December 3, 2009
Feinman on the Appropriate Standard in "Bad Faith" Insurance Cases
Jay Feinman (Rutgers-Camden) has posted to SSRN The Insurance Relationship as Relational Contract and the "Fairly Debatable" Rule for First-Party Bad Faith. Here is the abstract:
This article uses relational contract theory to discuss the standard to be applied to evaluate the behavior of insurance companies in first-party bad faith cases.
The article first briefly summarizes relational contract theory and describes the insurance contract as a prime example of a relational contract. It then describes the law of bad faith in first-party insurance cases-cases in which a policyholder alleges that the insurance company has violated the duty of good faith and fair dealing that is present in every contract and intensified in insurance contracts. The most widely adopted standard for bad faith is the “fairly debatable” test, under which an insurance company is liable only if it lacks a reasonable basis for denying benefits of the policy and knows or recklessly disregards the lack of a reasonable basis for denying the claim. Therefore, where a claim is “fairly debatable,” the company is held to have not acted in bad faith. Moreover, courts have created a procedural elaboration on the fairly debatable test, under which a policyholder who could not have established as a matter of law a right to summary judgment on the substantive claim is not entitled to assert a claim for an insurer’s bad-faith refusal to pay the claim.
The article argues that from the perspective of relational contract theory, the fairly debatable rule and the summary judgment elaboration are deeply flawed. Instead, negligence is a better rule because it recognizes that the relationship between the company and policyholder is one of security, in which the company has adopted a role of acting not as an adverse party to its insured, but in a responsible manner to give the insured the benefits it reasonably expects. A negligence rule also recognizes and deters the possibility of insurer opportunism in the area of claim practices. The rule also serves the broader social role of the insurance relation in providing indemnity and security for large numbers of people.
This article is a contribution to a symposium in memory of Professor Richard Speidel.
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Professor Feinman makes his conclusion fit his theory with a surprisingly imprecise analysis of first-party insurer bad faith. His article includes conspicuously unsupported and presumably unresearched statements such as these:
>> Through systematic reorganization of the claims process, incentives to employees and managers, and more aggressive approaches to litigation, the companies have embarked on a strategy that increases profits at the expense of claimants. This development has taken place across property, casualty, and disability insurances as a whole. (Page 567, footnotes not omitted.)
>>Companies have integrated fraud allegations into the claim process, routinely using referrals to their Special Investigation Units (SIUs) and suspicions of fraud to delay or deny payment. (Page 568, footnote not omitted.)
The article cites no support for these and many other generalizations. As one whose practice concentrates in assisting insurers in investigating and defending losses and claims thought to be fraudulent, I have never found that fraud allegations are "integrated" into the claims process (whatever that means), and SIU referrals are hardly routine. They are the exception, not the norm.
Professor Feinman also does a poor job supporting his thesis that relational contract theory warrants the adoption of a negligence rule in first-party insurer bad faith cases. To support his conclusion, he uses MIST and fraudulent claims as his only two classes of cases for which he contends "opportunism has become a major feature of the claims landscape." Problem is, MIST cases are not first-party insurance claims. The allegedly injured "victims" Professor Feinman believes insurers' aggressive defense postures discourage from pressing their claims are not parties to the insurance contract at all. They are third parties. A surprisingly imprecise choice of support for his argument that relational contract theory disfavors the fairly debatable rule and instead favors a negligence rule in first-party insurer bad faith cases.
Toward the end of his article, Professor Feinman asserts:
"[The fairly debatable rule] even permits the [insurance] company to intentionally injure the insured’s interest or to act with reckless disregard for the insured’s interest as long as there is some evidence that it has acted at the worst negligently, that is, that it can avoid summary judgment on the issue of intent." (Page 569)
Wrong again. This seems to be a misstatement of the summary judgment elaboration of the fairly debatable rule. As Professor Feinman had pointed out on page 561, the summary judgment elaboration pertains to the factual or legal basis for the insurer's decision on the underlying first-party coverage claim -- whether there are questions of triable fact regarding the basis of the insurer's denial of coverage -- and not to the insurer's intent in regard to its handling of that claim.
In February 2008, New York's highest court recognized that consequential damages may be recovered against an insurer that wrongfully denies coverage by breaching the policy's implied obligation of good faith and fair dealing. Bi-Economy Mkt., Inc. v. Harleysville Ins. Co. of N.Y., 10 NY3d 187 (2008). More recently, the New York Appellate Division, First Department, held that consequential damages do lie for breach of an insurance contract absent insurer bad faith. Panasia Estates, Inc. v Hudson Ins. Co., 68 AD3d 530 (1st Dept. 2009). A negligence rule for first-party bad faith cases ostensibly would permit the recovery of punitive damages against the insurer, in addition to contractual and consequential damages. In no other field or area of law are punitive damages recoverable for merely negligent conduct. The relational nature of an insurance contract, as unique and arguably imbalanced as it may be, simply does not warrant the extraordinary exception Professor Feinman proposes.
Posted by: Roy A. Mura | Feb 28, 2010 8:22:08 PM