Opinion ID: 2636865
Heading Depth: 2
Heading Rank: 2

Heading: Comparative Bad Faith as an Affirmative Defense in a Third Party Insurance Bad Faith Action

Text: Should AES be permitted to assert Kransco's comparative bad faith as an affirmative defense in the bad faith action brought against it by Kransco for breach of the covenant of good faith and fair dealing? More specifically to the facts at hand, may an insurer that breaches the covenant of good faith and fair dealing, by failing to settle a third party action within policy limits when there is a substantial risk of an excess judgment, later fault the insured's litigation misconduct for contributing to the amount of the verdict in excess of policy limits? In entering judgment notwithstanding the verdict, and in affirming that judgment on appeal, the trial court and Court of Appeal correctly answered no. To be sure, the duty of good faith and fair dealing in an insurance policy is a two-way street, running from the insured to his insurer as well as vice versa. ( Commercial Union Assurance Companies v. Safeway Stores, Inc., supra, 26 Cal.3d at p. 918, 164 Cal.Rptr. 709, 610 P.2d 1038.) But the scope of the insured's duty of good faith and fair dealing, and the remedies available to the insurer for a breach of that duty, are fundamentally and conceptually distinct from the insurer's reciprocal duty, and the remedies available to the insured for breach of that duty, under the insurance policy. As this court has explained, it is an insurer's breach of the covenant of good faith that is governed by tort principles, at least as concerns the availability of tort damages. ( Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566, 574, 108 Cal.Rptr. 480, 510 P.2d 1032 ( Gruenberg ).) In contrast, an insured's breach of the covenant is not a tort. (See California Fair Plan Assn. v. Politi (1990) 220 Cal.App.3d 1612, 1618, 270 Cal.Rptr. 243.) An insurer's tort liability is predicated upon special factors inapplicable to the insured. ( Foley, supra, 47 Cal.3d at pp. 684-685, 254 Cal.Rptr. 211, 765 P.2d 373 [insurer tort liability based on special relationship with insured]; California Fair Plan Assn. v. Politi, supra, 220 Cal.App.3d at pp. 1618-1619, 270 Cal.Rptr. 243 [same].) We suggested in Gruenberg, supra, 9 Cal.3d 566, 108 Cal.Rptr. 480, 510 P.2d 1032, that an insurer's breach of the covenant of good faith and fair dealing is not directly comparable with the insured's contractual breach, concluding that the insured's alleged contractual breach of the policy's cooperation clause by failing to submit to an examination and produce requested documents did not excuse the insurer's duty of good faith and fair dealing. ( Id. at pp. 576-578, 108 Cal.Rptr. 480, 510 P.2d 1032.) We observed that the insurer's duty is unconditional and independent of the performance of [the insured's] contractual obligations. ( Id. at p. 578, 108 Cal.Rptr. 480, 510 P.2d 1032, italics added.) Applying comparative fault principles (see Li v. Yellow Cab Co. (1975) 13 Cal.3d 804, 119 Cal.Rptr. 858, 532 P.2d 1226) [9] by recognizing a comparative bad faith defense in a third party insurance bad faith action would set the insurer's tortious breach of the covenant against the insured's contractual breach of the covenant, even though contractual breaches are generally excluded from comparative fault allocations. (See 12 West's U. Laws Ann. (1996) U. Comparative Fault Act, com. to § 1, p. 128 [comparative fault inapplicable to actions that are fully contractual in their gravamen].) This distinction between tort and contract liabilities convinced one state supreme court to reject comparative bad faith as a defense in a bad faith action against an insurer (the [insurer's] tort cannot be offset comparatively by the [insureds'] contract breach) and characterize the differing legal concepts as apples and oranges. ( Stephens v. Safeco his. Co. of America (1993) 258 Mont. 142, 852 P.2d 565, 568-569; see also First Bank v. Fidelity and Deposit Ins. (Okla.1996) 928 P.2d 298, 306-309 ( First Bank ) [rejecting comparative bad faith defense for an insured's misperformance of its contractual duties in a bad faith action against the insurer for refusal to defend].) In First Bank, supra, 928 P.2d 298, the Oklahoma Supreme Court noted its reliance on this court's jurisprudence ( Crisci v. Security Ins. Co., supra, 66 Cal.2d 425, 58 Cal.Rptr. 13, 426 P.2d 173; Comunale v. Traders & General Ins. Co., supra, 50 Cal.2d 654, 328 P.2d 198) in adopting as the law in Oklahoma California's treatment of an insurer's bad faith refusal to settle a claim as a tort. ( First Bank, supra, 928 P.2d at p. 306.) The First Bank court, however, rejected the rationale of a subsequent California Court of Appeal decision California, Casualty Gen. Ins. Co. v. Superior Court (1985) 173 Cal.App.3d 274, 283, 218 Cal.Rptr. 817 ( California Casualty )which for the first time held that in a bad faith action the insurer could interpose as a defense the tort concept of comparative fault, in an entirely new form known as comparative bad faith. [10] In the Court of Appeal and now in this court, AES places principal reliance on California Casualty. Although California Casualty involved a bad faith action by an insured against her insurer for breach of the covenant of good faith and fair dealing, it did not, as in this case, involve a claim of bad faith refusal to settle a third party action within policy limits on the insured's behalf. The insured in California Casualty asserted her automobile insurer in bad faith had failed to pay a claim she had suffered under the uninsured motorist provisions of her automobile policy. ( California Casual, supra, 173 Cal.App.3d at pp. 276-277, 218 Cal. Rptr. 817.) The insurer in turn sought to assert as an affirmative defense that the insured and her attorney `[were] guilty of bad faith conduct in the prosecuting, handling and management of [her] uninsured motorist claim.' ( Id. at, p. 277, 218 Cal. Rptr. 817.) The California Casualty court set the insurer's breach of the covenant of good faith and fair dealing against the insured's breach in applying principles of comparative fault, and held that an insurer sued by its insured for failure to pay her claim for uninsured motorist coverage may allege the insured's comparative bad faith as an affirmative defense. ( California Casualty, supra, 173 Cal.App.3d at pp. 276-284, 218 Cal.Rptr. 817.) The court ruled that the insured's undue delay in submitting information necessary to process her claim, which contributed to the insurer's failure to pay the claim, may reduce the insured's recovery for damages resulting from the insurer's bad faith nonpayment. ( Id. at p. 283, 218 Cal.Rptr. 817.) Responsibility and liability for damages were to be allocated between insurer and insured in proportion to the amount of bad faith attributable to each party. ( Ibid.; cf. Li v. Yellow Cab Co., supra, 13 Cal.3d at p. 829, 119 Cal.Rptr. 858, 532 P.2d 1226 [adopting and explaining comparative negligence standards].) The California Casualty court's recognition of a comparative bad faith defense sounding in tort does not withstand scrutiny in light of the authorities discussed above distinguishing an insurer's tortious breach of the covenant from an insured's contractual breach. The court reasoned that the comparative fault tort doctrine should apply to insurance bad faith cases because breach of the covenant is a tort: While the duty of good faith and fair dealing arises out of a contractual relationship between the parties, breach of the duty and ensuing damages are governed by tort principles. ( California Casualty, supra, 173 Cal.App.3d at p. 283, 218 Cal. Rptr. 817.) What the California Casualty court overlooked, however, is that it is an insurer's breach of the covenant of good faith and fair dealing that is governed by tort principles. ( Gruenberg, supra, 9 Cal.3d at p. 574, 108 Cal.Rptr. 480, 510 P.2d 1032.) An insured's breach of the covenant is not a tort, and hence does not give rise to tort damages recoverable by the insurer. ( California Fair Plan Assn. v. Politi, supra, 220 Cal.App.3d at p. 1618, 270 Cal.Rptr. 243.) As the Court of Appeal below recognized, the California Casualty court's holding is grounded on the faulty premise that the obligations of insurer and insuredand thus their bad faithare comparable. They are not. The parties are bound by a reciprocal obligation of good faith and fair dealing, but the particular duties differ given the differing performance due under the contract of insurance. A fundamental disparity exists between the insured, which performs its basic duty of paying the policy premium at the outset, and the insurer, which, depending on a number of factors, may or may not have to perform its basic duties of defense and indemnification under the policy. (See Foley, supra, 47 Cal.3d at p. 693, 254 Cal.Rptr. 211, 765 P.2d 373 [noting the insurer's and insured's interest are financially at odds].) An insured is thus not on equal footing with its insurerthe relationship between insured and insurer is inherently unequal, the inequality resting on contractual asymmetry. An insurer's tort liability for breach of the covenant is thus predicated upon special policy factors inapplicable to the insured. ( Foley, supra, 47 Cal.3d at pp. 684-685, 254 Cal.Rptr. 211, 765 P.2d 373.) The scope of the insured's duty of good faith and fair dealing in turn is confined by the express contractual provisions of the policy. ( Western Polymer Technology, Inc. v. Reliance Ins. Co., supra, 32 Cal.App.4th at p. 24, 38 Cal. Rptr.2d 78.) An insured's reciprocal duty of good faith and fair dealing does not always necessitate reciprocal conduct. (See, e.g., Commercial Union Assurance Companies v. Safeway Stores, Inc., supra, 26 Cal.3d at pp. 917-921, 164 Cal.Rptr. 709, 610 P.2d 1038 [insurer may be obligated to accept a settlement offer to protect its insured from personal liability but insured is not similarly obligated].) Because an insured's breach of the covenant does not sound in tort, the insured's contractual breach of an express policy provision cannot be raised by the insurer as a defense in a bad faith action brought against it by the insured. It would be illogical to allow the insurer in such a suit to instead interpose as a defense the insured's contractual breach of an implied policy provision (i.e., the covenant of good faith and fair dealing) based on those same express policy terms. The recent decision in Agricultural Ins. Co. v. Superior Court (1999) 70 Cal. App.4th 385, 82 Cal.Rptr.2d 594 ( Agricultural ) is in accord. Agricultural involved a bad faith action arising out of an insurance claim for earthquake damage. After the insurer paid the claim in part, controversies arose, ultimately leading to the insured's suit for breach of contract and bad faith. The trial court stayed the action to allow the insurer to complete its investigation. The insurer did, and then cross-complained, contending that the insured's claim was in significant part falsified. The insurer pleaded various contract theories, and also the tort theories of fraud and so-called reverse bad faith, i.e., tortious breach of the covenant of good faith and fair dealing by the insured. The insured demurred to the tort theories, and the trial court sustained the demurrers without leave to amend. ( Id. at p. 389, 82 Cal. Rptr.2d 594.) In denying in part the insurer's petition for a writ of mandate to set aside the trial court's order sustaining the demurrer to the reverse bad faith cross-claim, the Agricultural court explained: An insurer has no claim against its insured in tort for breach of the covenant of good faith and fair dealing. A breach of this covenant is, at base, a breach of contract. A relationship including specialized circumstances of reliance and dependence is necessary to transmute such a contractual breach into a tort. Such circumstances do not exist in the context of an insured's responsibilities toward its insurer, or in the reciprocal context of an insurer's legitimate expectations from its insured. Although a false claim by an insured might trigger adverse contractual or penal consequences, the obligations undertaken by an insured in entering into an insurance contract are simply not of the same character as the obligations undertaken by an insurer. Hence an insured does not bear a risk of affirmative tort liability for failing to perform the panoply of indefinite but fiduciary-like obligations contained within the concept of `insurance bad faith.' The trial court therefore correctly sustained the insured's demurrer to the insurer's `reverse bad faith' claim.... ( Agricultural, supra, 70 Cal.App.4th at pp. 389-390, 82 Cal.Rptr.2d 594.) In granting in part the insurer's petition for mandamus relief to set aside the trial court's order sustaining the demurrer to the fraud cross-claim, the Agricultural court explained: Although an insured does not bear the type of obligations which can give rise to a claim for tortious breach of covenant, an insuredno different than everyone elsehas a duty not to defraud. Firstly, an insured must not defraud in the procurement of the policy. Secondly, an insured must not defraud in making a claim on the policy. When an insured makes a claim to its insurer, the insurer's duty to investigate is triggered. If, because of the insured's false factual assertions, the insurer incurs expenses that would otherwise not have been necessary, justifiable detrimental reliance can be pleaded by the insurer. Although a mere inflated opinion of a claim's value is not fraud, deliberately false factual assertions can be fraud. There is a significant distinction between a mere aggressive claims position and an outright factual fraud. Hence the insurer's petition will be granted to the extent of directing the trial court to vacate its order sustaining without leave to amend as to the fraud cause of action.... ( Agricultural, supra, 70 Cal. App.4th at p. 390, 82 Cal.Rptr.2d 594.) We agree with the analysis and holding in Agricultural and disagree with the California Casualty court's extension of tort comparative fault principles to an insured's contractual breach of the covenant of good faith and fair dealing. By allowing an insurer to assert a defense of comparative bad faith, California Casualty 's holding misleadingly equates an insured's contractual breach of the reciprocal covenant of good faith and fair dealing with an insurer's tortious breach of the covenant. The holding is confusing and inconsistent insofar as it acknowledges an insured's breach of the covenant is not actionable in tort, but nonetheless can give rise to tort consequences because the insurer may assert it as a defense in a bad faith action to lessen responsibility for its own tortious conduct. [11] The Chief Justice disagrees, observing that in Knight v. Jewett (1992) 3 Cal.4th 296, at pages 314-315, 11 Cal. Rptr.2d 2, 834 P.2d 696, this court explained that the comparative fault doctrine is a flexible, commonsense concept, under which a jury properly may consider and evaluate the relative responsibility of various parties for an injury in order to arrive at an equitable apportionment or allocation of loss. (Cone. & dis. opn. of George, C. J., post, 97 Cal.Rptr.2d at p. 169, 2 P.3d at p. 17.) In the context of comprehensive general liability coverage, however, the insured is purchasing insurance in exchange for the payment of premiums precisely to avoid financial liability for its own negligent or fault-based conduct causing injury to others, and to further insure against the inherent risks of litigation that can result in a larger verdict against it, up to the amount of its policy limits. Hence, when an insured sues its liability insurer for breach of its express promise to defend and indemnify the insured against injury claims, and for breach of the concomitant duty to reasonably settle third party claims within policy limits under the covenant of good faith and fair dealing, commonsense notions of relative responsibility of the parties for proximate causation of an injury, equitable allocation of loss, and indeed responsibility for less-than-perfect litigation conduct that leads to an inflated verdict, have limited, if any, application. We agree with the Court of Appeal below that the jury should not have been instructed at all with principles of comparative bad faith, and accordingly reject AES's argument that it was error to affirm the trial court's judgment notwithstanding the verdict entered in Kransco's favor. We observe that rejection of comparative bad faith in this context does not leave the insurer without remedies for an insured's breach of the covenant of good faith and fair dealing. Evidence of an insured's misconduct may factually disprove the insurer's liability for bad faith by showing the insurer acted reasonably under the circumstances. ( Blake v. Aetna Life Ins. Co. (1979) 99 Cal.App.3d 901, 918-924, 160 Cal.Rptr. 528 [no insurer liability]; see also Campbell v. Allstate Ins. Co. (1963) 60 Cal.2d 303, 305, 32 Cal.Rptr. 827, 384 P.2d 155 [breach of cooperation clause]; Pry or, Comparative Fault and Insurance Bad Faith (1994) 72 Tex. L.Rev. 1505, 1522-1525 [discussing contract defenses].) The insured's breach of the covenant of good faith and fair dealing is also separately actionable as a contract claim. ( California Fair Plan Assn. v. Politi, supra, 220 Cal.App.3d at pp. 1614, 1618, 270 Cal.Rptr. 243.) Some forms of misconduct by an insured will void coverage altogether under the insurance policy. (See Imperial Cas. & Indem. Co. v. Sogomonian (1988) 198 Cal.App.3d 169, 182, 243 Cal.Rptr. 639 [material misrepresentation of policy application].) Of course, without coverage there can be no liability for bad faith on the part of the insurer. ( Waller v. Truck Ins. Exchange (1995) 11 Cal.4th 1, 36, 44 Cal.Rptr.2d 370, 900 P.2d 619.) And, as explained in Agricultural, supra, 70 Cal.App.4th at page 390, 82 Cal. Rptr.2d 594, an insured's fraudulent misconduct is separately actionable and can give rise to tort damages. These remedies adequately serve to protect an insurer from the insured's misconduct without creating the logical inconsistencies and troublesome complexities of a defense of comparative bad faith. The focus of AES's defense, at trial of the bad faith action, on appeal, and in the briefing on review in this court, has been to show that Kransco's assertedly negligent litigation conduct in the underlying Hubert action, specifically the tendering of the two false interrogatory responses during pretrial discovery, was the chief proximate cause of the huge Hubert punitive damages award handed down by an inflamed Wisconsin jury, allegedly incensed by Kransco's litigation misconduct. As a factual matter, there are a number of flaws in AES's argument. First, Kransco's general counsel, Stuart Schneck, who prepared and submitted the false interrogatory responses on Kransco's behalf, testified in the California bad faith action but was not a witness in the underlying Wisconsin products liability action. Hence, the Wisconsin jury was not presented with direct evidence that Schneck had been advised of the prior Slip `N Slide accidents before answering the interrogatories, a circumstance bearing directly on the question whether competent admissible evidence (as opposed to the arguments of Hubert's counsel, which were not evidence) supports an inference that the false interrogatory responses were a legal proximate cause of the Wisconsin jury's excess verdict. Second, in finding Kransco liable and awarding damages in the Hubert action, the Wisconsin jury may have relied exclusively upon the insured's manufacture and marketing of a defective product and the damages caused by the product. Both the compensatory and punitive damage awards properly were based only on the insured's production and sale of the Slip `N Slide toy, not upon the insured's erroneous discovery response. Although the plaintiffs counsel in the Wisconsin action may have taken advantage of the insured's erroneous discovery response to embellish its argument that the insured had acted maliciously in continuing to market and to profit from a toy that it knew had caused serious injuries in the past, the damage award did not reflect any damage or loss caused by the false or erroneous discovery response, and indeed there is no indication that Hubert suffered any damage as a result of the insured's incorrect interrogatory responses. Presumed to have followed the law, the Wisconsin jury determined its award on the basis of Kransco's underlying conduct that caused the plaintiffs injury the marketing of a dangerous product conduct that was covered under Kransco's policy of insurance with AES. As a factual matter, AES has not demonstrated that Kransco's litigation misconduct was a proximate cause of the Wisconsin jury's excess verdict and huge punitive damages award. Third, the record establishes that AES was made fully aware of the false interrogatory responses prior to its rejection of Hubert's $750,000 settlement offer, and that Kransco and its counsel approved the settlement terms and tendered Kransco's $100,000 self-insured retention. AES was thus in sole control of the decision whether to accept the Hubert settlement offer, well within policy limits, and rejected that offer with full knowledge that Kransco had furnished two false interrogatory responses during pretrial discovery. Hence, Kransco's litigation misconduct was not a factual cause of AES's decision to reject Hubert's midtrial settlement offer, the rejection of which ultimately led to submission of the case to the Wisconsin jury and the ensuing excess verdict and unprecedented punitive damages award. [12] As a matter of law, AES's assertion that Kransco's two false interrogatory responses alone begot the Wisconsin jury's record-breaking punitive damages award in the Hubert action is likewise flawed. Generally, punitive damages may be awarded only if it is proven that the defendant engaged in conduct intended to cause injury or engaged in despicable conduct with a conscious disregard of the rights or safety of others. (See, e.g., Civ.Code, § 3294, subds. (a), (c).) It is questionable whether Kransco's two false interrogatory responses, exploited in the eyes of the Wisconsin jury largely through Hubert's counsel's impassioned arguments, could themselves validly be deemed a legal proximate cause of the jury's punitive damages award and verdict, as AES would have us conclude. Most importantly however, and as recognized by the Court of Appeal below, to have any meaning, the express promise of a liability insurer to defend and indemnify the insured against injury claims, and the implied duty to reasonably and in good faith settle third party claims within policy limits in an appropriate case, must extend to insureds that are less than perfect litigants. An insured's known weaknesses as a litigant should inform the insurer's assessment of the likelihood of an excess judgment, not diminish the insurer's obligation to reasonably accept settlement offers within policy limits. (See Kinder v. Western Pioneer Ins. Co. (1965) 231 Cal.App.2d 894, 898, 903, 42 Cal.Rptr. 394 [insured's weakness as a trial witness due to contradictory pretrial statements and low intelligence provided additional reason to settle case].) An insurer legitimately expects its insured's cooperation in defending third party injury claims, but cooperation does not demand flawless discovery responses. We again emphasize that a liability insurer is not without redress for an insured's litigation misconduct, be it negligent or intentional. Evidence of the insured's misconduct or breach of its express obligations under the terms of the insurance policy (i.e., breach of the cooperation clause) may support a number of contract defenses to a bad faith action, by voiding coverage, factually disproving the insurer's bad faith by showing the insurer acted reasonably under the circumstances, or forming the basis for a separate contract claim, and an insured's intentionally fraudulent conduct may give rise to tort damages. ( Ante, 97 Cal.Rptr.2d at p. 165, 2 P.3d at p. 14.) An insurer may not, however, assert an insured's comparative bad faith as an affirmative defense to partially absolve itself of its own tort liability for breach of the covenant of good faith and fair dealing.