NATURE OF BAD FAITH LAW: LEGACY OF
SOUTH DAKOTA SUPREME COURT CASES
by Mike Abourezk and Marialee Neighbours
In South Dakota, insurance bad faith law is based on the legal principle that there is an implied covenant of good faith and fair dealing in every insurance contract. This covenant prohibits either party from preventing or injuring the other party's right to receive the benefits of the contract. Trouten v. Heritage Mut. Ins. Co., 632 N.W.2d 856, 862 (S.D. 2001). A claim for bad faith is an action in tort and is entirely separate from the contractual claim for policy limits. Champion v. United States Fidelity & Guaranty Co., 399 N.W.2d 320, 322-23 (S.D. 1987).
Bad faith law in this state has evolved through a series of South Dakota Supreme Court cases. In 1969, the South Dakota Supreme Court recognized the legal principle that "the insured's interests must be given 'equal consideration' with those of the insurer, or as it is often expressed 'at least equal consideration.'" Kunkel v. United Security Ins. Co. of New Jersey, 168 N.W.2d 723, 726 (S.D. 1969), citing Farmers' Insurance Exchange v. Henderson, 82 Ariz. 335, 313 P.2d 404 (Ariz 1957); Brown v. Guarantee Ins. Co.,155 Cal. App. 2d 679, 319 P.2d 69, 66 A.L.R. 2d 1202 (Cal. App. 2 Dist.1958). See also Trouten, 632 N.W.2d at 864.
Then in 1987, the Court adopted a "two-prong" test to prove first-party bad faith. See Champion, 399 N.W.2d at 323-24. The test required: (1.) the absence of a reasonable basis for denial of policy benefits; and (2.) the knowledge or reckless disregard of a reasonable basis for denial. Id.
In Champion, the Court explained that application of the bad faith test required a determination of whether a claim had been properly investigated, evaluated, and reviewed:
"It is appropriate, in applying the test, to determine whether a claim was properly investigated and whether the results of the investigation were subjected to a reasonable evaluation and review...."
Id., quoting Travelers Ins. Co. v. Savio, 706 P.2d 1258, 1275 (Colo.1985).
The Court noted that knowledge is imputed to an insurer when it recklessly disregards the lack of a reasonable basis for denial or ignores facts/proofs submitted by an insured:
" implicit in that test is our conclusion that the knowledge of the lack of a reasonable basis may be inferred and imputed to an insurance company where there is a reckless disregard of a lack of a reasonable basis for denial or a reckless indifference to facts or to proofs submitted by the insurer."
Id. at 324.
However, under Champion, insurers are permitted to challenge debatable claims:
"Under these tests of the tort of bad faith, an insurance company, however, may challenge claims which are fairly debatable and will be found liable only where it has intentionally denied (or failed to process or pay) a claim without a reasonable basis."
In another 1987 opinion, the Court ruled that an insurer did not give equal consideration to the interests of insureds when it forced insureds "to endure the rigors and uncertainties of trial." Helmbolt v. LeMars Mut. Ins. Co., Inc., 404 N.W.2d 55, 57 (S.D. 1987)(citations omitted). In Helmbolt, the Court said:
"[a] covenant is implied in an insurance contract that neither party will do anything to injure the rights of the other in receiving the benefits of the agreement. This covenant includes a duty to settle claims without litigation in appropriate cases."
Id. at 57 (citations omitted).
Consistently, the South Dakota Supreme Court has repeated the principle that insurance companies act in bad faith when they fail to fairly and adequately investigate insurance claims. In Walz v. Fireman's Fund Ins. Co., the Court held that an insurer had a duty to review current case law as well as facts:
"Whether Insurer acted in bad faith in conducting an inadequate investigation or failing to review case law is a question of fact for the jury. Isaac v. State Farm Mut. Auto. Ins. Co., 522 N.W.2d 752, 758 (S.D. 1994) (citation omitted). The issue is determined based upon the facts and law available to Insurer at the time it made the decision to deny coverage. Id. ...Isaac instructs us to look not only to the facts, but also to the law available to the insurer at the time it made the decision to deny coverage."
556 N.W.2d 68, 70-71, citing Isaac v. State Farm Mutual Insurance Co., 522 N.W.2d 752, 758 (S.D. 1994)(emphasis added); see also Harter v. Plains Ins. Co., 579 N.W.2d 625 (S.D. 1998); Sawyer v. Farm Bureau Mutual Ins. Co., 619 N.W.2d 644 (S.D. 2000).
Significantly, the South Dakota Supreme Court has not limited bad faith to just denial of insurance benefits. In 1997, in Julson v. Federated Mut. Ins. Co., 562 N.W.2d 117, 119 (S.D.1997), the Court recognized that bad faith does not simply apply to circumstances involving a claim denial. Professor Baron, a recognized insurance expert, discussed Julson and other South Dakota bad faith cases in a South Dakota law review article. See Rodger M. Baron, When Insurance Companies Do Bad Things: The Evolution of the "Bad Faith" Causes Of Action in South Dakota, 44 S.D. L. Rev. 471, 489-90 (1998/1999.) In that article, Professor Baron wrote:
"But, the obligation of good faith and fair dealing (the theoretical underpinning for the bad faith causes of action) extends to aspects of both performance and enforcement of the contract. This means that insurers can act in bad faith in ways which do not necessarily result in the denial of a claim."
Id. at 489-90.
Professor Baron also observed:
"The obligation of good faith and fair dealing extends to the assertion, settlement and litigation of contract claims and defenses . . . . The obligation is violated by dishonest conduct such as conjuring up a pretended dispute, asserting an interpretation contrary to one's own understanding, or falsification of facts. It also extends to dealing which is candid but unfair . . .. Other types of violation have been recognized in judicial decisions: harassing demands for assurances of performance, rejection of performance for unstated reasons, willful failure to mitigate damages, and abuse of a power to determine compliance or to terminate the contract."
Id. at 488, citing Restatement (Second) of Contracts § 205 cmt. e (1981).
Analyzing Julson, he noted:
"Perhaps the most significant aspect of the Julson opinion is that the court added a phrase to the standard two-prong first party bad faith test, which was adopted in the 1987 Champion decision. Notice the language supplied by the court in the bracketed portion of the two-prong test in the following portion of the Julson opinion:
For proof of bad faith, there must be an absence of a reasonable basis for the denial of the policy benefits [or failure to comply with a duty under the insurance contract] and the knowledge or reckless disregard . . . The court's inclusion of the bracketed portion into the two-prong test demonstrates the court's recognition that first part bad faith liability may extend to situations other than a mere claim denial."
Id. at 491.
Clearly, adding the words "or failure to comply with a duty under the insurance contract" to the bad faith test is important. This language means that bad faith can involve situations where no claim was actually denied-situations where an insurer abused the insured in some other way.
In 2001, the South Dakota Supreme Court held that a third-party beneficiary to a commercial general liability insurance policy could not be sued for bad faith. Trouten v. Heritage Mut. Ins. Co., 632 N.W.2d 856 (S.D. 2001). Irrespective of this holding, Trouten is noteworthy. In that case, the Court stressed the disparate bargaining position that exists between insurance companies and their policyholders:
"Furthermore, the relationship of insurer and insured is inherently unbalanced; the adhesive nature of insurance contracts places the insurer in a superior bargaining position."
Id. at 863, quoting Egan v. Mutual of Omaha Ins. Co., 24 Cal.3d 809,169 Cal.Rptr. 691, 620 P.2d 141 (1979).
Acknowledging that insurance companies have a fiduciary-like responsibility toward the public, the Court said:
"The insurer's obligations are ... rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public's interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements.... [A]s a supplier of a public service rather than a manufactured product, the obligations of insurers go beyond meeting reasonable expectations of coverage. The obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries, and with the public's trust must go private responsibility consonant with that trust."
Id. (citations omitted).
This quasi-public status is obvious in automobile insurance, particularly, uninsured motorist (UM) and underinsured motorist insurance (UIM) and worker's compensation insurance. However, the public service aspect of insurance is not limited to these kinds of insurance.