GENERAL COMMENTS ON CALIFORNIA LITIGATION
Thomas M. Herlihy, Esq.

Many insurers are all too familiar with California litigation. Some are only occasionally involved. California is no longer a unique forum for extra-contractual exposure. Significant punitive damage verdicts against insurers have been returned in many other states. But it is not unusual to see these other states look to California authority for support in the extension of insureds’ rights to coverage and damages.

The punitive damage headlines often overshadow some core principles of insurance litigation. Such principles are worth remembering as California litigation threatens or commences.

1. The Insurance Contract Still Means Something
California has plenty of case law for the proposition that the insurance contract controls the rights and obligations of the parties. For example, the insured generally has the burden of proof to establish that the claim is covered under the provisions of the insurance contract. (Royal Globe Insurance Co. v. Whitacker (1986) 181 Cal.App.3d 532, 537; Cal Union Insurance Company v. Trinity River Lands Co. (1980) 105 Cal.App.3d 104, 111.) The insurer has the right to limit the policy coverage; the plain language of that limitation or exclusion must be respected. (Continental Casualty Company v. Phoenix Construction Company (1956) 46 Cal.2d 523, 532; National Insurance Underwriters v. Carter, 17 Cal.3d 380, 386.)

Admittedly, many of these standards can be relaxed if the insured can advance arguments, such as contract of adhesion, to extend the scope of coverage to the reasonable expectations of the insured. Nonetheless, the courts still must look to the policy to determine whether the hoped-for extension is "reasonable." In so doing, the courts look to the plain meaning of the entire contract. Any argument for coverage based on an ambiguity in the policy cannot be based on a strained or grammatically incorrect reading of the policy - the insured’s argument for coverage must be grammatically possible. (Atlas Assurance Co. Ltd. v. McCombs Corp. (1983) 146 Cal.App.3d 135, 143; Producer’s Diary Delivery Co. Inc. v. Sentry Ins. Co. (1986) 41 Cal.3d 903, 912.)

Also, it is recognized that the insured has a duty to read the policy and will be presumed to have read it, know its contents, and be bound by its provisions whether the insured has read the policy or not. (Fields v. Blue Shield of California (1985) 163 Cal.App.3d 570, 578; Rutherford v. Prudential Insurance Company (1965) 234 Cal.App.2d 719, 727-728.)
This last concept is especially important when allegations are made inter alia that the terms of the contract were changed by the statements of the agent. Insureds who fail to read their policies cannot recover for fraud or misrepresentation in such circumstances because they cannot establish justifiable reliance on any false representations regarding coverage, inasmuch as they are bound by the clear and conspicuous limitations in the policy, despite alleged misrepresentations. (Hadland v. NN Investors Life Insurance Co. (1994) 24 Cal.App.4th 1578, 1586-1589.)

Thus, the predicate for all insurance litigation, even in California, remains the entitlement to coverage under the insurance contract.

2. Bad Faith Is Not Punitive Damages
Sloppy language, and sometimes sloppy thinking, has led to the misconception that bad faith (a breach of the implied covenant of good faith and fair dealing which gives rise to extra-contractual exposure) is the same as punitive damages. Not so.
The breach of the implied covenant of good faith and fair dealing does give rise to extra-contractual damages due to the underlying tort nature of the breach. (Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 684.) These extra-contractual damages can be significant: emotional distress, financial distress, attorneys’ fees, interest. However, these damages, while extra-contractual, remain compensatory. There must be some proof of causation between the insurer’s bad faith conduct and the damages. For example, if an insured suffers no financial loss as a result of the insurer’s denial of the claim, a bad faith claim cannot be maintained solely for emotional distress resulting from the delay or other mishandling of the claim, because there must be some economic loss which is proven to be the cause of emotional distress. (Gourley v. State Farm Auto Insurance Company (1991) 53 Cal.3d 121, 128; Waters v. USAA (1986) 41 Cal.App.4th 1063, 1079; Gruenberg v. Aetna Insurance Company (1973) 9 Cal.3d 566, 579.)

The breach of the implied covenant of good faith and fair dealing has been set forth in standard California jury instructions. There is case law that has helpful language to insurers with respect to this breach. For example, case language may support instructions akin to the following:
* The covenant of good faith and fair dealing does not mean that an insurer must compensate an insured for any loss that might be covered by the contract in the event of a claim. It means that the insurer cannot refuse to compensate an insured for a claim without proper cause. The test is whether under all circumstances, the insurer acted reasonably and in good faith.
* An insurance company is not required to pay every claim presented to it. An insurance company has a duty to deal fairly with claims that are submitted, but the insurer also has a duty to its other policyholders not to pay meritless claims.
* An insurer’s good faith belief that there was no coverage is proper cause for denying a claim, provided that the insurer’s interpretation is reasonable. In other words, a good faith denial of coverage is not a basis for finding bad faith.
* An erroneous denial of a claim for benefits under an insurance contract does not by itself justify a finding that the insurer breached the implied covenant of good faith and fair dealing.
* An insurance company does not breach the implied covenant of good faith and fair dealing by interpreting the policy to exclude coverage unless the interpretation is inherently unreasonable.
* An insurer may properly consider its own economic interests in denying a claim for benefits, if it presumes that the claim is not covered.

(Silberg v. California Life Insurance Company (1974) 113 Cal.App.3d 452; Austero v. National Casualty Company (1978) 84 Cal.App.3d 1, 30-31; Blake v. Aetna Life Insurance Co. (1979) 99 Cal.App.3d 901, 904; Safeco Insurance Company of America v. Guyton (9th Cir. 1982) 792 F.2d 551, 557; Seaman’s Direct Buying Service, Inc. v. Standard Oil Company (1984) 30 Cal.3d 752, 770; Hanson v. The Prudential Insurance Company of America (9th Cir. 1985) 772 F.2d 580, 584; and Congleton v. National Union Fire Insurance Company (1987) 189 Cal.App.3d 51, 59.)

The evidentiary standard necessary to establish a breach of the implied covenant of good faith and fair dealing remains preponderance of the evidence. The concepts of proper cause and reasonableness are the stock from which the insurer fashions arguments to defend the bad faith claim.
The bad faith concept is different from punitive damages. Punitive damages, codified by statute in California, are not compensatory, but are designed to punish or deter conduct which is deemed malicious, oppressive, fraudulent or in conscious disregard of the insurer’s rights. (Cal. Civil Code §3294.) It is important to emphasize that punitive damages must be established by clear and convincing evidence, not the lesser standard of preponderance of the evidence.

California has developed standard form jury instructions that cover this different burden of proof necessary for punitive damages. It is rare that the courts will allow other instructions that provide a more descriptive definition of the clear and convincing standard. Helpful punitive damage language is contained inter alia Luke v. Mercantile Acceptance Corp. (1952) 111 Cal.App.2d 431, 438; Brewer v. Second Baptist Church (1948) 32 Cal.2d 781, 800; Toole v. Richardson-Merrell, Inc. (1967) 251 Cal.App.2d 689, 715; G.D. Searle & Co. v. Superior Court (1975) 49 Cal.App.3d 22, 32.

Punitive damages are not a matter of right in California. The higher burden of proof raises the bar significantly with respect to the evidence necessary to allow punitive damages to proceed to the jury.
The concept can be seen as a trilogy. First, the plaintiff must establish a breach of contract before there can be a breach of the implied covenant of good faith and fair dealing. (Waller v. Truck Ins. Exch. (1995) 11 Cal.4th 1, 36.) Then, because punitive damages cannot arise from simply a breach of contract, plaintiff must establish a tort, e.g., breach of the implied covenant of good faith and fair dealing. Even then, the establishment of a breach of the implied covenant of good faith and fair dealing is not enough to support a punitive damage claim. (Neal v. Farmers Ins. Exchange (1976) 21 Cal.3d 910, 922; Silberg v. California Life Ins. Co., supra, at p. 462.) The greater quantum of evidence still is necessary, viz clear and convincing evidence.

3. Statutory Violations: Not A Cause Of Action But Perhaps A Basis For Liability
California has set forth in statute and regulations numerous obligations for insurers. The California Insurance Code, at Section 790.03, sets forth insurance claims practices to be avoided. The California (Fair Claim) Regulations, Title 10, Ch. 5, Subch. 7.5, at §§2695.1-.14, sets forth fair claims handling that should be followed.

Section 790.03 reads like the Ten Commandments, giving little guidance to insurers as to how claims should be handled correctly. It is a "Do Not" list. However, the Regulations do set forth time guidelines and procedures for specific duties.

It has been the law in California since 1988, when the California Supreme Court decided Moradi-Shalal v. Fireman’s Fund Ins. Co. (1988) 46 Cal.3d 387, that there is no private cause of action under Section 790.03. By extension, this applies to the Regulations.

The Insurance Code and the Regulations may provide a basis for an insured to argue that a failure to comply with either is evidence of a breach of the implied covenant of good faith and fair dealing. Whether that argument will allow the insured to submit jury instructions or have experts opine on statutory or regulatory violations is ultimately subject to the discretion of the trial court. But is it clear that an insurer violating the statutory or regulatory proscriptions faces the prospect that such evidence can be used to preclude reliance on certain policy provisions, even if the violations are not actionable themselves and/or do not become specific jury instructions. (Spray Gould & Bowers v. Associated Int’l Ins. Co. (1999) 71 Cal.App.4th 1260, 1274; Vesely v. Sager (1971) 5 Cal.3d 153, 164.)

4. The Limitation on Attorneys’ Fees
California allows for a limited and very specific recovery of attorneys’ fees for a breach of the implied covenant of good faith and fair dealing. (Brandt v. Superior Court (1985) 37 Cal.3d 813.)
In order to recover attorneys’ fees, the insured must establish that there has been a breach of contract and a breach of the implied covenant of good faith and fair dealing. Once that is established, the insured must submit evidence to prove attorneys’ fees have been incurred solely for pursuit of contract benefits. This is an important distinction. Attorneys’ fees cannot be awarded for fees incurred in pursuit of any recovery beyond the contract, e.g., fees incurred in pursuit of bad faith, other tort or punitive damages. It may be difficult to parse the attorneys’ fees to prove what portion relates to fees incurred to establishing a breach of contract, but that is what Brandt requires.

An important tactical reminder: Brandt suggests that attorneys’ fees can be determined by the court following the conclusion of the trial, subject to stipulation of the parties. It is a rare instance where the insurer will stipulate; and Brandt does provide a model jury instruction to be used if the issue is presented to the jury.

The latter tactic is recommended. If one of the insured’s defense themes is the overreaching/greediness of the insured in seeking coverage (and extra-contractual damages) where there is no entitlement or a reasonable dispute, the prospect of testimony by the insured’s attorney, or someone from the attorney’s office, about requested attorneys’ fees, usually six figure fees which perhaps may include the introduction of attorney bills, adds to the defense theme.

An inexperienced insured’s attorney may be unprepared for the presentation of this evidence. It should be precluded entirely if no evidence is submitted. The experienced attorney will be quite capable of presenting the evidence. But even this attorney will be uncertain as to how such evidence will be perceived by the jury and would much prefer to have that issue handled solely by the court on post-trial motion.

5. Evidence For Punitive Damages
The defendant may be entitled to bifurcate the punitive damage phase of any trial. (Cal. Civil Code §3295.)

When the punitive damage statutes were amended several years ago, this right to bifurcation was seen as a significant advantage to the defendant. But with the passage of time, and perhaps some painful experiences, most of the defense bar now concludes that bifurcation is rarely a sound trial tactic.

There may be very little punitive damage evidence that would be excluded via bifurcation. With the exception of financial information, most other evidence is arguably relevant to non-punitive damage claims for relief, e.g., breach of the implied covenant of good faith and fair dealing.

Moreover, bifurcation necessarily results in jury deliberation in at least two phases. First, the jury will deliberate on all evidence to determine whether there is a breach of contract, bad faith and sufficient clear and convincing evidence to establish malice, oppression or fraud in order to consider punitive damages. If the jury finds there is clear and convincing evidence of malice, oppression or fraud, the second phase would follow after the introduction of the punitive damage (financial) evidence, thus allowing the jury to deliberate on the amount of punitive damages. In such a bifurcated process, the defendant will argue in the second phase to a jury that already has determined there is sufficient evidence to support punitive damages.
More likely, the better tactic is to allow all evidence to go to the jury in a non-bifurcated proceeding. Then, the defense can explain the trilogy above. In a bad case for the defense, the attorney can concede on the contract and even extra-contractual issues, but strongly argue there is no clear and convincing evidence of malice, oppression or fraud, or conduct that should be punished to deterred by punitive damages.

Financial evidence to support any punitive damage claim should be based on net worth or net after-tax income, and not on inflated financial figures. (BMW of North America, Inc. v. Gore (1996) 517 U.S. 559, 560.) For insurance companies, the courts generally will allow the figures drawn from the filings with the California Department of Insurance. These figures are based on statutory accounting principles, and arguably would be different, and higher, if general accounting principles were used. However, the net worth and net after-tax income amounts in the filings usually are large enough to allow for sizable punitive damage awards.

Finally, most insurers in punitive damage litigation in California are familiar with the discovery requests whereby the insured seeks other claim files or documents regarding institutional insurance claim handling. The general rule, unfortunate as it may be, in discovery disputes is that plaintiff will be given great leeway in securing access to this information. (Colonial Life & Accident Ins. Co. v. Superior Court (1982) 31 Cal.3d 785.)

The courts remain conscious of privacy concerns, so redaction of privileged/confidential information is normally done. California Insurance Code §791.01 et seq. Occasionally the courts will give deference to the burden and expense of compliance and limit it accordingly. (Mead Reinsurance Co. v. Superior Court (1986) 188 Cal.App.3d 313, 317.) But in the era of computer information and paperless claim files, the mounting perception in discovery disputes is that the insurance company can provide all the information quickly and at relatively low expense.

It would appear from case law analysis that the stronger punitive damage case is one which is based on evidence confirming that the underlying dispute is part of institutional claims handling, which arguably should be punished or deterred. (Moore v. American United Life Ins. Co. (1984) 150 Cal.App.3d 610, 626; Neal v. Farmers Ins. Exchange (1978) 21 Cal.3d 910, 923.)

This is not to say that a punitive damage case cannot be established solely by presenting evidence of the conscious disregard by the insurer in the handling of one particular claim. Obviously, the total facts of the underlying claim handling are significant in determining for the plaintiff’s attorney whether the time and cost (even for the plaintiff, there is cost in Colonial Life discovery) is necessary to establish the punitive damage evidence.

 
6. A Hidden Gem - the SIU Regulations
In 1994 the Special Investigative Unit Regulations, contained at Title 10, Subchapter 9, Article 2 of the California Code of Regulations, became effective. The SIU Regulations require insurance companies to maintain antifraud units which must develop procedures and a dedicated staff to analyze claims, establish claim techniques and document claim reviews to ferret out fraudulent claims.

The SIU Regulations are helpful to insurers whose claims handling practices are subject to attack, i.e., as evidencing a bias or predisposition against payment of claims. Indeed, many plaintiff’s attorneys will argue that any time an insurance company conducts an investigation following receipt of a claim with verification of the loss, it must be assumed that the investigation is designed to find bases not to pay the claim. They argue that any further investigation after proof has been submitted is unnecessary, unless the goal is to reduce or deny the payment.

Such an argument overlooks the obligation, indeed the duty, insurance companies have to investigate. The Regulations also provide a further answer. The SIU Regulations justify almost every aspect of insurance company investigation, even if the individual claim is never suspected of being fraudulent. After all, how can an insurance company determine fraudulent claims without investigating all claims, inasmuch as fraudulent claims rarely identify themselves as such at inception?

Indeed, the SIU Regulations have minimum downside when asserted as a justification for all aspects of claim handling. To the extent that the plaintiff may seek to advance bad faith liability via breaches of insurer duties under Section 790 and the Fair Claims Regulations, the SIU Regulations provide the trump card to deter or defeat the argument.