Keeping Faith.

Over-aggressive defense of first-party claims and bad-faith lawsuits can backfire on insurers, leading to verdicts in favor of the plaintiffs.

Defending insurance bad-faith suits has never been easy, but recent case law developments suggest that more trying times are ahead, particularly when first-party claims are involved. Specifically, Pennsylvania's O'Donnell vs. Allstate decision and how it has since affected insurers and their defense counsel clouds the issue of how aggressively insurers may defend first-party and bad-faith claims.

In July 1994, Mary O'Donnell's home was burglarized. At the time of the burglary, an Allstate homeowners policy covered the property. The burglary was discovered by Jay McAtee, her son-in-law, who then notified the police. O'Donnell, who suffered from dementia, had been admitted to a nursing home about six months before. Her home was for sale at the time of the burglary and had been unoccupied since her admission to the nursing home. When police arrived at the scene, they noticed no forced entry and noted the lack of valuables in the home.

O'Donnell's daughter, Joan Mitro, contacted Allstate about two weeks after the burglary and stated that, because her mother was hospitalized, she would handle the claim on her mother's behalf. Allstate sent Mitro a letter requesting a list of all stolen items, the date and place of purchase of each item and receipts or other proof of ownership. Mitro's list of stolen items included rare coins, sterling silver, jewelry electronics and other items that Mitro estimated to be worth about $12,000.

Allstate became concerned when receipts for stolen items were in Mitro's name, and not O'Donnell's. Allstate then made additional requests, including requests for original receipts, a sworn proof-of-loss statement and contact information for other relatives who could verify the purchases. Mitro declined to provide this information. Allstate considered her refusal and other issues to be "red flags" that required further investigation. Allstate also contacted O'Donnell at the nursing home to request further verification regarding the allegedly stolen items.

Mitro, frustrated with Allstate's handling of the claim, filed a complaint against Allstate for breach of contract, bad faith and violations of the Unfair Trade Practices Act, stating that Allstate had unreasonably refused her claim and had issued neither payment nor denial of the claim. The matter proceeded to a jury trial, resulting in a verdict in favor of Allstate. Mitro appealed the decision. The appellate court agreed that the evidence supported the verdict in favor of Allstate.

Bad Faith After the Lawsuit

But it's not the court's ruling in favor of the insurer that makes O'Donnell matter. What's significant are the appellate court's statements that an insurer's conduct during or after litigation also can be construed as bad faith.

At issue in O'Donnell was whether discovery requests could be considered evidence of bad faith. In this regard, the appellate court stated:

"Specifically, we are asked to determine whether...the jury is restricted to considering only evidence of bad faith which occurred prior to the filing of the lawsuit, or, whether [the jury] may consider evidence of an insurer's bad-faith conduct occurring during the pendency of litigation."

Mitro claimed that, since she had already provided statements under oath prior to the institution of her lawsuit against Allstate, Allstate's requests for additional sworn statements after the lawsuit commenced were in bad faith. Mitro also claimed that Allstate's refusal to accept or deny the claim even after having taken her sworn statement also constituted bad faith. Mitro contended that Allstate submitted interrogatories for "frivolous" and irrelevant information, which constituted, in her mind, clear acts of bad faith.

The appellate court ultimately ruled that sworn statements before a lawsuit and depositions and other typical discovery after commencement of the suit were permissible and, in and of themselves, did not constitute bad faith. However, the court clearly stated that Pennsylvania's Bad Faith Statute is not restricted solely to an insurer's denial of a claim, but instead extends to the insurer's investigative practices and conduct during litigation.

Muddy Water

From the defense counsel's perspective, O'Donnell is highly significant. It raises the question of whether a lawyer's behavior in representing an insurance company in first-party and bad-faith litigation brought by an insured can somehow be construed as bad faith on the part of the insurance company. This concept potentially conflicts with the lawyer's ethical obligation to zealously defend his or her client. O'Donnell muddies the waters because, if further extended or expanded upon by the courts, it could impose a duty on the defense lawyer to the insured, who is the defense's adversary in the lawsuit.

Historically, once litigation was initiated, the insurance company hunkered down, prepared for litigation and took steps to defend the claim. That meant scheduling depositions, conducting discovery, filing requests for production of documents and hiring experts. While O'Donnell doesn't prohibit an insurance company from engaging in these activities, it suggests that requests in discovery may not be frivolous and that the conduct of the attorney may not be abusive. The insurance company is also obligated under O'Donnell to continue to recognize and meet its obligations to a policyholder even though that policyholder has entered into litigation against the insurer. In fact, the Superior Court in O'Donnell devoted seven pages of its opinion to an insurer's obligation to treat its insureds in good faith, despite ruling in Allstate's favor.

Because an insurer's behavior during litigation may be open to scrutiny, any additional file materials the insurance company generates during litigation also may be open to scrutiny at a bad-faith trial. Prior to O'Donnell, only the conduct of the insurance company prior to litigation was considered. Now, a jury can consider everything that the insurer does up to and including its actions during a bad-faith trial. This presents a catch-22: Even if the original first-party claim is rejected by the fact-finder, there is still the risk that a bad-faith claim could arise from an insurer's behavior during the underlying litigation.

It's important to remember that the O'Donnell ruling recognizes that there is nothing improper in defense counsel's conducting typical discovery. The insurer is still fully entitled to use the discovery process to conduct an investigation. But if the insurer's investigation (including that of its counsel) entails harassment of the insured or frivolous or excessive discovery, there may be a basis for a claim for bad faith.

Exercise Caution

The recommendation to counsel is to use caution during discovery and investigation. More particularly:

* During depositions of the insured, limit questioning to proper areas of inquiry and avoid any acrimony or sarcasm.

* Avoid excessively and unnecessarily long depositions.

* Avoid unnecessarily lengthy or repetitive interrogatories and production requests. Avoid irrelevant requests.

* Be circumspect in reports to the carrier. Avoid insults and derogatory comments about the insured and carefully choose words. For example, write that the "claim lacks merit" as opposed to "claim is bogus."

Bad-faith case law is complicated by the fact that each state has its own statutes and regulations. The significance of O'Donnell nationally is that, since nearly every state now recognizes first-party bad faith, it is only a matter of time until arguments and legal theories from one state affect the law in other states.

Don't Overreact 

Does O'Donnell tie the hands of the insurance company? Maybe. The point to be taken is this: Don't overreact to cases like O'Donnell. Attorneys still have an obligation to zealously defend their insurance company clients, and carriers still have the right to fully investigate claims. Insurers and defense attorneys should simply keep in mind that their conduct in defending first-party and bad-faith claims may be later scrutinized for bad faith by a jury. One Federal Court judge sitting in Pennsylvania, in fact, interpreted O'Donnell to stand for the proposition that behavior of an attorney defending an underinsured motorist claim may constitute bad faith and that such bad faith may be imputed to the insurance carrier. Adjusters, too, must remember that their actions during litigation may make or break a bad-faith claim. For that reason, adjusters must continue to treat an insured fairly through the pendency of the claim and any related litigation.

Anthony Williott is an insurance defense attorney with the law firm of Dickie, McCamey & Chilcote in Pittsburgh.