IN THE 1970s, a sequence of California decisions created a new tort--one for bad faith denial of an insurance claim. (1)
In the beginning, insurance policies were treated like any other type of contract. Relying on the common law rule announced in 1854 by the Exchequer Chamber, Hadley v. Baxendale, (2) courts limited damages to those contemplated by the parties at the time the contract was formed. (3) The business of insurance, however, is much different from other commercial pursuits. Individuals and companies obtain insurance to hedge against risks and potential losses they often are not economically able to suffer. Insurance companies have an unequal bargaining power. They are able to pass litigation costs off to insureds in the form of higher premiums, while an uninsured person or company is not able to do that. Insureds must in most cases accept adhesion contracts, with little or no power to bargain over details. Insurance policies, moreover, are extremely complicated documents, containing countless warranties and exceptions to coverage that often are not fully understood by the insured.
The tort of bad-faith denial of claims originated because of the peculiar nature of insurance contracts and an appreciation that the principles of contract law are inadequate to protect policyholders. (4) Simply put, states that have adopted this tort require insurance companies to act in good faith, and fairly deal with their insureds. (5)
Although about 45 American states have adopted the bad-faith tort for first-party claims, the type of bad-faith claim on which this article concentrates, the law is relatively new and in a state of flux. One area often litigated is the insured's right to inspect the insurer's claims file during discovery. Plaintiffs argue that it is the only way to prove bad faith, while defendants contend that information is protected by the attorney-client privilege or the work product doctrine, or both. A 2001 decision by the Ohio Supreme Court, Boone v. Vanliner Insurance Co., (6) has brought this issue into sharp focus. The court held that in a bad-faith case, all claims file materials created before the claim was denied are discoverable. The unique part of the decision was that the court found that materials showing an insurer's lack of good faith are unworthy of protection.
The mere allegation of bad faith on the part of the insurer, however, should not result in a blanket exception to the attorney-client privilege and the work product doctrine. Several cases, including Vanliner, have held that any information or documentation collected or produced before a claim is denied was prepared in the normal course of business and thus is not eligible for discovery immunity. This is an overgeneralized inference that ignores the principles behind the work product doctrine. To balance the competing interests, courts should require a factual showing of bad faith, not a mere allegation--that is, there must be specific facts and examples pleaded on which a reasonable judge could infer that there was a question of insurer bad faith.
BAD FAITH AND PRIVILEGES
A. A Bit of History
In the mid to late 1800s, states began regulating the insurance industry in response to its growth and widespread corruption. (7) In 1944, the U.S. Supreme Court held in United States v. Southeastern Underwriters Ass'n that insurance transactions were commerce and thus subject to federal regulation. (8) In response, Congress in 1945 enacted the McCarran-Ferguson Act, 15 U.S.C. [section] 1101 et seq., which provides that federal laws such as the Sherman and Clayton acts and the Federal Trade Commission Act, apply only to insurance transactions in areas overlooked by state law. Thus, states are given a great deal of discretion in the field of insurance law, and this can lead to widely divergent opinions.
Like other contracts, insurance policies carry an implied duty of good faith and fair dealing originating from common law. …