Bad Faith Under a Commercial General Liability Policy

Vol. 1, No. 8

Adam M. Smith is a partner with the law firm of Coughlin Duffy, LLP in Morristown, New Jersey. Mr. Smith concentrates his practice in the areas of insurance and reinsurance coverage litigation. He has extensive experience litigating complex insurance coverage disputes on behalf of insurers and reinsurers in jurisdictions across the nation. Caroline L. Crichton is an attorney with CNA Global Specialty Lines in New York, where she specializes in handling matters arising under directors and officers liability policies. Prior to joining CNA, Ms. Crichton spent six years in private practice, where she represented insurers in connection with coverage disputes involving bad faith, toxic tort, advertising liability, products liability, environmental, employment, and construction defect issues.


From The Reference Handbook on the Comprehensive General Liability Policy


  • Learn about the origins of a bad faith cause of action and the standards that apply to it.


This article addresses the doctrine of bad faith in the context of a commercial general liability policy. It begins with a discussion of the origins of and the standards applied to a bad faith cause of action. Next, it discusses the most common factual scenarios in which a bad faith claim is asserted and the types of damages that are permitted in bad faith actions.


Origins of the Bad Faith Cause of Action

Until the twentieth century, courts did not focus on the imbalance of bargaining power between insurers and policyholders. Up until that time, contract law provided the exclusive remedy for insurer bad faith, with damages limited to the amount due under the policy.1 In 1914, New York became one of the first states to hold that all contracts contain an implied covenant of good faith and fair dealing. The Court of Appeals of New York, responding to an insurer’s bad faith failure to settle an action within policy limits, explained that neither the rights of the insured nor the obligations of the insurer could be found exclusively in the “letter of the contract of insurance.”2 It observed, “[T]here is a contractual obligation of universal force which underlies all written agreements. It is the obligation of good faith in carrying out what is written.”3 Accordingly, because the insurer failed to deal fairly and in good faith with its insured, the court reasoned that it would be held liable for extracontractual damages—the insured’s attorneys’ fees in successfully appealing the verdict against it.4

In 1930, the Supreme Court of Wisconsin injected a new concept into insurance law: An insurance company is an agent of its insured and, in that capacity, must be held liable for any want of good faith in defending or settling an action on behalf of its insured. In its landmark decision, Hilker v. Western Auto Insurance Co.,5 the court considered whether an insured was entitled to recover from his insurer the amounts he paid in excess of his policy limit to satisfy judgments against him for injuries caused when his automobile struck a child. In addressing the issue, the court reasoned that “there is no escape from the conclusion” that an insurer functions as an agent and, thereby, as a fiduciary of its insured for the purpose of handling claims and conducting litigation.6 Given that the insured, in entering into the insurance contract, entrusts its insurer with the full and exclusive handling of a claim, the court reasoned that the insurer’s conduct will be viewed in the context of agency principles and, more importantly, will be carefully scrutinized given that its interests can be adverse to its insured.7 To that end, the court determined that as the insured’s agent:


[The insurer] ought to be held to that degree of care and diligence which an ordinarily prudent person would exercise in the management of his own business; and if an ordinarily prudent person, in the exercise of ordinary care, as viewed from the standpoint of the assured, would have settled the case, and failed or refused to do so, then the agent, which in this case is the indemnity company, should respond in damages.8


Because the insurer in Hilker had assumed absolute control of the claim but had failed to interview known eye-witnesses to the accident and squandered opportunities to settle the matter within its policy limit, the court found that it had failed to act reasonably in adjusting the insured’s claim and, therefore, was held liable for the full policy limit plus the amount by which the verdicts against the insured exceeded the policy limit.9

Following the Supreme Court of Wisconsin’s decision in Hilker, courts commonly began acknowledging that the unequal bargaining power that exists in the relationship between an insured and its insurer justifies the imposition of “special and heightened” duties similar to those imposed upon a fiduciary. As noted by one commentator:


The insurers’ obligations are . . . rooted in their status as purveyors of a vital service labeled quasi-public in nature. Suppliers of services affected with a public interest must take the public’s interest seriously, where necessary placing it before their interest in maximizing gains and limiting disbursements. . . . [As] a supplier of a public service rather than a manufactured product, the obligations of insurers go beyond meeting reasonable expectations of coverage. The obligations of good faith and fair dealing encompass qualities of decency and humanity inherent in the responsibilities of a fiduciary. Insurers hold themselves out as fiduciaries, and with the public’s trust must go private responsibility consonant with that trust.10


As a result of this special relationship, certain courts began to hold that a breach of the duty of good faith and fair dealing can give rise to a tort cause of action, separate and apart from the underlying breach of contract cause of action.11

Still, there remains a split of authority regarding whether an insurer’s breach of the implied duty of good faith and fair dealing may form the basis for an independent cause of action sounding in tort, or whether insurer bad faith is only actionable as a breach of contract. Most courts deem an insurer’s breach of the duty of good faith and fair dealing to give rise to an independent cause of action sounding in tort.12 Without a separate tort remedy, courts have rationalized that there would be little or no incentive for an insurer to promptly and faithfully fulfill its contractual obligations because the insurer’s maximum bad faith liability would always be determined by the policyholder’s liability and capped at policy limits.13 Thus, courts that have recognized an independent tort cause of action have done so in an effort to cure the perceived inadequacies of contract remedies: specifically, where an insurer could act with impunity, such as by purposefully denying or avoiding a claim without a reasonable basis for doing so. Even under the traditional view, however, the damages available to an insured can include more than just policy limits.


Standards Applied to Bad Faith Cause of Action

There is no uniform definition of what constitutes “bad faith.” Indeed, one commentator has described the concept as “having no definite meaning of its own” and has remarked that courts commonly illustrate bad faith in a negative fashion, “by explaining what it is not.”14

In 1957, a California appellate court became one of the first to formulate a definition of “bad faith” by identifying eight factors to consider in determining whether an insurer acted properly in refusing to settle an action:


  1. The strength of the injured claimant’s case on the issues of liability and damages;
  2. Attempts by the insurer to induce the insured to contribute to a settlement;
  3. Failure of the insurer to properly investigate the circumstances so as to ascertain the evidence against the insured;
  4. The insurer’s rejection of advice of its own attorney or agent;
  5. Failure of the insurer to inform the insured of a compromise offer;
  6. The amount of financial risk to which each party is exposed in the event of a refusal to settle;
  7. The fault of the insured in inducing the insurer’s rejection of the compromise offer by misleading it as to the facts; and
  8. Any other factors tending to establish or negate bad faith on the part of the insurer.15


Although some courts have adopted these factors,16 others have created their own specific bad faith definitions. For example, the Supreme Court of Michigan has defined bad faith conduct as the “arbitrary, reckless, indifferent, or intentional disregard of the interests of [the policyholder].”17 In addition, Michigan has identified bad faith factors that extend further than the Brown factors, applying beyond the settlement context:


  1. Failure to keep the insured fully informed of all developments in the claim or suit that could reasonably affect the interests of the insured;
  2. Failure to inform the insured of all settlement offers that do not fall within the policy limits;
  3. Failure to solicit a settlement offer or initiate settlement negotiations when warranted under the circumstances;
  4. Failure to accept a reasonable compromise offer of settlement when the facts of the case or claim indicate obvious liability and serious injury;
  5. Rejection of a reasonable offer of settlement within the policy limits;
  6. Undue delay in accepting a reasonable offer to settle a potentially dangerous case within the policy limits where the verdict potential is high;
  7. An attempt by the insurer to coerce or obtain an involuntary contribution from the insured in order to settle within the policy limits;
  8. Failure to make a proper investigation of the claim prior to refusing an offer of settlement within the policy limits;
  9. Disregarding the advice or recommendations of an adjuster or attorney;
  10. Serious and recurrent negligence by the insurer;
  11. Refusal to settle a case within the policy limits following an excessive verdict when the chances of reversal on appeal are slight or doubtful; and
  12. Failure to take an appeal following a verdict in excess of the policy limits where there are reasonable grounds for such an appeal, especially where trial counsel so recommended.18


A majority of states impose a stringent test for determining bad faith—one that requires more than mere negligence or poor judgment on the part of the insurer. For example, in Ohio, bad faith “imports a dishonest purpose, moral obliquity, conscious wrongdoing, breach of a known duty through some ulterior motive or ill will partaking of the nature of fraud. It also embraces actual intent to mislead or deceive another.”19

Still, a significant minority of states apply a less stringent negligence standard, which only requires that the insurer have failed to exercise ordinary care and prudence in defending or settling a claim. For example, in Idaho, “an inference of bad faith can almost always be suggested by the merest of showing that the insurer’s conclusions . . . are or may be incorrect or that the insured’s investigation was not complete in all details.”20

Regardless of which test is employed, the question of whether an insurer has acted in bad faith is always a fact-sensitive inquiry.21 For example, the Supreme Court of Minnesota has held that an insurer acted in bad faith where it failed to ever apprise its insured of the underlying plaintiff’s offer to settle within policy limits and delayed tendering its full $25,000 policy limit until the eve of trial.22 In that case, the claimant was a widow with five minor children. Her deceased husband had been struck and killed by the insured, who had been driving under the influence of alcohol. It was clear from the outset of the claim that the insurer knew its insured was liable and that damages were likely to greatly exceed policy limits. On those facts, the court determined that the insurer’s refusal to settle had been unreasonable. Consequently, the insurer was held liable for the entire $745,000 judgment entered against the insured at trial.

In contrast, the Supreme Court of Arizona has held that an insurer had not acted in bad faith when it failed to accede to a demand by its insured, a municipality, that it increase its $25,000 settlement offer and pay its full $100,000 policy limit to settle a claim that the municipality had failed to properly warn of a road hazard.23 After investigating the claim and analyzing the governing law—including a decision the insurer deemed favorable to the insured on the issue of the standard of care—the insurer concluded that there was a low probability of a finding of liability and offered only $25,000 to settle the matter. The plaintiffs rejected the offer and countered with a demand of $275,000. At that point, settlement discussions ceased and the matter was placed on the trial calendar. As the trial date approached, however, the insured became concerned about an excess verdict and demanded in writing that its insurer offer the full $100,000 policy limit to settle the case, but the insurer declined to increase its initial settlement offer. At trial, a judgment of $280,000 was entered against the insured. In rejecting the insured’s allegations that the insurer had acted in bad faith, the court reasoned that the municipality’s reliance on the insurer’s failure to abide by the mandates of its demand letter was misplaced. The court emphasized that the insurer’s obligation to its insured was one of “equal” consideration for both its own interests and those of its insured. Because the facts indicated that the insurer’s “diligent, good-faith investigation” yielded a settlement value of only $25,000, the court found that the insurer was not obligated to comply with its insured’s demand that it pay its full $100,000 policy limit and, therefore, was not liable for bad faith.

Finally, it bears emphasis that under either view, an evaluation of the insurer’s conduct is based upon the facts available to it at the time of the alleged bad faith, not with the benefit of hindsight. As the Michigan Supreme Court explained:


The conduct under scrutiny must be considered in light of the circumstances existing at the time. A microscopic examination, years after the fact, made with the luxury of actually knowing the outcome of the original proceeding is not appropriate. It must be remembered that if bad faith exists in a given situation, it arose upon the occurrence of the acts in question; bad faith does not arise at some later date as a result of an unsuccessful day in court.24



1. James A. McGuire & Kristin Dodge McMahon, Issues for Excess Insurer Counsel in Bad Faith and Excess Liability Cases, 62 DEF. COUNS. J. 337, 337 (1995).

2. Brassil v. Md. Cas. Co., 104 N.E. 622, 624 (N.Y. 1914).

3. Id.

4. Id.

5. 231 N.W. 257 (Wis. 1930).

6. Id. at 259.

7. Id.

8. Id. (quoting G.A. Stowers Furniture Co. v. Am. Indem. Co., 15 S.W.2d 544, 547 (Tex. Comm’n App.


9. Id. at 260.

10. Goodman & Seaton, Foreword: Ripe for Decision, Internal Workings and Current Concerns of the California

Supreme Court, 62 CAL. L. REV. 309, 346–47 (1974).

11. See, e.g., Comunale v. Traders & Gen. Ins. Co., 328 P.2d 198, 202 (Cal. 1958) (“An insurer who denies coverage does so at its own risk, and, although its position may not have been entirely groundless, if the denial is found to be wrongful it is liable for the full amount which will compensate the insured for all the detriment caused by the insurer’s breach of the express and implied obligations of the contract.”).

12. See, e.g., Stephens v. Safeco Ins. Co. of Am., 852 P.2d 565, 567 (Mont. 1993); Safeco Ins. Co. of Am. v. Butler, 823 P.2d 499, 503 (Wash. 1992).

13. Bibeault v. Hanover Ins. Co., 417 A.2d 313, 318 (R.I. 1980) (explaining need for a tort remedy to replace unsatisfactory contract remedies).

14. Eileen A. Scallen, Sailing the Uncharted Seas of Bad Faith: Seaman’s Direct Buying Service, Inc. v. Standard Oil Co., 69 MINN. L. REV. 1161, 1165–66 (1985).

15. Brown v. Guar. Ins. Co., 319 P.2d 69, 75 (Cal. Ct. App. 1957).

16. Clearwater v. State Farm Mut. Auto. Ins. Co., 792 P.2d 719, 722 (Ariz. 1990) (the Brown factors are to be considered by the trier of fact in third-party bad faith claims); Helmbolt v. LeMars Mut. Ins. Co.,

404 N.W.2d 55, 57 (S.D. 1987) (the eight factors are relevant to a determination of whether an insurer’s refusal to settle constitutes bad faith).

17. Commercial Union Ins. Co. v. Liberty Mut. Ins. Co., 393 N.W.2d 161, 164 (Mich. 1986).

18. Id. at 165.

19. Centennial Ins. Co. v. Liberty Mut. Ins. Co., 404 N.E.2d 759, 762 (Ohio 1980); see also First Marine Ins. Co. v. Booth, 876 S.W.2d 255, 257 (Ark. 1994) (“To be liable for bad faith the insurer must engage in affirmative misconduct, without a good faith defense, in a malicious, dishonest, or oppressive attempt to avoid liability.”); Turner Constr. Co. v. First Indem. of Am. Ins. Co., 829 F. Supp. 752, 762–64 (E.D. Pa. 1993) (Pennsylvania law) (bad faith imports a dishonest purpose and means the breach of a known duty through a motive of self-interest or ill will); White v. Cont’l Gen. Ins. Co., 831 F. Supp. 1545, 1555 (D. Wyo. 1993) (the tort of bad faith “is an intentional one, requiring proof that the defendant’s conduct in denying the claims was made either knowing that the claim was not fairly debatable, or with reckless disregard as to whether it was fairly debatable”); Gen. Star Nat’l Ins. Co. v. Liberty Mut. Ins. Co., 960 F.2d 377, 380 (3d Cir. 1992) (interpreting New York law and noting that the New York Court of Appeals requires a showing of a gross disregard of the insured’s rights); Universal Life Ins. Co. v. Veasley, 610 So. 2d 290, 295 (Miss. 1992) (simple negligence does not support a claim of bad faith); Matt v. Liberty Mut. Ins. Co., 798 F. Supp. 429, 434 (W.D. Ky. 1991), aff’d, 968 F.2d 1215 (6th Cir. 1992) (Kentucky law) (“liability for bad faith will arise only in those instances where an insurer acts with some degree of conscious wrongdoing, reckless or in a manner which reveals an unjustified gamble at the stake of the insured”); Ganaway v. Shelter Mut. Ins. Co., 795 S.W.2d 554, 556 (Mo. Ct. App. 1990) (mere negligence will not support a claim of bad faith); Dolan v. Aid Ins. Co., 431 N.W.2d 790, 794 (Iowa 1988) (bad faith requires intentional or reckless conduct by an insurer); Ins. Co. of N. Am. v. Citizensbank of Thomasville, 491 So. 2d 880, 882 (Ala. 1986) (recovery under a theory of bad faith in Alabama requires a showing of intentional conduct by the insurer); Mission Ins. Co. v. Aetna Life & Cas. Co., 687 F. Supp. 249, 253 (E.D. La. 1988) (“Something more than mere error of judgment is necessary to constitute bad faith on the part of the insurer.”).

20. State Farm Fire & Cas Co. v. Trumble, 663 F. Supp. 317, 321 (D. Idaho 1987).

21. Commercial Union, 393 N.W.2d at 165.

22. See Short v. Dairyland Ins. Co., 334 N.W.2d 384 (Minn. 1983).

23. Glendale v. Farmers Ins. Exch., 613 P.2d 278 (Ariz. 1980).

24. Commercial Union, 393 N.W.2d at 166. rut20553_15_c15_311-334.indd 316 11/1/10 8:59 AM.

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Pages 311–316 from The Reference Handbook on the Comprehensive General Liability Policy, 2010, published by the American Bar Association Tort Trial and Insurance Practice Section. Copyright © 2010 by the American Bar Association. Reprinted with permission. All rights reserved. This information or any or portion thereof may not be copied or disseminated in any form or by any means or stored in an electronic database or retrieval system without the express written consent of the American Bar Association. Click here to order the book.


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