N.D. of California: A Good Faith Dispute Over Coverage Not Enough to Dismiss Bad Faith Counterclaim

Great American Ins. Co. v. Quintana Homeowners Assoc. et al., 2018 WL 3632111 (N.D. Cal. July 31, 2018) (slip op.), began as a simple declaratory judgment action by Great American seeking to affirm its coverage position that it did not owe its insured, the Quintana Homeowners Association, a defense or indemnity pursuant to its umbrella “follow form” policy for an underlying real estate litigation involving the Association.  However, the Association counterclaimed for, among other things, breach of the duty of good faith and a declaratory judgment that Great American had a duty to defend and contribute to its settlement of the underlying litigation.  The Association sought punitive damages based on Great American’s oppression, malice, and fraud in denying coverage and failing to assist with settlement.

As part of its bad faith counterclaim, the Association alleged that Great American unreasonably: 1) refused to pay defense costs after the primary’s limits were exhausted; 2) failed to contribute to the underlying settlement; 3) failed to properly investigation the claim; 4) failed to give the Association’s interests due consideration, 5) failed to consider arguments that would support a defense and indemnity obligation, and 6) misrepresented policy terms.  Id. at *3.  Great American moved to dismiss the Association’s bad faith counterclaim, arguing it could not be liable for bad faith because there was a “good faith coverage dispute.” Id. Focusing on claims regarding the failure to investigate and participate in the third party settlement, the court sided with the Association, noting that the Association alleged more than a simple coverage dispute; the complaint alleged a failure to investigate and consider evidence that would have supported a defense obligation.  Holding that this allegation was sufficient at the pleading stage, the court noted that “a genuine dispute over coverage ‘does not relieve an insurer from its obligation to thoroughly and fairly investigate, process and evaluate the insured’s claim.'”  Id. (internal citations omitted).  Moreover, the case Great American relied upon for this argument involved an insurer who in fact did provide a defense but no indemnity coverage.  Id.

With respect to the refusal to settle claim, Great American argued that it could not be liable for a bad faith refusal to settle because the third party settlement did not involve an excess judgment over policy limits.  Though the court noted that an excess judgment is generally “needed to establish liability and damages for wrongful refusal to settle,” such a claim may also be actionable if “the insurer’s conduct goes beyond a simple failure to settle within policy limits or the insured suffers consequential damages.”  Id. at *4.  Because the Association’s allegations went beyond a simple failure to settle and included the failure to provide a defense, and because the Association alleged it had incurred attorneys’ fees, interest, as well as “other economic and consequential damages,” the court found the Association had stated a claim for bad faith based on a refusal to settle.

Great American could not entirely knock out the Association’s claim for punitive damages either.  The Association based its punitive damages request on allegations that Great American had engaged in “malicious and oppressive,” and fraudulent conduct in denying coverage, which was unsupported by the “follow form” policy language, and in contrast to the primary insurer’s coverage position whose policy it followed.  Id. at 4-5.  The court found the Association’s supporting allegations that Great American failed to ask questions or investigate its claim satisfied the statutory elements for “oppression and malice”; however, the Association’s allegations failed to meet the federal pleading standard for fraud.  

At the pleadings stage, allegations of a failure to properly investigate and consider coverage for the claim proved enough to push a bad faith counterclaim past a motion to dismiss.  In this case, the stakes remain high, as the insured was able to squeak by with a claim for punitive damages.  The fact that the primary insurer provided an initial defense based on its reading of the same policy language undermined Great American’s argument that there existed a “good faith coverage dispute” between the parties, signaling that an insurer likely faces an uphill battle denying defense coverage after the primary has been exhausted on a “follow-form” umbrella policy.  As if to summarize the result here, the court explicitly warned that “an insurer who denies coverage does so at its own risk.”  Id. at *3.