The Current Standard of Bad Faith Claims in New York
First Party Claims
New York Insurance Law section 2601 requires “good faith claim practice” with regard to the adjustment of first-party claims in New York. The violation of this statute subjects the insurer to administrative penalties issued by the insurance department, rather than a suit for punitive damages by the purportedly aggrieved party.
The U.S. Circuit Court of Appeals for the Second Circuit, which examined New York’s bad faith scheme, held that “under New York law, parties to an express contract are bound by an implied duty of good faith, but breach of that duty is merely a breach of the underlying contract.” Harris v. Provident Life and Acc. Ins. Co., 310 F.3d 73, 80 (2nd Cir., 2002).
New York State Appellate courts have, likewise, upheld this principle, see, e.g., Murphy v. American Home Prods. Corp., 58 N.Y.2d 293, 304, 448 N.E.2d 86, 91, 461 N.Y.S.2d 232, 237 (1983), and Pernet v. Peabody Eng’g Corp., 20 A.D.2d 781, 782, 248 N.Y.S.2d 132, 134 (1st Dep’t 1964). Although, one court in the matter of Belco Petroleum Corp. v. AIG Oil Rig, Inc., 179 A.D.2d 516, 579 N.Y.S.2d 24 (1stDept., 1992) rejected the proposition that Insurance Law 2601 provides an exclusive remedy in the way of administrative fines. Rather, the First Department held that suits for punitive damages were cognizable where the insurer’s bad faith acts were particularly grievous and tended to reflect “morally reprehensible conduct aimed at the general public.” This case, however, has to date proven to be the exception and not the rule of law.
Accordingly, punitive damages continue to be unavailable under the statute as New York continues to hold that a party that breaches a contract of any kind, be it insurance or not, is bound to pay only consequential damages (not punitive damages).
Third Party Claims
In addressing claims of bad faith with respect to third parties, the insurer’s failure to negotiate in good faith may result in a verdict against the insured for greater than the policy limit and therefore damage the insured beyond his coverage.
In the matter of Pavia v. State Farm Mutual Automobile Insurance Company, 82 N.Y.2d 445, 626 N.E.2d 24, 605 N.Y.S.2d 208 (1993), the New York Court of Appeals established the standard of care for a finding of “bad faith.” The court held that in order to establish a prima facie case of “bad faith” the plaintiff must establish that the insurer’s conduct constituted a “gross disregard” of the insured’s interests. The court defined “gross disregard” as:
“….a deliberate or reckless failure to place on equal footing the interests of its insured with its own interests when considering a settlement offer. In other words, a bad faith plaintiff must establish that the defendant insurer engaged in a pattern of behavior evincing a conscious or knowing indifference to the probability that an insured would be held personally accountable for a large judgment if a settlement offer within the policy limits were not accepted.”
Establishing Bad Faith
The court noted that in order to prove a case of “bad faith” the plaintiff must show “the insured lost an actual opportunity to settle the claim at a time when all serious doubts about the insured’s liability were removed.”
The factors to be considered to establish proof of “bad faith” include:
- The likelihood of a plaintiff’s ability to succeed on the liability issue in the underlying action.
- The potential magnitude of the damages.
- The financial burden each party may be exposed to as a result of a refusal to settle.
- The insurer’s failure to properly investigate the claim and any potential defenses.
- The information available to the insurer at the time the demand for settlement is made.
- The insured’s fault in delaying or ceasing settlement negotiations by misrepresenting the facts.
How to Handle Bad Faith Letters
Bad faith letters should be answered by the claims representative. The reasons why settlement cannot be entertained at the time of the letter should be discussed by the claims representative. Additionally, the avenues of investigation that the claims representative is undertaking with respect to possible defenses should be outlined in the letter to plaintiff’s attorney. Requesting an extension to answer the “bad faith” letter would also be good practice.
Conducting an investigation of the defenses raised by the defense counsel and by the insured should also be undertaken, as the failure to conduct an inquiry could constitute a breach of the insurer’s obligation to investigate and defend its insured. Therefore, unless a decision is made to settle the claim, viable avenues of investigation should be pursued.
Preliminary forecasts of liability cannot be used against the insurer in a subsequent “bad faith” action and thus appear to be proper entries in the claims file.
Procedures and guidelines that set forth how a “bad faith” letter is to be handled should not be available as a weapon against the insurer in a “bad faith” action. A violation of such a policy would constitute mere negligence, which is not actionable.
The duty to defend is broader than the duty to indemnify. In New York, the insurer is duty bound to continue to defend its insured even after an offer of the policy, even if one claimant is still pursuing a suit against the insured. Further, if there are portions of the lawsuit that are for covered losses (i.e. claims) and portions that are uncovered (i.e. punitive damages), the insurer must defend both the covered and uncovered claims, though this can be done under a “reservation of rights letter.”
Settlement with one claimant leaving other claims uncovered. It is not “bad faith” to settle with only one claimant leaving other claims uncovered as long as the settled claim was fairly negotiated. However, the failure to settle a meritorious excess claim may expose the carrier to bad faith allegations, even if the reason for the failure to settle was the attempted protection of other claims. As the duty is to the insured and not to “potential claimants,” once the insurance carrier is made aware of a claim which will likely expose the policy, the duty to the insured is invoked.
The insurance carrier can be held liable for consequential damages to its insured based on an unfair denial. In New York an insured can maintain a claim for actual losses, including special damages and compensatory pain and suffering awards that arose from the carrier’s unjust denial of coverage. This is not inconsistent with the principles discussed above, however, as the insurer is not being saddled with a punitive award, but is instead being ordered to make the insured whole based on the insurer’s breach of contract. The difference is that a monetary award for pain and suffering may be necessary to make a plaintiff whole in such an instance.
Denials based on late notice/failure to notify may be difficult to sustain. New York Insurance Law section 3420(a)(3) grants the injured claimant an independent right to notify the carrier of a loss, even if the insured gives late notice or fails to notify the carrier entirely. Further, the notice required of a claimant is measured “less rigidly” than that required of the insured. The only requirement on the claimant is that he or she act diligently in attempting to ascertain the carrier’s identity and then notify the carrier promptly after learning of its identity.
All denials must be timely. New York Insurance Law section 3420 (d) requires that one “give written notice as soon as is reasonably possible of disclaimer…or denial … to the insured and the injured person or any other claimant.” The failure to deny or disclaim timely and properly will vitiate the disclaimer or denial.