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Insurer’s Duty Of Good Faith Continues After Litigation Commenced

Insurers Duty Of Good Faith Continues After Litigation CommencedThe implied covenant of good faith and fair dealing continues even after litigation has been initiated.

Crackhead Craig resided in a home located adjacent to the Robb Field Recreational Area in Ocean Beach. Gophers had overrun Robb Field for many years and began spreading out into the adjacent residential area. Crackhead’s backyard was pockmarked with gopher holes. Crackhead observed the San Diego Parks and Recreation Department using a burrow blaster machine that ignited flammable gas that was injected into the gopher tunnels to try to control the gopher population in the park.

Crackhead could not afford to hire a commercial pest exterminator so he contacted a friend in the construction business and obtained a small box of dynamite. Crackhead began lighting sticks of dynamite and dropping them down into the gopher holes to exterminate the gophers. After a few weeks of dynamiting, Crackhead’s backyard no longer had gophers but was severely damaged.

While walking through his kitchen a few months later, Crackhead noted that there were cracks in his tile floor and in the drywall of his home. Crackhead believed several earthquakes that had occurred over the past two years had caused the damage. Crackhead made a claim with Allsnake Insurance Company under his earthquake coverage.

Allsnake investigated the claim. Adjuster Sean McScrewem informed Crackhead that Allsnake had concluded that the damage had been caused by the dynamite explosions when Crackhead tried to exterminate the gophers in his backyard. Allsnake denied the claim.

Crackhead retained Attorney Seickem Bulldog to represent him. After receiving the notice of representation from Attorney Bulldog, Adjuster McScrewem offered $5,000 to resolve the claim despite contending that it was not caused by earthquake damage. Attorney Bulldog rejected the settlement offer. Attorney Bulldog retained a civil engineer who determined that the cracks in the slab and drywall were caused by the earthquakes, and that the cracks were at least a year or two old. Therefore, the dynamiting activity played no role in causing the structural damage to the house. He estimated the repairs would cost $75,000. The engineer’s report was shared with Allsnake. Allsnake again rejected the claim but increased its offer to $7,500. The offer was rejected by Crackhead.

Seickem Bulldog filed suit against Allsnake for breach of contract, breach of the implied covenant of good faith and fair dealing, and declaratory relief. Allsnake filed an answer asserting multiple affirmative defenses, which were either unrecognized defenses in California or were not applicable under the facts of the case.

The parties went to mediation to try to resolve the lawsuit. At the mediation, Allsnake withdrew its $7,500 offer and made a new offer of $1,500. Attorney Bulldog and Crackhead walked out of the mediation.

The matter proceeded to trial. Attorney Bulldog sought to introduce as evidence the pre-litigation settlement offers of $5,000, $7,500, and the $1,500 offer made at mediation. In addition, Attorney Bulldog sought to introduce the answer filed by Allsnake in response to the complaint. Attorney Bulldog asserted they were being introduced as evidence of Allsnake’s conduct of bad faith and on the issue of malice for the punitive damage claim. Allsnake’s counsel objected.

Judge Solomon permitted the introduction of the settlement offers of $5,000 and $7,500 but sustained Allsnake’s objection to the introduction of the settlement offer made at mediation for $1,500. Judge Solomon also sustained the objection to the introduction of Allsnake’s answer despite the fact that it contained affirmative defenses that were completely without merit.

Attorney Bulldog left the courthouse, returned to his office, and called you for your advice. What would you tell him?

Insurance Carrier’s Duties of Good Faith and Fair Dealing Continue After Litigation Commences

The implied covenant of good faith and fair dealing continues even after litigation has been initiated. The California Supreme Court has held, “[A]n insurer’s duty of good faith and fair dealing does not evaporate after litigation has commenced.” (White v. Western Title Ins. Co. (1985) 40 Cal.3d 870, *885.) Furthermore, the courts have extended that obligation and held that an insurer owes a continuing duty to fully investigate an insured claim and that duty does not evaporate after litigation has commenced. (Jordan v. Allstate Insurance Co. (2007) 148 Cal.App.4th 1062, *1076, fn. 7.) To hold otherwise would effectively “encourage insurers to induce the early filing of suits and to delay serious investigation and negotiation until after suit was filed when its conduct would be unencumbered by any duty to deal fairly and in good faith … the policy of encouraging prompt investigation and payment of insurance claims would be undermined …” (Id.)

Ordinarily, settlement offers are inadmissible under Evidence Code Sections 1152 and 1154. However, special rules have developed in the area of insurance litigation. In the case of White v. Western Title Ins. Co. (1985) 40 Cal.3d 870, the court held that Evidence Code Section 1152 does not preclude the introduction of settlement offers when they are introduced for the purpose of establishing bad faith as compared to being introduced to establish liability under the policy for the contractual benefits. White distinguished between a cause of action that is based primarily upon a privileged communication and one that is based upon an underlying course of conduct that was evidenced by the communication.

In the White case, the defendant insurer had made three settlement offers. Two of the offers were lower than what the jury ultimately determined were the contractual benefits due. A third offer was made after the trial court had held that the policy provided coverage. The trial court in White permitted plaintiff to admit the first two settlement offers but precluded the carrier from introducing its third offer that was almost twice the amount that the jury determined to have been the contractual benefits due. The Court of Appeal agreed that the trial court’s rulings were proper and that Evidence Code Section 1152 did not prohibit introduction of the offers into evidence to establish the conduct of the carrier that constituted bad faith.

In addition, one of the offers was a statutory offer to compromise under Code of Civil Procedure Section 998. However, White held that the language in Code of Civil Procedure Section 998 precluding the admissibility of the settlement offer at trial should be treated and construed in the same manner as the language in Evidence Code Section 1152. The settlement offer can be admitted to prove the conduct of the carrier that would establish liability for breach of the implied covenant of good faith and fair dealing but not to prove liability on the breach of contract claim.

While the White decision has been criticized by some courts, it remains the law in California. In fact, Evidence Code Section 1152 was amended in 1987 to address the issue of the admissibility of settlement offers in insurance litigation. Evidence Code Section 1152(b) provides: “[I]n the event that evidence of an offer to compromise is admitted in an action for breach of the covenant of good faith and fair dealing or in violation of subdivision (h) of Section 790.03 of the Insurance Code, then at the request of the party against whom the evidence is admitted, or at the request of the party who made the offer to compromise that was admitted, evidence relating to any other offer or counteroffer to compromise the same or substantially the same claimed loss or damage shall also be admissible for the same purpose as the initial evidence regarding settlement.…”

Therefore, Evidence Code Section 1152(b) now permits the trial court to allow the introduction of settlement offers made by the insurer but requires the trial court to also permit the insurer to introduce all of its offers as well as any counteroffers made by the insured. Consequently, Allsnake’s offers of $5,000 and $7,500 should be admissible at trial.

At the time the White decision was issued, the mediation privilege did not exist. In the Crackhead Craig hypothetical, one of the offers made by Allsnake was made during the course of mediation. The mediation statutes of Evidence Code Sections 1115 through 1128 establish almost a complete ban upon the admissibility of discussions made during the course of mediation as well as any discovery that was directed to confirm the mediation communications. (Cassel v. Superior Court (2011) 51 Cal.4th 113, *123.) Therefore, Allsnake’s settlement offer of $1,500 made during the course of mediation was properly excluded by Judge Solomon.

Although California courts follow the White rule, federal courts have rejected the application of White and hold that settlement offers are not admissible pursuant to Rule 408 of the Federal Rules of Evidence. (See Clemco Indus. v. Commercial Union Ins. Co. (N.D. CA 1987) 665 Fed.Supp. 816, 829, aff’d (9th Cir. 1988) 848 Fed.2d 1242.) Many attorneys representing insureds who end up in federal court erroneously believe that the defendant’s lowball settlement offers will be admissible at time of trial under the reasoning of White. Those attorneys will be sorely disappointed when that evidence is excluded by a federal district judge. Consequently, if you find yourself in the position of establishing bad faith by the lowball settlement offers made by the insurance carrier, you should do everything possible to remain in state court.

In addition to settlement offers being used to establish bad faith, settlement offers may also be used to establish malice for the purposes of recovering punitive damages. (See HMS Capital, Inc. v. Lawyers Title Co. (2004) 118 Cal.App.4th 204, *219; Shade Foods, Inc. v. Innovative Products Sales & Marketing, Inc. (2000) 78 Cal. App.4th 847, *915.)

Many carriers will attempt to argue that the settlement offers are privileged communications and that they should be excluded under Civil Code Section 47(b). However, the courts have distinguished a claim that is based upon the settlement offer versus a claim that uses the settlement offer as evidence of an underlying course of conduct. (White v. Western Title Ins. Co., supra, 40 Cal.3d 870 at *888.) Civil Code Section 47(b) prohibits the use of judicial communications as a basis of establishing liability. For instance, a pleading cannot be used as the basis for a defamation cause of action against a pleader. However, Section 47(b) does not prevent the use of a settlement offer as evidence of prior misconduct. (Id.)

The final question arises as to whether the answer filed by Allsnake was admissible as evidence of bad faith or malice. One court stated that pleadings are not privileged under Civil Code Section 47(b). The dictum in a footnote in Nies v. National Auto. & Cas. Ins. Co. (1988) 199 Cal.App.3d 1192, *1203 stated, “[W]e reject [the carrier’s] contention that the evidence was barred by Civil Code Section 47, subdivision [b]” (citing White v. Western Title Ins. Co.). While the dictum in Nies suggests that the pleadings are not privileged communications, at least one court has upheld the application of the privilege of Civil Code Section 47(b) to exclude the admission of the pleadings on the grounds that the pleadings are “literally the subject of immunity under Civil Code Section 47, subdivision (b).” (California Physicians’ Service v. Superior Court (1992) 9 Cal.App.4th 1321, *1390.)

While it is possible that an argument could be fashioned that the pleading should be admitted, it is likely that most trial courts will reject that contention under California Physicians’ Service and exclude the introduction of such pleadings.

Conclusion

Evidence Code Section 1152(b) and the ruling in White, and the cases that have expanded upon that ruling, are controlling authorities when attempting to introduce evidence of unreasonable settlement offers by insurance carriers. While the law is still evolving in the area of pleadings, the current state of the law appears to hold that the carrier’s pleadings will be inadmissible at time of trial to evidence its bad faith through the assertion of unmeritorious affirmative defenses or cross-complaints to recover benefits already paid to the insured.

In general, the courts hold that any prejudice the carrier may claim regarding the introduction of the settlement offers at trial can be addressed by a limiting instruction by the trial court. (Shade Foods, Inc. v. Innovative Product Sales & Marketing, Inc., supra, at *915.) Consequently, counsel for policyholders should be prepared to suggest a limiting instruction that can be given to make the trial judge feel more comfortable when admitting the insurer’s settlement offers.


This article was also published in the Trial Bar News. The APA citation for the Trial Bar News article is as follows:

Copley, R. K. (2016). Insurer’s duty of good faith continues after litigation commenced. Trial Bar News, 39(1), 7-8, 28-29.

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