Opinion ID: 1530347
Heading Depth: 2
Heading Rank: 3

Heading: The Insurer's Implied Covenant of Good Faith and Fair Dealing

Text: The requirement that all parties to an insurance contract act in good faith toward one another spans at least three centuries of American legal thought. [16] By the twentieth century, courts and commentators clarified the doctrine, steadily referring to the newly-coined implied covenant of good faith and fair dealing. [17] Despite its evolution, the term good faith has no set meaning, serving only to exclude a wide range of heterogeneous forms of bad faith. [18] The covenant is best understood as a way of implying terms in the agreement, [19] whether employed to analyze unanticipated developments [20] or to fill gaps in the contract's provisions. [21] Existing contract terms control, however, such that implied good faith cannot be used to circumvent the parties' bargain, [22] or to create a free-floating duty ... unattached to the underlying legal document. [23] Thus, one generally cannot base a claim for breach of the implied covenant on conduct authorized by the terms of the agreement. [24] Recognized in many areas of the law, [25] the implied covenant attaches to every contract, [26] including contracts of insurance. [27] Stated in its most general terms, the implied covenant requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain. [28] Thus, parties are liable for breaching the covenant when their conduct frustrates the overarching purpose of the contract by taking advantage of their position to control implementation of the agreement's terms. [29] This Court has recognized the occasional necessity of implying contract terms to ensure the parties' reasonable expectations are fulfilled. [30] This quasi-reformation, however, should be [a] rare and fact-intensive exercise, governed solely by issues of compelling fairness. [31] Only when it is clear from the writing that the contracting parties would have agreed to proscribe the act later complained of ... had they thought to negotiate with respect to that matter may a party invoke the covenant's protections. [32] As noted earlier, the implied covenant of good faith and fair dealing doctrine applies to insurance contracts. But, in that context, the case law frequently (and unfortunately) equates a lack of good faith with the presence of bad faith, [33] and the parameters of an action for bad faith refusal to pay insurance proceeds are well settled. [34] Thus, in this case, State Farm's refusal to cooperate with the Dunlaps did not subject it to liability for bad faith, because its conduct did not involve the failure or refusal to pay an insurance claim. Moreover, even if this were deemed to be a failure-to-pay case, State Farm reasonably relied on the exhaustion provision. The question thus becomes whether the scope of the duty arising out of the covenant of good faith and fair dealing is limited to the insurance company's obligation to fairly and promptly process and pay its insured's claims. The answer to that question is no. State Farm learned the answer to that question in a case decided in another jurisdiction. In Schwartz v. State Farm Fire and Casualty Company, [35] two people were seriously injured by an uninsured motorist. Andrew Schwartz, one of the injured, had a primary policy with another insurance company, and a $2 million umbrella policy with State Farm. The excess policy applied only when... there is payment by your underlying coverage. [36] Elliot Weinstein, the other injured party, was covered by Schwartz's policies because he was a passenger in Schwartz's car. Both men submitted demands for policy limits to the primary insurer and State Farm. Weinstein obtained full payment from the primary insurer, and concluded his arbitration with State Farm before Schwartz. Without notifying Schwartz, State Farm paid Weinstein approximately $1.5 million of the $2 million in available excess coverage. A few months later, when Schwartz received full payment from the primary insurer, he notified State Farm and was paid the remaining $471,960. Schwartz sued State Farm, alleging that State Farm knew to a reasonable degree of certainty that the two claims would exceed all available policy limits but failed to take any steps to protect Schwartz's claim. [37] State Farm argued that it had no duty to Schwartz until such time as the primary insurance was exhausted, and that it complied with its duty to pay as soon as the exhaustion requirement was satisfied. The Schwartz court disagreed, holding that State Farm breached the implied covenant of good faith and fair dealing: We conclude that the duty applies to an excess insurer, just as it does to a primary insurer. We reject the notion that, simply because a condition precedent to a particular obligation  the obligation to pay  has not yet occurred, the insurer is relieved of the implied covenants that inhere in every contract. [38] The court continued: There was no doubt that the Schwartzes' claim would be covered by the State Farm policy once the primary insurer exhausted policy limits. As an excess insurer, State Farm, like any other insurer, was obliged under the implied covenant of good faith and fair dealing to do nothing to impair the Schwartzes' right to the benefits of the agreement. Payment in full to its other insured, the Weinsteins, might well impair those rights if that payment prevented the Schwartzes from receiving a fair share of benefits under the policy. That is for jury determination at trial. [39] Other jurisdictions, using similar reasoning, have found breaches of the implied covenant of good faith and fair dealing based on conduct other than a failure to process or pay claims promptly. For example, in Rawlings v. Apodaca , the Arizona Supreme Court noted that, [t]he implied covenant is breached, whether the carrier pays the claim or not, when its conduct damages the very protection or security which the insured sought to gain by buying insurance. [40] In that case, the insurer withheld an investigative report that its insured needed to assert a claim against the tortfeasor, who was insured by the same carrier. See, also: Union Bankers Ins. Co. v. Shelton, 889 S.W.2d 278, 283 (Tex.1994) (holding that insurer breaches implied covenant of good faith and fair dealing when it cancels insured's health policy without reasonable basis.) Delaware, likewise, recognizes that the covenant of good faith and fair dealing implied in all contracts comprehends duties other than the duty to promptly process and pay claims. Our courts have held that the covenant also requires an insurer to notify its insured of the policy's limitations period if that time limit is shorter than the applicable State statute of limitations. [41] Similarly, an insurer may not deny coverage based on an insured's failure to give notice of a claim unless the insurer establishes that it was prejudiced by the lack of notice. [42] In sum, the implied covenant of good faith `is the obligation to preserve the spirit of the bargain rather than the letter, the adherence to substance rather than form....' [43] It requires more than just literal compliance with the policy provisions and statutes. The implied covenant of good faith and fair dealing requires that the insurer act in a way that honors the insured's reasonable expectations. [44]