Does the Implied Covenant of Good Faith and Fair Dealing Impose a Broad Duty on Insurers to Act “Reasonably” or “Properly” in Handling Claims?

Christina Phillips | Property Insurance Coverage Law Blog | October 30, 2019

The United States District Court for the District of Minnesota in Selective Insurance Company of South Carolina v. Sela,1 recently addressed whether the implied covenant of good faith includes a broader obligation to act “reasonably” and “properly” in making a decision about whether to pay benefits. Sela had submitted a claim for hail damage to his home. Selective investigated the claim and filed suit alleging that Sela made fraudulent misrepresentations and was not entitled to coverage. Sela counterclaimed for breach of contract, breach of the implied covenant of good faith and fair dealing, and bad faith, pursuant to Minn. Stat. §604.18.

Under Minnesota law, the implied covenant imposes two obligations on insurance contracts. First, the implied covenant is breached when a party to a contract unjustifiably hinders the other party’s performance under the contract. Second, the implied covenant is breached when a party to a contract acts dishonestly, maliciously or otherwise in subjective bad faith in exercising unqualified discretion that is given to the party in the contract.

In granting Selective’s motion in limine to dismiss Sela’s claim for breach of the implied covenant of good faith, the trial court found the two obligations imposed by the implied covenant to be irrelevant in a case involving the denial of insurance benefits. The court concluded that common law does not impose a broad obligation of reasonableness on insurers. Rather, the only question in a denial-of-benefits case is whether the insurance contract requires the insurer to pay the claim. Such a determination is based on the language of the insurance contract.2

The trial court noted that Minnesota decided to address the issue of unreasonable claims handling through §604.148, and not by importing broad reasonableness obligations into insurance contracts via the implied covenant of good faith and fair dealings. It is within the bad faith claim that Sela will have to prove that Selective did not have a “reasonable basis” for denying his claim and that the person or persons at Selective who denied the claim “knew of the lack of a reasonable basis.” We will have to wait and see if Sela is permitted to recover damages and attorney fees pursuant to Minn. Stat. §604.18, as this part of the case is set for trial in December.
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1 Selective Ins. Co. of South Carolina v. Sela, 2019 WL 3858701 (D. Minn. Aug. 16, 2019).
2 Id. at * 2.

To Claim Damages For Repair Costs Or Not? Beware The Economic Waste Doctrine

J. Curtis Greene | Barnes & Thornburg | October 22, 2019

When claiming damages for construction defects, the doctrine of economic waste is often forgotten or ignored, even among sophisticated parties and counsel, potentially at great cost. Unwary parties to a dispute typically jump to – and focus significant time, money and energy on – seeking damages equal to the cost to repair or replace, without considering what the applicable state law says about economic waste.

In most states, the measure of damages for a construction defect claim center on the cost to repair or replace the defective work, unless the repair cost is clearly disproportionate to the subject property’s probable loss in value because of the construction defect. Put differently, using the repair cost as a measure of damages is “unfair” when such costs are imprudent and unreasonable in light of the property’s probable change in market value if the repair is made.

That’s where the economic waste doctrine comes into play. In such cases, the measure of damages becomes the difference between the fair market value of the property with the defect and without the defect, and the complaining party is not permitted to recover the cost to repair.

Rooted in equity and justice, the economic waste doctrine centers on the idea that, although damages measured by the reduction in property value may not be sufficient to place the injured party in the same position they would have been in if the contract had been properly performed, their financial outcome will be substantially similar.

Take for example a situation where a contractor installed several hundred square feet of expensive ceramic tile in a commercial building, just the wrong color. Or, they installed the wrong brand of windows throughout the building, but with similar performance specifications. Or, they installed a roof with defective discoloration on the backside of a house. It is likely that repairs in any one of these circumstances could result in unreasonable economic waste. Contractors that overlook the economic waste doctrine could find themselves paying substantially more in repair or replacement damages than they may have been required to pay under the law. And, if the complaining party is not prepared to present evidence of the required alternative measure of damages in this situation, it may not be entitled to recover damages at trial.

Jurisdictions differ in how they apply the economic loss doctrine, but here are some considerations that may tip the scale:

  • What would be the probable change in market value of the property if the repair is made? And, to what extent would the cost to repair or replace exceed any decrease in value caused by the defect?
  • Does the claimed defect provide similar general quality and appearance to that which the owner contracted for?
  • Would making the repair require substantial destruction, significant dismantling, or unreasonable expense?
  • To what extent does the defect relate to an aesthetic aspect of the property? Is the defect related to a personal customization? Is it offensive to aesthetic sensibilities?
  • What is the property used for and what is the effect of the defect on such use? Is the property a home, a commercial place of business with customer traffic, or a secluded warehouse or storage facility?
  • Would the damages awarded equitably place the claimant in the position it would have been in had the contract been performed properly?
  • What was the overall condition and age of the property prior to the repairs?
  • Was the contractor’s breach intentional or willful?
  • Is a safety or a health concern involved?

While this list not all-inclusive, it demonstrates that not all damages cases are the same. In most instances, the cost to replace or repair will carry the day, but in some cases the economic waste doctrine may apply. For the alert contractor, invoking the doctrine can substantially impact the ultimate resolution.

Court Holds Documents Created by Counsel During Claims Handling Were Not Privileged

Jason Cieri | Property Insurance Coverage Law Blog | October 16, 2019

We’ve all seen it before. The insured files a claim, the insurance company sends out an adjuster to adjust the loss, the loss is more complex, or a situation arises that the adjuster cannot handle so the insurance company forwards the claim to their legal department. At that point, an attorney becomes involved and the adjustment of the claim, as well as the communication between the parties is limited and calculated.

The decision for an insurance company to involve an attorney in what is commonly understood to be the business function of claims handling has significant implication for the privileges that typically protect against the disclosure of communications with, or work by, such attorneys.

The problem occurs when attorneys, acting as claims handlers (also known as Super Adjusters), improperly undermine policyholders’ interests and cloak such actions behind supposed privileges.

In Otsuka America v. Crum & Forster Specialty Insurance Company,1 the insured sued and filed motions indicating that certain documents that Crum & Forster were withholding as privileged should be discoverable. After conducting an in-camera inspection, the trial court ordered Crum to disclose all documents. Crum moved to reargue the motion citing attorney-client and work-product privileges. The court found that “an attorney’s communication is not privileged when the attorney is hired for business or personal advice, or to do the work of a nonlawyer.” The court also found that “[t]he payment or rejection of claims is a part of the regular business of an insurance company.”

Most importantly, the court ruled that reports prepared by insurance investigators, adjusters, or attorneys prior to the decision on coverage are not privileged even when those reports are multipurpose reports and motivated in part by potential litigation. Additionally, the court stated that a memorandum created by a claims handler allegedly summarizing counsel’s opinion on its investigation of coverage was not protected.

In honor of Breast Cancer Awareness month, I leave you with a quote from author and philanthropist Ann Romney:

Women wear many hats in their lives. Daughter, sister, student, breadwinner. But no matter where we are or what we’re doing, one hat that moms never take off is the crown of motherhood. There is no crown more glorious.

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1 Otsuka America, Inc. v. Crum & Forster Specialty Ins. Co., No. 650463/2018, 2019 WL 4131024 (N.Y. Sup. Ct. August 30, 2019).

Are My Children and Their Spouses Required to Submit to an Examination Under Oath for My Property Damage Claim?

Paul LaSalle | Property Insurance Coverage Law Blog | October 13, 2019

In a recent case, a federal appeals court held that named insureds’ son and daughter-in-law were required to submit to an examination under oath (“EUO”) because they resided in the insureds’ house, and that their failure to do so precluded recovery on the insurance claim.1

In that case, two fires hit the insureds’ home in just seven months. At the time of both fires, the insureds lived with their two sons, their daughter-in-in law, and their grandchild. After the first fire, which was caused by cooking efforts that went awry, the insureds filed an insurance claim. Their insurer subsequently paid them over $600,000, and also paid for the family to live in an apartment temporarily due to the damage to their home.

While the family was still living in the apartment, the insureds filed a second insurance claim seeking approximately $330,000 for additional damage to their home from the second fire. In reviewing the second claim, the insurer hired a private investigator who determined that someone intentionally started the fire. The insurer also discovered that one of the insureds’ sons had been at the house the night of the second fire.

To determine how much coverage, if any, it should provide for the second fire claim, the insurer requested the adult family members to submit to an EUO and asked the insureds to provide tax, bank, phone and Facebook records. The insureds’ son and daughter-in-law refused to make themselves available for a full EUO. Moreover, the insureds never gave the insurer the requested documents.

The insureds filed a breach of contract action when the insurer denied coverage on the second claim. In its defense, the insurer maintained it properly denied the claim because the insureds did not honor the conditions in their insurance policy.

The insureds’ insurance policy required, as a precondition of coverage, that “the insured person … submit to examinations under oath.” The policy defined “insured person” to include the person named in the insurance agreement and that person’s relatives who live in the same house.

The court found that the son and daughter-in-law qualified as insured persons under the policy’s definition. Consequently, their failure to appear for an EUO after repeated requests was a violation of a condition precedent that precluded recovery on their second fire claim. Furthermore, the court held that the named insureds’ failure to provide the requested documents, which were all relevant to whether the insureds committed fraud by starting the second fire, was a violation of the policy’s cooperation clause that also precluded recovery.

If your EUO is requested by an insurer, contact your local Merlin Law Group attorney for proper representation with regard to the EUO.
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1 Durasevic v. Grange Ins. Co. of Michigan, No. 18-2035, 2019 WL 3035750 (6th Cir. July 11, 2019).

Adjusting to Public Adjusters: Avoiding Claim Denials

Gene A. Weisberg | Gladstone Weisberg | September 25, 2019

Innocent policyholders can find their claims denied if their public adjuster commits fraud on a claim.

Courts routinely hold that a public adjuster’s fraud is the policyholder’s fraud, even when done without the policyholder’s knowledge. When a public adjuster or lawyer takes over the claim presentation for the policyholder, and supplies false or inflated claim information, there may be sufficient grounds to void the policy or enforce a misrepresentation or concealment policy exclusion.

The focus on fraud investigations typically is whether the policyholder has misrepresented or concealed a material fact in connection with the claim presentation.

However, when a public adjuster is retained, communications typically go through him or her. General agency law binds the policyholder to what the public adjuster or attorney represented on the policyholder’s behalf, even if the policyholder does not know or understand what is occurring. This is because under agency law, an agent’s actions are considered to be the principal’s actions. Thus, if the public adjuster or lawyer is committing fraud, as a matter of law so is the policyholder client.

Most public adjusters are honest. Yet a persistently large number fraudulently inflates repair claims to increase their own fees, which are a percentage of the insurance payout. This problem is magnified when adjusters try to exploit anxious policyholders after major storms sweep through regions.

If the claim submission includes claims for amounts for which there is no proper basis, such that it meets the standard of intentional misrepresenting or concealing of material facts, this could impact the policyholder’s right to recover any amount. Thus, policyholders are well-advised to pay attention to what the public adjuster does on their behalf, ask questions and otherwise make sure they know what is being represented on their behalf.

Public-adjuster fraud a large concern

Such scams are expensive lessons for policyholders. The fraud provides an important reason for policyholders to stay alert, aware and involved throughout the life of a claim. Innocent policyholders can find themselves forced to pay for significant damage repairs out of pocket when their insurer denies a claim.

Insurers also must stay alert, and work to detect repair scams by public adjusters and lawyers before the claims spiral into costly lawsuits that consume time and money, while also breeding ill will.

Public-adjuster fraud thus remains a significant concern for insurers and their policyholders around the U.S. The home damage can be acute. Policyholders are distraught and often vulnerable to come-ons by public adjusters they hire to help handle their damage claims.

National statistics on public-adjuster fraud are in short supply. The arrests/convictions database of the Coalition Against Insurance Fraud, however, lists 133 records about public-adjuster fraud cases specifically, and 705 fraud articles about adjusters generally.

“The court ordered all payments that the company had made were to be repaid, with interest, because of the public adjuster’s fraud.”

Because an agent’s actions are considered to be the principal’s action, when a public adjuster, who acts as the insured’s agent, fraudulently inflates a claim, even if the policyholder did not know it was inflated, it still is fraud when the public adjuster knew. Several states apply this rule in different contexts to public adjusters and lawyers, and recent civil cases reinforce the general rule.

In New York, a policyholder had to repay money the insurer paid for an inflated claim.1 The public adjuster and a company adjuster worked together to make and pay inflated claims, an arrangement for which both later were criminally convicted. The insurance company sued to recover from the insured all amounts paid on the claims, not only the inflated portions but the entire claim. The court ordered all payments that the company had made were to be repaid, with interest, because of the public adjuster’s fraud.

The court relied on the “well-settled rule that a principal, even if innocent, is liable for acts of fraud that are within the scope of an agent’s actual or apparent authority.” The court explained that this general principle applies in the insurance context:

[A] principal who has expressly or impliedly appointed another person to make proof of loss under an insurance policy is barred from recovery, under a policy which provides that it shall be void for fraud or false swearing of the insured after the loss, where the agent is guilty of fraud or false swearing in or in connection with the proof of loss; and this is so even though the insured is ignorant of the misrepresentation and innocent of any intent to deceive or defraud, and [even when] the act of the agent is to the detriment rather than the benefit of the insured.2

The insureds in Chubb v. Consoli argued that public adjusters should be exempt from general agency principles. The court held that there is no reason to justify such an exemption.

More recently, the Federal Court of Appeals in Colorado rejected an argument that a public adjuster’s submitting an inflated claim without the policyholder’s knowledge is outside the scope of the public adjuster’s agency and adverse to the policyholder’s interest, as the insured sought a ruling that he was not bound by the public adjuster’s fraud.3 The court ruled that it was proper to instruct the jury that the policyholders hired the public adjuster and lawyer “to act as their agents in connection with their insurance claim”, and that “the general agency rule that ‘[t] acts or omissions of the public adjuster and attorney are the acts or omissions of the plaintiffs.’”4

The insureds sought to modify that jury instruction to say that only “legal and authorized” acts or omissions of the public adjuster and attorney were the insured’s acts, based on a theory that a principal is not responsible for the agent’s intentional crimes. The court rejected this argument.

Unlike the New York case, where the claim was paid before the fraud was discovered, in the Colorado case, the insurer was suspicious of the claim.

“The insureds fired the public adjuster and attorney after growing suspicious of their integrity.”

The amount claimed greatly exceeded its experts’ evaluation, and the insurer’s engineer determined that the fire that was the subject of the claim did not cause any of the claimed losses. The insureds fired the public adjuster and attorney after growing suspicious of their integrity. Despite all of these factors, the court held that it was proper to give a jury instruction stating that the policyholders were bound by the public adjuster’s acts or omissions.

In both of these cases, the policyholders signed sworn statements in proof of loss, that the public adjuster prepared, claiming inflated amounts. This was a factor in the courts’ determining that fraud was established.

N.Y. court upholds claim denial

In another New York case, the court affirmed a summary judgment for the insurance company when the claim was denied based on misrepresentation and concealment of material facts when a proof of loss, including duplicative items, was submitted.5 The court found that the proof of loss included duplicative items, items in which it demonstrably had no insurable interest, and claimed loss for debris removal expense it later admitted were never incurred. Moreover, even if these items were put aside, of the nearly $675,000 remaining claimed losses, only $275,000 were supported.

The court stated “[o]vervaluation of insured property raises a presumption of fraud in proportion as to the excess, and such presumption becomes conclusive where, as here, the insurer demonstrates that the difference between the amounts claimed in the proof of loss and the losses actually shown to have been sustained are grossly disparate and without reasonable explanation …”6

The insured sought to attribute the overvaluation solely to its public adjuster. The court said that even if that were true, the public adjuster was acting within the scope of his authority when he submitted the claims. The fact that the insured signed the proof of loss, and was the primary beneficiary of the representations in the proof, also were factors. After all, although public adjusters are paid more when the claim payment is higher because they receive a percentage of the policy benefits paid, the majority of the claim payment goes to the insured.

Court: Public adjuster fraud is insured’s fraud

In Washington State, a Federal District Court similarly found that fraud by the policyholder’s public adjuster was fraud by the insured. This warranted claim denial and the right to a refund of money paid on the claim before the fraud was known.