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December 18, 2002 | Publication| Can It Be 'Bad Faith' For An Insurer To File A Declaratory Action?
This is one of a series of articles under the by line “Butler on Bad Faith” originally published in Mealey's Litigation Report: Insurance Bad Faith, Vol. 16, #16, p. 21 (December 18, 2002). © Copyright Butler 2002.
In recent months, insurance company clients of the author have faced allegations that the filing of a declaratory action, by an insurer, to determine or cut off coverage, is bad faith. This is a somewhat novel and, as it turns out, disfavored cause of action. To begin with, a “declaratory judgment action is the preferred manner of deciding a dispute between an insured and insurer over the construction and effect of the terms of the insurance contract.” Franklin v. Professional Risk Managment Services, Inc., 987 F. Supp. 68, 70 (D. Mass. 1997). Indeed, where there is a coverage dispute during an ongoing third party liability action, it has been called “the better part of wisdom” that the insurance carrier resolve the question “by the simple expedient of a declaratory judgment proceeding at the inception of the litigation.” American Fidelity Fire Ins. Co. v. Johnson, 177 So. 2d 679, 683 (Fla. 1st DCA 1965).
In any event, the author's researches have led to the thoughts herein. The bottom line is - there is no good reason, nor even any need, to allow a bad faith cause of action for the filing of a declaratory action. The fact that an insurer filed a declaratory action, or did not file one, adds nothing to the establishment of liability for bad faith. Moreover, if the insurer files such an action without justification, or for an improper purpose, there already are remedies at common law.
Let us consider a couple exemplary cases.
In State Farm Fire & Casualty Co. v. Trumble, 663 F. Supp. 317 (D. Idaho 1987), there was a fire that destroyed the house of the Trumbles on November 17, 1985. About six weeks later, the Trumbles submitted a sworn statement in proof of loss. The insurer took an examination under oath in March, 1986, and, on the last day of that month, rejected the proof of loss.
One week later, on April 7, 1986, apparently without denying the claim, the insurer filed a declaratory action in the United States District Court for the District of Idaho. The declaratory action asked for a determination of no coverage on grounds of arson and fraud. The Trumbles counterclaimed for, among other things, bad faith.
The insurer filed a motion for summary judgment on the bad faith count only. Although the standard for first party bad faith under Idaho law was “fairly debatable,” White v. Unigard Mut. Ins. Co., 730 P.2d 1014 (1986), the insurer cited, and the District Court accepted, an Arizona case for the bad faith standard - no “reasonable basis” for denial of the claim. In support of the motion, the insurer filed an expert report that the fire was incendiary, and the sworn admission of the Trumbles that they were the only ones in the house when the fire started. The Trumbles opposed the motion with an expert report that the accidental fire started in the kitchen - and that the insurer's expert had not ruled out the kitchen as a place of origin.
[W]hile [the insurer] has the right to file a declaratory judgment action, if the action is shown to have an absence of a reasonable basis, and that no reasonable basis exists for denying the claim causing denial or delay in payment which is unreasonable, then a claim for bad faith may exist. The bad faith claim takes account of all of the activities of the insurer, including the filing of the declaratory judgment action, in an attempt to prove that there is no reasonable basis for denying the benefits of the policy and that [the insurer] had knowledge or reckless disregard in obtaining the knowledge of the lack of a reasonable basis for denying the claim.
663 F. Supp at 320.
Respectfully, the prose is near gibberish, and the conclusion nonsense. If the denial of the claim had no reasonable basis, it does not matter whether the filing of the declaratory action was reasonable. On the other hand, if the denial of the claim was reasonable, so was the filing of the declaratory action. One way or the other, the filing of the declaratory action is irrelevant or surplus to the fundamental issue of “reasonableness.” If, as the District Court agreed, “merely invoking the right to a declaratory judgment action does not, in and of itself, support an action for bad faith,” 663 F. Supp at 320, then it matters not.
One wonders also what would have been the outcome under a “fairly debatable” analysis.
Sinclair Oil Corp. v. Republic Ins. Co. v. Royal Ins. Co. of Am., 967 F. Supp. 462 (D. Wy. 1997), was a pollution exclusion case. Sinclair was the defendant in numerous suits and claims arising out of alleged contamination from a refinery in Wyoming. Sinclair's CGL insurers and its umbrella insurer filed declaratory actions, invoking the “sudden and accidental” language of the applicable exclusions. The case involved certified questions to the Supreme Court of Wyoming, Sinclair Oil Corp. v. Republic Ins. Co. v. Royal Ins. Co. of Am., 929 P.2d 535 (Wyo. 1996) and various proceedings not discussed here. But the germane allegations involved the “litigation conduct” of the insurance carriers.
While the insurance carriers were investigating the claim, to determine if there was coverage for the claims against Sinclair, Sinclair was attempting to settle with the claimants. Sinclair contended the insurance carriers essentially dragged out the investigation, knowing Sinclair was waiting to hear if indemnity dollars would be available to contribute to possible settlement. During that time the carriers promised a prompt decision, but never delivered it. Then they told Sinclair there would be no decision before a pending settlement conference but, the next day, filed a declaratory action in Utah and faxed a denial letter. Sinclair immediately sued the insurance carriers in Wyoming, which resulted in the opinion under consideration here.
At the time of these events there was, in the law of Wyoming, the recent case of Hatch v. State Farm Fire and Cas. Co., 842 P.2d 1089 (Wyo. 1992) (Hatch I). Hatch I established so-called “procedural” first party bad faith. If an insurance carrier used “oppressive and intimidating claims practices” when it “investigated, handled or denied” a claim, that would give rise to a cause of action. It was within the context of a motion for judgment on the pleadings, that the District Court examined the conduct of Sinclair's insurance carriers under the standard in Hatch I. (The District Court did not discuss why a first party bad faith standard was applicable to a third party claim).
In the pleading before the District Court, Sinclair alleged that the umbrella carrier “‘[s]talled' in announcing its secret decision to deny the claim” during the above-mentioned negotiations. 967 F. Supp. at 465. The purpose, alleged Sinclair, was to win the race to the courthouse so it could “‘shop' for and file in what it believed to be a favorable forum.” Id. at 466. The allegations against the CGL carriers were “substantially similar.” Id. at 468.
The District Court granted the motion for judgment on the pleadings.
As a matter of law these allegations do not state a claim for Hatch I-type bad faith. If they did, then every time an insurer filed a declaratory judgment, an insured could bring a Hatch I-type claim simply by alleging that the insurer had concealed that it had secretly made up its mind to deny the claim and had begun preparation for filing a declaratory relief action sometime before telling the insured that is what it intended to do. This would change Hatch I-type bad faith from an examination of the insurer's objective actions in ‘investigation, denial and handling of claims' to examination of an insurer's litigation decisions. Thus, instead of examining the insurer's actions regarding the claim, courts would be required to examine such litigation decisions as to when an insurer made an actual decision to deny a claim in comparison to when it informed the insured, or when the insurer made a decision to deny the claim in comparison to when it filed for declaratory judgment to determine coverage.
The prose is not much better than Trumble, above. But the conclusion is more sound.
One fundamental flaw in the effort of plaintiff lawyers to conjure bad faith out of the filing of a declaratory action is - an aggrieved plaintiff already has an available remedy. If, as was alleged in Trumble, an insurance carrier files a civil action without probable cause, the remedy is an action for malicious prosecution. See, e.g., Robb v. Chagrin Lagoons Yacht Club, Inc., 662 N.E.2d 9, 13 (Ohio 1990). If, as was alleged in Sinclair Oil, an insurance carrier uses a properly filed civil action “to accomplish an ulterior or wrongful purpose,” the remedy is an action for abuse of process. See, e.g., Toste Farm Corp. v. Hadbury, Inc., 798 A.2d 901, 907 (R.I. 2002). In either case, there is no need for the law to recognize another cause of action based on the same alleged conduct.
Furthermore, as discussed in connection with Trumble, it adds nothing to a first party bad faith claim that an insurance carrier did or did not file a declaratory action. Either the claim was denied wrongfully, or it was not. The rightness or wrongness of the declaratory action is dependent on that fundamental determination, and adds nothing to the case.
Finally, in the third-party setting, it might be bad faith not to file a declaratory action where there is a discovery dispute and ongoing litigation. This wise and “preferred manner” of deciding the question settles the doubts both of the insured and the insurance carrier sooner rather than later. The law ought not discourage that beneficial practice.

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