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Bad faith: a new era for Montana?

After a decade or more of expanding and uniquely broad business liability rulings, the Montana Supreme Court has apparently retreated. In 1990, with Story v. City of Bozeman, it adopted a more conservative interpretation of bad faith liability. The dust hasn't settled yet and many things remain unclear. But perhaps this case signals a new trend. One that will provide relief for Montana employers and businesses who have been subject to millions of dollars in bad faith damages, while at the same time still allow aggrieved parties appropriate and reasonable redress through the Montana courts.

Montana's Legal Anomaly

The authors discussed Montana's bad faith precedents in some detail for an earlier article (see the Montana Business Quarterly, Summer 1988). The following summary, however, should provide a context for understanding the court's most recent rulings, and suggest some implications for the future.

From a legal point of view, all other states but Montana clearly distinguish between breach of contract lawsuits and those involving tort issues. Other state courts have assumed a party has the right to breach a contract if the breaching party compensates the other party for actual losses. This "right to breach a contract" arises from principles of freedom of contract and rational decision making. The courts recognize that damages designed to compensate individuals for their actual losses (compensatory damages) are sufficient to discourage breach of contract. Normally, in breach of contract cases, the jury is not allowed to assess punitive damages against the breaching party.

In the view of other state courts, however, punitive damages play a quite different role if the lawsuit involves tort issues. There, a jury is allowed to assess punitive damages as well as compensatory damages against an individual who intentionally commits a grievous act such as assault, battery, liable, slander or fraud. This "right to punitive damages" is based on the notion that one who intentionally causes grave harm to others must be punished and serve as an example to deter others.

Unlike other state courts, Montana has eroded the distinction between breach of contract and tort cases by allowing tort-like punitive damages in ordinary breach of contract cases. This has elevated simple breach of contract cases and caused tremendous uncertainty among Montana businesses. Free to decide damages, juries have virtually no restriction when determining tort-like punitive awards. Awards need not bear any relation to actual losses suffered by the breached party. Instead, damages are based on what the jury deems sufficient punishment for the wrongdoer.

Many contract cases that might have been marginal and trivial instead became worth - potentially - millions of dollars. Thus, almost every breach of contract case in Montana alleged bad faith and requested that the jury award punitive as well as compensatory damages to the plaintiff. Montana's legal approach was considered so drastic that precedent-watchers like the Wall Street Journal routinely published articles wondering what the state's legal system might do next.

The Growth of Bad Faith in Montana

Montana's bad faith doctrine originated in insurance cases. The state's Supreme Court felt that for breach of insurance contracts, compensatory damages alone were insufficient to encourage timely and fair settlement of claims. If the insurance company failed to settle in a timely fashion, the claimant could, at most, receive only what was owed to begin with. In such a case, the court reasoned, the claimant had no leverage against the insurance company. Hoping to inspire insurance companies to settle claims properly and thereby live up to the insurance contract's implied covenant of good faith, Montana's court began to consider punitive damages in breach of insurance contracts cases.

This doctrine was extended to another industry in 1984 with First National Bank in Libby v. Twombly. Montana's Supreme Court held that First National's improper recovery on promissory obligations amounted to the tort of bad faith and therefore the bank should be forced to pay punitive damages.

Approximately at the same time, Montana courts applied this radical legal theory to employment cases. A covenant (promise) of good faith and fair dealing existed in almost every employment context, the court reasoned. And so it treated a breach of this implied promise as a tort justifying punitive damages.

Another 1984 case, Adair v. Petroleum Marketing Company, established when the implied covenant of good faith and fair dealing would arise in employment cases. The court held that the promise of good faith existed whenever there were "objective manifestations by the employer giving rise to the employee's reasonable belief that he or she had job security and would be treated fairly." If an employer dismissed an employee and destroyed the employee's expectations of continued employment, then a bad faith dismissal could result. This finding threatened employers with the possibility of six-figure punitive damage awards.

In 1987, the Montana Legislature attempted to limit punitive damage awards for employment disputes. (Montana voters did not specifically vote on this legislation.) Punitive damages should not be awarded, it said, except where an employee's dismissal violated public policy. For example, if an employee were dismissed because of religious beliefs, punitive damages still could be considered because a specific statute prohibiting religious discrimination in the workplace would have been violated. Despite these efforts at tort reform, however, Montana's wrongful discharge statute has been upheld by the Montana Supreme Court as constitutional and it remains the law today.

The Extent of Bad Faith in Montana

Only a few states besides Montana have been willing to apply the tort doctrine of bad faith to insurance, employment, and banking cases. And no other court has so broadly applied the tort of bad faith to arms-length commercial transactions. Alone among State Supreme Courts, Montana has extended the tort doctrine of bad faith to virtually every breach of contract case, including arms-length commercial transactions.

In the 1985 case of Nicholson v. United Pacific Insurance, the Montana Supreme Court stated that each party to a contract has a justifiable expectation that the other party will act in a reasonable manner concerning the performance of a contract. If one party arbitrarily, capriciously, or unreasonably deprives the other party of the benefit of a contract, or if the injured party's expectations are violated, the injured party should be entitled to tort damages, according to the court.

This case extended the tort remedy of punitive damages to commercial contracts. Moreover, it confirmed that the standard of misconduct required to show bad faith is merely unreasonable behavior.

After the Nicholson case, Montana applied this same standard to contracts involving franchises and the sale of a business. Such cases left Montana alone in the field of bad faith. Even California (second only to Montana in the liberality of its interpretations) limited tort actions in commercial contracts to those cases where special relationships of must and confidence existed.

Is Montana Retreating?

Last year, in Story v. City of Bozeman, the Montana Supreme Court rejected its previously liberal use of the tort of bad faith, at least in arms-length contract transactions. The Court held that "the tort of bad faith may still apply in exceptional circumstances," and adopted standards set by the California case of Wallace v. Kroehler Manufacturing Co. In effect, punitive damages will be appropriate only if contracting parties have a unique and special relationship that gives rise to expectations beyond those normally found in arms-length transactions.

What now defines the "special relationship" entitling an aggrieved party to punitive damages? The Wallace standard sets forth the somewhat ambiguous prerequisites for finding a "special relationship" (see sidebar).

While it adopted a new standard last year, the Montana Supreme Court also reemphasized some tenants of the old standard. "Every contract, regardless of type, contains an implied covenant of good faith and fair dealing," said the court. "A breach of this covenant is a breach of the contract."

However, "in the great majority of ordinary contracts," said the court, "the breach of the covenant is only a breach of the contract and only contract damages are due." By adopting this language, the court ruled out punitive damages for ordinary breach of contract cases. It restricted such damages to breach of contract cases where the parties are in some "special relationship" as defined by the Wallace standard.

Implications for the Future

Three days after it decided the Story case, the Montana Supreme Court rendered an opinion in Lachenmaier v. First Bank Systems, Inc. The Lachenmaier opinion may suggest Montana's future approach to bad faith litigation, so we will analyze it in some detail.

The Lachenmaiers had problems paying off an operating loan issued by First State Bank of Forsyth, a part of First Bank Systems. First Bank Systems transferred the problem loan to Credit Services, Inc., a wholly-owned subsidiary of First Bank Systems. First Bank Systems' General Office and its Credit Services subsidiary were making plans to liquidate the Lachenmaier's assets and foreclose on the debts. At the same time, First Bank's local branch office in Forsyth continued to loan the Lachenmaiers money and even encouraged them to borrow more.

The situation deteriorated and a lawsuit followed. The Lachenmaiers claimed tort damages for breach of the implied covenant of good faith and fair dealing. The court held that the "relationship between a bank and its customers is generally described as that of a debtor and a creditor ... and as such does not give rise to fiduciary [held or founded in trust or confidence] responsibility."

The court also noted that tort damages were available only in breach of implied covenant cases involving "special relationships." The Lachemnaiers' relationship to First Bank Systems was not "special" in the sense of the Wallace standard, said the court. Therefore, the Lachenmaiers were not entitled to punitive damages. A year earlier this case would likely have been decided much differently.

What will the Wallace standard - made in California - mean to Montana's Supreme Court? California has applied the Wallace bad faith doctrine to both insurance and employment cases but not to other arms-length commercial transactions. If Montana follows the California approach in interpreting Wallace, it would still apply the tort of bad faith in insurance cases, but would restrict the use of tort-like punitive damages in arms-length commercial transactions such as franchises, the sale of a business, and banking transactions. As previously mentioned, Montana's 1987 legislation governing employment decisions specifically restricts punitive damage awards to those dismissals involving public policy violations.

Montana businesses should feel some relief based on the Supreme Court's new direction. But there's still plenty of uncertainty. Only time will tell if the Wallace standard will be interpreted in Montana as it has been in California. At the least Montana's Supreme Court recognized that its bad faith decisions had become the most extreme in the country. Business interests will eagerly watch to see whether the reversal continues.

Jerry Furniss is an associate professor and Jack Morton is a professor in The University of Montana's Department of Management. They are both attorneys.
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Title Annotation:laws and litigations on bad faith
Author:Furniss, Jerry L.
Publication:Montana Business Quarterly
Date:Sep 22, 1991
Words:1809
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