Over the last six decades, much has been said, written, litigated, and legislated about bad faith in the insurance industry. Yet today even knowledgeable professionals struggle to present a succinct, precise definition. There are statutory factors and court precedents galore, but no statement on the meaning of bad faith comes closer to capturing the principle than a single sentence in an opinion of the California Supreme Court from 1958: “The insurer should not be permitted to profit by its own wrong.”
The case was Comunale v. Traders & General Ins. Co., 50 Cal.2d 654, and at issue was the question of whether an insurance company that denied coverage for an accident, and therefore refused to settle a claim or defend the insured at trial, should be liable for the ultimate judgment against the insured, over and above policy limits.
The facts were these:
Traders and General Insurance Company had a policyholder named Sloan, who struck and injured a husband and wife as they crossed the street. Traders claimed that, since Sloan was driving a truck that did not belong to him, the company had no duty to defend or indemnify him. The Comunales offered a settlement for less than the $20,000 limit of Sloan’s policy, but because Trader’s denied the claim, Sloan could not afford to settle.
Therefore, the Comunales sued him, winning a judgment of $26,250, which Sloan could not pay. Thus, the Comunales sued Traders and won a verdict of $11,250. Not done yet, the Comunales assumed Sloan’s rights against Traders and sued the company for the portion of their previous judgment against Sloan which exceeded his policy limits. The Comunales won again, but the trial court granted a judgment for Traders notwithstanding the verdict.
The case then went to the California Supreme Court, which had to decide whether Sloan had a lawful cause of action against Traders for amounts in excess of the policy limits, and whether Sloan could legally assign that right to the Comunales.
In delivering the opinion of the Court, Chief Justice Gibson wrote that “There is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement.” This principle was “applicable to policies of insurance.” But just what did “good faith and fair dealing” mean?
Justice Gibson explained that Traders had a duty to “take into account the interest of the insured and give it at least as much consideration as it does to its own interest.” By refusing to accept the settlement, Traders had exposed Sloan to the risk that at trial a jury would award more than the policy limits. Rather than place its policyholder in such jeopardy, Traders had a duty to settle the claim.
Justice Gibson believed that “an insurer who denies coverage does so at its own risk.” But where would the risk be if, either way, Traders would only have been on the hook for the value of the policy? Since malfeasance would invite no additional risk, insurers would have every incentive to deny claims and bide their time to see if they would ultimately have to pay. If they did, they would not have to pay any more than they would have paid if they had accepted the claim in the first place. Therefore, the Court held that “if the denial is found to be wrongful [the insurance company] is liable for the full amount which will compensate the insured for all the detriment….”
Traders was on the hook for the full judgment, not simply what it would have lost if it had acted in good faith. In the decades since Comunale, different states have enacted Insurance Codes, and high courts have written rules. But all bad faith law still derives from one simple principle articulated in this opinion: “The insurer should not be permitted to profit by its own wrong.”