Date: Thursday, August 30th, 2018 by Megan Starling.
Article originally published here.
While an insured’s claim against its insurer for bad faith is recognized in most jurisdictions, there is no corresponding recognition for a “reverse bad faith” claim by an insurer against its insured. As a concept, “reverse bad faith” is an action by an insurer against its insured “when the insured willfully submits a fraudulent claim and then sues the insurer in tort for the insurer’s ‘bad faith’ in refusing to pay the fraudulent claim.” However, even after considering the public policy reasons for allowing a reverse bad faith claim, and acknowledging wrongdoing by insureds, courts have been unable, or unwilling, to take the next step, and recognize a “reverse bad faith” cause of action. This article analyzes courts’ reasons for refusing to accept “reverse bad faith” claims, and alternatives to a “reverse bad faith” claim.
Failing to Accept “Reverse Bad Faith”
Over the past few decades, insurers have attempted to plead “reverse bad faith” to no avail. Insurers’ arguments are usually based on public policy. Specifically, insurers have argued that there is strong public policy against accommodating insureds attempts to profit by filing false or incomplete claims in the hopes of reaping the benefits of suing the insurer for bad faith failure to settle or delaying settlement. Those benefits include expedited and greater settlements in order for the insurer to avoid the high litigation costs of defending a bad faith claim. The increased litigation and settlement costs for such claims will likely raise premiums for all policyholders, and result in financial harm to shareholders. Accordingly, a “reverse bad faith” cause of action would deter false or incomplete claims and frivolous bad faith actions, thus serving a legitimate public purpose. Courts have yet to be persuaded.
Generally, courts have held that the public policy implications of an insured’s special relationship with its insurer trump the public policy reasons cited by insurers. For example, in Agricultural Insurance Co. v. Superior Court, 70 Cal.App.4th 385 (Cal. Ct. App. 1999), the insured’s property was damaged by an earthquake. Following the earthquake, the insured submitted a claim to its insurer. The claim was partially paid, but controversies between the parties arose, and the insured sued for bad faith and breach of contract. After an investigation revealed that the insured “had deliberately misrepresented and concealed material facts,” the insurer cross-claimed to plead, among other things, “reverse bad faith” and fraud. The court, however, held that a claim of “reverse bad faith” does not exist. “Although there is an implied covenant of good faith and fair dealing in every contract, although each party is bound to it, and although this principle applies to insurance contracts, the potential liability for breach is different for insurers and insureds.” Furthermore, the court stated that the insurer’s exposure to potential liability for acting in bad faith “flows from special factors which do not apply to the insured.” It identified those special factors as the fiduciary responsibilities owed by the insurer to the insured, the adhesive nature of insurance contracts, and the dilemma faced by insureds in paying for damages if the insurer breaches the contract. The court also rejected the insurer’s arguments that business entities controlled by wealthy individuals (like the plaintiff in Agricultural), have equal bargaining power, and thus, should be subject to tort liability. Even if the insured had equal or even greater bargaining power than the insurer, the court stated that the insurer provided “no basis for a ruling that the same words in an insurance policy can impose varying duties on different insureds according to their respective levels of wealth.” Accordingly, the Agricultural court’s “special factors” provided the basis for denying the claim for reverse bad faith.
The Sixth Circuit applied a similar reasoning in State Auto Property and Casualty Insurance Co. v. Hargis, 785 F.3d 189, 196 (6th Cir. 2015) in rejecting the insurer’s argument for reciprocal application of Kentucky’s Unfair Claims Settlement Practices Act (“KUCSPA”). State Auto’s argument was based on the ”strong public policy against allowing insureds to profit from their own wrongdoing while simultaneously subjecting insurers to inordinate increased costs for investigation, defense, and litigation.” Id. at 193. Further, the insurer argued that “without reverse bad faith, insureds can take a ‘no risk gamble’ by seeking punitive damages, while their insurers (and by extension shareholders and policyholders) bear the burden of the high investigation and defense costs associated with those [bad faith] claims.” Id. at 196. In rejecting State Auto’s arguments, the court relied on the reasoning of the Supreme Court of Kentucky in Farmland Mutual Insurance Co. v. Johnson, 36 S.W.3d 368, 379-80 (Ky. 2000):
Insofar as the exclusion of the insureds from the scope of KUCSPA is concerned, the legislative decision to exclude the insured from the class is reasonable and natural. One reason for this distinction is that the insured is not in the insurance business. A second reason is that a bad faith action is based upon the fiduciary duty owed by an insurance company to its insured based upon the insurance contract. The KUCSPA is designed to “protect the public from unfair trade practices and fraud.” Furthermore, the disparate bargaining positions of an insured and an insurer following a loss are sufficient to justify treating the insureds as a different class for purposes of inclusion within the scope of the act. 36 S.W.3d at 380 (footnotes omitted).
State Auto Property and Casualty Insurance Co. v. Hargis, 785 F.3d at 196. Other states have similarly rejected the public policy arguments addressed in State Auto in refusing to recognize a “reverse bad faith” cause of action.
Given the decisions regarding the viability of a “reverse bad faith” claim, it is hard to disagree with Couch on Insurance that the utility of “reverse bad faith” is “more illusory than real.” It must be remembered, however, that not every jurisdiction has heard a “reverse bad faith” claim. Further, though courts have yet to be persuaded, there are at least arguable public policy reasons for recognizing reverse bad faith claims.
Alternatives to “Reverse Bad Faith”
At present, without a recognized claim for reverse bad faith, a plaintiff-insured has every reason to claim bad faith against its insurer in nearly any litigation. However, although a “reverse bad faith” cause of action has not yet gained acceptance, there are alternatives for an insurer defending against an unsupported bad faith claim. Two of these acceptable alternatives to “reverse bad faith” are: 1) fraud; and 2) statutory remedies.
Courts may reject “reverse bad faith” as unnecessary because an insurer can bring a claim for fraud against its insured. The Supreme Court of Ohio, for example, denied a claim for “reverse bad faith” while stating that “[t]here are other avenues for the insurer to pursue in the event that an insured submits a fraudulent claim. An insurer drafts the policy, can refuse the insured’s claim, and could assert a cause of action against the insured for fraud.” In the context of insurance, claims of fraud by an insured is not limited to statutory or common law fraud. Most insurance policies expressly provide that fraud by an insured is an absolute defense to coverage. Thus, insurers can deny an insured’s fraudulent claim by relying on a concealment or fraud provision in the policy.
Courts have gone even further in recognizing fraud as a defense to coverage. In Neidenbach v. Amica Mutual Insurance Company, 842 F.3d 560, 567 (6th Circuit 2016) (applying Missouri law), the Sixth Circuit went so far as to void the applicable insurance policy pursuant to the policy’s “Concealment or Fraud” provision where the insured materially misrepresented the value of personal property lost in a fire. Approximately one year prior to the loss and claim, the insureds had filed a Chapter 13 bankruptcy petition stating they had only $7,000 worth of personal property. However, on the insureds’ sworn statement of loss to the insurer, “they sought reimbursement of $262,500 worth of personal property — a difference of $250,500.” Agreeing with the district court, the Sixth Circuit stated “that the misrepresentations on the Proof of Loss were material because an accurate inventory of the property destroyed by the fire was necessary for [the insurer] to make a coverage determination.” Coupled with a finding that these material misrepresentations were intentional, the court voided the policy under the “Concealment or Fraud” provision.
In addition to defenses based on fraud, some states provide statutory remedies to insurers faced with frivolous bad faith claims. Tennessee, for one, has adopted a statute titled “Action brought in bad faith by policyholder,” T.C.A. §56-7-106, which states:
In the event it is made to appear to the court or jury trying the cause that the action of the policy holder in bringing the suit was not in good faith, and recovery under the policy is not had, the policy holder shall be liable to the insurance company, corporation, firm, or person in a sum not exceeding twenty five percent (25%) of the amount of the loss claimed under the policy; provided, that the liability, within the limits prescribed, shall, in the discretion of the court or jury trying the cause, be measured by the additional expense, loss, or injury inflicted upon the defendant by reason of the suit.
The right to pursue an action under this statute “becomes vested in the insurer at the time of the institution of the insured’s action, and thus the action becomes part of the controversy.” Illinois, Massachusetts, New Jersey, and Nebraska also have statutes which provide that an insurer may, under certain circumstances, maintain a cause of action against an insured for bad faith in bringing a suit.
In sum, an insurer may have a few arrows in its quiver to use when forced to defend against a fraudulent claim, and/or an insured’s filing of a frivolous bad faith action. Choosing which alternative to “reverse bad faith” to employ will rest on the facts of the case, the applicable policy language and the law of the applicable jurisdiction.
The relatively few courts to have considered the question of common law “reverse bad faith” have ruled against recognizing this cause of action. However, as many jurisdictions have never considered the question, the viability of the doctrine remains uncertain. Public policy arguments in favor of recognition of “reverse bad faith” do exist. Indeed, the above-quoted Tennessee statute suggests that at least one state legislature finds the reasons for “reverse bad faith” compelling; perhaps, a court will too. But even if courts continue to reject the viability of a “reverse bad faith” claim, they may accept a claim of fraud against the insured, depending on the facts of the case and the relevant policy language. Accordingly, with or without widespread acceptance of a “reverse bad faith” claim, insurers are not completely defenseless against fraudulent claims or frivolous lawsuits.
The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice. Tokles & Son Inc. v. Midwestern Indemn. Co., 65 Ohio St.3d 621, 631 (Ohio 1992)  Id. at 391.  Id. at 389.  Id.  Id.  Id. at 396.  Id.  Id. at 397.  Id.  Id. at 399.  Id.  See, Tokles & Sons Inc. v. Midwestern Indem. Co., 65 Ohio St.3d 621, 605 N.E.2d, 945 (1992); Johnson v. Farm Bureau Mut. Insurance Co., 533 N.W.2d 203, 208 (Iowa 1995); First Bank of Turley v. Fidelity and Deposit Insurance Co. of Md., 928 P.2d 298, 308 (Okla.1996);  Couch on Insurance 3d, § 208:4. Applicability of “Reverse Bad Faith” to Hold Insured Liable to Insurer In Tort, 14 Couch on Ins. § 208:4.  Tokles, 6 Ohio St.3d at 632-33.  Id. at 562.  Id. at 563.  Id. at 565.  Id. at 567.  Adams v. Tennessee farmers Mut. Ins. Co., 898 S.W.2d 216, 217 (Tenn. Ct. App. 1994).
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