In a typical multi-state coverage action, a conflicts analysis based on states' particular interests in having their laws apply to a claim often yields acceptable results for issues that can be discretely divided by location. The analysis may yield less desirable results, however, or, even become so balky as to defy use, for issues like bad faith claims handling. Two types of problems can arise. A court may face difficult conceptual problems if it attempts to apply different state laws to a pattern of insurer conduct that relates to claims in many states. Alternatively, the court may apply a single state's law, e.g., the law of the place of contracting. This law, which will apply to conduct in many states, may provide limited remedies for bad faith, and fewer usable precedents.
One strategy for developing a multi-state bad faith claim is the use of reference to standards of conduct embodied in certain laws which, in fact, are relatively uniform across the country, specifically, the Unfair Claims Settlement Practices Acts in the various states. As discussed below, use of these laws seldom results in an award of punitive damages; indeed, they generally do not provide a private right of action for the policyholder. Nonetheless, they can be used to help establish a standard of conduct for common law bad faith claims that may support coverage claims where, as is frequently the case, an insurer has attempted to "mend the hold."
The "mend the hold" doctrine has been described as a "corollary of the duty of good faith" that the law imposes on the parties to a contract.1 As Judge Posner describes the doctrine in the Seventh Circuit's Harbor Insurance Company case:
A party who hokes up a phony defense in the performance of his contractual duties and then when that defense fails (at some expense to the other party) tries another defense for size can properly be said to be acting in bad faith.2
Policyholders must frequently address the fact that the insurer has "mended the hold," or engaged in analogous types of conduct: e.g., issuance of a "permanent" reservation of rights that is never followed by a claim determination, or denial of a claim based on non-existent or merely perfunctory claim investigation. Reference to standards embodied in unfair claims handling practices acts can help a policyholder identify the insurer's wrongful conduct at the outset of the litigation and develop allegations relating to that conduct into an element of the claim, if not necessarily as a claim for extra-contractual damages. It can help the policyholder develop strategies for discovery, and to articulate its attack on claim denials based on inadequate investigation, and on defenses based on theories that have been rejected under the relevant law.
The National Association of Insurance Commissioners ("NAIC") has drafted a model Unfair Claims Settlement Practices Act3 that, in one form or another, has been adopted in at least 45 states.4 The model Act identifies fourteen claims settlement "practices" which are violations under the model Act when committed "with such frequency to indicate a general business practice."5 As NAIC noted in the "Legislative History" of the Act, "In the past it has been difficult for regulators and insurers to solve problems because there were no ground rules."6
The part of the Act that has been most often adopted into state law is a list of claims handling practices, many of which are all too familiar to policyholders in large coverage actions. These practices include:
"Failing to adopt and implement reasonable standards for the prompt investigation and settlement of claims arising under its policies";
"Refusing to pay claims without conducting a reasonable investigation"; and
"Failing to affirm or deny coverage of claims within a reasonable time after having completed [the] investigation related to such claim or claims."7
Pursuant to the Act, NAIC also adopted a more specific "Unfair Property/Casualty Settlement Practices Model Regulation."8 The model Regulation or related regulations have been adopted in about half the states.9 While many of its provisions relate specifically to first-party property claims, Section 4 of the model Regulation, relating to "File and Record Documentation," includes a number of requirements especially relevant to the concerns of policyholders seeking coverage for third-party claims, who often find that discovery provides them with fragmented, disorganized claim files:
"Detailed documentation shall be contained in each claim file in order to permit reconstruction of the insurer's activities relative to each claim";
"Each relevant document within the claim file shall be noted as to date received, date processed or date mailed";
"For those insurers that do not maintain hard copy files, claim files must be accessible from Cathode Ray Tube (CRT) or micrographs and be capable of duplication."10
Significantly, the model Regulation defines "documentation" as including, but not limited to, not only pertinent communications, but also "notes" and "work papers."11
Taken together, the model Act and model Regulation establish reasonable ground rules for the procedural side of the insurer's claims handling activities. They also provide persuasive standards for evaluating those activities in coverage litigation.
Attention to claims handling procedure from the very start of coverage litigation can have significant benefits for the policyholder. It can enable the policyholder to focus its discovery, dispositive motions and in limine motions on clearly identifiable conduct, rather than on grand issues relating to the insurer's ultimate intent, and whether it has acted as a responsible corporate citizen. Especially where the policyholder claims that the insurer has wrongfully refused to provide a defense, this focus is likely to put the insurer in the awkward position of having to explain, for example: how it initially evaluated the claim (or why it failed to do so); what information it believed would help resolve the claim (and why its claims handlers are never able to identify that information); and what type of cumulative information was developed as the file was passed through the inevitable succession of claims handlers. If no information was accumulated, and no one developed any "institutional memory" of the claim, then claims handling activities effectively did not exist.
As suggested above, a focus on the insurer's claims handling proficiency may also help the policyholder limit the insurer's ability to "mend the hold," by forcing the insurer to stand by the determinations of its claims handlers. In essence, the model Act and Regulation require the insurer to develop and provide evidence of proficiency in handling claims and reaching claim determinations. An insurer that fails to handle claims in a competent manner should be precluded from using the court and/or their coverage counsel as de facto claims handlers.
The most significant limitations in the Act and the model Regulation are that they were not intended to provide a private cause of action, and obviously cannot result in an award of punitive damages.12 Although a few state laws do provide a statutory right of action for bad faith claims handling, the general standards under the model Act and Regulations were intended to function as a regulatory scheme to be enforced by state insurance commissioners.13 Consequently, in coverage litigation, insurers are likely to be successful in resisting discovery relating to their general business practices. Even where a private right of action exists, the costs and difficulties of discovery, and of proving a general pattern of violative behavior, may present practically insuperable barriers to obtaining a bad faith determination.
Another significant limitation in the usefulness of the model Act and Regulation for policyholders is the fact that relatively few states have adopted the provision of the Act that provides that a single flagrant violation of the Act constitutes a violation.14
Notwithstanding these limitations, reference to the model Act and Regulation in the context of a common law claim of bad faith can be the Archimedes lever that helps move large coverage litigations onto the playing field where the insurer's failure to satisfy its duty of good faith and fair dealing with its policyholder can be addressed as an integral part of the claim.15
Significantly, this duty is implicit in every contract, including every insurance contract.16 As the Restatement (Second) of Contracts explains, good faith in the performance of a contract "emphasizes faithfulness to an agreed common purpose and consistency with the justified expectations of the other party."17 As policyholders know, bad faith has many manifestations, including "evasion of the spirit of the bargain, lack of diligence and slacking off, [and] willful rendering of imperfect performance."18 Too often, however, it has been difficult for policyholders in large coverage actions to make a clear issue of bad faith that merely permeates the insurer's claims handling but has not been investigated by the relevant agency. Use of the Model Act and Regulation from the start of litigation can allow the policyholder to develop a record of the insurer's misconduct and make visible to the court insurer behavior that might otherwise go unremarked and unnoticed.
1 Harbor Ins. Co. v. Continental Bank Corp., 922 F.2d 357, 373 (7th Cir. 1990).
3 Unfair Claims Settlement Practices Act ("Model Act"), in NAIC Model Insurance Laws, Regulations and Guidelines, 900-1 to 900-10 (2005).
4 Id. at 900-5 to 900-8 (list of states adopting the Act or related legislation or regulations).
5 Id. at 900-3, Model Act, 3.B. Under Section 3.A., commission of even a single act can be a violation if the act is "committed flagrantly and in conscious disregard of this Act." However, the vast majority of states that have adopted the Model Act have not included this provision. See Steven Plitt and Christie L. Kriegsfeld, The Punitive Damages Lottery Chase is Over: Is there a Regulatory Alternative to the Tort of Common Law Bad Faith and Does it Provide an Alternative Deterrent, 37 Ariz. St. L. J. 1221, 1249 (Winter 2005).
6 Id., Legislative History.
7 Model Act, at 900-2, sections 4C, 4F and 4G.
8 Unfair Property/Casualty Claims Settlement Practices Model Regulation ("Model Regulation"), in NAIC Model Insurance Laws, Regulations and Guidelines, 902-1 to 902-18 (January 1997).
9 Id. at 902-11 to 902-14.
10 Id. at 902-2, Model Regulation, sections 4.B, 4.C and 4.D.
11 Id., section 3.E.
12 Model Act, at 900-9 (Legislative History); Model Regulation, at 902-15 (Legislative History).
13 See, e.g., Taylor v. Standard Ins. Co., 28 F. Supp. 2d 588, 590 (D. Haw. 1997).
14 See, e.g., Lees v. Middlesex Ins. Co., 229 Conn. 842, 849, 643 A.2d 1282, 1285 (1994).
15 See, e.g., Miglicio v. HCM Claim Management Corp., 288 N.J. Super. 331, 672 A.2d 266 (Law Div., Atlantic Co. 1995).
16 E.g., Germania Ins. Co. of N.Y. v. Rudwig, 80 Ky. 223, 232 (Ky. App. 1882).
17 Restatement of the Law (2d) of Contracts (1981), 205.
18 Id., comment d.
John Agar is Of Counsel with the Newark, New Jersey law firm of Robertson, Freilich, Bruno & Cohen LLC. He routinely represents policyholders in complex insurance coverage disputes.