The Duty of Good Faith and Fair Dealing

Grey SuitIn theory, insurance is a good thing. You pay premiums to a company and, in exchange, the company provides protection to you in the event of an unforeseen loss, whether the loss is a car accident, fire, theft, health problem, disability, a lawsuit against you, or myriad other setbacks of everyday life. You pay for protection and you have a right to expect it when you need it.

However, insurance is not an arrangement between parties of equal footing. The insurance company has all the power. You decide whether to apply for insurance and pay premiums, which company, and whether to submit a claim when you have a loss. That’s all you get to decide. The insurance company decides the cost of the insurance, whether to accept you as an insured, the detailed limitations and requirements of the coverage provided by the policy, the validity of your claim, the value of your claim, and whether and when to pay your claim.

Unfortunately, the unequal footing of an insurance contract has inevitably led to insurance companies routinely taking advantage of policyholders. Fortunately, courts across the country, including those in Arizona, have evened the playing field by implying a duty of good faith and fair dealing in every insurance policy. The rationale for the duty of good faith was best expressed by the Arizona Supreme Court:

An insurance policy is not obtained for commercial advantage; it is obtained as protection against calamity. . . . In securing the reasonable expectations of the insured under the insurance policy there is usually an unequal bargaining position between the insured and the insurance company. . . . When the loss insured against occurs the insured expects to have the protection provided by his insurance. Often the insured is in an especially vulnerable economic position when such a casualty loss occurs. The whole purpose of insurance is defeated if an insurance company can refuse or fail, without justification, to pay a valid claim. We have determined that it is reasonable to conclude that there is a legal duty implied in an insurance contract that the insurance company must act in good faith in dealing with its insured on a claim, and a violation of that duty of good faith is a tort.

Because a violation of the duty of good faith is a tort, a policyholder who hires an attorney and takes an insurance company to court may recover not only the amount that should have been paid on the claim, but can also recover extra-contractual monetary losses and damages for emotional distress, anxiety, embarrassment, frustration, and attorney fees.

arizona-insurance-lawUnlike some other areas of the insurance law, a policyholder can recover emotional distress damages even though the insurance company may not have intentionally caused the distress and even though the distress may not be severe. In addition, in some circumstances a policyholder can recover punitive damages against the insurance company, which are intended to punish and set an example of the company.

The duty of good faith requires that an insurance company treat its policyholder with fairness and honesty and requires that it must consider its policyholder’s interests equal to its own. This is called “equal consideration”. There are two types of insurance bad faith, although each occurs when the insurance company does not treat its policyholder with “equal consideration”.

In my experience as an insurance lawyer, the most common type of insurance bad faith occurs when an insurance company denies, delays or underpays a claim made by its own policyholder. Lawyers refer to this as “first-party bad faith”. Basically, Arizona courts require an insurance company to have an objective, reasonable basis to support their position on a policyholders’ claim. If an insurance company denies or delays payment of a valid claim without a reasonable basis, it is liable for bad faith. If it disputes only part of a claim, it must pay the undisputed portion of the claim or be liable for bad faith.

Although an insurance company may avoid liability for bad faith by proving that its conduct was the result of “mere negligence” or that the claim was “fairly debatable”, it can only do so if it conducted a fair and adequate investigation of the claim, including available information supporting the claim. In Arizona, an insurance company can be liable for bad faith even if it eventually makes full payment of the claim.

The other type of insurance bad faith pertains only to liability insurance. Liability insurance applies when the policyholder is sued by another party and requires the insurance company to defend the policyholder against litigation involving a covered claim and to pay any judgment against the policyholder up to the monetary limit of the policy. Ordinarily the policy gives the insurance company the right to control the litigation defense and the right to decide whether to accept settlement within the policy limit.

Again, because insurance companies routinely abused these rights, courts imply the duty of good faith in the policy. Basically, an insurance company violates the duty of good faith if it unreasonably refuses to provide a defense to the lawsuit and/or fails to accept an offer to settle the lawsuit for an amount within the policy’s monetary limits where judgment against the policyholder then exceeds those limits. Lawyers refer to this as “third-party bad faith”.

If your liability insurance company refuses to provide you a defense to a lawsuit against you and/or refuses to settle the lawsuit for a reasonable amount within the monetary limits of your policy, you should immediately seek help from an experienced insurance attorney. It may be possible to settle the lawsuit against you in exchange for assigning your rights against your insurance company to the other party in the lawsuit. However, such agreements are complicated and must be precisely set up, drafted and executed to satisfy judicial scrutiny that could otherwise void the settlement and/or the agreement.