Insurer’s Refusal to Settle Can Lead to Bad Faith Liability

Did you know that that an insurer can be liable for bad faith failure to settle even if it never receives a firm settlement offer? The Louisiana Supreme Court recently ruled that it can and also that an insurer can be found liable for misrepresenting or failing to disclose “pertinent” facts to the insured.

The Court ruled in response to two certified questions from the federal Fifth Circuit Court of Appeals, so its ruling wasn’t applied to the underlying facts in the case.

On Nov. 21, 2005, Danny Kelly, who was covered by a $25,000 automobile liability policy issued by State Farm, was involved in an accident. The attorney for the accident victim mailed a letter to State Farm on Jan. 6, 2006, stating he would recommend releasing State Farm and its insured for payment of the policy limits. State Farm did not respond to the letter, nor did State Farm inform Kelly that it had received the letter.

Slightly more than two months later, on March 22, 2006, State Farm offered to settle the case for its $25,000 policy limits, but the offer was rejected and a lawsuit was filed. That same day, State Farm sent Kelly a letter informing him that he might face personal liability above the policy limits and recommending that he retain his own attorney.

Once again, State Farm failed to inform Kelly of the Jan. 6 letter it had received from the accident victim’s attorney.

The case proceeded to trial and Kelly was hit with a judgment of over $175,000. As a result, Kelly filed suit against State Farm in federal court for bad faith in (1) failing to notify him of the Jan. 6 letter and (2) failing to accept the offer in the Jan. 6 letter. The federal court, in turn, asked the Louisiana Supreme Court whether Kelly had a cause of action against his insurer under Louisiana law for these omissions.

The Louisiana Supreme Court was not asked to decide whether these specific failures constituted bad faith; rather, it was asked whether an insurer could be liable under subsection A of Louisiana’s bad faith statute, L.R.S. 22:1973, for failure to settle without having received a firm settlement offer and also whether an insurer could be liable under subsection B of L.R.S. 22:1973 for misrepresenting or failing to disclose facts not related to coverage under the policy.

Addressing the first question, the Louisiana Supreme Court began with the language of L.R.S. 22:1973(A), which provides that an insurer “owes to his insured a duty of good faith and fair dealing” and “has an affirmative duty to adjust claims fairly and promptly and to make a reasonable effort to settle claims with the insured or the claimant or both.”

As an initial matter, the Court had to determine if the duties in subsection A granted an insured a cause of action against his or her insurer for bad faith failure to settle. Subsection B of L.R.S. 22:1973 lists acts and omissions which, if committed, constitute a breach of the insurer’s duty of good faith and fair dealing imposed in subsection A, but the list does not specifically include the failure to settle a case.

In prior decisions, the Court held that third parties had no cause of action against an insurer under subsection A, but could assert a claim against an insurer under Subsection B exclusively for violations of the listed acts and omissions. Accordingly, State Farm argued that subsection B provided an exclusive list of acts and omissions that were violations of subsection A; thus, in order for failure to settle a claim to constitute a breach of an insurer’s duty of good faith, Kelly had to show that failure to settle a claim fell within the acts and omissions listed in subsection B.

The Court rejected State Farm’s argument. It held that the basis for an insured’s cause of action against his or her insurer for breach of the duty of good faith and fair dealing under L.R.S. 22:1973(A) was broader than a cause of action that could be brought by a third party against an insurer and was not limited to the prohibited acts listed in L.R.S. 22:1973(B).

In short, the Court concluded that the addition of rights in favor of third parties against an insurer under subsection B was not intended by the legislature to take away or reduce any of the insured’s rights available under subsection A. Therefore, Kelly did not have to show that failure to settle was somehow included in the acts and omissions listed in subsection B.

The Court then held that the insurer could be liable to its insured under L.R.S. 22:1973(A) for bad faith failure to settle, even if the insurer never received a firm settlement offer. The Court reasoned that the insurer’s “affirmative duty” under subsection A of L.R.S. 22:1973 to make a reasonable effort to settle claims was not triggered only by receipt of a firm settlement offer. Instead, the insurer’s obligation was triggered by its knowledge of each particular situation, which the insurer had an affirmative duty to gather during the claims process.

The Court concluded that, therefore, an insurer could be liable for failure to settle even without receiving a firm settlement offer. It did not elaborate how far an insurer had to go to avoid liability if no firm settlement offer was received. But in a footnote it noted that the existence of a firm settlement offer would be a factor in the analysis of whether the insurer was in bad faith, as it would put the insurer on notice that the matter could be resolved and could potentially be resolved without exposing the insured to an excess judgment.

The second question answered by the Court was whether an insurer could be liable under subsection B of L.R.S. 22:1973 for misrepresenting or failing to disclose facts unrelated to coverage under the policy. More specifically, L.R.S. 22:1973(B)(1) prohibits insurers from “misrepresenting pertinent facts or insurance policy provisions relating to any coverages at issue.”

State Farm argued that this subdivision of subsection B prohibited insurers from misrepresenting either (1) pertinent facts “relating to any coverages at issue” and/or (2) policy provisions “relating to any coverages at issue.”

The Court took a broader reading of this provision and concluded that an insurer could be liable for misrepresenting either (1) “pertinent facts,” or (2) “insurance policy provisions relating to any coverages at issue.”

By reading the phrase “pertinent facts” as not restricted to coverage issues, the Court seems to have increased the scope of potential liability for an insurer under subsection B fairly dramatically. After all, facts that may be “pertinent” will vary from situation to situation. In addition, the Court broadly interpreted the word “misrepresenting.”

In the underlying facts from which the certified questions arose, State Farm did not, strictly speaking, misrepresent any facts to Kelly; rather, it simply did not disclose to him that it had received the Jan. 6 letter suggesting a willingness, but not making an offer, to settle within policy limits.

Nonetheless, the Court interpreted the word “misrepresenting” to encompass any communication from the insurer that either stated something that was not true or failed to state something that was true. The ruling raises the possibility that a seemingly innocuous fact that is not disclosed to an insured by his or her insurer may, in hindsight, be deemed “pertinent” and subject an insurer to bad faith liability under L.R.S. 22:1973(B).

Kelly seems to broaden an insurer’s potential liability for bad faith to its insured. In a footnote, the Court attempts to stave off too broad an application of its ruling, noting that Louisiana courts have recognized that “tight reins must be kept on a cause of action for insurer settlement practices.”

Despite having broadly interpreted the statute, the Court nonetheless found it “appropriate to reiterate that L.R.S. 22:1973 should be strictly construed. … a strict application of the statute does not contemplate gamesmanship, such as having unrealistic offers … presented through ‘carefully ambiguous demands coupled with sudden death time tables’ in order to ‘set up’ the insurer for an excess liability judgment.”

Time will tell if such warnings will be heeded, but insurers would be well advised to vigorously pursue all possibilities of settlement and to err on the side of caution in deciding what information should be passed on to their insureds.