Washington Supreme Court erodes insurer’s right to attorney-client privilege when insurer is sued for bad faith handling of a first-party claim

In another controversial 5-4 decision, the Washington Supreme Court on 2/21/13 substantially eroded the attorney-client privilege for first party insurers being sued for bad faith claims handling. See Cedell v. Farmers Ins. Co. of Wash., Wash. Supreme Court No. 85366-5 (en banc, Feb. 21, 2013). First, the court held that in cases in which an insured is claiming bad faith in the handling and processing of first-party claims, other than UIM claims, there is a presumption of no attorney-client privilege. Second, the court held that when an insured is suing an insurer for bad-faith handling of a first-party claim, the “civil fraud” exception to attorney-client privilege does not require the insured to show actual fraud. Rather, if after in camera review of the claimed privileged materials the court finds “there is a foundation to permit a claim of bad faith to proceed, the attorney-client privilege shall be deemed to be waived.” The Supreme Court added that an insured’s ability to pierce an insurer’s attorney-client privilege through the assertion of civil fraud in this manner applies to bad faith cases arising from UIM as well as all other first-party claims.

The Cedell case involved a first-party claim on a homeowner’s policy for a house fire, and an allegation that the insurer had violated its duty of good faith claims handling of the fire-loss claim. The insurer retained coverage counsel during the claims process, and that attorney examined witnesses under oath, directly interacted with the insured during the claims process, issued a coverage position letter on behalf of the insurer and made a time-limited settlement offer to the insured. Although Washington courts have long held that normal claims handling functions cannot be shielded with attorney-client privilege by retaining an attorney to perform them, the Cedell court went much further today in creating a “presumption” of no attorney-client privilege whenever an insurer is sued for bad faith handling of a first-party claim (the court excepted UIM claims from this newly created presumption). The insurer may overcome the presumption upon a showing in camera that the attorney was providing legal counsel to the insurer (e.g., a coverage opinion) and was not engaged in the insurer’s quasi-fiduciary functions, such as investigating and evaluating the claim.

The second holding of the Cedell opinion is a more significant departure from prior law and seriously erodes the first-party insurer’s right to protect confidential communications with its counsel. The attorney-client privilege historically has not protected communications in which an attorney and client are actively discussing how to commit fraud—this is known as the “civil fraud exception” to attorney-client privilege. But for first-party insurers (including UIM insurers), the Washington Supreme Court now says fraud need not be established to pierce the insurer’s attorney-client privilege. If the civil fraud exception to attorney-client privilege is asserted, the court must engage in a newly created two-step process. First, upon a showing that “a reasonable person would have a reasonable belief that an act of bad faith has occurred,” the trial court will perform an in camera review of the claimed privileged materials. Second, after in camera review and upon a finding there is “a foundation to permit a claim of bad faith to proceed,” the insurer’s attorney-client privilege “shall be deemed to be waived.” In sum, the Washington Supreme Court has turned the “civil fraud exception” to attorney-client privilege into a “bad faith” exception for first-party insurers.

Soha & Lang attorneys are available to assist insurer clients in understanding and addressing the impact of this decision both during the claims handling process and after an allegation of bad faith claims handling has been made.

Washington Law Prohibits Binding Arbitration Provisions in Insurance Policies

In a unanimous decision, The Washington Supreme Court held that Washington law prohibits binding arbitration clauses in insurance contracts. Dep't of Transp. v. James River Ins. Co., __Wn.2d. __, _P.3d.__ (2013).


RCW 48.18.200(1)(b) prohibits insurance contracts from “depriving the courts of this state of the jurisdiction of action against the insurer.” The court found that this statue prohibits binding arbitration agreements in insurance contracts. The court also held that the statue was not preempted by the Federal Arbitration Act because of an exception in the act for state law regulating the business of insurance.

Washington Insurers Denied Right To Jury Trial

On October 25, 2012, the Washington Supreme Court ruled that an insurer was not entitled to have the reasonableness of “covenant judgment” determined by a jury. Bird v. Best Plumbing Group, LLC, 86109-9, 2012 WL 5269734 (Wash. Oct. 25, 2012).

  

The insured was a plumbing company that was sued for severing a sewage line on the claimant’s property. When the claimant sued for damages, the insurer defended the insured without a reservation of rights. The claimant made a $2 million policy-limits demand. The demand was rejected. The insured then settled with the claimant for $3.75 million subject to a covenant not to execute against the insured and an assignment of rights to the claimant. The trial court found the $3.75 settlement amount reasonable after a four-day hearing, in part due to a treble-damages provision in Washington’s trespass statute that was never pled.

On appeal, the insurer contended that the reasonableness hearing violated its right to jury trial under Article I, Section 21 of the Washington State Constitution because the hearing set the presumptive damages for the claimant’s soon-to-follow bad faith lawsuit against the insurer. The Court of Appeals rejected the argument, reasoning that the reasonableness hearing was an equitable proceeding with no right to trial by jury. The Court of Appeals then affirmed the trial court’s finding of reasonableness. The insurer appealed to the Washington Supreme Court.

In a six to three opinion, the Washington Supreme Court affirmed the decisions of the trial court and Court of Appeals. The Washington Supreme Court:

•   Approved the application of RCW 4.22.060 reasonableness hearings to settlements involving a covenant judgment (i.e. a settlement between an insured defendant and a plaintiff where the plaintiff agrees to seek recovery only from a specific asset—the proceeds of the defendant’s insurance policy and the rights owed by the insurer to the insured, but do not release the insured from liability);
• Held that determining the reasonableness of a covenant judgment under RCW 4.22.060 is an equitable proceeding to which no jury trial right is afforded;
• Held that the due process rights of the insurer were not violated where the insurer was afforded notice of the reasonableness hearing, allowed to intervene, and given the opportunity to participate in a lengthy and highly contested hearing on the issue of the reasonableness; and
•  Held that the trial court did not abuse its discretion in holding the $3.5 million covenant judgment was reasonable.

The opinions expressed in in this blog are those of the author and do not necessarily reflect those of Soha & Lang, P.S. or its clients.

Ambiguity Found by Washington Supreme Court in ACV Settlement Provision

The Washington Supreme Court held today in Holden v. Farmers Ins. Co. that an insured was entitled to recover sales tax under an actual cash value (“ACV”) loss settlement provision in her renter's insurance policy because of ambiguity regarding whether ACV includes sales tax.

The claim arose out of a fire to Laura Holden’s apartment, which damaged her personal property. Ms. Holden’s policy provided for settlement at ACV, but included an endorsement that would have allowed her to recover at replacement cost if she replaced the property within 180 days of the loss. Ms. Holden elected not to replace the damaged property. The carrier paid Ms. Holden $1,174, based upon the fair market value (“FMV”) of her loss. (This was apparently a rather small fire.) The loss payment, however, did not include sales tax. Ms. Holden argued that the ACV payment should have included an adjustment based upon sales tax even though she did not replace the damaged property.

In its 6 to 3 decision, the Washington Supreme Court held that the following provision was ambiguous regarding whether Ms Holden was entitled to recover sales tax:

Covered loss to property will be settled at actual cash value. Payments will not exceed the amount necessary to repair or replace the damaged property, or the limit of insurance applying to the property, whichever is less.

The policy defined ACV as FMV but did not define FMV. The Supreme Court acknowledged that in another (non-insurance) context FMV “is the amount of money which a well informed buyer, willing but not obliged to buy the property, would pay, and which a well informed seller, willing but not obligated to sell it, would accept.” However, the court held this definition of FMV did not resolve the sales tax issue and that there is nothing intrinsic in the notion of FMV that necessarily includes or excludes sales tax.

In construing the loss settlement provision, the court considered evidence regarding the insurer’s claims handling practices in unrelated claims including that the insurer sometimes determined ACV by applying depreciation to replacement cost value, and sometimes included sales tax in its determination of replacement cost.

The court noted that the policy’s loss settlement provision does not clearly exclude or include sales tax and does not define FMV. The fact that the loss settlement provision references replacement cost, combined with the carrier’s claims handling practices, and the lack of a definition of FMV, according to the majority, created an ambiguity, which must be resolved in favor of the insured.