Taking the Last Step in Insurance Law's Most Significant Event: The End of First-Party Insurance Bad Faith in California

FDCC Quarterly, Summer 2006 by Cross, John

I.

INTRODUCTION

An examination of the past twenty-five years in the field of insurance law presents a panoply of dramatic events that have had a significant impact on the insurance industry and make it difficult to select the single most significant development in the field. One tends to focus on the most recent events and find them the most compelling. Consider the proliferation of the APH claims: asbestos, pollution, and health hazard claims. The resulting controversies and litigation have transformed the insurance industry as well as insurance law. Many venerable insurance companies have gone out of business as a consequence of this onslaught of litigation. Some businesses became unable to obtain conventional insurance. The nation also has been besieged by natural disasters that compounded the problems of the insurance industry. The Northridge earthquake and Hurricane Andrew caused huge losses from which many segments of the insurance market have yet to recover. Now the September 11 terrorist attacks have dealt the industry another devastating blow.

Despite the immensity of these events, I have concluded that the most significant event of the past twenty-five years in the field of insurance law was the expansion and contraction of insurer bad faith liability.1

True, indeed. In fact, there is now an entire industry devoted to insurance bad faith.2 Many plaintiffs' and defense lawyers devote their practices to it. Each side comes armed with paid industry "experts," poised to give testimony about what constitutes proper insurance industry practices. The public at large devotes a considerable amount of its scarce judicial resources to provide a forum for resolving these disputes. A lot of smart and highly-compensated people devote a lot of time and energy to deciding whether an insurance claim was handled properly. And whatever the result, the public pays for it all through taxation and insurance premiums.3

Of course, society makes similar resource allocations in other areas. There are costs whenever the law provides someone with a remedy for something. But first-party insurance bad faith law carries some additional baggage. First, insurance bad faith is not a traditional legal doctrine. One cannot defend it-even if it were a good thing-by arguing that it is an established part of our jurisprudence. second, insurance bad faith requires the courts to distort established legal principles to afford a tort remedy in cases that do not justify one. Instead, contract law and traditional tort law causes of action can sufficiently redress serious insurer claim handling misconduct. Finally, even if a different approach were called for, it is a matter for the legislature. California courts should not have created an entirely new body of law-unique to the insurance industry-on their own.

In the opening quotation to this article, Justice Woods writes about the expansion and contraction of insurer liability, and its significance. Yes, insurer liability expanded-quite a bit. And then it contracted . . . somewhat. But there is a final paragraph in insurance bad faith law that remains and needs to be written. It would set out the California Supreme Court's decision to abolish the last remnant of the "tortification" of contract law4-firstparty insurance bad faith.

But to get to this destination, we need to see where we've been. So we will start by reviewing the creation of first-party insurance bad faith law in California. Then, we will examine subsequent developments in closely-related areas of the law that refuted several key premises underlying first-party bad faith. Finally, we'll survey the actions that would remain were there no insurance bad faith-ones that provide appropriate remedies. An inescapable conclusion will follow from this: California's first-party insurance bad faith doctrine must go!

II.

THE RISE OF FIRST-PARTY INSURANCE BAD FAITH

The first-party insurance bad faith tort action has humble origins indeed. It began with the application of familiar contract principles. As time went on, tort law doctrine slipped into the cases. Finally, we were left with a unique tort law cause of action directed solely to insurers, yet not one subject to tort defenses.

A. The Excess Liability cases

The California Supreme Court-seemingly unwittingly-began setting out legal principles that would ultimately morph into the new insurance bad faith tort in Comunale v. Traders & General Insurance Co.5 Comunale, like the other early bad faith cases, involved an action against an insurer following a judgment against its insured in excess of the insured's policy limit. The court held that in many situations insurers should be responsible for awards exceeding their insureds' policy limits. In the underlying case against the insured, Traders had failed to defend and thus also failed to settle a liability claim against its insured. The court ruled that Traders should bear responsibility for the entire judgment-even the amount over its policy limit-if it had wrongfully failed to protect its insured.