THE ROAD FROM CLAIM DECISION TO TRIAL:

WHAT TO LOOK AT IN EVALUATING A CLAIM FILE FOR PURPOSES OF TRIAL

Sean P. Nalty

Partner

Protected by the Attorney

I. INTRODUCTION

Over the past several years, California has gained a reputation of being a difficult place for corporations to try actions successfully. Not the least among these are insurance companies faced with claims for breach of contract, breach of the covenant of good faith and fair dealing ( “ bad faith ” ), and punitive damages as a result of the denial of a claim for benefits.

It is true that jurors in Northern California, particularly San Francisco, Alameda, and Marin Counties, have a well-earned reputation of being anti-big business. Insurance companies, like almost all corporations, are not sympathetic defendants. It also is true that trials are very unpredictable and sometimes, despite everyone ’ s best efforts, a jury comes back with a significant verdict that is not expected. Not even the best analysis and the most skilled advocate can always prevent adverse verdicts.

There is, however, an analysis of the claim file that may assist in predicting possible success at trial. The key to this analysis is that it takes much more than a reasonable claim decision to have a successful trial verdict. Although it is difficult to succeed at trial with a bad claim decision, there is no guarantee that the company will succeed at trial even with a reasonable claim decision.

The purpose of this paper is to discuss what an insurance company should evaluate to determine potential success at trial in California. The purpose of this paper is not to advocate that this analysis should be performed each time an adverse claim decision is made by the company. Rather, the intent is to provide guidance in evaluating a claim when the insured or the insured ’ s attorney threatens legal action. The often-heard phrase: “ I ’ ll see you in court if this matter is not settled now. ” What should the company look at in determining whether to pursue litigation or to pursue settlement? The purpose of this paper is to provide an answer to this question.

For purposes of this analysis, it is assumed that a claim professional has made a decision on a California claim that he or she believes is reasonable and fair. It is assumed that the claim decision is consistent with the policy language and that there are no issues concerning ambiguity in the policy language. It also is assumed that the company ’ s claims handling procedures and practices were followed and that there were no obvious significant problems in the handling of the claim.

II. NATURE OF A JURY TRIAL

The place to start is a brief analysis of the dynamics of a jury trial. A jury trial, in many ways, is much like a stage play. The witnesses and the attorneys are the actors, the judge is the director, and the jurors are critics. The plot involves a search for the truth, perhaps, but there is no way to determine the actual truth. The jurors were not in the meeting when the decision was made to close the claim; the jurors cannot get into the head of the insured and actually determine if the insured is telling the truth. A more accurate description of a jury trial is that, using the evidence the judge allows to be considered by the jury, each party tells a story of what they believe is the truth. At the end of the trial, the jury chooses which story they believe more accurately represents the truth. The jury determines which story is more compelling and supported by the evidence.

Most critics of the theater have been to the theater many times and know the dynamics of a good production. They usually know something about the actors and the director and often have an understanding of the story before the start of the play. This is not true for juries. Sonya Hamlin, in her book What Makes Juries Listen-A Communications Expert Looks at the Trial, characterizes juries in this fashion:

The jury system is actually bizarre. Where else in our society would you invite disparate laymen, novices with absolutely no experience or previous information in a given field, to be the ultimate judges about issues in that field, with almost no restrictions on their qualifications . . . . They ’ ve never been to court, know nothing about trial procedure or the law. They hear the case just once-orally. They may have little schooling and little information about most aspects of our society, let alone expertise in the subject in question. They may be innately bright or slow, interested or disinterested, privately prejudiced or not. They ’ re recruited and pressed into service, not even willing volunteers.

Hamlin opines that, despite all of this, the jury system works because:

We can all judge human behavior because we have all shared the human experience. In order for us to judge anything, we depend on our backlog of experiences. We ask ourselves is that true, is it possible, is it practical, what would someone normally do and what would the consequences be? When jurors sit in court and listen to (the attorneys) or to witnesses ’ testimony they ’ re thinking, ‘ C ’ mon, people don ’ t act like that, ’ or ‘ Look at him, he ’ s lying, ’ or ‘ That was cruel, ’ or ‘ Ha! That ’ s just greed. ’ They know about living and being human. Their process of evaluating and judging is in the gut.

Hamlin is correct in her conclusion that this human dynamic, this gut instinct, often plays a significant role in the decisions made by a jury. A mistake made by attorneys and claim professionals is to evaluate the strength of the company ’ s position at trial only through a review of the claim file.

Although the claim file from a poorly handled claim provides a indication that the company will not succeed at trial, the claim file that reflects a well-handled claim does not necessarily mean that the company will succeed at trial. Why? Although it is a significant piece, the claim file is only one piece of the evidence in an insurance case. It is only one part of the script that the jury will consider. It is devoid of the human dynamic that will dominate the trial. The required analysis is broader than the claim file and includes those elements that go directly to the human dynamic that is at the core of a jury trial.

• ISSUES THAT MUST BE ANALYZED IN ADDITION TO THE CLAIM FILE

• What is the Company ’ s Trial Theme?

The evaluation of the claim file for purposes of trial starts by determining what story the company will tell the jury. What will be the company ’ s theme at trial? The theme or themes are ideas that provide the overriding supporting rationale for the actions of the company and help explain and link together the individual pieces of evidence. The best themes appeal to the jurors ’ notions of fairness, equity, and common sense. A good theme taps into the experiences of the jury and compels the jury to view the facts and disputed issues in favor of the company. The theme gives the jury an overall impression of the events and provides the rationale that will cause a juror to adopt the company ’ s position. The theme must ring true to the jury.

Crafting a theme that is compelling to a jury is difficult for an insurance company and usually involves several components. One important component is to explain to the jurors, who will have little or no knowledge of insurance, the purpose of insurance, the significance of the policy terms, and the role the company plays in the claim process. The jury must understand that the company cannot pay every claim. The company ’ s role is to carefully, and after a complete investigation, distinguish between payable claims and meritless claims based on the terms of the policy. In this way, the company will ensure that benefits are available to individuals who are entitled to them and insure that coverage will remain affordable.

The claim file often provides the more specific information that is incorporated into this general theme. The specifics usually center on the reasons for the claim decision. In a disability case, for example, the theme may be that the insured is choosing not to work rather than being prevented from working by a sickness or injury. In a property damage case, the theme may be that the repair estimates provided by the insured are inflated and unreasonable or include damages that are not part of a covered claim. These specifics are combined with the overall theme concerning the purpose of insurance and the role of an insurance company.

By far, the most important components of any theme in an insurance action are fairness and equity toward the insured while, at the same time, enforcing the contractual terms. To be successful, and regardless of what other components may be part of the company ’ s theme, the company must be able to demonstrate to the jury, over and over again throughout the trial, that it consistently treated the insured fairly, investigated the claim thoroughly, and applied the terms of the policy in a reasonable and intellectually honest fashion. More than anything else, this will compel the jury to decide the case in favor of the company. Juries do not want to reach results that they perceive are unfair.

The simpler themes are more effective. It is difficult for jurors to understand complex concepts, due in large part to the way information is communicated during a trial. Jurors come from a world of “ sound bite ” communication- everything you need to know in 30 seconds or less. Yet, at a trial, jurors get most of the information through lengthy (more than 30 seconds) oral testimony. Jurors cannot ask questions or request certain information. The information often is not presented in a cohesive fashion and there are unexplained informational gaps because of evidentiary rulings. The simple themes more effectively bring unity to information presented in a disjointed fashion and give the jury the vehicle to understand the company ’ s position even though they may have difficulty following certain testimony.

Try to stay away from technical defenses as the primary theme. Defenses based on enforcing what the jury perceives to be technical language in the policy in a manner that seems unfair to a layperson normally are not successful.

Ultimately, the strength of the theme will have a significant impact on the company ’ s success at trial. This strength is measured by its inherent fairness and equity as well as the quality and quantity of the evidence that supports it. Although discovery in the action will help the company refine trial themes, the claim file, and the basis for the claim decision, will go a long way in defining the trial theme.

Finally, in reviewing the claim file, keep an eye on the types of themes the insured might rely on at trial. It is easier for an insured to craft a simple theme, most often that of the underdog insured as the victim of corporate greed. The fairness of the company ’ s conduct is critical to defeating this approach by the insured.

• Burden of Proof at Trial

Issues concerning the burden of proof at trial play a central role in evaluating the claim file. At a trial, the law designates that the plaintiff insured has the burden of proof on each of the causes of action alleged in the complaint, and the defendants have the burden of proving affirmative defenses. The textbook example in the insurance context is that the insured has the burden to prove that coverage exists under the terms of the policy or that benefits are payable under a policy. The company normally has the burden to establish the application of exclusions under the policy.

The legal significance of the burden of proof is that the party with the burden must prove, by a preponderance of the evidence, each fact necessary to establish a cause of action or affirmative defense. Therefore, considering all the admissible evidence, and the instructions given by the court, the jury must conclude that the party with the burden of proof has established each necessary fact by a preponderance of the evidence.

This is significant in an insurance matter because, among other reasons, it gives the company a vehicle through which to challenge the insured without accusing the insured of being a liar. Oftentimes the entitlement to insurance benefits comes down to an evaluation of the credibility of the insured. Is the information given by the insured enough to establish entitlement to coverage?

For example, in the context of a claim for disability or health benefits, oftentimes the insured ’ s claim for benefits is based exclusively on the insured ’ s subjective complaints, such as chronic pain. Evidence is developed during the claim investigation that the insured ’ s behavior is inconsistent with the complaints of chronic pain.

At trial, the insured often argues that the “ big bad ” company denied the claim because it doesn ’ t believe the insured ’ s complaints of chronic pain. In arguing such a case to the jury, unless the evidence is overwhelming, the insurer wants to avoid arguing that the claim was denied because the insured is lying about the nature and extent of the pain complaints. Jurors will be reluctant to call an insured a liar.

Rather, the company is better off arguing to the jury that the insured did not meet his or her burden of proof-that the insured did not establish by a preponderance of the evidence that he or she was entitled to benefits. This framing of the issue allows the jury to find in favor of the company without having to find that the insured is a liar. In California, success on the coverage issue normally results in a defense verdict.

Therefore, in reviewing a claim for purposes of litigation and trial, look at the facts in the claim file with an eye toward the burden of proof. Can the insured meet this burden to establish coverage or entitlement to benefits? Is the evidence compelling?

It is important that a company not push an action to trial based exclusively on the argument that the insured ’ s evidence does not meet his or her burden of proof. It is difficult to defend successfully an action based exclusively on attacks on the insured ’ s evidence. The key to the burden of proof is that the company has compelling evidence in support of its position on each issue upon which the insured has the burden. Then, in evaluating whether the insured meets his or her burden of proof, the jury can consider the company ’ s evidence in addition to the evidence offered by the insured. Taking all the evidence together, the goal is to have the jury conclude that the insured did not met his or her burden of proof.

• The Witnesses-the Actors in the Drama

The witnesses who will testify on behalf of the company play a significant role in the outcome of the trial. They are the actors in this drama. A trial on even the best claim decision can be lost if the witnesses are unable to communicate effectively the company ’ s position.

Witnesses have an uphill battle. People no longer get information through long verbal explanations. The days of great oratory are gone. Verbal communication in fact is de-emphasized; information is provided in glitzy packages on television or the computer screen. People want bullet points and videotapes. People simply are not accustomed to processing lengthy verbal communications of complex information.

The uphill battle of any witness is compounded by the fact that a jury plays a passive role during the trial. People often become engaged in conversations by asking questions and expressing opinions. The jury does not have this option. They sit and listen, without asking questions and without being able to do anything to help themselves stay interested and connected to the information being delivered to them, except perhaps taking notes. It is not surprising, therefore, that jurors often have glazed looks in their eyes.

It also is no wonder that, after a lengthy trial, jurors often have difficulty recalling the specific testimony of each witness. Jury interviews do establish, however, that jurors will remember the gist of testimony given by witnesses who are likable, knowledgeable, experienced, credible, and honest.

It is critical, therefore, that the company evaluate the potential witnesses. This means going beyond the claim file and sitting down with the principal players in the claim to evaluate their demeanor and testimony. How will the witnesses communicate to a jury in an artificial situation, under pressure, while being challenged by the insured ’ s counsel? What are the communication skills and deficiencies of each witness? Is the witness shy and easily intimidated, or does the witness have a commanding presence? Is the witness dull, likable, overeager, inexperienced, smart, obnoxious, arrogant, or outgoing? Does the witness come across as simply restating “ the company line. ” Does the witness have the experience, competency, and presence to command the jury ’ s attention and provide compelling testimony?

It is important to remember that, oftentimes, good, honest, hardworking people have difficulty, in a trial setting, explaining to the jury the complex issues that are involved in an insurance bad faith action. The most well-spoken person around the water cooler or at the lunch table is not necessarily the most effective witness. Most people are scared to speak to an audience; most people find it difficult to make clear, straightforward, and direct statements in the formal setting such as a trial court. Often anxiety brings out the worst performance in a witness.

Evaluate the witness ’ s body language and demeanor. A witness ’ s unspoken communication often impacts the jury as much as the statements by the witness. These intangibles contribute greatly to that gut reaction of the jury, that human dynamic that we all use in judging one another. Does the person ’ s body language cause him or her to seem defensive, aloof, or disingenuous? A witness who does not make eye contact, or who seems tense, apprehensive, or hesitant, presents a different picture than does a witness who has a sincere smile and appears relaxed.

So, in evaluating a claim file for purposes of trial, formulate at least a rough idea of potential themes and then determine generally what the company is going to need to prove at trial. From this, determine the company ’ s potential trial witnesses. The most critical aspect of the entire evaluation process is to talk to witnesses and determine if their thought processes and actions on the claim withstand specific scrutiny. Ask tough specific questions concerning their role in the claim, their analysis of the claim, and the factual foundation for their conclusions. Pay special attention to the communication skills of the witnesses and their demeanor and try to determine if these skills will allow them to overcome the pressure and anxiety associated with testifying at trial.

• The Insured

Evaluating the credibility of the insured is another important aspect of this analysis and is difficult to do only through the claim file. Nonetheless, the credibility of the insured and sympathy for the insured will play a major role in shaping the outcome of the trial.

Try to discern from the information in the claim file the type of individual that the company will see on the stand at trial. Oftentimes medical records provide clues; field reports concerning personal contacts with the insured are valuable as well in this analysis. The claim examiner ’ s interactions with the insured also provide important clues. This information should be viewed with the understanding that, by the time the matter goes to trial, the insured ’ s attorney will have worked with the insured to try to transform even the most obnoxious individual into sweetness and light. However, some individuals will make poor witnesses despite the best preparation, and this is important to understand when evaluating the matter for trial.

Unless the insured is a poor witness, jurors are inclined to believe the insured unless the company can show the jury significant discrepancies in the insured ’ s story. Sometimes attorneys and claim professionals get excited about inconsistencies in an insured ’ s story; yet, unless they are significant, jurors oftentimes dismiss them or believe the insured ’ s explanation. If the company ’ s trial defense is based on discrepancies in the insured ’ s story, make sure the discrepancies are significant and will be understood by the jury. Over emphasizing minor discrepancies may suggest a pettiness or harshness on the part of the insurer that may cause the jury to identify with the insured. The company needs the jury to identify with it and to view the insured as wrong or unlike themselves. At the least, the discrepancies must cause the jury to conclude in their gut that the insured ’ s position does not make sense.

• Documentary Evidence

Documentary evidence can be compelling at trial. Attorneys always are looking for that “ smoking gun ” document that demonstrates the “ true ” intent of the company in handing the claim. A true smoking gun document is most often easily identified.

The more difficult issue is to evaluate the impact of documents that appear at first glance to be benign. Insurance company employees work with documents all the time, often the same documents over and over again. The meaning of a document often depends on the context in which it was generated and the purpose of the document. Understanding the context in which a document is generated, and how it is used, is critical to understanding the evidentiary value of the document.

Counsel for insureds, and their “ bad faith experts ” regularly take a document, or phrases within a document, out of context and argue that the document means something nefarious. Can the insured make a compelling argument that the document means something else?

For purposes of this analysis, first try to set aside the company ’ s knowledge of the context surrounding a document and determine how the jury will react to the document based simply on its content without the company ’ s explanation. Then evaluate the evidentiary force of the document based on the anticipated argument by the insured ’ s counsel and the insured ’ s expert that will put a negative spin on the document. Is this argument persuasive? One key to this determination is to analyze how well the insured can connect the nefarious spin on the document to what the insured claims is the improper conduct in the handling of the claim.

Finally, return to the issue of the document placed in the proper and accurate context. Does the company have a witness who can persuasively place the document in context? If the company can place the document in proper context, will this testimony be strong enough to overcome the persuasiveness of the insured ’ s negative spin? How well can the company separate the document from the claim? In other words, can the company present evidence to the jury that the information in the document has little or no relation to the issues pertaining to the claim decision.

• Expert Testimony

It is important to evaluate the expert opinions in the claim file. Certainly, it is important to determine if, in the handling of the claim, the opinions relied on were accurately understood and applied in a fashion that is consistent with the expert ’ s opinion. This, however, is only part of the analysis.

It also is important to analyze the credibility of the expert and the basis for the expert ’ s opinion. How will this expert, and his or her opinion, withstand a cross-examination? An expert opinion is much like a building: The foundation must be strong for the expert ’ s opinion to withstand cross-examination. At trial, the company may have to ask a jury to agree with and follow the opinions of a particular expert. The company has a better chance to accomplish this task if the foundation of the expert ’ s opinion is strong. It also is important to conduct this same analysis of the opinions of any experts that the insured may rely on in trying to establish entitlement to benefits.

Therefore, go beyond the opinion itself to evaluate its foundation. Does the expert have the required expertise to render the opinions relied on in handling the claim? Has the expert reviewed all of the relevant records, information, or testing? Is the opinion of the expert comprehensive? Look critically at the expert ’ s report. Review the expert ’ s curriculum vitae.

The company also must consider how often the company has hired the expert and what types of opinions the expert has rendered. In California, the courts almost without exception allow discovery into other reports prepared by an expert as long as the privacy rights of the insured are protected by redacting the report. An expert who has been used often by the company, and consistently issues reports favorable to the company, may not be a persuasive witness at trial and in fact may harm the company ’ s cause by suggesting bias on the part of the company in selecting the expert. A jury also may conclude that the expert is biased in favor of the company because he or she wants to continue to receive assignments from the company.

• Differences Between Breach of Contract and Bad Faith and the Importance of the Claim Decision

Experience has demonstrated that sometimes juries have a difficult time differentiating between breach of contract and bad faith. To an attorney or experienced insurance professional, the difference is obvious. Breach of contract simply is the failure to perform under the terms of the contract. Bad faith, on the other hand, is a tort and is established in California when the insurer denies coverage or benefits unreasonably and without proper cause. Bad faith opens the company up to numerous tort damage claims, whereas breach of contract damages are limited to whatever is required for performance of the contract.

Why is this distinction significant in terms of evaluating a claim? The answer involves the dynamics and focus of the jury. The foundation of any defense in an insurance action is the strength of the defense on the issue of coverage or entitlement to benefits ( “ contract issue ” ). A jury can find bad faith only after they have determined that coverage exists under the policy and, if a benefit determination is at issue, that benefits should have been paid. To find bad faith, a jury must conclude that the company ’ s coverage and or benefit determination was unreasonable and without just cause.

A strong contract defense will at least cause the jury to debate the contract issue. After vigorous debate on the contract issue, the jury will be less likely to conclude that an insurer was unreasonable in concluding that the insured was not entitled to coverage or benefits. A jury is less likely to conclude that the company ’ s decision was unreasonable if they had to struggle with the same determination.

At the opposite end of the spectrum, if a jury concludes that the insured ’ s entitlement to benefits is obvious, then the deliberations will quickly turn to the issue of whether the insurer was unreasonable in the claim decision. The company is in trouble if the first words out of the jurors ’ mouths, at the beginning of deliberations, are: “ You ’ ve got to be kidding. They denied this claim? ”

Therefore, in addition to evaluating the merits of the claim decision, it is important to determine if the claim facts are conducive to a jury understanding (a) the basis for the claim decision, and (b) the difference between breach of contract and unreasonable conduct. A textbook example is a good claim decision made by an obnoxious claim representative. Being obnoxious is not bad faith; yet a jury may lose sight of a good claim decision because of the dynamics of the claim handling.

Oftentimes the insured ’ s counsel and bad faith expert will use “ the mud strategy ” – throw enough mud at the claim decision and hope that some of it sticks. In other words, the insured will criticize and challenge the claim decision at every turn in the hope that the jury will blend the issue of breach of contract and bad faith and lose sight of the distinction between the two.

In evaluating the claim file, try to determine if the claim handling and claim decision are such that a jury will be able to see through the mud. The ability to simplify the claim handling and claim decision is important. The company ’ s theme also plays an important role. A consistent theme that is used as the anchor by which to explain the claim decision will bring clarity to the claim decision.

The ability of the company ’ s witnesses to articulate the basis and rationale of the claim decision also is critical. The witnesses must be able to articulate the nature and scope of the investigation done by the insurer, the reasons that certain avenues of investigation were followed and the reasons that other avenues were not pursued. The more effectively this is accomplished, the more likely the jury will be to focus on the coverage/contract issue.

• The Genuine Dispute Doctrine

A body of law in California holds that, if there is a genuine dispute concerning whether coverage exists under a policy, the insurer as a matter of law cannot be found to have acted in bad faith in denying the claim. The courts have labeled this the “ genuine dispute doctrine. ”

Two cases of particular interest that applied the genuine dispute doctrine are Fraley v. Allstate Insurance Co. (2000) 81 Cal.App.4 th 1282 ( “ Fraley ” ) and Chateau Chamberay Homeowners Assn. v. Associated International Insurance Co. (2001) 90 Cal. App.4 th 335 ( “ Chateau ” ). Although these cases most often are discussed in relationship to a summary judgment, the analysis by the courts also provides an excellent basis to evaluate the strength of the company ’ s position on a bad faith cause of action. Both cases discuss good claims handling and illustrate the type of conduct that should result in a positive verdict for a company at trial.

a. Fraley v. Allstate

The court in Fraley was faced with fire loss. According to the court, Allstate promptly secured a contractor to provide an estimate of the cost of repair and paid the insured the amount of the estimate. In fact, the court found that the terms of the Allstate policy at issue were not ambiguous, that Allstate followed the policy language properly, and that it paid the required the benefits to the insured.

Nonetheless, Fraley brought a cause of action for bad faith based on the allegation that Allstate acted in bad faith by hiring captive contractors and low-balling the repair estimates. He relied solely on the differential between Allstate ’ s original repair estimate of $115,000.00 and the replacement cost arbitration award of $364,500.00. He argued that the discrepancy between Allstate ’ s initial cost of repair estimate and the arbitration award was evidence that Allstate low-balled its insured with its repair estimate.

The court in Fraley held that this contention did not allow Fraley to overcome Allstate ’ s motion for summary judgment on the issue of bad faith. The court, relying on several cost estimates that were obtained by both parties and that ranged from $110,000.00 to $291,106.57, concluded that there was a genuine dispute regarding Allstate ’ s contractual obligation. The significant part of this opinion, for purposes of this paper, is the court ’ s statement that: “ [w]here the parties rely on expert opinions, even a substantial disparity in estimates for the scope and cost of repairs does not by itself suggest the insurer acted in bad faith. ”

The holding in Fraley is that an insurance company can rely on its own independent experts in making a claim decision. In addition, the court was quick to point out that Allstate, in handling the claim, acted promptly and paid what Allstate thought was owed on the claim. In other words, Allstate had fairness and reasonableness on its side and this, more than anything else, resulted in the court ’ s ruling in Allstate ’ s favor.

b. Chateau

The opinion in Chateau is even more instructive about what to look for in evaluating a claim file for purposes of trial.

The coverage issue at the heart of the dispute in Chateau arose out of the Northridge earthquake. Associated International Insurance Company ( “ AIIC ” ) issued a $5 million policy of property insurance to the Chateau Chamberay Homeowners Association ( “ HOA ” ), covering the common areas of a 66-unit condominium building. The building was damaged in the Northridge earthquake on January 17, 1994, and HOA promptly submitted a claim. On January 20, 1994, AIIC employed an adjustor, a general contractor, and an engineer to evaluate the loss. AIIC completed a site inspection and paid in advance $50,000 to HOA on February 1, 1994.

HOA retained the services of a public adjustor and two structural engineers. On February 4, 1994, one of these engineers submitted a report that stated that the building seemed to have survived the earthquake with relatively little damage. The report also made repair recommendations, such as the installation of plywood on all exterior walls of the first and second floors, to minimize any further damage which might occur from future seismic activity. Two weeks later, the contractor hired by HOA was installing shear paneling that was not necessary for emergency shoring but was needed for purposes of meeting current building codes. Finally, during its investigation, AIIC discovered, in reviewing HOA board meeting minutes, that the building had pre-earthquake problems, including land erosion, water intrusion, and tile buckling.

It was agreed between AIIC and HOA that HOA ’ s adjustor would submit a repair estimate that would be used as a basis to attempt to resolve the claim. On May 24, 1994, prior to receiving this estimate, AIIC paid another $100,000 in benefits to HOA. On June 22, 1994, AIIC formally advised HOA that certain repairs would not be covered, such as those necessary to comply with new building codes, those that were made to condominium units (not common areas), and those necessary to repair pre-earthquake damage. On September 29, 1994, HOA ’ s adjustor submitted a repair estimate of $6,493,793, which included many repair costs that were not necessitated by earthquake damage, such as defective floors, removal of stucco in order to install plywood sheathing that was not made necessary by earthquake damage, repair of water intrusion problems, and repairs to individual units not covered under the AIIC policy.

AIIC had a number of problems with this estimate and began discussions with HOA ’ s adjustor to try to resolve these issues. Despite these disagreements, AIIC paid another $300,000 in benefits under a reservation of rights in December 1994. Faced with AIIC ’ s contention that its estimate was grossly overstated, HOA ’ s adjustor withdrew the estimate in March 1995.

In June 1995, HOA submitted another estimate, this time in the amount of $5,771,522. Like the prior estimate, this estimate also included items that AIIC concluded were not properly part of the earthquake claim, such as the costs to comply with current building codes, the cost of repair of pre-existing damage, the cost of installation of caissons and grading, the cost to repair floor vibrations, and the cost to repair the interior of certain individual apartment units. Despite AIIC ’ s disagreement over the scope of this estimate, and the scope of the covered loss, AIIC made another benefit payment of $ 1 million on September 14, 1995. After additional efforts by AIIC to define the scope of the claim and resolve it were rejected by HOA, AIIC made another benefit payment of $449,161.48. Following this payment, AIIC took the formal position that no further benefits were owed under this claim.

HOA responded by suing AIIC for breach of contract and bad faith. AIIC moved for summary judgment on HOA ’ s claim for bad faith based on the argument that there was a genuine issue concerning the scope of the covered loss. HOA opposed the motion by submitting a declaration from an insurance expert that concluded, without factual support, that AIIC ’ s handling of the claim was in bad faith. The trial court granted AIIC ’ s motion and the matter went forward on HOA ’ s cause of action for breach of contract.

Before the trial, the parties stipulated that the coverage dispute would be resolved by binding arbitration. The arbitrator concluded that AIIC owed $610,753 in additional benefits under the claim. The total benefits paid by AIIC constituted 45 percent of HOA ’ s original claim. Nonetheless, HOA appealed the trial court ’ s granting of AIIC ’ s motion for summary judgment on the cause of action for bad faith, arguing that AIIC ’ s investigation was inadequate and that it delayed unreasonably in the payment of benefits under the claim. The Second District Court disagreed, affirming the trial court ’ s decision.

The Second District premised its decision on basic concepts that are at the core of the covenant of good faith and fair dealing and at the core of evaluating a claim decision for purposes of trial. The court made the important distinction between a simple breach of contract and conduct that rises to the level of tortious bad faith. Bad faith, according to the court, “ demonstrates a failure or refusal to discharge contractual responsibilities, prompted not by an honest mistake, bad judgment or negligence but rather by a conscious and deliberate act, which unfairly frustrates the agreed common purposes and disappoints the reasonable expectations of the other party thereby depriving that party of the benefits the agreement. ” (Emphasis added.) An erroneous denial of coverage is a breach of contract but does not rise to the level of tortious conduct.

The court also recognized a simple concept that often gets lost in the analysis of the handling of a claim: An insurer, although it must give as much consideration to the interests of the insured as it does its own, “ is entitled to give its own interests consideration when evaluating the merits of an insured ’ s claim. ” Consequently, “ [w]here there is a genuine issue as to the insurer ’ s liability under the policy for the claim asserted by the insured, there can be no bad faith liability imposed on the insurer for advancing its side of that dispute. ”

Based on these principles, the court addressed the application of the genuine issue doctrine. Citing Fraley, the court stated: “ It is now settled law in California that an insurer denying or delaying the payment of policy benefits due to the existence of a genuine dispute with its insured as to the existence of coverage liability or the amount of the insured ’ s coverage claim is not liable in bad faith even though it might be liable for breach of contract. ”

Finally, the court concluded: “ While many, if not most, of the cases finding a genuine dispute over an insurer ’ s coverage liability have involved legal rather than factual disputes, we see no reason why the genuine dispute doctrine should be limited to legal issues. That does not mean, however, that the genuine dispute doctrine may properly be applied in every case involving purely a factual dispute between an insurer and its insured. This is an issue which should be decided on a case by case basis. ”

The cases that address the genuine issue doctrine, when they are applied on a case-by-case basis, provide a framework for insurers to evaluate the handling of a claim for purposes of trial. AIIC ’ s handling of the claim in Chateau was fair. AIIC was presented with two estimates that contained repair costs that AIIC did not believe were covered under the policy. It promptly investigated the claim and paid benefits it concluded were owed. The court concluded that the only inference that could be drawn from the record was that AIIC had a reasonable and legitimate basis for questioning HOA ’ s claim.

The court in Chateau also provided specific guidelines for what conduct can give rise to a bad faith claim. The court described this conduct as follows: (1) misrepresenting the nature of the insurer ’ s investigatory activity, (2) providing false documents or testimony, (3) failing to honestly select independent experts to make the appropriate loss evaluations, (4) relying upon expert reports that were not reasonable or, (5) failing to conduct a thorough investigation. Although this is not an exclusive list, it provides some idea of the type of conduct that will rise to the level of bad faith, thereby reducing the likelihood of a successful verdict at trial.

III. CONCLUSION

There are no guarantees at trial. However, evaluating the claim file with an eye toward the dynamics of a trial, and the individuals who will present the company ’ s story to the jury, are essential in predicting possible success at trial.

Sonya Hamlin, What Makes Juries Listen-A Communications Expert Looks at the Trial, Prentice Hall Law & Business 1985, Chap. 1, ps.2-3

Id. at Ch. 1, p.2.

The California Supreme Court, in Colonial Life v. Superior Court (1982) 31 Cal.3d 785, set the groundwork for discovery that extended outside of the four corners of the claim. There, the court allowed the discovery of claim files dealing with claims that were not the subject of the particular action. The court concluded that the claim files were discoverable as a result of allegations that the insurance company had a pattern and practice of bad faith claims handling. This same rationale also has resulted in courts requiring the production of reports prepared by a particular expert. The argument is that the insurer selects the expert in bad faith because the insurer knows, from experience, that the expert will prepare a report favorable to the company.

The issue addressed by the court was the application of the provision in the Allstate policy that required Allstate to first pay the actual cash value of a loss. The insured then had 180 days from this payment to replace the structure and submit any differences in cost between the cost to replace the structure and the actual cash value. In theory, the insured could use the actual cash value payment to begin the repair or replacement of the structure. The court held that the insured was not entitled to the replacement cost benefit because the repair of the structure was not done within 180 days of the payment of the actual cash value benefit .