Reverse bad faith refers to a cause of action which would allow the insurance company to assert a counterclaim for affirmative relief against an insured who brought a frivolous, bad faith action. Steven Plitt and Jordan R. Plitt, 1 Practical Tools for Handling Insurance Cases, § 7:18 (Thomson Reuters 2011). A reverse bad faith claim is “an independent tort that allows an insurer to seek affirmative relief for an insured’s breach of the duty of good faith and fair dealing.” Legal commentators have addressed arguments both for and against the adoption of a cause of action for reverse bad faith and are split on the issue. A common law tort for reverse bad faith has not yet been recognized in any jurisdiction. However, only a handful of jurisdiction have even addressed the issue. See, e.g., Tokles & Sons, Inc. v. Midwestern Indem. Co., 65 Ohio St.3d 621, 605 N.E.2d 936, 945 (Ohio 1972); Johnson v. Farm Bureau Mut. Ins. Co., 533 N.W.2d 203, 208 (Iowa 1995); First Bank of Turley v. Fidelity and Deposit Ins. Co. of Maryland, 1996 OK 105, 928 P.2d 298, 308 (Okla. 1996); Agricultural Ins. Co. v. Superior Court, 70 Cal.App.4th 385, 82 Cal.Rptr.2d 594, 595 (Cal. Ct. App. 1999). See also In re Tutu Water Wells Contamination Litigation, 78 F.Supp.2d 436, 452 (D. V.I. 1999) (“thus, the mere assertion by Cigna that the insured shares a similar contractual duty of good faith, without more, necessarily fails to rise to the exceptional level required for imposition of tort liability”).
Recently, the Sixth Circuit Court of Appeals, predicting whether Kentucky would recognize an independent tort of reverse bad faith, concluded that Kentucky would not recognize the tort.
The Court in State Auto Property & Cas. Ins. Co. v. Hargis, 785 F.3d 189 (6th Cir. 2015) predicted that Kentucky courts would not permit a tort action for reverse bad faith. In this case, the insured, Lori Hargis (Hargis), insured her home with State Auto under a standard homeowner’s policy. The house burned to the ground in the early morning hours of December 9, 2007. The home was not occupied at the time of the fire. The Kentucky State Police and State Auto both determined that the fire was intentionally set. Hargis filed a claim which she later admitted was fraudulent. Prior to her admission of fraud, State Auto paid out in excess of $425,000, including a mortgage payoff of $386,720.34. State Auto commenced an action in state court to declare the policy void based on what it believed was fraud. Hargis removed the case to federal court and asserted a counterclaim against State Auto for breach of contract and bad faith under the common law of Kentucky, breach of Kentucky’s Consumer Protection Act (KCPA) and the Kentucky Unfair Claims Settlement Practices Act (KUCSPA). However, State Auto’s investigation eventually led to Hargis’s admission that she had solicited a friend to burn down her house to collect the insurance proceeds. The investigation resulted in a federal indictment that charged Hargis and her friend with conspiracy to use fire to commit wire fraud. Hargis plead guilty to these charges and admitted during the change-of-plea hearing that she had solicited her friend to burn down the house for $10,000 from the insurance proceeds, as well as other misconduct. Hargis was sentenced to a 60-month prison term and was ordered to pay restitution to State Auto. The restitution ordered that Hargis pay the full amount sought by State Auto.
When the indictment was returned against Hargis, State Auto moved for partial summary judgment in its favor regarding Hargis’s bad faith claims. The motion was granted with the Court finding that State Auto’s refusal to pay the claim was at least fairly debatable and that the indictment provided further support for the Court’s belief regarding fair debatability.
Initially the case was stayed pending resolution of the criminal case. After the criminal case was resolved, State Auto moved for summary judgment in its favor on all remaining claims. Hargis opposed summary judgment with respect to State Auto’s claim for reverse bad faith. The District Court granted State Auto’s motion for summary judgment in part and denied it in part. First, the District Court declared that State Auto had no further obligations under the policy and that the policy was void ab initio. The Court awarded damages for Hargis’s fraudulent insurance acts to the extent State Auto was not fully compensated by the order of restitution entered in the criminal case. Finally, the Court rejected State Auto’s claim for reverse bad faith. In rejecting the reverse bad faith claim, the Court stated:
[State Auto] argues that the Court should recognize a cause of action of reverse bad faith in the insurance context and award [State Auto] damages associated with Plaintiff’s fraudulent claim. [State Auto] maintain[s] that there is a 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. . . .
[State Auto cites] no Kentucky case that has adopted the claim by an insurer for reverse bad faith against an insured. In fact, the Court is not aware of any jurisdiction that has recognized a cause of action for reverse bad faith. (Citations omitted) This Court likewise declines to do so.
On appeal, because there was no controlling decision from the Kentucky Supreme Court, the Sixth Circuit Court of Appeals was compelled to predict how the Kentucky Supreme Court would rule on the issue of reverse bad faith by looking to all of the available data.
In support of the prediction that the Kentucky Supreme Court would adopt reverse bad faith, State Auto relied upon the general description offered by the Kentucky Supreme Court regarding the common law, as a “moving stream” that “seeks to purify itself as it flows through time” and the statement that “[a]bove all else, court-made law must be just.” However, the Court found that it was only in the most general sense that the cases relied upon by State Auto offered any insight into how the Kentucky Supreme Court would resolve the reverse bad faith issue on first impression.
One recurring feature of the decisions that had been offered by the Kentucky Supreme Court was that the Court considered how other courts would address the issue.
State Auto argued that because there were no decisions in Kentucky or elsewhere that recognized a common law claim for reverse bad faith, there was no reason to conclude that the Kentucky Supreme Court would not decide to allow the tort for an insured’s bad faith since the implied covenant of good faith and fair dealing in Kentucky imposed contractual obligations on both parties. Therefore, State Auto contended that it would be unjust for Kentucky law to allow the insured to assert a common law tort claim for bad faith without having to face the threat of a reciprocal tort claim for reverse bad faith.
The Sixth Circuit acknowledged that Kentucky law implied a covenant of good faith and fair dealing into all contracts and that the covenant of good faith was reciprocal. The Court also acknowledged that, under Kentucky law, a breach of the covenant of good faith could be a viable basis for a breach of contract claim. Finally, the Court noted that a separate tort claim for bad faith arose from a violation of a duty to act in good faith but that bad faith was imposed by the common law and not the terms of the contract. Under Kentucky law, an independent tort claim for breach of the duty of good faith was permitted only where there was a special relationship between the parties and where distinct elements were present such as unequal bargaining power, vulnerability, and trust among the parties. The fact that Kentucky had only recognized a breach of the implied covenant of good faith and fair dealing as a tortious breach when it involved parties in a special relationship not found in ordinary commercial settings, such as between an insurer and insured, where additional elements of unequal bargaining power, vulnerability and trust among the parties existed, undercut State Auto’s contention that the mutuality of the implied contractual obligation alone would lead the Kentucky Supreme Court to adopt a common law for reverse bad faith.
Next, the Court considered the fact that the Kentucky Legislature adopted the KUCSPA demonstrating that the Legislature believed insureds were in need of protection but that insurers were not.
It was significant to the Court that a common law tort claim for reverse bad faith had not been recognized in any other jurisdiction.
Finally, the Court addressed State Auto’s theme that it would be “unjust” for Kentucky law to allow Hargis to escape the consequences of her intentionally fraudulent conduct. The Court dismissed this plea by noting that Hargis did not escape the consequences of her intentionally fraudulent conduct, but instead had a civil judgment against her for all of the damages incurred by State Auto and had been criminally convicted for her fraudulent conduct. State Auto’s argument that the threat of punitive damages was necessary to deter such fraudulent conduct was, to the Court, hard to imagine. The Court found it hard to imagine that a possible claim for reverse bad faith would be a deterrent if the threat of criminal prosecution was not.
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