Contracts are the hardest documents to sign. This is especially true if the contract involves ownership that, when put in jeopardy, can cause inconvenience and are not easily replaced if lost. Once you put your name on a contract, the deal is closed. It signifies your agreement to everything written on the document. Although it’s not directly stated, contracts require both parties to act in good faith. This rule should be applied fairly to all contracts and to every party. It works differently, however, with insurance contracts. The commitment to deal fairly and in good faith falls, to a larger extent, on the insurance companies.
Laws protecting the insured
There are laws protecting the insured. These laws allow the insured to take legal action against the insurer if the insurer breaches their duty to good faith and fair dealing. However, the same action is largely unavailable for insurers that wish to protect themselves from the insured violating their duty.
Reverse bad faith
Then came reverse bad faith. Reverse bad faith is the failure to pay a claim without a reasonable basis. Under this doctrine, the insurer is allowed to bring a lawsuit against the insured should the insured breach the contract to good faith and fair dealing. Here’s an example of why the insurance companies need a law like this. In 2007, a homeowner filed a claim worth $866,000 after their house was burned down. State Auto, their insurance company, paid in excess of $425,000. State Auto later filed a lawsuit against the homeowner due to the suspicion that the fire was intentional. At first, the insured counterclaimed but then later admitted to committing arson. The insured was then sentenced to prison and ordered to settle restitution that includes attorney fees among others.
Why Kentucky rejected State Auto’s claim
State Auto filed a complaint but the Sixth Circuit predicted that Kentucky law would not recognize a claim for reverse bad faith. The Sixth Circuit acknowledged that this was an issue of first impression in Kentucky. Kentucky court based its rejection on four reasons which included:
- The Court recognized that the covenant of good faith is “an obligation between two parties.” However, a special relationship between the parties is required. When an insurer brings a bad faith claim against its insured, the insurer isn’t in a position of unequal bargaining power or vulnerability. Thus, the special relationship necessary to maintain an independent tort does not exist.
- The specific elements of proof in a standard bad faith claim can’t be met because the insured is under no obligation to pay.
- The Court looked to other jurisdictions and noted that no other states have recognized a claim for reverse bad faith.
- State Auto argued that it was “unjust” for insurers to have no reciprocal cause of action for willful and malicious claims against them. The Court explained that the insured was federally indicted and ordered to pay restitution of the claim proceeds and all associated costs.
This issue has been a popular subject online - how the court saw that the common duty of good faith is not a two-way street. It does seem unfair that reverse bad faith in insurance cases protects one party more than another. It will be interesting to see how this ruling affects claims and cases in Kentucky in the future.