Opinion ID: 1179883
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Heading: Are bad faith claims governed by a tort or a contract statute of limitations?

Text: Bad faith actions against insurers usually fall into the category of first-party or third-party actions, depending on the type of coverage at issue. Clearwater v. State Farm Mut. Auto. Ins. Co., 164 Ariz. 256, 258, 792 P.2d 719, 721 (1990). An action alleging that the insurer acted in bad faith in its duty to indemnify or protect the insured from third-party claims is governed by a third-party claims analysis, regardless of whether the insured or the third party sues the insurer. Id. In contrast, first-party actions arise out of a direct obligation by which the carrier contracts to pay benefits directly to the insured (or a beneficiary) for losses incurred by either. Id.; see also Department of Ins. Rules, Art. 8, R4-14-801(B)(4), (10) (defining first- and third-party claimants). Because Taylor's action finds fault with State Farm's failure to protect Taylor from Rivers' claim, the third-party analysis applies. A cause of action for bad faith refusal to settle was recognized by this court as a valid third-party claim in Farmers Ins. Exch. v. Henderson, 82 Ariz. 335, 338, 313 P.2d 404, 405-06 (1957). The cause of action stems from the duty of good faith and fair dealing, which is derived from the underlying contractual relationship and is implied in all contracts. Rawlings v. Apodaca, 151 Ariz. 149, 154, 726 P.2d 565, 570 (1986); Wagenseller v. Scottsdale Memorial Hospital, 147 Ariz. 370, 383, 710 P.2d 1025, 1038 (1985). The duty of good faith requires that neither party act in a manner that would damage the rights of the other party to receive the benefits flowing from the underlying contractual relationship. Rawlings, 151 Ariz. at 153-54, 726 P.2d at 569-70; Wagenseller, 147 Ariz. at 383, 710 P.2d at 1038. Although the underlying contract provides the basis for a bad faith action, this court has recognized the insurance carrier's breach of the duty of good faith as a tort. Noble v. National Am. Life Ins. Co., 128 Ariz. 188, 189, 624 P.2d 866, 867 (1981). Moreover, the court of appeals has applied the tort statute of limitations to bad faith claims. Ness v. Western Sec. Life Ins. Co., 174 Ariz. 497, 500, 851 P.2d 122, 125 (App. 1992). [3] California has expressly recognized that a liability insurer's breach of the duty of good faith when considering a settlement with a third-party claimant is a tort. Crisci v. Security Ins. Co., 66 Cal.2d 425, 58 Cal. Rptr. 13, 426 P.2d 173 (1967). This court, however, has never decided as a contested issue which statute of limitations applies to an action for bad faith failure to settle. Due to the nature of the underlying dispute in a third-party failure-to-settle claim, and the historical development of bad faith law, we believe the tort statute of limitations is appropriate. In Rawlings, this court was asked to decide for the first time whether the covenant of good faith and fair dealing in a first-party claim sounded in tort or contract. In constructing the appropriate framework, we noted that the insurance relationship is unique from that of other contracts because it is characterized by elements of public interest, adhesion, and fiduciary responsibility. 151 Ariz. at 158, 726 P.2d at 574. The insured receives intangible benefits from the relationship, such as peace of mind and the knowledge that the carrier will give equal consideration in all matters to the insured's interests. Id. at 157, 726 P.2d at 573. When the carrier fails to deliver these non-commercial benefits, contract damages are seldom adequate. Id. at 159, 726 P.2d at 575. Moreover, because the insured may be injured when the insurer manipulates its bargaining power to its own advantage, the insurer may breach its duty of good faith without actually breaching express covenants in the contract. Likewise, the insurer may breach an express covenant without breaching the implied covenant of good faith and fair dealing. Id. at 157-60, 726 P.2d at 573-76. We noted this distinction in Rawlings and stated that in special contractual relationships, when one party intentionally breaches the implied covenant of good faith and fair dealing, and when contract remedies serve only to encourage such conduct, it is appropriate to permit the damaged party to maintain an action in tort and to recover tort damages. Id. at 160, 726 P.2d at 576. Taylor acknowledges that Rawlings allowed a first-party bad faith claim to proceed in tort but urges that it notes a lack of consensus on the nature of bad faith claims. We recognize the almost even split in jurisdictions regarding which rubric best fits bad faith claims and that bad faith actions contain characteristics of both tort and contract. However, we believe the Rawlings' rationale is especially applicable to third-party cases like the one before us because the relationship between the parties, rather than any express contractual provisions, begets the cause of action. [4] Here, Taylor purchased insurance from State Farm to obtain protection that could exist only if State Farm would in good faith defend any covered claims made against him. By implication, State Farm necessarily had a duty to consider settling. Henderson, 82 Ariz. at 341, 313 P.2d at 408. Because Taylor's injury resulted from State Farm's failure to give equal consideration to his interests when refusing to settle with Rivers  a breach of State Farm's implied duty of good faith  it is more appropriate that Taylor's third-party claim for bad faith failure to settle be governed by the tort statute of limitations. Thus, the two-year period from accrual, specified in A.R.S. § 12-542, applies. See Richardson v. Allstate Ins. Co., 117 Cal. App.3d 8, 172 Cal. Rptr. 423, 426 (1981) (the nature of the right sued upon determines the appropriate statute of limitations) (quoting Jefferson v. J.E. French Co., 54 Cal.2d 717, 7 Cal. Rptr. 899, 900, 355 P.2d 643, 644 (1960)); Employers' Fire Ins. Co. v. Love It Ice Cream Co., 64 Or. App. 784, 670 P.2d 160 (1983).