Fairly Debatable or Genuine Dispute Defenses to Bad Faith

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A bad faith claim should be dismissed on summary judgment if there was a genuine dispute on a reasonable factual dispute or an unsettled area of insurance law. In determining if a dispute is genuine, the court does not decide which party is “right” as to the disputed matter, but only that a reasonable and legitimate dispute actually existed. [Chateau Chamberay Homeowners Ass’n v. Associated Int’l Ins. Co., 90 Cal. App. 4th 335, 348 n.7 (2001), as modified on denial of reh’g (July 30, 2001).

Insurers, afraid of a bad faith judgment, should consider the fact that there can be no bad faith claim for denial of coverage if the insurer was correct as a matter of law in denying coverage. [Frog, Switch & Mfg. Co., Inc. v. Travelers Ins. Co., 193 F.3d 742, 751 n.9 (3d Cir. 1999).] When a court finds that Great American was not obligated to provide coverage under the terms of the Policy, the bad faith claim similarly fails. Before succumbing to the extortionist bad faith suit and offering up millions to avoid trial the honest insurer who knows it acted toward its insured fairly and in good faith must consider that an insurer does not act in bad faith if it declines to pay sums that are reasonably in dispute. While an insured may present evidence showing that the insurer knew there might be some question as to whether there was a legitimate question or difference of opinion over the eligibility, amount or value of the claim. An insured needs to present some evidence of a clear entitlement to coverage. If the insurer is convinced the evidence does not exist providing the insured with an entitlement to coverage, it must, in good faith, refuse to pay and be willing to litigate to the highest court available to prove that it acted properly.

The tort of bad faith is like the mythical vampire—it hides in the dark. The law of unintended consequences applies to the situation and the reasons for its creation – bad acts by insurers costing innocent insureds to suffer was not cured by the tort of bad faith. Rather, insurers and their customers were hurt by the fear of the assessment of tort and punitive damages, increased the cost of insurance across the country. The truth about the tort of bad faith is that it will die only if it is put into the light of day. It does not solve the problem anticipated. Rather, it created a new problem: multiple bad faith suits brought even when the reason for the denial of all or a part of a claim were made because there was a genuine dispute between the insurer and the insured or that the decision to deny was fairly debatable.

Insurers seem to forget, or ignore, the fact that to establish a claim for bad faith in the insurance context, a plaintiff must show two elements: (1) the insurer lacked a “fairly debatable” reason for its failure to pay a claim, and (2) the insurer knew or recklessly disregarded the lack of a reasonable basis for denying the claim.

The tort of bad faith makes a few lawyers very rich; a few insureds receive indemnity for which they did not bargain, and makes the cost of insurance prohibitive to those who seek only to receive the benefits of the contract.

If the courts of the United States still believe – regardless of the evidence now available – that the existence of the tort of bad faith is a good thing and helps to deter insurers from mistreating their insureds, they must limit the use and abuse of the tort of bad faith.

Policyholders and their lawyers rely heavily on bad faith claims in coverage litigation to not only get the insurer’s attention, but to press for favorable settlements due to the risk of high jury awards if the bad faith claim gets that far in litigation. Bad faith lawsuits are traditionally not interested in whether the claim made by the insured was one claimed by the insured but rather are an attempt to profit from a claim – a purpose anathema to the purpose of insurance, to provide indemnity.

There is no doubt that allegations that an insurer acted in bad faith gets an insurer’s attention. However, if an insured can go further and specifically seek punitive damages they can get in the driver’s seat of coverage litigation and change the issue from interpretation of the contract to whether – regardless of coverage – the insurer acted badly and should be punished.

Sometimes, the fear of being abused by courts is the fat that in Wyoming, although typically measured by the objective standard whether the validity of the denied claim was not fairly debatable. Even if a claim for benefits is fairly debatable, the insurer may breach the duty of good faith and fair dealing by the manner in which it investigates, handles or denies a claim. [State Farm Mut. Ins. Co. v. Shrader, 882 P.2d 813, 828 (Wyo. 1994)] A fairly debatable reason to deny a claim is not a defense against torts that may flow from engaging in oppressive and intimidating claim practices. So, when making the decision to fight a bad faith suit the insurer must also be confident that it not only had a good, fair, and genuine reason to deny the claim but must also be able to prove that they treated the insured fairly and investigated thoroughly and in good faith before making the decision not to pay.

If the insured’s claim was fairly debatable the insurer is entitled to deny it without risking a bad faith suit. [Blanchard v. Mid-Century Ins. Co., 933 N.W.2d 631, 637 (S.D. 2019)]

Of course, an insurer does not get to determine coverage unilaterally. There must be a reasonable basis for that determination. A claimant can test the reasonableness of the insurer’s determination of no coverage in the circuit court and, if no genuine dispute exists, the bad faith claim can proceed. On the other hand, if a genuine dispute does exist governing the coverage question, the insured’s claim is fairly debatable and the tort claim for bad faith based upon the insurer’s refusal to pay the claim may not be maintained. [Travelers Indem. Co. v. Armstrong, 565 S.W.3d 550, 568 (Ky. 2018)] A reasonable basis in law or fact for denying the claim is established by the absence of a contractual obligation in an insurance policy for coverage. [Messer v. Universal Underwriters Ins. Co., 598 S.W.3d 578 (Ky. Ct. App. 2019)]

When a claim is “fairly debatable,” an insurer is entitled to debate it. [Anderson v. Cont’l Ins. Co., 85 Wis.2d 675, 271 N.W.2d 368, 376 (1978)] A claim is fairly debatable if it can be disputed on any logical basis, and the question can generally be decided as a matter of law by the court. The pertinent question is whether an insurer has no reasonable basis for denying a claim. A determination whether a particular claim is fairly debatable implicates the question whether the facts necessary to evaluate the claim are properly investigated and developed or recklessly ignored and disregarded. An imperfect investigation alone is not sufficient cause for recovery if the insurer in fact has an objectively reasonable basis for denying the claim. [Reuter v. State Farm Mut. Auto. Ins. Co., 469 N.W.2d 250, 254–55 (Iowa 1991); Peterson v. W. Nat’l Mut. Ins. Co., 930 N.W.2d 443 (Minn. App. 2019)]

It seems clear to me that the tort of bad faith has served its purpose. It should be killed. The courts of the United States should return to the common law of contracts where the insured is provided the benefits of the contract of insurance promised by the policy.

For many years after the inception of the tort of bad faith there were few defenses – other than the basic contract terms and conditions – to defend against claims of the tort of bad faith. The “fairly debatable” or “genuine dispute” defenses have changed the law in favor of insurers and provided a potential defense that should make it easier for an insurer to defend against the tort.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 54 years in the insurance business. He is available at http://www.zalma.com and zalma@zalma.com.

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