Opinion ID: 1205488
Heading Depth: 2
Heading Rank: 3

Heading: Tort or Contract Recovery

Text: California has led the way in the modern development of the bad faith cause of action for insurer misconduct. In Comunale v. Traders & Gen. Ins. Co., 50 Cal.2d 654, 328 P.2d 198 (1958), and Crisci v. Security Ins. Co, 66 Cal.2d 425, 58 Cal.Rptr. 13, 426 P.2d 173 (1967), both third-party cases, the California Supreme Court held that an insurer's breach of the implied covenant of good faith and fair dealing gives rise to a cause of action in tort, as well as contract. By characterizing the insured's cause of action as sounding in tort, the courts adopting this reasoning made available to the insured a broader range of compensatory damages and certain additional items of recovery, such as damages for emotional stress and punitive damages, which are generally not available in actions founded solely on breach of contract. W. Shernoff, S. Gage & H. Levine, Insurance Bad Faith Litigation, § 1.07[2] (1994). The theoretical underpinnings of Comunale and Crisci were instrumental in the landmark case of Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 108 Cal.Rptr. 480, 510 P.2d 1032 (1973). In Gruenberg, the California Supreme Court extended the tort of bad faith in the third-party context to the first-party situation. The insured in Gruenberg alleged bad faith and outrageous conduct on the part of his insurance companies for denying payment of three fire insurance policies. The court in Gruenberg, relying on its earlier reasoning in Comunale and Crisci, explained that, in third-party cases: we considered the duty of the insurer to act in good faith and fairly in handling the claims of third persons against the insured, described as a `duty to accept reasonable settlements;' in the case before us we consider the duty of an insurer to act in good faith and fairly in handling the claim of an insured, namely a duty not to withhold unreasonably payments due under a policy. These are merely two different aspects of the same duty. That responsibility is not the requirement mandated by the terms of the policy itselfto defend, settle, or pay. It is the obligation, deemed to be imposed by law, under which the insurer must act fairly and in good faith in discharging its contractual responsibilities. Where in doing so, it fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of the implied covenant of good faith and fair dealing. Gruenberg, 108 Cal.Rptr. at 485, 510 P.2d at 1037 (emphasis added). [10] The decision in Gruenberg established that the defendant's duty of good faith and fair dealing, implied by law, is unconditional and independent of the performance of plaintiff's contractual obligations. The Gruenberg court explained that, because an insurer's duty is independent of the contract, an insured's non-performance of its contractual duties cannot excuse a breach of the duty of good faith and fair dealing. Id. 108 Cal.Rptr. at 488, 510 P.2d at 1040. Therefore, the court concluded that insurance companies owe an absolute duty of good faith and fair dealing to their insureds. Id. In allowing a tort recovery for breach of the covenant of good faith and fair dealing in an insurance contract, some courts have emphasized the `special relationship' between insurer and insured, characterized by elements of public interest, adhesion, and fiduciary responsibility. Seaman's Direct Buying Service Inc. v. Standard Oil Company of California, 36 Cal.3d 752, 206 Cal.Rptr. 354, 362, 686 P.2d 1158, 1166 (1984). In adopting the tort of bad faith in the first-party context, the Arizona Supreme Court observed that: The special nature of an insurance contract has been recognized by courts and legislatures for many years. A whole body of case and statutory law has been developed to regulate the relationship between insurer and insured. An insurance policy is not obtained for commercial advantage; it is obtained as protection against calamity. In securing the reasonable expectations of the insured under the insurance policy there is usually an unequal bargaining position between the insured and the insurance company.... Often the insured is in an especially vulnerable economic position when such a casualty loss occurs. The whole purpose of insurance is defeated if an insurance company can refuse or fail, without justification, to pay a valid claim. We have determined that it is reasonable to conclude that there is a legal duty implied in an insurance contract that the insurance company must act in good faith in dealing with its insured on a claim, and a violation of that duty of good faith is a tort. Noble v. National American Life Ins. Co., 128 Ariz. 188, 189-90, 624 P.2d 866, 867-68 (1981) (citations omitted). Other jurisdictions have used similar reasoning in recognizing a common-law cause of action in tort for breach of the duty of good faith and fair dealing. See, e.g., Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165, 167 (Tex.1987); State Farm Fire & Cas. Co. v. Nicholson, 777 P.2d 1152, 1157 (Alaska 1989); White v. Unigard, 112 Idaho 94, 730 P.2d 1014 (1986). Notwithstanding the various characteristics unique to a contract for insurance that justify a first-party bad faith cause of action in tort, there is a minority of jurisdictions that have rejected a common-law cause of action for insurer bad faith in first-party cases. A common argument used by courts that do not recognize first-party bad faith is the absence of a fiduciary relationship between the insurer and insured in a first-party situation. The first-party relationship is distinguishable from the third party situation. In third party claims, the absolute control of trial and settlement is in the hands of the insurer. That control gives rise to a fiduciary relationship between the insurer and the insured. In first party claims the insurer is not in a position to expose the insured to a judgment in excess of policy limits through its unreasonable refusal to settle a case nor is the insurer in exclusive control of the defense. Although an insurer must make a good faith attempt to settle claims [K.S.A. 40-240(9)(f) ], the insurer and insured in a first party relationship have an adversarial relationship, rather than a fiduciary relationship. Spencer v. Aetna Life & Cas. Ins. Co., 227 Kan. 914, 611 P.2d 149, 155 (1980) (brackets in original); see also Farris v. United States Fid. & Guar. Co., 284 Or. 453, 587 P.2d 1015 (1978) (concluding that the fiduciary position of the insurer in representing the insured in litigation gives rise to cause of action in tort); Lawton v. Great Southwest Fire Ins. Co., 118 N.H. 607, 392 A.2d 576 (1978) (absent a fiduciary relationship, insured can only bring a bad faith cause of action in contract); Beck v. Farmers Ins. Exchange, 701 P.2d 795, 800 (Utah 1985) (In the first-party situation ... the reasons for finding a fiduciary relationship and imposing a corresponding duty are absent. No relationship of trust and reliance is created by the contract[.]) (citing Santilli v. State Farm Life Ins. Co., 278 Or. 53, 562 P.2d 965, 969 (1977)). We regard this rationale as unpersuasive because it is premised on the assumption that tort liability in the third-party context is based solely on an agency theory and the resulting fiduciary obligations. The agency relationship, however, is not a condition precedent for imposing tort liability on insurers who fail to perform their obligations in good faith. Hawai`i law imposes a duty of good faith and fair dealing in all contracts, not only those in which there is an agency relationship. Whether a breach of this duty will give rise to a cause of action in tort, then, depends upon the duty or duties inherent in a particular type of contract. In the insurance context, we believe that the fiduciary duty on the part of the insurer in the third-party context, albeit significant, is but one component of a broader duty to act in good faith and deal fairly with its insureds so as not to deprive the insured of the very benefits for which he or she has contracted. What are the benefits which flow from the insurance contract and the relationship it creates? Obviously, the insured buys the company's express agreement to pay certain types of claims. But the implied covenant of good faith is an implied covenant. Wagenseller [v. Scottsdale Memorial Hospital, 147 Ariz. 370, 710 P.2d 1025 (1985) ]. In delineating the benefits which flow from an insurance contract relationship we must recognize that in buying insurance an insured usually does not seek to realize a commercial advantage, but, instead, seeks protection and security from economic catastrophe. Noble v. National American Life Ins. Co., [128 Ariz. 188, 189] [624 P.2d 866, 867 (1981) ]; Egan v. Mutual of Omaha Ins. Co., [24 Cal.3d 809, 169 Cal.Rptr. 691, 695] [620 P.2d 141, 145 (1979), cert. denied, 445 U.S. 912] [100 S.Ct. 1271, 63 L.Ed.2d 597] (1980); Crisci v. Security Ins. Co., [66 Cal.2d 425, 58 Cal.Rptr. 13, 19] 426 P.2d 173, 179 (1967) ]. Thus, the insured's objective in buying the company's express covenant to pay claims is security from financial loss which he [or she] may sustain from claims against him [or her] and protection against economic catastrophe in those situations in which he [or she] may be the victim. Noble [, 128 Ariz. at 189] 624 P.2d at 867; Chavers v. National Security Fire & Cas. Co., 405 So.2d 1, 6 (Ala.1981). In both cases, he [or she] seeks peace of mind from the fears that accompany such exposure. Because of the disparity in bargaining power and the nature of the contract, the insurer receives both premium and control. Barrera v. State Farm Mutual Automobile Ins. Co., [71 Cal.2d 659, 79 Cal.Rptr. 106, 117] 456 P.2d 674, 685 (1969) ]. Thus, in third-party situations, the insured surrenders to the insurer the right to control and manage the defense of claims made against him [or her]. See Parsons v. Continental National American Group, [113 Ariz. 223] 550 P.2d 94 (1976) ]. In first-party situations the insurer sets the conditions for both presentment and payment of claims. In both first- and third-party situations the contract and the nature of the relationship effectively give the insurer an almost adjudicatory responsibility. The insurer evaluates the claim, determines whether it falls within the coverage provided, assesses its monetary value, decides on its validity and passes upon payment. Although the insured is not without remedies if he [or she] disagrees with the insurer, the very invocation of those remedies detracts significantly from the protection or security which was the object of the transaction. Thus, the insurance contract and the relationship it creates contain more than the company's bare promise to pay certain claims when forced to do so; implicit in the contract and the relationship is the insurer's obligation to play fairly with its insured. Parsons v. Continental National American Group, supra, Egan v. Mutual of Omaha Ins. Co., supra . Rawlings v. Apodaca, 151 Ariz. 149, 154-55, 726 P.2d 565, 570-71 (1986) (footnote omitted). Therefore, while an insurer in the first-party situation does not have the same control of the insured's side of the litigation that would give rise to a fiduciary duty, [i]t does not necessarily follow that the insurer is completely free of any obligation of good faith and fair dealing to its insured, since the ... duty [of good faith and fair dealing] is based on the reasonable expectations of the insured and the unequal bargaining positions of the contractants, rather than the insurance company's control of the litigation. Craft v. Economy Fire & Cas. Co., 572 F.2d 565, 569 (7th Cir.1978). Accordingly, we reject the argument that, absent a fiduciary relationship, an insured can only bring a bad faith cause of action in contract.
The issue of tort liability arising from a contractual relationship is not new in this jurisdiction. In Goo v. Continental Cas. Company, 52 Haw. 235, 473 P.2d 563 (1970), this court considered merging tort and contract principles when we addressed the issue of whether punitive damages should be recoverable for breach of contract. We discussed the public policy reasons underlying punitive damages and acknowledged that Hawai`i allows punitive damages for wilful, malicious, wanton or aggravated wrongs where a defendant has acted with a reckless indifference to the rights of another. Id. at 239, 473 P.2d at 566 (citing Bright v. Quinn, 20 Haw. 504 (1911); Howell v. Associated Hotels, Ltd., 40 Haw. 492 (1954); Glover, Ltd. v. Fong, 40 Haw. 503 (1954)). In addition, we noted that a small but growing number of jurisdictions allow juries to award punitive damages in appropriate contract cases, Goo, 52 Haw. at 240, 473 P.2d at 566 (citations omitted), and that [t]he scope of what is recognized by common law courts as a tort has grown so that torts and contract are no longer distinct, rather they overlap. Id. at 240-41, 473 P.2d at 567 (citations and footnote omitted). However, because the facts in Goo did not warrant an award of punitive damages, we declined to expressly decide whether punitive damages were recoverable in a claim based upon breach of contract. Two years later, in Dold v. Outrigger Hotel, 54 Haw. 18, 501 P.2d 368 (1972), we held that tort damages may be allowed for certain wilful or reckless contractual breaches. In Dold, we stated: [T]he plaintiffs are not limited to the narrow traditional contractual remedy of out-of-pocket losses alone. We have recognized the fact that certain situations are so disposed as to present the fusion of the doctrines of tort and contract. Though some courts have strained the traditional concept of compensatory damages in contract to include damages for emotional distress and disappointment, we are of the opinion that where a contract is breached in a wanton and reckless manner as to result in a tortious injury, the aggrieved party is entitled to recover in tort. Id. at 22, 501 P.2d at 371-72 (citations omitted). Although the facts in Dold did not warrant punitive damages, Dold established that Hawai`i permitted a tort recovery for certain types of contractual breaches. See Amfac, Inc. v. Waikiki Beachcomber Inv. Co., Ltd., 74 Haw. 85, 139 n. 23, 839 P.2d 10, 37 n. 23, reconsideration denied, 74 Haw. 650, 843 P.2d 144 (1992).
The tort remedy recognized in Dold was premised on a tortious breach of contract theory. Penn contends, therefore, that allowing tort damages for breach of the implied covenant of good faith and fair dealing is unnecessary in this jurisdiction because of the availability of a tort remedy in a breach of contract action, i.e., tortious breach of contract. We disagree. Under Dold, compensatory tort damages are available for certain wilful or reckless contractual breaches. In addition, our decision in Dold implied that we would allow punitive damages in a tortious breach of contract action under the proper factual situation. However, the tort of bad faith is not a tortious breach of contract, but rather a separate and distinct wrong which results from the breach of a duty imposed as a consequence of the relationship established by contract. Anderson v. Continental Ins. Co., 85 Wis.2d 675, 271 N.W.2d 368, 374 (1978). Therefore, the tort of bad faith allows an insured to recover even if the insurer performs the express covenant to pay claims. As such, an insurer could be liable for the tort of bad faith for certain conduct where it would not be liable for a tortious breach of contract. Accordingly, we conclude that the tortious breach of contract action we established in Dold is distinguishable from the tort of bad faith. If the implied covenant of good faith and fair dealing, implied in all contracts, is the legal principle underlying the adoption of a bad faith tort cause of action in the insurance context, a logical concern is that such a holding will open the floodgates for tort actions based upon the breach of any contract. See Kewin v. Massachusetts Mutual, 409 Mich. 401, 295 N.W.2d 50 (1980). However, [b]ecause of the nature of first-party insurance contracts, that concern is unfounded. The public interest in insurance contracts, the nature of insurance contracts, and the inequity in bargaining power between the insurer and the policyholder all serve to distinguish insurance contracts from other types of contracts. Braesch v. Union Ins. Co., 237 Neb. 44, 464 N.W.2d 769, 774 (1991). Moreover, [t]ort actions for breach of covenants implied in certain types of contractual relationships are most often recognized where the type of contract involved is one in which the plaintiff seeks something more than commercial advantage or profit from the defendant. When dealing with an innkeeper, a common carrier, a lawyer, a doctor or an insurer, the client/customer seeks service, security, peace of mind, protection or some other intangible. These types of contracts create special, partly noncommercial relationships, and when the provider of the service fails to provide the very item which was the implicit objective of the making of the contract, then contract damages are seldom adequate, and the cases have generally permitted the plaintiff to maintain an action in tort as well as contract. Rawlings, 151 Ariz. at 159, 726 P.2d at 575 (citing W. Prosser & W. Keeton, Law of Torts § 92 at 660-61 (5th ed. 1984)). We agree that the policy considerations surrounding the adoption of the tort of bad faith in the insurance context are atypical and will not necessarily extend to all types of contracts. Thus, the availability of a tort recovery for breach of the implied covenant of good faith and fair dealing may be justified in actions brought on insurance contracts, but not necessarily in actions brought on other types of contract. We are also persuaded that there are sound reasons for recognizing a cause of action in tort for breach of the implied covenant of good faith and fair dealing in the insurance context. Adopting the tort of bad faith is consistent with the case law and statutory provisions dealing with insurer misconduct in this jurisdiction. In addition, the special relationship between insurer and insured is, as the Rawlings court observed, atypical, and the adhesionary aspects of an insurance contract further justify the availability of a tort recovery. Finally, a bad faith cause of action in tort will provide the necessary compensation to the insured for all damage suffered as a result of insurer misconduct. Without the threat of a tort action, insurance companies have little incentive to promptly pay proceeds rightfully due to their insureds, as they stand to lose very little by delaying payment. Accordingly, we hold that there is a legal duty, implied in a first- and third-party insurance contract, that the insurer must act in good faith in dealing with its insured, and a breach of that duty of good faith gives rise to an independent tort cause of action. The breach of the express covenant to pay claims, however, is not the sine qua non for an action for breach of the implied covenant of good faith and fair dealing. Rawlings, 151 Ariz. at 157, 726 P.2d at 573. The 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. Id. Because the instant case involves a first-party insurance contract, we now address the proper standard for imposing liability in the first-party context.