"Bad faith" claims are often plead by insureds in coverage cases. However, both carriers and insureds should be aware of some of the difficult issues raised in litigating such claims. First, the standard utilized by the New Jersey courts to determine if "bad faith" exists, i.e. whether the claim was "fairly debatable," can set a very high burden for insureds. Second, bad faith claims are subject to attack if the insured is not able to prevail on summary judgment on the coverage issue. Finally, even when a bad faith claim is present, it is common for sophisticated insureds to have little or no additional consequential damages. Absent egregious conduct warranting punitive damages, significant extra-contractual damages as a result of a failure to pay or a delay in payment are rare.
The "Fairly Debatable" Standard
Since the New Jersey Supreme Court's well-known decision in Pickett v. Lloyd's, 131 N.J. 457 (1993), the New Jersey courts have applied the "fairly debatable" standard under both "first party" and "third party" policies. Litigation under a "first party" policy is "a suit by an insured against his insurance company because of its failure to settle his claim . . . ." Pickett, 131 N.J. at 457 (citing Indus. Fire & Casualty Ins. Co. v. Romer, 432 So.2d 66 (Fla. Dist. Ct. App. 1983)). A similar claim, also analyzed under the "fairly debatable" standard, arises when an insurer fails to defend or indemnify an insured under a third party liability policy. See Hudson Universal Ltd. v. Aetna Ins. Co., 987 F. Supp. 337 (D.N.J. 1997); Universal-Rundle v. Commercial Ins. Co., 319 N.J. Super. 223, 250 (App. Div. 1999).1
In Pickett, the New Jersey Supreme Court held that a cause of action seeking consequential damages for a bad faith failure to pay an insurance claim will be recognized "when the failure to pay . . . results from a denial or a withholding of benefits for reasons that are not even debatably valid" and "the economic losses sustained by the policyholder are clearly within the contemplation of the insurance company." Pickett, 131 N.J. at 461. The Court adopted what it considered to be a balanced approach, "[i]f a claim is fairly debatable no liability in tort will arise." Id. at 473 (quoting Bibeault v. Hanover, 417 A.2d 313, 319 (R.I. 1980)).2 Simple negligence on the part of the insurer will not be enough to sustain a claim of bad faith. The Court also recognized "delay" as a component of bad faith but held that "bad faith is established by showing that no valid reasons existed to delay processing the claim and the insurance company knew or recklessly disregarded the fact that no valid reasons supported the delay." Id. at 481; see also Griggs v. Bertram, 88 N.J. 347 (1982).
The Pickett standard can be a high burden for plaintiffs to meet. In Universal-Rundle, the plaintiff cross-appealed the dismissal of it's bad faith claim. 319 N.J. Super. at 223. Using the fairly debatable standard, the Appellate Division held that the trial court properly granted the defendant's motion for summary judgment. Id. The court noted that the defendant "need not prove that it conducted a fool-proof investigation." Id. at 250. It was enough that the defendant undertook some investigation and contacted the plaintiff regarding the claim. Id. at 249-50
In M & B Apartments v. Teltser, the Appellate Division affirmed the dismissal on summary judgment of cross claims for bad faith made by NAS, a fourth tier excess carrier, against Federal Ins. Co., a third tier excess carrier. 328 N.J. Super. 265, 273 (App. Div. 2000). NAS claimed that Federal acted in bad faith by refusing to settle the plaintiff's claim. The court found that Federal's decision not to settle was fairly debatable given the fact that Federal was not liable for any loss "unless and until the damaged or destroyed property was actually repaired or replaced by the insured with due diligence and dispatch." Id. The court noted that at the time Federal refused to settle the condition had not been met, thus, Federal was under no obligation to pay or settle. Id. at 273-74.
A debate over the meaning of policy language will also preclude a finding of bad faith. In Villa Enterprises v. Federal Ins. Co., the insurer refused to defend the insured based on its interpretation of the policy's advertising injury coverage. 360 N.J. Super. 166 (N.J. Super. Ct. Law Div. 2002). The policy language at issue had not previously been interpreted by courts in New Jersey. Id. at 189. The insurer advocated a position that had been followed in California, which led the court to rule that "it was not such an obviously incorrect" interpretation sufficient to support a finding of bad faith. Id.; see also HGM Communications v. Hartford Fire Ins., No. A-1154-05T (N.J. Super. Ct. App. Div. Jan. 19, 2007) (court dismissed bad faith claim because the denial of business interruption coverage was fairly debatable given the endorsement in the policy).
Cases where the courts have upheld bad faith claims typically involve more than just policy interpretation disputes, like those involving a long-running series of boilerplate correspondence or a carrier's refusal to acknowledge the existence of the policy or of standard policy terms. See Princeton Gamma-Tech Inc. v. Hartford Ins. Group, No. SOM-L-1289-91 (N.J. Super. Ct. Law Div. June 5, 1997).
Summary Judgment On The Coverage Claim May Be A Prerequisite
The Pickett court was clear, "a claimant who could not have established as a matter of law a right to summary judgment on the substantive claim would not be entitled to assert a claim for an insurer's bad-faith refusal to pay the claim." Pickett, 131 N.J. at 473. This holding has been described as the "polestar of the Pickett analysis," Polizzi Meats, Inc. v. Aetna Life & Cas. Co., 931 F. Supp. 328, 340 (D.N.J. 1996), but has not become a widely accepted standard. Cf. Cross, Returning To "Go" (But Not Collecting $200): Reexamining Insurance Bad Faith in Light of Modern California Law on Summary Judgment and the Genuine Dispute Doctrine, The Tort and Insurance Practice Law Journal, Summer 2005, at 1085-86. In contrast, if summary judgment is entered in favor of the claimant it is not the end of the analysis. Hudson Universal, 987 F. Supp. at 342. See also Feit v. Great-West Life and Annuity Ins. Co., No. 03-2948, 2005 U.S. Dist. LEXIS 24686, at *22 (D.N.J. Oct. 18, 2005) (if factual issues exist as to whether the plaintiff is entitled to coverage the court must dismiss the bad faith claim while allowing the underlying insurance dispute to proceed).
Whether a coverage decision is fairly debatable can be decided as a matter of law. HGM, No. A-1154-05T5 at 16. Not surprisingly, bad faith claims are frequently dismissed on summary judgment. HGM, No. A-1154-05T5; M & B Apartments, 328 N.J. Super. at 265; Universal-Rundle, 319 N.J. Super. at 223. In order for a bad faith claim to survive summary judgment, the plaintiff must show sufficient evidence of improper conduct. The plaintiff must show more than a factual dispute over liability. Cross, supra at 1085-86.
Damages as a result of an insurer's bad faith are measured using contract principles. Pickett, 131 N.J. at 474. An insurer is liable to an insured for consequential damages in excess of the policy amount if the damages were fairly within the contemplation of the insurer. See Cromartie v. Carteret Saving & Loan, 277 N.J. Super 88, 103 (App. Div. 1994). Courts "should carefully scrutinize the proofs of extra-contractual damages." Pickett, 131 N.J. at 481.3
Only in those cases where an insured is an individual or a small company that is relying on limited insured assets to carry on its business, such as in Pickett, would consequential damages for failure to pay a claim in a first party case be reasonably foreseeable. A similar argument can be made under third party liability policies. An adverse result in an underlying action is clearly the foreseeable result of an insurer's failure to defend. However, for large sophisticated insureds, it is extremely unlikely that the company would not have the resources to defend itself and would certainly be expected to do so to protect its rights. If the insured defends itself and suffers a verdict in excess of the policy amounts, it may be difficult for it to prove that the verdict was caused by the insurer's original failure to defend.
Punitive damages, of course, can be awarded in bad faith cases. In order for punitive damages to be awarded, a plaintiff has to show more than bad faith. Pickett, 131 N.J. at 476 (requiring "egregious circumstances"). Unless an insurer conspires to defraud multiple insureds, completely ignores the insured's claim, or engages in some other repetitive, knowingly improper behavior, it is unlikely that punitive damages will be awarded.
While insurers facing bad faith claims in New Jersey should not ignore the possibility of extra-contractual or punitive damages, the hurdles facing a plaintiff cannot be overlooked. The "fairly debatable" standard is not difficult for insurers to meet as long as they can show that they did not disregard the claim and conducted a reasonable, but not necessarily fool-proof, investigation of the claim's validity. The insurer should take the time to document all of the steps taken in investigating and assessing an insured's claim. If it is determined that the claim was wrongfully denied, insurers should carefully scrutinize any claim by the insured that it suffered damages in excess of what would have been originally owed under the policy.
1 This article does not address cases where an insurer agrees to defend the insured but unreasonably fails to settle the claim within the policy limits. See Rova Farms Resort v. Investors Ins. Co., 65 N.J. 474 (1974).
2 The Court held that a cause of action for bad faith in the first party insurance context did not conflict with the regulatory framework of the New Jersey Unfair Claims Settlement Practices Act, N.J.S.A. 17:29B-1 et seq.; 131 N.J. at 468. Legislation is pending in the New Jersey Senate, S.1958, that would provide a private cause of action for first party insureds for unfair claims practices. The bill was introduced on June 8, 2006, and has been referred to the Senate Commerce Committee. Failure to comply with N.J.S.A. 17:29B-4, although not creating a cause of action, has been used as evidence of bad faith against an insurer. Miglicio v. HCM Claim Mgmt. Corp., 288 N.J. Super. 331 (N.J. Super. Ct. Law Div. 1995).
3 Although the foreseeability of consequential damages is typically measured at the time of contracting, see Bannon, Encyclopedia of N.J. Causes of Action (2d ed.) at p. 35 (2004), the Pickett court seemed to relieve the plaintiff of that obligation. Pickett, 131 N.J. at 475; but see Cromartie, 277 N.J. Super. at 103.
John P. Scordo is a Partner in Day Pitney's Morristown, New Jersey office, focusing his practice on commercial litigation in state and federal courts, primarily involving insurance disputes, mass tort, and commercial contract matters. Kristine Russo Begley is an Associate in the Morristown, New Jersey office.