peals vacated the judgment of the District Court and remanded recognized cause of action in Louisiana, narrowed the issue the case to the district court for further proceedings consistent presented by the first question to “whether an insurer’s af- with the Supreme Court’s analysis. firmative duty to make a reasonable effort to settle claims is

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Middle District of Pennsylvania Denies Multiple Challenges to Privileged Documents Redacted by Insurer in Bad Faith Claim Related to Uninsured Motorist Coverage

Lane v. State Farm Mut. Auto. Ins., No. 3:14-CV-01045 (M.D. Pa. May 18, 2015).

Insured not entitled to compel production of un-redacted documents revealing pre- and post-complaint communications protected by work product and attorney client privilege.

On August 31, 2011, James Lane was injured in an automobile of counsel, and thus were not discoverable. In his motion, accident. Lane’s State Farm automobile insurance policy car- Lane argued that the mental impressions contained in those ried uninsured/underinsured motorist coverage of $100,000. two pages of redacted claims log entries were “necessarily A month after he submitted his claim to State Farm, Lane’s relevant to a bad faith claim” and that State Farm’s continu- damages were assessed at an inquest in the Supreme Court ing evaluation of his UM claim entitled him to “discovery of of New York, Orange County. Despite having notice of the pro- records and materials post-dating the litigation.” The Court ceeding, State Farm did not attend the inquest. Lane received rejected Lane’s arguments for three reasons: 1) Lane failed to a judgment in the amount of $200,000. put forward “plausible justifications” as to how post-complaint mental impressions could be relevant to the facts of his claim; State Farm asked for and received numerous medical authori- 2) courts of the Third Circuit have held that the “mere exis- zations to obtain Lane’s records and eventually examined Lane tence of a bad faith claim does not make otherwise privileged under oath, but did nothing else to resolve the claim. In March information per se discoverable;” and 3) Lane was unable to 2013, Lane demanded that State Farm settle the UM claim demonstrate the substantial need required for production of for $100,000; State Farm countered with an offer of $27,000. the two pages in question under the Federal Rules of Civil Unsatisfied, Lane filed suit in Pike County, Pa., alleging that Procedure. State Farm acted in bad faith by refusing to settle his claim. State Farm removed the action to federal court for the Middle The Court relied upon similar reasoning in dismissing Lane’s District of Pennsylvania. arguments that he was entitled to receive un-redacted copies of documents containing pre-complaint attorney communica- Lane filed a motion to compel production of various docu- tions and work product. Lane argued that he was entitled to ments from State Farm related to State Farm’s claims handling receive the documents because attorney communications may and reserve process. Lane’s motion presented three issues be discoverable when they are put at issue in the litigation, for resolution by the court: 1) whether post-complaint mental but failed to provide an explanation as to how this general prin- impressions of State Farm employees constitute work-product; ciple applied to his motion. The Court noted that State Farm 2) whether the procedures for setting reserves and the reserve never asserted an “advice of counsel” defense and declared history of the claim are irrelevant, confidential, and/or privi- that if a mere relationship to a lawsuit was all that was required leged; and 3) whether the portions of State Farm’s evaluation to make documents discoverable, the privilege would “essen- of the claim containing mental impressions of defense counsel tially [be] obliterate[d].” are protected by attorney-client privilege. Finally, the Court addressed the discoverability of State Farm’s In its privilege log, State Farm noted that it redacted por- reserve history for Lane’s claim. Lane submitted a docu- tions of its claims log, which were created after Lane filed ment request seeking both copies of the reserve history and suit. State Farm contended that those entries were created changes thereto, as well as the insurer’s “methods and criteria in anticipation of litigation and contained mental impressions for setting reserves.” State Farm objected to production on

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the grounds that the reserve history was irrelevant and its cedures. The Court disagreed, finding that Lane presented an methods for setting reserves were privileged. Lane argued insufficient basis to overcome his burden of proving that the that because his claim centered on a dispute with State Farm reserve materials were relevant or discoverable. Therefore, the as to the appropriate value of the claim, he should be entitled court denied Lane’s motion to compel discovery in total. to receive information related to the reserve history and pro-

Sixth Circuit Court of Appeals Rules That Kentucky Supreme Court Would Not Recognize “Reverse Bad Faith” Claim

State Auto Prop. and Cas. Ins. Co. v. Hargis, No. 13-5020 (6th Cir. May 6, 2015).

Sixth Circuit Court of Appeals denies motion for certification of questions to the Kentucky Supreme Court regarding viability of “re- verse bad faith” claims on basis that insurer provided insufficient evidence to conclude Court would adopt the claim under Kentucky law.

On December 9, 2007, Lori Hargis’s home burned to the State Auto moved for summary judgment on Hargis’s bad faith ground under suspicious circumstances. After the fire, Hargis claims, and the district court granted the motion on the basis submitted an insurance claim for $866,000 and collected that State Auto’s refusal to pay was “at least debatable” in light more than $425,000 from State Auto. State Auto subsequently of Hargis’s subsequent indictment. The insurer also amended alleged that Hargis violated provisions of the policy regard- its complaint to include claims for insurance fraud and “re- ing “intentional loss” and “concealment or fraud” by setting verse bad faith,” and moved for summary judgment on all other or conspiring to set the fire, and by falsifying the amount of pending claims. Hargis’s sole opposition was to summary property losses she suffered. judgment on the reverse bad faith claim.

State Auto filed suit in Kentucky state court to void the policy. The district court denied summary judgment on the reverse Hargis removed the case to federal district court and filed bad faith claim because State Auto provided no counterclaims against State Auto for breach of and showing that such claims were recognized in any jurisdiction. bad faith under Kentucky , the Kentucky Consum- State Auto appealed the ruling and then requested that the er Protection Act (“KCPA”), and the Kentucky Unfair Claims district court certify to the Kentucky Supreme Court the ques- Settlement Practices Act (“KUCSPA”). State Auto survived tion of whether a reverse bad faith claim would sound in Hargis’s summary judgment motion on the breach of contract under Kentucky law. After the district court refused to certify claim when it demonstrated the existence of a genuine issue the question because the claim was no longer pending before of material fact regarding its arson defense by presenting it, State Auto repeated its request to the Sixth Circuit Court of circumstantial evidence of Hargis’s motive and opportunity to Appeals. commit the crime. State Auto argued that the Kentucky Supreme Court would The case never went to trial. Under the weight of the insurer’s adopt the claim of reverse bad faith because it had previously mounting evidence, Hargis was forced to admit she had solic- shown a willingness to expand on and create new claims ited a friend to commit the arson in order to collect money on under Kentucky law. However, the Sixth Circuit observed the insurance claim. Both Hargis and her co-conspirator were that such expansions occurred in light of the state Supreme indicted in January 2011 for “conspiracy to use fire to commit Court’s “consideration of how other courts have addressed wire fraud in violation of 18 U.S.C. § 844(h) and (m),” a charge the issue.” Unable to present supporting case law from to which Hargis pleaded guilty. other jurisdictions, State Auto argued in the alternative that

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the implied covenant of good faith and fair dealing imposes to include first-party claims, it declined to provide “reciprocal contractual obligations on both the insurer and the insured. In rights or remedies” to insurers under the KUCSPA. According- light of those obligations, State Auto argued it was “unjust” for ly, the Sixth Circuit found that the Kentucky Supreme Court’s the law to require the insurer to observe the covenant without refusal to make the protections of the KUCSPA reciprocal requiring the insured to do so as well. Moreover, State Auto indicated “a willingness to conclude in a related context that complained that reverse bad faith claims were a necessary tool insureds are in need of protection that insurers are not.” to prevent insureds from lodging costly bad faith claims against the insurer with comparatively little or no risk for themselves. The court then surveyed the reasoning of other states’ courts in declining to adopt the common law tort claim of reverse In response, the court examined Kentucky law on the implied bad faith. Courts in other jurisdictions generally have refused covenant of good faith and fair dealing, noting that Kentucky to adopt the claim because: (1) insurers have other remedies law only recognizes a tort claim for breach of the covenant available to combat fraud on the part of the insured; (2) insur- where the insured and the insurer were in a special relationship ers are in a more secure and advantageous position relative to and “distinct elements are present, such as: unequal bargain- the insured; and (3) the parties’ relationship does not impose ing power, vulnerability, and trust between the parties; nonprofit upon the insured the same fiduciary duties borne by the motivations for contracting (e.g., peace of mind, security); and insurer. Only the Oklahoma Supreme Court reserved the pos- inadequacy of standard contract damages.” The court found sibility that malfeasance by the insured could sound in tort and that such reasoning cut against State Auto’s argument that “the merit adoption of the claim. mutuality of the implied contractual obligation alone would lead the Kentucky Supreme Court to adopt a common law tort for Finally, the Sixth Circuit rejected State Auto’s argument re- reverse bad faith.” garding the “unjust” nature of allowing Hargis to “escape the consequences of her intentionally fraudulent conduct,” noting Next, the court examined the state’s bad faith jurisprudence that Hargis had been subjected to a civil judgment for dam- and observed that the Kentucky Supreme Court recognized ages, incarceration, and restitution. As the court observed, her first-party tort claims for bad faith because of the presence of conviction made it easier for State Auto to prevail on its claims “the special relationship between an insurer and its insured” of insurance fraud and breach of contract. Therefore, the court and “the kind of distinct elements that are recognized as giving predicted that the Kentucky Supreme Court would not adopt a rise to an independent tort claim for bad faith.” However, while common law tort claim for reverse bad faith by an insured, and the Kentucky Supreme Court expanded bad faith jurisprudence denied State Auto’s motion for certification.

This publication has been prepared by the Insurance Practice for information purposes only. The provision and receipt of the information in this publication (a) should not be considered legal advice, (b) does not create a lawyer-client relationship, and (c) should not be acted on without seeking professional counsel who have been informed of the specific facts. Under the rules of certain jurisdictions, this communica- tion may constitute “Attorney Advertising.” © 2015 Saul Ewing LLP, a Delaware Limited Liability Partnership. ALL RIGHTS RESERVED.

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