Can an Insurer’s Failure To Settle Amount to Bad Faith?

11.14.2013

The United States District Court for the District of Colorado recently addressed the question of whether an insurer’s failure to settle constitutes bad faith in Larson v. One Beacon Ins. Co., 2013 WL 5366401 (D. Colo. Sept. 25, 2013).  The District Court, in affirming the Recommendation of the Magistrate Judge, allowed the plaintiff to proceed with a claim that the insurer acted in bad faith when it failed to settle a legal malpractice suit for the $1 million policy limit.  The insurance company’s failure to settle early in the case ultimately exposed the plaintiff to a settlement in the amount of $4.5 million.  Because the parties had not yet completed discovery, the Court denied the insurer’s motion for summary judgment with regard to the bad faith claim, leaving the decision of whether the insurer had acted in bad faith for a later date.

Cynthia Coreyn Tester-Lamar was an attorney who was insured against malpractice liability under a policy issued by One Beacon Insurance Company (“One Beacon”) with a maximum policy limit of $1 million.  In 2010, former clients of Ms. Tester-Lamar brought a malpractice suit against her, alleging that her drug and alcohol addiction compromised her representation of them in an underlying action.  Not only did Ms. Tester-Lamar struggle with substance abuse issues throughout the time that she represented these clients, but she also mislead these clients as to her whereabouts and the progress on their respective cases.  On two separate occasions, the clients offered to settle for the $1 million One Beacon policy limit.  Although evidence existed suggesting that the clients’ damages could exceed $4 million, One Beacon declined both offers to settle.  Ms. Tester-Lamar had strongly opposed settlement, despite the fact that her retained counsel advised her that he believed she had potential exposure in excess of the policy limits.

In 2012, Ms. Tester-Lamar filed for Chapter 7 bankruptcy.  On behalf of Ms. Tester-Lamar, the bankruptcy trustee and the plaintiff in the District Court action, Douglas Larson, then entered into a settlement agreement with the clients in the amount of $4.5 million.  Subsequently, Mr. Larson commenced this action against One Beacon, asserting the following three claims: (1) breach of the insurance contract; (2) bad faith breach of the insurance contract; and (3) violation of C.R.S. § 10-3-1115, in that One Beacon unreasonably delayed or denied payment of a claim for benefits.

With regard to the breach of contract claim, the District Court agreed with the Magistrate Judge that summary judgment to One Beacon was appropriate because the plaintiff had failed to identify a specific contractual provision that One Beacon had allegedly violated.  Turning to the bad faith claim, the Court discussed the basis for a bad faith claim and the relevant inquiry for determining whether an insurer has acted in bad faith.  The Court explained, “a claim for bad faith breach of contract in the third-party context arises when the insurer has acted unreasonably in attending to the claims made against the insured by third parties.”  Id. at *2.  The key question is whether a reasonable insurer under the circumstances would have denied or delayed payment of the claim under the facts and circumstances.  Importantly, the reasonableness of an insurer’s actions is determined objectively, according to the standards generally applicable in the insurance industry.  Typically, those standards are established through testimony by expert witnesses.

In Larson, neither party presented any evidence setting forth the particular insurance industry standards implicated by the plaintiff’s bad faith claim.  Rather, the parties’ dispute concerning the reasonableness of One Beacon’s actions centered around the following issues: whether One Beacon had adequately advised Ms. Tester-Lamar of her potential exposure, whether One Beacon had adequately advised Ms. Tester-Lamar to retain independent counsel, and whether One Beacon had adequately investigated the allegations in the underlying dispute so as to make an informed recommendation regarding the settlement.  Unfortunately, neither party came forward with any evidence establishing the relevant insurance industry standards and practices that inform these issues.

Although the Court lacked the necessary evidence to render a decision on the reasonableness of One Beacon’s actions, the opinion does set forth some of the Court’s lingering questions.  For example, the Court requested evidence of reasonable insurance industry practices governing the degree of detail that is appropriate in a letter advising an insured to obtain independent counsel.  Further, the Court questioned whether the comprehensiveness of such a letter is affected by the fact that the insured may be a lawyer or otherwise expected to possess knowledge of her legal rights and exposure.  The Court noted a distinction between “recommending personal counsel” and “advising the insured about an option to retain personal counsel”—a difference that could be material in determining reasonableness.

In Larson, the plaintiff’s failure to come forward with evidence of the requisite insurance industry standards was fatal to the claim.  However, because the parties had not yet completed discovery, the Court declined to grant summary judgment to One Beacon on the bad faith claim, instead offering One Beacon the opportunity to move again for summary judgment at the close of discovery.  Although the Court did not rule definitively on the bad faith claim, it offered some sound advice to future plaintiffs: be prepared to present evidence of the practices of the insurance industry relating to all decisions made and actions taken by an insurer.  According to the Larson court, this evidence is essential to determining whether an insurer’s conduct is objectively reasonable.

Jaime Wisegarver is an associate in the Litigation Section, where she handles a variety of civil and commercial matters, including insurance recovery litigation and counseling. For more information, please contact Jaime at (804) 771-5634 or jwisegarver@hf-law.com.