Bad Faith Breach of Contract in the Insurance Context and in the Oil and Gas Context: A Comparison
Graves, Sheila R., Faulkner Law Review
PART I. THE INTRODUCTION
In 2007, the Alabama Supreme Court issued Exxon Mobile Corporation v. Alabama Department of Conservation and Natural Resources; a fifty-one page opinion that begins like a chemical engineering textbook with vocabulary including slop oil, diamondoids, cogenerated electricity, flare offs, and sweetened sour gasses. The complex thirty-four volume transcript (1) and a jury award that was the largest punitive damages award in Alabama's history (2) made one justice wishfully consider handing-off the decision to the Rotary Club (3) whose simple Code of Ethics would ask only whether Exxon was an honest, fair, and friendly corporation and did it seek the benefit of all concerned? (4)
Exxon rightly answered to the highest court of the State which applied the legal elements of fraud and breach of contract. Alabama's citizens should applaud the wisdom and courage of those elected to Alabama's Supreme Court for their ability to justly apply the law of the State, to simplify complex and evolving science, to root out the correct legal issues, and to resist the temptation of wrongfully accepting enormous punitive damages. The task of the Court was at once simple and complex. In one sense, the case required only a relatively straightforward determination of whether the disputed issue arose under contract or fraud principles. (5) Did Exxon have an intentional scheme to cheat Alabama out of royalties due under the lease deserving of punitive damages, or is this case simply a question of contract interpretation that, even if breached in bad faith, would not allow punitive damages? The fact that $3.5 billion rested upon this answer complicated the question. (6) The Court applied the law of the state and determined that a fraud claim could not stand. Though correct in its application of the current law, the Alabama Supreme Court has twice alluded to a remedy that would have far-reaching effects on future oil and gas litigation. (7) Justice Lyons called this remedy "tortious bad faith breach of contract," (8) also known as the no reliance fraud standard in breach of contract. (9)
Part I section A of this note includes a necessarily simplified recitation of the facts where the issue in Exxon emerged as a question of whether a fraud was perpetrated on the State, deserving of punitive damages, or whether Exxon and the State were in a contract dispute where only compensatory damages were available. The note investigates the overlap where a tort is the basis of the breach so that traditional compensatory contract damages may give way to tort's punitive damages in Part I section B. Part I section C explores the elements of the tort in question in Exxon; namely fraud. Section C gives special attention to the element of justifiable reliance. The section reveals the element of reliance as the bottleneck for cases like Exxon, where the State cannot provide proof that it adopted a different course of action after it perceived the alleged fraud. Part II is a careful examination of the current law in bad faith breach of contract where punitive damages are awarded. Here, the note refers to the three exceptions to the general rule that allow punitive damages in contract disputes. (10) Two exceptions have no application in Exxon, but the third exception, the no reliance fraud standard in the insurance context, is explored in depth. Part II includes the exception's history and its application in Alabama and other jurisdictions. The note examines policies behind insurance contract protections. The part exposes several motives that form the basis of the willingness for courts and legislatures to routinely allow punitive damages in insurance contracts even when the element of reliance cannot be proved. These motives are: to protect the non-breaching party from severe financial damage, to provide deterrence to the breaching party, to punish the culpable party who demonstrates malice, fraud, or a conscious disregard for the rights of others, and to guard against violations of public policy. Part III proposes that it is consistent for the Alabama legislature to protect Alabama's valuable natural resources by expanding the law to apply the no reliance fraud standard to oil and gas contracts for the same reasons they already do so in the insurance context. Part IV concludes by presenting the argument for the Alabama Legislature to extend the no reliance fraud standard from the insurance context to include the oil and gas contract context. An oil corporation would thereafter be on notice that, in Alabama, (the state that may hold the largest natural gas deposits in our nation) it will be subject to punitive damages for bad faith breach of contract in the oil and gas context even if each element of fraud cannot be proved.
A. The Overview of Underlying Facts
The events that gave rise to this complex case began in 1981 when Alabama first leased its newly discovered natural gas fields to the Exxon Corporation. (11) Exxon began production and started making lease payments on contacts, executed in 1981 and again in 1984, that included Exxon's agreement to pay over $5.5 million on the production from their wells. (12) The Alabama Department of Conservation and Natural Resources (DCNR) eventually audited the leases, and a discrepancy arose between the State and Exxon in their understandings for the method of calculating royalties. (13) This discrepancy amounted to over $50 million that, according to DCNR's calculations, Exxon owed the State. (14) Negotiations failed; the parties could reach no mutual agreement. (15)
Exxon was the first to involve the courts when it sought a declaratory judgment in July of 1999. (16) It asked for the proper method of calculating royalties under the lease. (17) The State counterclaimed, alleging fraud and breach of contract. (18) In an amended counterclaim, the State requested punitive damages. (19)
On December 19, 2000, the jury returned a verdict for the State, awarding $60 million for unpaid royalties plus interest of $27.4 million and an astonishing $3.4 billion in punitive damages. (20) Predictably, Exxon appealed and, almost exactly two years later, the Alabama Supreme Court reversed and remanded the case because the trial court heavily relied upon a letter protected by attorney-client privilege that was improperly admitted. (21)
At the second trial, a jury again returned a verdict for the State in roughly the same amount of compensatory damages and interest; however, this time the jury awarded even more in punitive damages. (22) The full verdict amount was a stunning $11.9 billion. (23) On December 1, 2003, Exxon moved for a judgment as a matter of law (JML) and; alternatively, for a new trial or a remittitur on the punitive damages. (24) The judge reduced the punitive damages award to $3.5 billion, but denied the JML and the motion for a new trial. (25) Exxon appealed. (26) The Alabama Supreme Court concluded that the State failed to establish its fraud claim as a matter of law and it reversed the judgment, including the punitive damage award. (27)
B. The Overlap of the Theories of Contract and Tort Damages The Alabama Supreme Court's unpopular holding refused $3.5 billion and reversed two separate Alabama juries, but nevertheless correctly applied the current law of Alabama. The elected justices knew that the citizens of the State would very likely fail to understand its decision owing to the seeming complexity of the case. (28) However; this note, through a careful examination of the availability of damages in contract or tort actions (and, more to the point, the growing gray area where the two overlap) will reveal the actual simplicity and accuracy of the decision and offer a solution.
Foundationally, breach of contract is based on strict liability principles. (29) For the aggrieved party, the typical remedy will simply be to make the party whole with an award of foreseeable contract damages. (30) By contrast, tort liability is based on punishing conduct which is socially unreasonable and for that reason an acceptable remedy for the harmed party will often include punitive damages. (31)
Tidy, but in the real world, this neat, compartmentalized approach to contract and tort damages law must succumb to a more complex analysis. When the breach is accomplished though a tort, as was the allegation in Exxon, contract damages may be less appropriate than tort's punitive damages. Modern courts have created several exceptions, but have not completely overcome the more limited traditional rule.
The traditional rule of contract damages has survived for over 150 years. Since 1854, the "Hadley Rule" has required the party that breached to pay any damages that arose naturally or were within the contemplation of both parties at the time they made the contract. (32) The Hadley Rule endures in modern times because of society's continued desire to encourage commercial and economic activity through predictable expectations of possible damages for breach. (33) The Revised Uniform Commercial Code (Revised UCC) Article II (34) and the Restatement (Second) of Contracts (35) continue to embrace the old notions of good faith performance of contracts. To this day, parties to a contract enter into an agreement that carries the implied covenant of good faith and fair dealing. (36) Neither party is expected to act in such a way as to affect the right of the other to receive the benefit of the contact. (37) Therefore, when one party deprives the other party of the benefit of the bargain, a breach may be said to have occurred. The parties have typically agreed to perform the contract or pay compensatory damages if there is a breach, regardless of the motive behind the breach. (38) The goal is to put the damaged party in only as good a position as he would have been if the contract had been performed. (39) But, when one party to the contract breaches by, for example, proposing not to perform the contract, the victim may have been moved beyond the scope of the foreseeable. This is bad faith breach of contract. (40)
The victim understandably desires to seek the more punishing tort-like damages and courts seem increasingly willing to deter bad conduct with large judgments. (41) However, some judges, like Seventh Circuit Court of Appeals Chief Judge Richard Posner, warn that forsaking the ancient rule (which allows for foreseeable damages only) threatens the undesirable outcome of turning every breach action into a tort action deserving of punitive damages, in circumvention of the sensible principles of freedom of contract and consideration. (42)
Turning the focus now to tort damages; the traditional rule for tort damages is quite different from contract damages. For example, if the plaintiff seeks to prove a bad faith breach of contract based on the tort of fraud (as is the case in Exxon), he must not only prove each element of fraud by clear and convincing evidence, (43) but also that the defendant defrauded him consciously or deliberately. (44) Consequently, the question central to the Exxon litigation arises* May the plaintiff request damages from a bad faith breach of contract arising from an alleged tort under tort theory and include punitive damages rather than under contract theory that excludes punitive damages? The answer is simple, but the requirements for the plaintiff are anything but.
The simple answer is; yes, the plaintiff may seek punitive damages and he has two options. He can rely on a tort theory of damages and prove bad faith breach of contract occurred as a result of, for example, fraud by proving the existence of bad faith as well as each element of the alleged tort by clear and convincing evidence. Alternatively, he can rely on a contract theory of damages and persuasively argue that he falls squarely into one of the three existing limited exceptions where punitive damages are appropriate on contract theory where there is no underlying tort. The remainder of this note attempts to expose the complex requirements for the plaintiff using the intricacies of the Exxon litigation to illustrate the overlap of tort and contract damage theories.
Exxon (45) is currently engaged in the business of successfully exploiting the vulnerability of current laws on punitive damages in Alabama, Alaska, New York, Oklahoma, Texas, and Wyoming. (46) The corporation is reportedly worth well over $40 billion and holds the distinction of having made more money than any other corporation in history. (47) It also appears more than willing to risk simple contract damages for carefully calculated bad faith breaches of contract skillfully constructed to fall at least one element shy of any tort. Never fearing punitive damages, Exxon easily committed bad faith breach in Alabama, steered clear of fraud and any existing exceptions, and placed a $50 million gamble that, but for the Alabama's expensive and time-consuming audit, would have paid off.
C. Exxon's Bad Faith Breach of Contract with Respect to the Elements of Fraud
It is well established in Alabama that a successful breach of contact claim will not include punitive damages; however, if the basis of the breach of contract is fraud, the claim may properly request punitive damages. (48) Of course, the injured party must prove every element of fraud. (49) In Alabama, fraud has four elements. (50)
The first element is falsity. (51) Quite simply, if there is no false fact, there is no fraud. (52) In the lease agreement between Exxon and Alabama, Exxon promised to pay certain royalties. (53) A dispute over the amount of royalties owed resulted in litigation. (54) Exxon paid according to its calculations. For some time, the State accepted the payments without disagreement, at least partially due to the fact that the State had difficulty in finding an expert qualified to perform the complex offshore natural gas lease audits. (55) Ultimately the DCNR completed an audit and the State alleged that Exxon contrived to lower the amount it owed to the State. (56) Specifically, the State contended that Exxon agreed to pay a certain percentage for profits on the amount of gas successfully produced by drilling. (57) Exxon submitted reports on its profits on cogenerated plant fuel, but because if its interpretation of certain contract provisions, it deducted all profits on the slop oil and the sulfur that were also profitable products of drilling. (58) The burden is on the plaintiff, here the State, to prove a false representation of an existing fact. (59) If the jury was convinced by the State and believed that Exxon submitted reports excluding profits that should have been included, then the element of falsity would have been established.
The second element, materiality, is more complex than the falsity element. A material "statement" may be one that the defendant made, or it may be one that the defendant concealed when he was under a duty to reveal the statement. (60) The analysis, however, does not end there. Once it is proven that there is a misstatement or omission, the statement must be evaluated for its degree of materiality. Imagine a specific fraudulent statement on a continuum. Untrue statements can be anything from inconsequential to egregious to criminal, or anything in between. In other words, at one end of the spectrum are statements that might cause little to no effect on conduct; at the other end of the spectrum are those statements in which the contracting party makes vital decisions based on the fraudulent statement. Typically, the latter will be found to be material, the former will not. This wide spectrum makes the element of materiality necessary.
Returning to Exxon, the State pointed to the oil corporation's contractual obligations as evidence of the element of materiality. (61) Exxon was required to submit payments on gross production and gross sales. (62) The State argued that Exxon's payments included various deductions that amounted to misrepresentations of material facts. (63) Exxon responded that the statements were valid, that is innocent or true, but even if statements had been false, they were not material, (64) because according to the lease, the payments were always subject to DCNR audits. (65)
The massive corporation found itself in a comfortable position. With nothing more than compensatory damages on the line, Exxon calmly sought a declaratory judgment. (66) If the State could not prove that Exxon's interpretation was an unreasonable interpretation, there would be no clear and convincing evidence of falsity. If the State could prove falsity, Exxon could still seek to place its claim on the low side of the continuum, arguing that that any false statement or omission was legally insignificant and consequently lacked materiality. In other words, even if the court believed that there was a material misstatement, the State would still have two more elements to prove.
The third element of fraud requires the plaintiff to prove he suffered damages as a direct result of the material false statement. (67) Generally speaking, the fraud must be the cause of some economic harm. (68) Under this causation element, damages are usually calculated by the loss of money. (69) Most commonly, fraud entails property injuries. (70) The purpose, broadly stated, is to either put the complaining party in the position he would have been in if the alleged fraud had not been committed; or assure the complaining party that he is in no worse a situation than he would have been in had the statement been true. (71)
With respect to Exxon, Alabama believed it was in a worse position. (72) Any lease audits will be time consuming and expensive, but oil and gas leases are arguably as complex as leases can be. The required experts in oil and gas leases are rare and usually industry insiders. (73) The State argued that because every contract assumes the duty of good faith and fair dealing, it did not perceive the necessity of the expense and hardship of auditing Exxon at every turn. (74) Testimony revealed economic damages. (75) Once the DCNR detected the alleged fraud, the resulting back audits and the confirmation of the accuracy of the back audits for litigation purposes reached roughly $1.6 million in taxpayer dollars. (76)
The State had presented arguments for three of the four elements and had but one last hurdle. However, Alabama now faced its greatest challenge because the final element revealed itself as the bottleneck for the State (and any like-plaintiff) in its attempt to prove the fraud claim on bad faith breach of contract on the lease contract between Alabama and Exxon; the element of justifiable reliance.
Suppose Alabama had offered convincing proof of three elements of fraud. Further suppose that a deliberating jury now believed that Exxon did intentionally represent that the figures it reported were accurate when it knew that they were not, and that the reports were material to the agreement, and that Exxon caused the State to suffer damaging economic loss in investigating Exxon's fraudulent reports. The final barrier between a successful and an unsuccessful fraud claim looms. Will a jury (or ultimately, the Supreme Court of Alabama) also believe Alabama's reliance was reasonable?
Justifiable reliance, the final element, also called reliance or reasonable reliance, (77) is perhaps the most complex element. (78) Reliance reveals itself as the sticking point for many plaintiffs in making a successful fraud claim. To prove reliance, the plaintiff not only has to prove he acted or failed to act, but also that it was his justifiable reliance on the material misstatement that caused his act or failure to act. Further, he must show that the defendant intended to deceive him. (79) This element requires that the defendant deceived the victim by design and that the victim either took or failed to take action when his reliance on the material misstatement was justified. (80)
When the litigation began in 1999, Exxon contended that its lease interpretation was reasonable and that the corporation never intended to defraud the State. (81) In response to Alabama's argument that the State had justifiably relied, Exxon offered proof that by 1995, Alabama was fully aware that the parties differed in their interpretations of the royalty payments. (82) Exxon convincingly argued that this was the appropriate point to see if Alabama would change its course of action. (83) Evidence proved that Alabama did not. (84) Alabama did not reject the lease payments or even begin the audits (that were always anticipated, according to the lease agreement) until 1996. (85) Moreover, the State could not prove that it changed its course in any way that could have resulted in damages. Exxon offered damning evidence that according to the lease, Alabama held all the cards. The lease provided that if Exxon breached the agreement, Alabama could exercise its right to force Exxon to forfeit all its rights under the lease. (86) The lease specifically noted the making of "any false return or false report concerning operations or production." (87) The State made no attempt to cancel the lease, to begin an audit, or to do anything differently. (88) To the contrary, it continued to accept monthly payments from Exxon. (89)
This raises several important questions. First, why would a fraud action, where reliance is all but impossible to prove, prevail in two trials, go through two Hammond hearings, and two appeals to the Supreme Court? Second, what prompted the outpouring of amicus curiae in support of the State? Finally, what motivated the largest punitive damage judgment in Alabama history, when evidence on the element of justifiable reliance was certainly not proved by substantial evidence and might even be characterized as so sparse as to be non-existent? The answer to each of these questions, in a word, is justice.
Alabamians and others following the issue in this trial instinctively perceived that something was deeply unfair. How could an enormous corporation easily concede that it committed a bad faith breach of contract and have a well-documented reputation for the exact conduct in the past, in this state and other states, and not deserve punishment? Surely courts have made exceptions to allow punitive damages when a bad faith breach exploits innocent parties to a contract.
Perhaps not surprisingly, the citizens and onlookers were right. As with virtually every rule, there are exceptions to the rule on punitive damages. Courts may award punitive damages in three types of contract claims without a separate tort claim: fraudulent concealment, (90) promissory fraud, (91) and bad faith breach of an insurance contract. (92)
PART II. THE EXCEPTIONS FOR PUNITIVE DAMAGES IN CONTACT CLAIMS
Once the Supreme Court was convinced that one or more elements of fraud were not present, any argument for punitive damages including the underlying tort was without merit. The State's only hope was to fall into one of the three existing exceptions where punitive damages were available on contract claims. The first two exceptions, fraudulent concealment and promissory fraud, offer no protection. The victim of fraudulent concealment contends that the contract is void from the beginning because he would not enter into the agreement unless induced by untrue statements or suppression of facts. (93) The DCNR did not make that claim. Similarly, the victim of promissory fraud seeks to punish the party who intentionally and deliberately deceived him. (94) In a successful promissory fraud action, the court may award punitive damages to the harmed party when the deceptive party, at the time the contract was made, had no intention of performing his promise. (95) Distinctions aside, both fraudulent concealment and promissory fraud were without merit in the Exxon litigation for the same reason: the State neither brought the meritless claims nor alleged any misrepresentation occurred until after completion of the leases.
However, the third exception, bad faith breach in the insurance context (the no reliance fraud standard) is attractive because of certain similarities in its purpose and history to oil and gas contracts. Under this exception, courts and legislatures nationwide have recognized and punished the outrageous conduct of insurance companies as sophisticated breaching parties who are under a good faith obligation to those with whom they contract. Important reasons for the exception allowing punitive damages in the insurance context include: the severe damage to the non-breaching party, the importance of deterrence, the culpability of the offending party who demonstrates malice, fraud, or a conscious disregard for the rights of others, as well as numerous violations of public policy. (96) Arguably, these very reasons could be persuasively applied to oil and gas leases like those in Exxon. Because there is no current exception for oil and gas contracts, no argument was proffered by the State, but a single sentence in Justice Lyons' concurrence in Exxon drew a line between possible similarities in insurance contracts and oil and mineral contracts. (97) If the Alabama legislature (98) broadened the application of punitive damages to include the no reliance fraud standard in bad faith breach of oil and mineral contracts, based upon the similarity in the contracts and the goals of punishment, the potential for far-reaching positive effects on future oil and mineral contracts in Alabama would exist.
A. The No Reliance Fraud Standard; Bad Faith Breach of an Insurance Contract
The final recognized exception to the general rule against allowing punitive damages on breach of contract claims has deep roots in Alabama and enjoys wide acceptance in every state. (99) The no reliance fraud standard allows for an award of punitive damages when the bad faith breach is committed by an insurance company even if the policyholder cannot prove all the elements of fraud. (100) Generally, an actionable bad faith breach of contract is accomplished when a company wrongfully delays or refuses to pay its policyholder. (101) The remedy is also making headway in wrongful discharge in labor law and in some states the no reliance fraud standard is being tested for its strength by applying good faith and fair dealing in fiduciary relationships in various other settings including lease law between landlords and tenants, and in banking and commercial contracts. (102) This note proposes that it is to appropriate to expand the no reliance fraud standard to include oil and gas lease law because of its similarities to the most accepted application; the insurance context. To that end, the note will make a careful examination of the history of bad faith breach of an insurance contract in Alabama and in other states.
1. The History
Contracts include the implied covenant of good faith and fair dealing; meaning neither party is expected to act in such a way as to affect the right of the other to receive the benefit of the contact. (103) When a party acts in bad faith, the other party may pursue a breach of contract action. (104) Importantly, courts have also held that the failure to act in good faith constitutes a tort and carries the tort theory of damages, under certain specific circumstances. (105) One such circumstance has had a profound impact in the insurance industry. (106) Courts are now holding insurance companies liable not only for damages under a policy but also for substantial punitive damages. (107) To understand the rationale behind these decisions and to draw parallels to the oil and gas context, one must understand the problem the public once faced in the insurance context.
Insurers regularly took advantage of their policyholders' lack of adequate remedies when the company denied or delayed payments due under a policy. (108) The policyholder had few choices. Similar to the choice for Alabama in the Exxon litigation, a policy holder could chose to sue by way of a contract claim where he was limited to contract damages that might not cover all his economic loss (including expensive litigation.) He could alternatively choose to sue for a tort remedy, and if so, he would very likely face the losing battle of proving all the elements of fraud.
Insurance companies, not unlike oil corporations, formed a noticeable pattern concerning evading their duties under contracts and were boldly expanding the pattern with variations on the theme. Often, one of their insured would be sued under a policy. Sometimes the insurance company would either refuse to represent the policy holder or refuse to accept reasonable settlement offers; other times the company would undertake to represent their insured at a settlement negotiation, but with the same result. The company would again refuse a reasonable settlement offer. At trial, the injured plaintiff would often prevail and the judgment would be greater than the settlement offer and, more importantly, greater than the insured's coverage limit. The insured, and not the insurance company, would find himself on the hook for damages owed in excess of the amount of coverage he would receive from the insurance company. The company, on the other hand, was no worse off for having gambled because punitive damages were unavailable. It only paid the amount that it had agreed to under the contract's policy coverage limits. The fatal flaw of the reasoning in the insurance companies' scheme was that all contracts carry the duty of good faith and fair dealing. A slow, but monumental change began in 1958 in the landmark case of Comunale v. Traders and General Insurance Company. (109) In Comunale, the California Supreme Court awarded a recovery in excess of policy limits and became the first court to hold an insurance company liable for excess (punitive) damages when the company refused to accept a reasonable settlement on behalf of its insured (bad faith). (110)
It all began with an ordinary traffic accident. (111) A California couple was walking in a pedestrian crosswalk when an insured truck driver hit and injured them. (112) His policy limit was $10,000 per person injured. (113) The couple sued, but the insurance company wrongfully refused to defend the driver. (114) The injured couple offered to accept $4,000 to settle the controversy. (115) The driver, who could not pay $4,000, again asked his insurance company to represent him or pay the amount of the settlement that was well under his policy limits. (116) Once more, the company wrongfully refused to defend him, but worse still; it wrongfully refused to pay the reasonable settlement on behalf of its insured. (117) At the close of the trial, the court awarded the injured couple $26,250. (118) Because the driver could not pay, the couple sued the insurance company. (119) The California Supreme Court held that the company failed to uphold its fiduciary duty to the driver under the contract, so for the first time, a court held an insurance company liable for a breach of contract and was required to pay damages in excess of policy limits. (120)
The type of breach of contract described so far is known as a "third-party claim" because the claims always included the company, its insured, and another party who claimed damages. The question of whether an insurance company would be held liable for a breach between only itself and its policy owner (a first-party dispute) remained unanswered for fifteen years.
In 1973, the California Supreme Court was again the first to answer the question. (121) There, in a first-party bad faith breach of contract dispute, the court held that when the insurance company intentionally schemes to deny benefits, it could award damages to compensate the insured for economic harms not addressed in the policy. (122) Just such a scheme occurred early one morning when a cocktail lounge caught fire.
The insured owner rushed to the scene. (123) He was arrested under suspicion of arson largely because the insurance adjuster divulged to investigating officers the fact that the insured had a great deal of fire coverage. (124) The insured owner faced criminal charges as well as a civil charge for defrauding his insurer. (125) While his criminal charges were pending, the insurance company commenced its civil action, knowing the insured could not appear and his failure to appear for examination on the civil charge would void his policy. (126) Eventually, the unfounded arson charges were dropped, but the insurance company stood by its decision to void his coverage. (127) The insured sued, asking the court for compensatory and punitive damages. (128) The court relied on its Comunale decision involving third-party actions for breach of contract in the insurance context and announced that it again found that the court would hold an insurance company accountable to its duty of good faith and fair dealing. (129) Where it fails in this duty, the action rises to the level of a tort and punitive damages are appropriate whether the claim is by a third-party against the insured or by the insured himself. (130)
2. The Response in Alabama
Finding these decisions persuasive, other states began to announce comparable decisions. Alabama was among these states. By the early 1980s the Alabama Supreme Court was also weighing in on the State's view of first-party actions for bad faith breaches of contract by an insurance company. This time a fire destroyed a nightclub in Mobile, Alabama. (131)
Investigators and adjusters set the amount of recoverable loss at $13,000. (132) Arson was likely. (133) The company offered a reward for information leading to the arrest of the arsonist. (134) The insurance company had information that the insured (135) was in financial difficulty and that she had talked about burning down the building. (136) The insured was never formally charged with arson. (137) The insurance company refused to pay the reasonable amount but instead offered to pay only $8,000 on the owner's claim. (138) The owner sued and won a judgment in the exact amount of the recoverable loss. (139) The owners next brought suit against the insurance company for its bad faith refusal to settle. (140) At the trial, the jury award reached $42,500 before the insurance company filed a motion that resulted in a judgment notwithstanding the verdict for the insurance company. (141) The question on appeal was whether Alabama recognizes a cause of action in tort for bad faith breach of contract in a first-party action in the insurance context. (142)
The Alabama Supreme Court began with the recognition that parties to a contract have the duty of good faith and fair dealing, and when one party intentionally breaches, that breach is a bad faith breach of contract. (143) By this time, the Court was consistently allowing recovery on third-party claims within policy limits and where the insured incurred a judgment in excess of the policy limits due to some wrongful act of the insurance company. (144) The Court now had the opportunity to resolve the question in a first-party claim. (145) Apparently the Court had been waiting for the factual circumstances of this case and took its first opportunity to recognize the intentional tort of bad faith in first-party insurance actions as a separate tort. (146) The Court undertook to protect the public because it recognized a pattern of willful refusal to honor claims when the purpose of the contract was to shield the policy owner from financial disaster. (147)
One has only to flip a few pages in the Southern Reporter to see that the Court began relying on its decision immediately. (148) The Court handed down a second decision on the same day. In Gulf Atlantic Life Insurance Company v. Barnes an insurance company refused to pay death benefits to a policy holder upon the death of one of her children. (149) It cited Chavers and carried the same reasoning. (150) The writers of the opinion left no doubt that the plaintiff requesting punitive damages carried a heavy burden. The test for a breach of an insurance contract would require proof of intent, knowledge, and an unreasonable denial of coverage. (151) Only those plaintiffs who could satisfy the burden could be awarded punitive damages on the tort of bad faith breach of contract. (152)
3. The Response in Other States
Other courts in the Eleventh Circuit were in agreement. In Florida, a family was injured in an automobile accident with an underinsured motorist. (153) The family had uninsured motorist insurance and filed a claim. (154) The policy limit was $150,000. (155) The family engaged in unsuccessful negotiation with the insurance company who offered $40,000 in the face of documentation of far greater expenses. (156) The failure to agree eventually led to arbitration where the family was awarded $165,000. (157) The family sued their insurer for bad faith in the handling of the claim. (158) The Florida Legislature had already passed a statute that the court had interpreted to allow only third-party claims. (159) Two decisions in Florida's federal courts and the decisions in California were persuasive. (160) The court announced that the duty of good faith and fair dealing is more than a contractual obligation, but is also a legal duty and h