Wolfe and Wyman

San Francisco Bay Area Office
500 YGNACIO VALLEY ROAD, SUITE 250
WALNUT CREEK, CALIFORNIA 94596-8209
TELEPHONE (925) 280-0004
FACSIMILE (925) 280-0005

Los Angeles County Office
2530 WILSHIRE BOULEVARD, 2nd FLOOR
SANTA MONICA, CALIFORNIA 90403-4643
TELEPHONE (310) 828-3488
FACSIMILE (310) 828-9488

HISTORY OF THIRD PARTY BAD FAITH IN CALIFORNIA

California courts have long held that an implied covenant of good faith and fair dealing is implicit in every contract of insurance. "Bad faith" liability originated in California through a series of landmark decisions wherein the courts held that the breach of the implied covenant of good faith may constitute a tort. As such, insurers would be subject to tort damages, including punitive damages, rather then being held to simply the contractual damages.

Although bad faith actions are most common between an insured and its insurer, California has a unique and frequently changing history of third party bad faith actions against insurers. In 1979, in the case of Royal Globe Ins. Co. V. Sup Ct. (Keoppel) , 23 Cal. 3d 880 (1979), the California Supreme Court held that, although a third party claimant was not a party to the contract of insurance, the Unfair Claims Practices Act set forth in the California Insurance Code section 790.03(h) impliedly authorized a direct action against insurers by victims of unfair claims settlement practices, including third party claimants.

Nine years later, in the case of Moradi-Shalal v. Fireman's Fund Ins. Cos , 46 Cal. 3d 287 (1988), the California Supreme Court reversed itself with regard to third-party bad faith claims. The court overruled Royal Globe thereby ending a third-party's right to sue in a separate civil suit for bad faith. As the law stood after Moradi-Shalal , insurers were precluded from engaging in unfair settlement practices, however, the penalty for such an act was confined to administrative sanctions against the insurer which rarely were imposed.

On February 26, 1999, the California legislature proposed two new bills that would, once again, change the law with respect to third-party bad faith claims, including those arising out of automobile accidents. Senate Bill 1237 was introduced by Senator Martha Escutia and Assembly Bill 1309 was introduced by Assemblyman Jack Scott and co-authored by Senator Jackie Speier. As previously discussed, prior to these Bills, the law only provided for administrative sanctions against an insurer found to have committed unfair claims settlement practices. In addition, prior to these Bills, the law provided for the determination of civil suits by civil court actions and only contained provisions for certain alternative dispute resolution procedures such as mediation or arbitration when the court ordered the parties to participate. Senate Bill 1237 and Assembly Bill 1309 address both of these issues by expanding a third-party claimant's right to sue an insurer in a separate civil suit for unfair claims settlement practices and expanding a party's right to choose arbitration instead of a civil suit in certain situations.

SENATE BILL 1237 AND ASSEMBLY BILL 1309

Senate Bill 1237 ("SB 1237") and Assembly Bill 1309 ("AB 1309") have been combined together to form what is known today as the "Fair Insurance Responsibility Act of 2000" or "FAIR" which was signed into law on October 10, 1999, and was to take effect beginning on January 1, 2000. FAIR essentially restores a person's right to sue another person's insurer for the insurer's unfair claims settlement practices.

A. TITLE 13.7 - "OBLIGATION TO SETTLE INSURANCE CLAIMS FAIRLY"

FAIR adds Title 13.7 entitled "Obligation to Settle Insurance Claims Fairly" to the California Civil Code. Specifically, section 2871(a)(1) of the Civil Code states that any insurer doing business in the State of California shall act in good faith toward, and deal fairly with, third-party claimants. If the insurer fails to act in good faith and violates any provision of Section 790.03(h) of the California Insurance Code, section 2871(a)(1) then allows a third-party claimant to bring a civil action against the insurer to recover damages, including general, special, and exemplary damages.

1. Who May Sue

Only third-party claimants have the right to sue under FAIR. A "third-party" is defined in section 2870(a)(1) as an individual "seeking recovery against an insured under a liability insurance policy" for either:

-bodily injury (no bad faith claim lies on an underlying claim of purely emotional distress);

-wrongful death (including persons seeking damages for loss of consortium and the like, resulting from wrongful death); or

-property damage resulting from a motor vehicle accident.

No cause of action may be asserted by a drunk driver who is injured in an accident while intoxicated or under the influence of drugs at the time of the accident. Note the FAIR claim is only barred where the driver is convicted of driving under the influence. As such, if the intoxicated driver is killed in an accident thereby precluding any conviction for the offense, his/her next of kin may sue under FAIR for unfair claims settlement practices in its dealings with them. In addition, FAIR only precludes a person "injured" in an accident while under the influence. As injury is defined in section 2870(a)(5) as "actual bodily injury, sickness or disease," it appears that an intoxicated person may be able to sue for property damage arising out of the accident.

2. Who May Be Sued

An action under FAIR may only lie against an "insurer doing business in the State of California." The remedies provided are available against any insurer who violates the standards set forth in California Insurance Code section 790.03(h) in the handling, processing or settling of a claim covered under its insured's policy of insurance.

"Insurer" is broadly defined to include:

-a liability insurer licensed or regulated under the Insurance Code;

-the third-party administrator of a "private self-funded liability protection program"; and

-a cooperative corporation consisting solely of physicians and surgeons.

Self-insured businesses are expressly exempted from FAIR liability. In addition, worker's compensation insurers, public entitles, whether self-insured or privately insured, and professional liability insurers, in certain circumstances are also exempted from FAIR liability.

Under section 2871(b), a third-party claimant may only assert such a civil claim if he/she:

-makes a written pretrial settlement demand sent by certified mail which the insurer has rejected; and

-obtains a judgment or arbitration award exceeding that demand.

The demand for settlement may not exceed the coverage limits and is deemed rejected by the insurer if the insurer does not respond to this demand within thirty (30) days of its receipt of the demand. In addition, the amount awarded in the final judgment may be considered as evidence of bad faith by the insurer, but can not be the sole consideration.

As a practical matter, this is a major limitation on FAIR actions. Financial circumstances often compel injured parties to settle before trial or arbitration. In this event, no FAIR action lies against the insurer no matter how egregious the insurer's settlement practices.

3. Honest Mistake Defense

As FAIR liability is predicated on an insurer's failure to act in good faith and deal fairly with the third party claimant, an honest mistake in judgment regarding settlement of a claim is a defense to statutory liability. The "honest mistake" may relate to any matter "in connection with the settlement" of the claim. This includes mistakes as to coverage, liability, and damages. The insurer has the burden of persuading the jury that the mistake was an honest one. However, the case will never get to the jury if the claimant can not establish that the insurer did not make an "honest, intelligent and knowledgeable evaluation" of the claim.

B. TITLE 11.65 - "ALTERNATIVE DISPUTE RESOLUTION ACT"

FAIR also added Title 11.65 entitled "Alternative Dispute Resolution Act" (commencing with section 1776) to Part 3 of the California Code of Civil Procedure. Where the claimant's settlement demand or the policy limits are $50,000.00 or less, the insurer may avoid FAIR liability altogether by a timely request for arbitration of the underlying claim. Specifically, section 1777 allows a claimant who is represented by counsel to request arbitration pursuant to this title as long as his/her demand does not exceed $50,000.00. The insurer has thirty (30) days to respond to the demand made by the claimant or it is deemed refused. An insurer who agrees to proceed with arbitration is then conclusively presumed to have complied with the duty under Civil Code 2871(a) to act in good faith.

The insurer's request for arbitration must be made either within one hundred and fifty (150) days after service of a civil complaint, if the policy limits do not exceed $50,000.00, or within ninety (90) days of a claimant's settlement demand that does not exceed $50,000.00.

In order to aid claimants in making this determination, section 1777 allows a claimant to demand and obtain insurance coverage policy limits information concerning all applicable, and potentially applicable, policies of insurance, to decide whether to participate in arbitration. The insurer must respond within ten (10) days and verify in writing that the information about coverage and policies is accurate. Any insurer that releases this information will not be subject to civil liability to the insured or any other insurer for the release of this information.

1. Withdrawing From Arbitration

Either the claimant or the insurer may request that the claim be removed from arbitration upon a showing of "good cause" in a petition to the court having jurisdiction over the amount in controversy. "Good cause" consists of:

a)a change in the nature or extent of the claimant's injury or damages which was not reasonably discovered earlier and which causes the claimant to believe the reasonable value of the claim exceeds $50,000.00;

b)discovery of new information showing insurance coverage exceeds $50,000.00;

c)insurer's discovery of evidence indicating that the claim is fraudulent;

d)change in the law affecting the remedies available or the right to recover;

e)an opposing party has unreasonably interfered with completion of the arbitration; or

f)the interests of justice support permitting a party to commence a civil action.

If the court permits the claimant to remove the claim from arbitration, the conclusive presumption of insurer good faith remains in tact, unless the "good cause" removal was the insurer's misrepresentation, error or unreasonable interference in the arbitration proceedings. However, if the insurer removes the claim from arbitration, the conclusive presumption of insurer good faith no longer applies.

PROPOSITIONS 30 AND 31

Before FAIR could come into effect on January 1, 2000, the Consumers Against Fraud and Higher Insurance Costs was established to overturn these Bills. This coalition was able to prepare a petition and secure enough signatures from persons against FAIR such that these Bills were never put into effect as scheduled. Instead, SB 1237 became Proposition 30 and AB 1309 became Proposition 31. These Propositions will be voted on at the March 7, 2000 elections. Both Bills will not become effective until then, and only if a majority of California voters vote "Yes" on these Propositions. As such, the law with regard to third-party bad faith claims is still open in California.

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Third Party Bad Faith in California: Where Are We Going?

Third Party Bad Faith in California:
Where Are We Going?