California Court Affirms Decision Finding Bad Faith Where Insurer Interprets Policy Against Insured's Interests

On August 31, 2017, the California Court of Appeal discussed a variety of topics touching upon important matters in insurance “bad faith” litigation in Pulte Home Corp. v. Am. Safety Indemnity Co., 14 Cal.App.5th 1086 (Aug. 31, 2017). In this blog, we discuss the case in detail as well as the potential benefits the opinion provides to insureds’ future claims for bad faith. Before we discuss the details of the case, we first address the basics of insurance bad faith. Next, we detail the issues addressed in the case, the facts of the case, the court’s reasoning and ultimate rationale. Finally, we address the Pulte’s broader impact, solidifying the insurer’s good faith duty to interpret ambiguous policy provisions in favor of the insured.

What is Insurance Bad Faith?
Before we discuss Pulte, we first need to briefly cover the basics of a claim for relief called “insurance bad faith.” Insurance bad faith relies on the underlying insurance contract, but more than a breach of contract claim, a bad faith claim asserts that the insurer breached the contract’s implied promise of good faith and fair dealing. Unlike the express provisions of the insurance policy contract, the implied promise requires that the insurer refrain from conduct that unreasonably or without proper cause harms the insured’s right to benefits under the insurance contract, it is said to have acted in “bad faith.”

The courts have established several well-defined duties that, if the insurer fails to perform them, can result in a breach of the implied covenant of good faith and fair dealing. For example, an insured may show bad faith by establishing that the insurer failed to meet its duty to conduct a thorough and fair investigation into all possible bases for coverage. Determining whether the insured has acted in bad faith is important because it directly affects the insured’s potential recovery. When an insurer acts in bad faith, the insured may have access to a substantial additional recovery, including emotional distress, consequential and punitive damages and attorney’s fees.

Pulte Home Corp. v. Am. Safety Indemnity Co.
The events leading to Pulte began in 2011 and 2013, when residents sued Pulte Home Corp. (“Pulte Home”) for defective construction. American Safety Indemnity Co. (“American Safety”) issued several sequential comprehensive general liability (“CGL”) insurance policies to three of Pulte’s subcontractors, and during 2003 to 2006, it added endorsements to those policies that named Pulte as an additional insured. American Safety failed to defend Pulte Home against the residents’ construction claims. American Safety did not defend Pulte Home because it asserted that the CGL policies did not cover the construction defects at issue. As a result, Pulte Home sued American Safety alleging that the policies did provide coverage and that it should have defended the claims for construction defect. The trial court found in favor of Pulte Home, asserting that the policies covered the construction defect claims as a matter of law. Accordingly, the trial court proceeded on claims of breach of contract and bad faith, with the bad faith claim based in part by denying the duty to defend. Ultimately, the trial court awarded contract damages for failure to defend, punitive damages and attorney’s fees.

American Safety appealed the trial court’s verdict, mounting several challenges to the judgment. Ultimately, the California Court of Appeal upheld the trial court’s substantive decision and rejected American Safety’s arguments. In doing so, the appellate court found that the trial court correctly interpreted ambiguous coverage provisions in favor of the insured when it found bad faith. As a corollary to that finding, the court also affirmed that American Safety improperly interpreted the insurance contract in its own favor, and that it did so unreasonably and in bad faith. While the appellate court did find that the trial court abused its discretion as to certain attorney’s fees that were originally based in contingency but awarded as hourly, it only directed the trial court to recalculate the fees and adjust the punitive damages award accordingly on a one-to-one ratio of compensatory damages to punitive damages.

Pulte strengthens California’s bad faith case law requiring an ambiguous insurance contract to be interpreted in favor of the insured and solidifies the principle that an insurer must interpret ambiguities favorably to the insured, or else it may be held liable for insurance bad faith.

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