DTCI: Insurance ‘Bad faith setup’

By Robert M. Baker IV & Lisa M. Dillman
 

Baker

Dilman

Just like it sounds, “bad faith setup” involves manufacturing bad faith claims against an insurer by design, using aggressive pre- and post-suit tactics. Because plaintiffs’ attorneys are becoming increasingly creative in their efforts to expand an insurer’s duty of good faith and fair dealing, it is important for practitioners to affirmatively consider this concept early and often in the defense of their insurance clients and to implement simple, consistent practices to combat bad faith setup.

For many years, there has been a national trend to add bad faith claims to coverage lawsuits against insurers. The Indiana Supreme Court’s 1993 decision in Erie Insurance Co. v. Hickman subjected Indiana to this trend as well. 622 N.E.2d 515 (Ind. 1993). Ever since Erie, bad faith claims are included in garden variety declaratory actions as a matter of practice. Problems arise when navigating these claims because bad faith case law interpreting the tort and defining its boundaries remains fairly underdeveloped in Indiana. This creates the perfect environment for creative, aggressive, or frustrated insured’s counsel to push the limits in developing novel theories for recovering bad faith damages.

Recently, the legal profession has seen the advent of law firms and practice groups within law firms formed with the objective of advising clients on “insurance recovery.” These firms and practice groups market their services to commercial policyholders seeking representation in coverage matters, as well as advice and assistance in enforcing rights under their insurance policies, which include filing suit against insurance companies to obtain payment of disputed claims. These lawsuits almost always contain a first-party bad faith claim against the insurance company. The harsh reality is that bad faith claims provide leverage for the insured against the insurance company. The truth is that the claims often work as intended. The incentive to set up bad faith against an insurer is strong. That is why defense counsel must be conscious of the bad faith setup and be prepared to tackle these claims head-on.

The following are some of the best tools you can use to diffuse the bad faith setup. See also Jeffrey Michael Cohen, Steven J. Brodie, and Aram C. Bloom, “The Bad Faith Set Up: Doin’ It and Dodgin’ It.”

Early preparation

The most important tool in combating the bad faith setup is to establish a strong footing early in the case. Early evaluation is critical. It goes without saying that any case with a high-dollar demand or one in excess of limits creates potential for a bad faith claim. The same goes for claims with clear liability exposure.

In addition to the factual characteristics of a claim, a wise practitioner must also account for the opponent’s ability or proclivity to work the case into a bad faith claim. Is your opponent an experienced “insurance recovery” specialist? If so, expect the bad faith setup and accept it as an element of the claim you must defend. Is your opponent naturally aggressive or creative? Your aggressive or creative opponent is looking for ways to win. The bad faith setup may spring from this competitive spirit. Is the plaintiff frustrated? Frustration may unwittingly drive your opponent to look for bad faith where there otherwise would be none. It is amazing how far a simple, sincere expression of concern or sympathy for the plaintiff or policyholder can go. When you have assessed who you are dealing with, you are better prepared to handle the bad faith claim.

If there is a question about coverage, be the first to file declaratory judgment and join the policyholder and the third-party claimant if applicable. Seeking declaratory relief early in the process may underscore the insurer’s reasonable efforts at resolving a good faith dispute about coverage. See, e.g., Masonic Temple Ass’n of Crawfordsville v. Indiana Farmers Mut. Ins. Co., 779 N.E.2d 21, 29 (Ind. Ct. App. 2002) (affirming summary judgment on first-party bad faith claim, noting “[t]he proper response when an insurer questions whether an insured’s claim falls within the scope of its policy coverage is to file a declaratory judgment … .”).

Deliberate communication

Another important consideration in defending the bad faith set up is how to treat self-serving communications from opposing counsel or, more likely, communications from the insured, but drafted by counsel. Each communication (including email) must be treated as if it will be seen by the jury in a bad faith case. This presents an opportunity to create a counter-exhibit in response. In so doing, care must be taken to respond in detail, acknowledging the communication for what it is and clearly explaining how and why the insurer’s conduct was reasonable. If the insured is uncooperative or unresponsive, make sure that the letter emphasizes the consequences of that conduct pursuant to the terms of the insurance contract. Try to always write the last letter in the negotiations because no communication from the policyholder or a third-party claimant’s counsel should go unanswered.

Another potentially effective way to attack self-serving communications designed to set up bad faith is to resort to the rules of evidence. It can be argued that the rules of evidence do not allow the admission of self-serving statements generated for purposes of litigation because they are inherently untrustworthy and should be excluded as unreliable hearsay statements. See Timberlake Constr. Co. v. U.S. Fidelity & Guar. Co., 71 F.3d 335, 341-42 (10th Cir. 1995) (citing Palmer v. Hoffman, 318 U.S. 109, 114 (1943)). This inherent lack of credibility in self-serving statements that have been generated for later use in litigation has been articulated best perhaps by Judge Posner:

There is no more facile a method of creating favorable evidence than writing a self-exculpatory note. Such notes have no warrants of reliably and allowing them to be placed in evidence would operate merely as a subsidy to the forest-products industry.

Lust v. Sealy, Inc., 383 F.3d 580, 588 (7th Cir. 2004). See also United States v. McIntyre, 997 F.2d 687, 699 (10th Cir. (1993), cert. denied, 510 U.S. 1063, (1994) (“If any person in the process is not acting in the regular course of business, then an essential link in the trustworthiness chain fails … .”).

Self-serving letters authored by counsel in anticipation of litigation are not exempt from hearsay under the business records exception because (1) it is “well-established that one who prepares a document in anticipation of litigation is not acting in the regular course of business”; and (2) such statements are inherently unreliable. See Timberlake, 71 F.3d at 342. See also Fed. Rule Civ. P. 803(6) (noting business records exception applies “unless the source of information or the method or circumstances of preparation indicate lack of trustworthiness”).

And even if self-serving statements made in anticipation of litigation are determined not to be hearsay (or fall within a hearsay exception), such statements are nevertheless “dripping with motivations to misrepresent” and should be excluded. Hoffman v. Palmer, 129 F.2d 976, 991 (2d Cir. 1942). See also 13B Miller, Indiana Evidence § 801, p. 268 (3d ed. 2009) (“A determination that the statement is not hearsay because it is offered for a purpose other than proof of the truth of the statement does not render the evidence admissible … the potential for unfair prejudice and jury confusion must not outweigh the statement’s legitimate probative value.”) (citations omitted).

Precision and responsiveness in settlement negotiations

Perhaps the area most susceptible to bad faith setup is settlement negotiations in both the first-party and third-party context. It goes without saying that every settlement demand must be taken seriously and treated with respect. Demands that have time limits placed on them could be used as evidence of the insurer’s bad faith failure to settle. Every time-limited demand requires attention and prompt action.

Upon receiving the time-limited demand, assess and address at least three things:

1) The time limit imposed – if it is too short, immediately, and in writing, ask for more time to respond and provide the reasons additional time is needed. If the time limit has expired, you can still tender the policy limits as soon as appropriate and include a letter explaining why the limits could not have been tendered sooner.

2) Unacceptable conditions – if the conditions imposed on settlement are unacceptable, immediately, and in writing, communicate the conditions that are unacceptable and explain why they cannot be accepted.

3) Unclear conditions – if the conditions to settlement are unclear, immediately, and in writing, request clarification.

Another way to diffuse bad faith claims is to accept the demand if appropriate and tender policy limits in an interest-bearing account contingent upon the results of a declaratory judgment action or upon the conditions imposed upon the settlement being met. Settlement funds could be tendered into an escrow or interest-bearing account or deposited with the clerk of courts if an action is pending. This process is discussed in Cricket Ridge, LLC v. Wright, 880 N.E.2d 1271 (Ind. Ct. App. 2008), in the context of containing accrual of prejudgment interest, but the same procedure could be employed to contain bad faith exposure.

Know your client’s duties of continuing good faith

Another potential bad faith setup tactic to watch for is the accusation of “continuing bad faith” as a result of insurer’s counsel’s litigation conduct. See generally Barker, et al., “Litigating about Litigation: Can Insurers Be Liable for Too Vigorously Defending Their Insureds?”, 42 Tort Trial & Ins. Prac. L. J. 827 (2007). Practitioners should not let allegations of continuing bad faith through litigation conduct chill their representation of insurance clients, but practitioners should be aware of post-litigation duties imposed on insurers.

The Indiana Court of Appeals has recognized that the duty to act in good faith continues while litigation is pending. However, in general, only evidence of litigation conduct before a claim of bad faith is filed is relevant to assessing the claim of bad faith. Gooch v. State Farm Mutual Automobile Insurance Co., 712 N.E.2d 38, 42-43 (Ind. Ct. App. 1999) (finding that jury could consider insurer’s post-litigation conduct in determining whether it had properly investigated the insured’s uninsured motorist claim).

In addition, most courts (including Indiana) that have recognized a post-litigation duty of good faith have also recognized that the duty does not mean courts should alter the normal rules of litigation. See R. Papetti, “The Insurer’s Duty of Good Faith in the Context of Litigation,” 60 Geo. Wash. L. Rev. 1932, 1964 (1992). The Indiana Court of Appeals has recognized that the duty to act in good faith during litigation is meant to usurp neither the court’s control of the litigation process nor the right to zealously advocate on behalf of a client. Gooch, 712 N.E.2d at 42-43.

Practitioners must remember that the adversarial process exists for the purpose of testing the propriety of a claim. That does not mean the litigation process can be used to delay payment, leverage a coverage position, or to avoid properly investigating information relevant to the insurer’s coverage position. But it does mean that counsel can defend the insurer vigorously. So long as counsel’s litigation conduct is permitted by the trial rules and within the bounds of the ethical rules, litigation conduct cannot support a claim for continuing bad faith.

Whether a bad faith setup is intentional or whether it simply injects itself into your case by a frustrated or aggressive insurer’s counsel, practitioners should be aware of the concept when defending coverage claims, advising their insurance clients on coverage, or assisting in the adjustment of high-dollar losses. It is hoped that recognition of an insured’s effort to build a case of bad faith early in a disputed claim can avoid protracted bad faith litigation.•

Robert M. Baker is an associate and Lisa M. Dillman is of counsel at Lewis Wagner in Indianapolis. The opinions expressed in this article are those of the authors.