Duties of the Insured and the Insurer
Good Faith & Fair Dealing
The Implied Covenant of Good Faith and Fair Dealing
The principle on which insurance has existed for the last three to four centuries is that the business of insurance must be conducted with the utmost good faith often referred to with the Latin phrase uberrima fides. The principle is called an implied covenant (an agreement or contract) of good faith and fair dealing. The covenant must be fulfilled religiously by both the insurer and the insured. This means, simply, that both parties to the insurance contract must treat each other in such a way that neither will deprive the other of the benefits of the contract.
The first reported decision acknowledging the need for utmost good faith in insurance was stated in the British House of Lords by Lord Mansfield in 1766. He made clear that the duty of good faith is not unilateral but is, rather, a mutual obligation imposed on both the insured and the insurer.[1] This is still the law followed in England and was adopted by United States appellate courts that recognizes the existence of the covenant of good faith and fair dealing. The duty to deal with one another in good faith in all insurance transactions exists during every moment of the insurance transaction, from the negotiation for the contract, throughout its term, to its conclusion.
A breach of the implied covenant of good faith originally resulted only in the imposition of contract damages. The insured would receive the benefits promised by the policy or, if the insured breached the covenant, the policy would be voided. Tort damages were not available. Breach of the covenant was considered breach of the insurance contract and damages were only available as any run-of-the-mill breach of contract.
Finding that insurers were – in the opinion of the courts – taking advantage of their insureds the courts of many states found it necessary to create a new tort they called the “tort of bad faith.”[2] Although the foundation of the tort of bad faith is grounded in contract principles it is treated as a tort for the purpose of assessing damages.
No longer is a breach of an insurance contract limited to contract damages. After the creation of the tort of bad faith people who were abused by their insurers could be required to pay tort damages in addition to contract damages. The tort remedies available for bad faith conduct included damages for emotional distress, bodily injury, loss of earnings, and in rare cases punitive damages.
The tort of bad faith stems both from the contractual relationship between the insurer and the insured, as well as from the codified 'good faith' obligation. To prove that an insurance company committed the tort of bad faith in Indiana, a plaintiff must establish that his claim was underpaid or wrongfully denied in the first place. [Foster v. State Farm Fire and Casualty Company, 211 WL 3610425, at *18 (N.D. Ind. Aug. 17, 2011); aff'd, 674 F.3d 663 (7th Cir. 2012).
Not every jurisdiction recognizes a tort of bad faith. The District of Columbia law does not 'recognize a tort of bad faith by insurance companies in the handling of policy claims. [Choharis v. State Farm Fire & Cas. Co., 961 A.2d 1080, 1087 (D.C. 2008).
Of course, if a lawful basis for denial of a claim actually exists, the insurer, as a matter of law, cannot be held liable in an action based upon the tort of bad faith. The party asserting bad faith bears a heavy burden. [Madison Cty. v. Evanston, 340 F. Supp. 3d 1232, 1267 (N.D. Ala. 2018)]
The adjuster and insurer must understand a fundamental principle of insurance contract law: that “every contract imposes on each party a duty of good faith and fair dealing in its performance and its enforcement.”[3] The duty imposed by the contract is defined as follows:
In every insurance contract there is an implied covenant of good faith and fair dealing that neither party will do anything which will injure the right of the other to receive the benefits of the agreement. Gruenberg v. Aetna Insurance Co., 9 Cal.3d. 566, 108 Cal. Rptr. 480 (1973).
The covenant is mutual and the principles of good faith and fair dealing impose an affirmative obligation on the insured to cooperate as much as it requires the insurer to treat the insured fairly with regard to every claim presented.[4]
This “is a duty imposed by law, not one arising from the terms of the contract itself.”[5] The duty to deal fairly and in good faith is nonconsensual in origin rather than consensual,[6] and is an essential part of every insurance contract. It is imposed to fulfill the spirit, as well as the letter, of the insurance relationship.