Insurer misconduct: Is it fraud or just bad faith?

The tort of fraud may be a viable basis for recovery of punitive damages against insurers

2014 August

When an insurer breaches its duties under its insurance policy, it may be liable not only for breach of contract, but also for the tort of bad faith. As one court long ago explained:

In every insurance policy there is implied by law a covenant of good faith and fair dealing. . . . This implied obligation requires an insurer to deal in good faith and fairly with its insured in handling an insured’s claim against it. . . . The duty of dealing fairly and in good faith with the other party to a contract of insurance is a duty imposed by law, not one arising from the terms of the contract itself. In other words, this duty of dealing fairly and in good faith is nonconsensual in origin rather than consensual. Breach of this duty is a tort.

(Richardson v. Employers Liab. Assur. Corp. (1972) 25 Cal.App.3d 232, 239), disapproved on other grounds, (Gruenberg v. Aetna Ins. Co. (1973) 9 Cal.3d 566).

Furthermore, “punitive damages may be recovered upon a proper showing of malice, fraud or oppression even though the conduct constituting the tort also involves a breach of contract.” (Fletcher v. Western Nat’l Life Ins. Co. (1970) 10 Cal.App.3d 376, 400; See Cal. Civ. Code, § 3294.)

Insureds frequently attempt to recover punitive damages from insurers by arguing that an insurance carrier acted with “malice” or “oppression.” However, “fraud,” also often is a viable basis for the recovery of punitive damages against insurers. “Fraud” is an intentional misrepresentation, deceit, or concealment of a material fact known to the defendant with the intention on the part of the defendant of thereby depriving a person of property or legal rights or otherwise causing injury.

(Cal. Civ. Code § 3294, subd.(c)(3).)

And, when fraud is asserted, a plaintiff need not prove malice or oppression to recover punitive damages. (See, e.g., Glendale Fed. Sav. & Loan Ass’n v. Marina View Heights Dev. Co. (1977) 66 Cal.App.3d 101, 135, [“The words ‘oppression, fraud, or malice’ in Civil Code section 3294 being in the disjunctive, fraud alone is an adequate basis for awarding punitive damages”] Stevens v. Superior Court (1986) 180 Cal.App.3d 605, 610, [reversing order sustaining demurrer; “A fraud cause seeking punitive damages need not include an allegation that the fraud was motivated by the malicious desire to inflict injury upon the victim. The pleading of fraud is sufficient.”].)

A strong argument can be made that conduct that constitutes a breach of the implied covenant of good faith and fair dealing also is fraudulent. Indeed, California courts have noted that “bad faith conduct, involving deceit, has often been regarded as fraudulent . . . .” (Richardson, 25 Cal.App.3d at 245.) Furthermore, facts that support a bad-faith cause of action also may support independent causes of action against an insurer for negligent misrepresentation, intentional misrepresentation, concealment, and making a promise without an intent to perform. (2 Witkin, Summary of California Law (10th ed. 2005) Insurance, section 251, page 371.)

The starting point with the analysis is the nature of the relationship between an insurer and its insured. The governing principles have been summarized by a court of appeal as follows:

In Vu v. Prudential Property & Casualty Ins. Co. (2001) 26 Cal.4th 1142, the Supreme Court recognized that while the relationship between the insurer and insured is not a true fiduciary one, it is nevertheless “special,” citing and quoting from cases that have used various terms to describe that relationship: “[L]ater cases have built upon this premise and declared that an insurer and its insured have a ‘special relationship’. Under this special relationship, an insurer’s obligations are greater than those of a party to an ordinary commercial contract. In particular, an insurer is required to ‘give at least as much consideration to the welfare of its insured as it gives to its own interests.’ Cases have referred to the relationship between insurer and insured as a limited fiduciary relationship [citation]; as ‘akin to a fiduciary relationship’; or as one involving the ‘qualities of decency and humanity inherent in the responsibility of a fiduciary’. The insurer-insured relationship, however, is not a true ‘fiduciary relationship’ in the same sense as the relationship between trustee and beneficiary, or attorney and client. It is, rather, a relationship often characterized by unequal bargaining in which the insured must depend on the good faith and performance of the insurer. This characteristic has led the courts to impose ‘special and heightened’ duties, but ‘[w]hile these “special” duties are akin to, and often resemble, duties which are also owed by fiduciaries, the fiduciary-like duties arise because of the unique nature of the insurance contract, not because the insurer is a fiduciary.’

(Bock v. Hansen (2014) 225 Cal.App.4th 215, 229.)

Furthermore, the fact that an insured has a claim for breach of contract – and even recovers the benefits due under a policy – does not preclude it from pursuing recovery for fraud any more than it precludes it from pursuing recovery for bad faith.

Courts have recognized in a variety of settings actions by an insurer that support claims for one species of fraud or another. For example, in Sharp v. Automobile Club (1964) 225 Cal.App.2d 648, the insured sought recovery for breach of contract and for fraud. The court of appeal recognized that the insurer could be found liable for fraud and for punitive damages based on the amount awarded under the policy. The court upheld the propriety of a punitive damages award, noting that at the time of policy renewal, the insurer had represented that a particular provision in the policy applied in a certain way when its practice was to the contrary. (Id. at 652-53; See also Kenevan v. Empire Blue Cross & Blue Shield (S.D.N.Y. 1992) 791 F. Supp. 75, 80 [claim of misrepresentation based on language in insurer’s promotional brochure was independent of claim based on failure to provide policy benefits and thus could support claim for fraud distinct from claim for breach of contract]; Sparks v. Republic Nat’l Life Ins. Co. (1982) 132 Ariz. 529, 647 P.2d 1127, 1139 [brochure that was only document reviewed by insured served as both insurance contract and evidence of carrier’s misrepresentation affirming award of punitive damages based on representations in brochure describing master policy; “Tort liability . . . was a separate and distinct issue from the contractual issue.”], cert. denied, (1982) 459 U.S. 1070; Guar. Trust Life Ins. Co. v. Palsce (Ind. Ct. App. 1994) 641 N.E.2d 1266, 1268 [affirming award of punitive damages based on representations in brochure describing master policy].)

In finding that insurers can be liable for fraud and breach of contract, courts often have pointed to evidence of the insurer’s conduct in refusing to pay a claim as supporting a finding of fraud. For example, in Wetherbee v. United Ins. Co. (1968) 265 Cal.App.2d 921, 71, the insured purchased a disability policy. She then sought to cancel it because she was concerned that the insurer could unilaterally terminate it. The insurer assured her that if she became disabled, she would draw benefits as long as she lived and the policy could not be canceled. The insured then continued her policy and purchased a second one. Thereafter, she became disabled. The insurer initially paid her benefits, but then stopped, citing a requirement that the insured be continuously confined indoors to receive benefits. The insured sued. The court of appeal affirmed the fraud finding and the propriety of a punitive damages award. In doing so, it stated that the insurer’s “intent not to live up to the representations contained in its letter can clearly be inferred from its subsequent conduct.” (Id. at 932.)

In Miller v. National American Life Insurance Co. (1976) 54 Cal.App.3d 331, the insured sued his insurer for breaching its contract and for fraud in inducing the insured to purchase the policy. The insured contended that the insurance policy expressly obligated the insurer to pay his monthly mortgage payments in the event that he became totally disabled. The insurer argued that because these “representations” were contained only in the insurance policy, they were insufficient as a matter of law to support a fraud cause of action. The court readily rejected this argument, stating:

The contention is without merit. It is well settled that a “promise made with no intention of performing is actionable fraud where the other party relies upon it as an inducement to enter into an agreement.” . . . While the inducement may be more blatant where . . . the insurance company misrepresents its intentions in a separate letter intended to dissuade an insured from terminating his coverage, it is no less apparent where, as here, it is found in the very contractual promises that constitute the consideration for which the insured enters the agreement and exchanges his premium payments.

(Id. at 338.)

The court then held that how the insurer responded to the claim could be evidence that would establish its fraud. As the court explained:

The law is established in California that, since direct proof of fraudulent intent is often an impossibility, because the real intent of the parties and the facts of a fraudulent transaction are peculiarly in the knowledge of those sought to be charged with fraud, proof indicative of fraud may come by inference from circumstances surrounding the transaction, the relationship, and interest of the parties. . . . Subsequent conduct of an insurer in processing a claim may support an inference of prior intent not to fulfill its representations.

(Id. at 338-39.)

The court specifically noted that the insurer’s “later handling of the claim may also be seen as bad faith and procrastination in furtherance of [its fraudulent] intention.” (Id. at 339.

Another court more recently reached the same conclusion. In Petersen v. Allstate Indemnity Co. (C.D. Cal. 2012) 281 F.R.D. 413, the insured claimed that his insurer had promised to pay future medical expenses arising from an automobile accident and after initially doing so, denied coverage when the expenses mounted. He sued for breach of contract and promissory fraud. The insurer sought judgment on the pleadings. The court denied the motion. Citing Weatherbee and Miller, the court explained:

[The insurer’s] misrepresentation as to its willingness to perform under its policy is shown by the facts . . . indicating [the insurer’s] eagerness to cease costly performance based on minimal evidence that its obligation had ended. . . [The insurer] partially performed by paying some money . . . However, . . . after performance became more costly . . . [the insurer] informed [its insured] that it would no longer pay for [his] medical care because [his] condition was not covered by the policy. . . .Thus, . . . [the insurer’s] decision to deny coverage only after further performance would become very costly supports the inference that its initial promise of coverage was made without intent to perform. . .

Furthermore, [the insurer’s] misrepresentation of its intent to perform is shown by its alleged failure to pay a covered claim and failure to provide a more substantiated explanation or its denial of coverage.

(Id. at 420-21.)

The damages available for fraud include the premium paid by the insured, even if the insured recovers damages for the insurer’s breach of contract. Indeed, courts have recognized that an insured can recover as damages the premiums it paid and that such an award will, in turn, support an award of punitive damages. For example, in Wetherbee, the court concluded that an insured had stated a cause of action for fraud when she alleged that the carrier induced her not to cancel her policy by misrepresenting the terms of the benefits that would be received under that policy. The court recognized that the insured

had suffered actual damage in the amount of the premiums paid over a period of five and one-half years for insurance coverage which was not as represented. . . . It is settled that although punitive damages are recoverable only where actual damages are recovered, the actual damages need not be more than nominal.

(265 Cal.App.2d at 930.)

As the court explained,

damage resulting from this wrongful conduct – the payment of premiums for coverage which defendant never intended to provide – clearly cannot be deemed nonexistent merely because plaintiff has now recovered judgment against defendant and has thus obtained redress for its wrongful conduct. Under the circumstances here present, it was entirely proper for the trial court to instruct the jury that it could find insurance coverage as well as actionable fraud.

(Id. at 931.)

A federal court also has held that an insured may recover “for both breach of contract and for fraud in an action where the fraud consist(s) of a misrepresentation by an insurer as to its willingness to honor the terms of a policy.” (Glesenkamp v. Nationwide Mut. Ins. Co. (N.D. Cal. 1972) 344 F. Supp. 517.) In Glesenkamp, the insured sued the insurer for fraud based on representations made at the time it sold its policy and for breach of contract based on its refusal to pay policy benefits after she made a claim. The insured prevailed on summary judgment of her breach of contract claim. The insurer then argued that her fraud claim was barred because she otherwise would receive a double recovery. The court of appeal disagreed, explaining as follows:

[T]he operative facts underlying the breach of contract claim are different than those underlying the fraud claim. The breach of contract came only after plaintiff suffered her personal injuries, at the time defendant refused to honor her claim for those injuries. The alleged fraud occurred at the time when the contract was entered into by the parties. Defendant’s failure to honor the claim serves only to evidence earlier fraudulent acts, not as an operative element of the fraud. Therefore, any cases dealing with alternative tort or contract recovery in an action in which both claims are based on the same act, incident, or operative facts are not precedent for the present case. The fact that plaintiff alleges actual damages in her fraud claim which equal those sought and recovered under the breach of contract claim does not mean that plaintiff has suffered no actual damages by way of defendant’s alleged fraud in excess of those recovered under the breach of contract claim. Plaintiff may not, of course, recover again for the injuries she suffered in the accident, as she has already been fully compensated for said injuries through summary judgment on the breach of contract claim.

(Id. at 519.)

The court then quoted Wetherbee as follows:

The damage resulting from this wrongful conduct−the payment of premiums for coverage which defendant never intended to provide – clearly cannot be deemed nonexistent merely because plaintiff has now recovered judgment against defendant and has thus obtained redress for its wrongful conduct. . . .

(Ibid.)

Therefore, when an insurer denies coverage, an insured may have claims not only for breach of contract and bad faith, but also for fraud. Even though the basis for all three claims may be the same contract, and even though the fraudulent activity involved may be the premise of both the bad-faith claim and the fraud claim, an insured may be able to recover different types of damages, such as some or all of the premiums it paid, in addition to the benefits due under the policy. Furthermore, if it turns out that there is no breach because a policy actually does not provide coverage, an insured still may be entitled to recover compensatory and punitive damages based on the insurer’s fraud.