HNRK Coverage Corner

On December 11, 2018, Judge Garaufis of the EDNY issued a decision in Government Employees Ins. Co. v. Saco, 12-cv-5633 (NGG), holding that a plaintiff in a bad faith action against a third-party insurer was entitled to collect the amount of a judgment in excess of the policy limits, even if the insured was not actually liable for the full amount of that judgment.

Saco arose from a personal injury case following a car accident.  The defendant in the injury lawsuit (Kusulas) was insured by GEICO.  After GEICO failed to tender the full policy limits to settle the case, a trial ensued, after which the plaintiff (Saco) was awarded a judgment that exceeded the limits of Kusulas’ policy.  A portion of the judgment, totaling $1.2 million, was for future damages.  Under Article 50-B of the CPLR, the defendant’s obligation to pay future economic damages (which are paid periodically rather than as a lump sum) terminates upon the plaintiff’s death.  Saco assigned her rights against GEICO to Kusulas in exchange for a promise that Kusulas would not execute her judgment against Saco or any of her personal assets.  Two years later, Kusulas died, thus terminating the future damages payments owned to her pursuant to the judgment. Kusulas’ estate, as assignee of Saco’s rights under the policy, pursued a claim against GEICO for bad faith in failing to settle the claim before trial for the full policy limits.  In such a bad faith action, an insured can recover the amount of the judgment against it in excess of the policy limits.  GEICO argued that because Saco would never be obligated to pay the full amount of the future damages awarded to Kusulas, the available damages in the bad faith action should be limited to the amounts for which the insured would actually be liable. 

Judge Garaufis disagreed.  His decision provides an excellent overview of the law governing bad faith claims against third-party insurers:

It is a well settled and enduring principle of New York law that an insurer may be held liable for the breach of its duty of good faith in defending and settling claims over which it exercises exclusive control on behalf of its insured.  A bad faith case is established where the liability is clear and the potential recovery far exceeds the insurance coverage.  A bad-faith cause of action cannot lie for conduct amounting to ordinary negligence; rather, success on such a claim requires a showing that the insurer’s conduct constituted a gross disregard of the insured’s interests.  As this court has previously recounted, bad-faith actions sound in contract, not tort, because of the general principle that a covenant of good faith and fair dealing is implied in all contracts, including insurance policies.

But an action based on the breach of the implied covenant of good faith and fair dealing is no ordinary contract action.  In an action where the insurer is accused of violating its implied obligation to act in good faith by failing to make a reasonable settlement of a claim within policy limits, the court may impose compensatory damages in excess of the policy limits.  Although bad-faith actions csound in contract, the New York Court of Appeals has explained that the amount of the excess judgment is a permissible measure of damages in these cases because it is class of harm that naturally and foreseeably flows from an insurer’s failure to accept a pretrial settlement offer within the policy limits.  Accordingly, when the harm has been caused by the insurer’s breach of its obligation to perform in good faith, the insurer should be required to remedy that harm by paying the excess judgment. Soto v. Farm Ins. Co., 635 N.E.2d 1222, 1224 (N.Y. 1994). By contrast, New York courts have traditionally not permitted the imposition of consequential bad-faith damages for emotional distress, injury to credit, or lost business opportunity, as these injuries are speculative, remote and could not be within the contemplation of the parties at the time of the execution of the insurance contract.

An award of damages exceeding the limits of an insurance policy is often classified as punitive in nature owing to the disingenuous and dishonest behavior necessary to support bad-faith liability on this ground.  This measure of damages is distinct from the normal imposition of punitive damages, which are not permissible in the context of a bad-faith action.

Under controlling circuit precedent, a bad-faith cause of action accrues against an insurer, as soon as the excess judgment against the insured becomes final, regardless of whether the insured has the ability to pay any part of the excess judgment.  In rejecting the countervailing so-called "payment rule," courts have given three general reasons for extending the cause of action.  First, courts have expressed concern that an insurer who has acted in bad faith should not be able to avoid judgment-thus, effectively, reaping a windfall-simply because its policyholder is judgment-proof.  Second, allowing an insurer to escape liability for the excess judgment if the insured is insolvent would discourage settlement.  After all, why would an insurer that knows its insured is insolvent ever choose to settle a claim at the policy limits? If the case goes to trial and liability is not found, the insurer would end up paying nothing; if the case goes to trial and liability is found, the most the insurer would have to pay is the limit of the policy. Because there would be no possibility in this circumstance that the insurer would end up on the hook for more than the: limits of the policy, the insurer would never have good reason to settle, thereby contradicting the purpose of bad-faith actions.

The Court concluded that “the measure of damages in a third-party bad-faith action is the amount of the judgment in excess of the policy limits plus interest,” and therefore, “it is the initial adjudication of liability, rather than a subsequently reduced amount, that matters.”  Judge Garaufis acknowledged, however, that the case presented a “close” question, and suggested that at a later stage, “the Second Circuit may find it useful to certify this issue to the New York Court of Appeals.” In the context of first-party insurance, New York similarly does not recognize a separate tort cause of action for bad faith claims handling.  Section 2601 of the Insurance Law forbids certain specified “unfair claim settlement practices,” including “not attempting in good faith to effectuate prompt, fair and equitable settlements of claims submitted in which liability has become reasonably clear.”  But the Court of Appeals has held that there is no private cause of action for violations of this statute. See Rocanova v. Equitable Life Assurance Soc’y of the U.S., 83 N.Y.2d 603, 614 (1994).  As in the third-party context, however, the New York Court have sometimes permitted recovery of consequential damages in excess of the policy limits on the ground that bad faith in the adjustment of a first-party insurance claim constitutes a breach of the policy's implied covenant of good faith and fair dealing.