Bad Faith Allegations Versus an Insurer's Attorney-Client Privilege

Recently, the Washington Court of Appeals addressed the issue in the first-party context. In Cedell v. Farmers Ins. Co. of Washington, Case No. 38921-5-II (Wash. App. Div. 2 Aug. 3, 2010), the court held that bad faith allegations alone, even if supported by some evidence, do not eviscerate an insurer's right to attorney-client privilege. Rather, the insured must establish fraud.

In Cedell, the insured filed a bad faith action against his insurer after the insurer had not settled his claim stemming from an accidental fire at his home over a year after the incident. During the course of discovery, the insured sent interrogatories and requested documents including the case file on the insured's claim. The insurer produced heavily redacted documents, withheld documents and refused to respond to interrogatories on the basis of attorney-client privilege and work product protection. After finding that the facts of the case were adequate to support a good faith belief the insurer engaged in wrongful conduct, the trial court conducted an in camera review of the redacted documents. The court ordered the insurer to produce the insured's entire claims file including all attorney-client privileged and work product documents.

On appeal, the court rejected the insured's argument that insurers have no attorney-client privilege rights in a first-party bad faith claim simply because information about the insurer's handling of the claim is central to the bad faith allegations. See also W. Va. ex rel. Allstate Ins. Co. v. Madden, 601 S.E.2d 25, 34, 36-37 (W. Va. 2004) (holding filing a first-party bad faith claim action alone does not automatically waive the insurer's attorney-client privilege, but a crime fraud exception may overcome the privilege); cf. City of Myrtle Beach v. United Nat'l Ins. Co., No. 4:08-1183-TLW-SVH, 2010 WL 3420044, at *5 (D. S.C. Aug. 27, 2010) (finding no per se waiver upon allegations of bad faith, but waiver occurs when insurer voluntary injects facts relating to attorney-client privilege in its answer and asserted defenses); Dion v. Nationwide Mut. Ins. Co., 185 F.R.D. 288, 294-95 (D. Mont. 1998) (finding that first-party bad faith allegations do not automatically waive insurer's attorney-client privilege). Instead, the Washington Court of Appeals held that insurers do not lose attorney-client privilege protection unless an otherwise recognized exception, such as fraud, applies.

Importantly, the Cedell court distinguished between a prima facie showing of fraud versus a showing of bad faith. Although the trial court had found sufficient facts to support a finding of bad faith, it had not made sufficient findings to support fraud. See also U.S. v. Zolin, 491 U.S. 554, 574 (1989) (holding that a party seeking to establish the crime fraud exception must present evidence sufficient to support a reasonable belief that in camera review of the documents may yield evidence of fraud). Accordingly, without a factual basis for finding fraud, the Court of Appeals held that the trial court abused its discretion by ordering an in camera review of the evidence and ordering disclosure and production of the privileged information.

Per Se Waiver of Attorney-Client Privilege

Other courts have been less protective of the privilege. For example, the Florida Supreme Court's decision in Allstate Indemnity Company v. Ruiz, 899 So.2d 1121, 1131 (Fla. 2005), has paved the way for the broadest unconditional waiver of attorney-client privilege in bad faith actions in Florida. In Ruiz, pursuant to the statutory right for bad faith actions under Fla. Stat. 625.144, the insured brought a bad faith action against his insurer after it denied coverage for an accident claim involving an automobile that the insurer's agent incorrectly removed from the insured's policy prior to the accident.

Florida's courts had long recognized that insurers are obligated to produce “all materials, including documents, memoranda and letters, contained in the insurance company's file, up to and including the date of judgment in the original litigation” in third-party bad faith actions. See Id. at 1126-27, quoting Stone v. Travelers Ins. Co., 326 So.2d 241, 243 (Fla. 3d DCA 1976). In contrast, courts had not applied the per se waiver consistently in first-party bad faith actions because a fiduciary relationship does not exist between the insurer and insured in first-party actions. See Id. at 1126-27, quoting Stone v. Travelers Ins. Co., 326 So.2d 241, 243 (Fla. 3d DCA 1976).

Receding from its prior decision in Kujawa v. Manhattan National Life Insurance Company, 541 So.2d 1168, 1169 (Fla. 1989), the Ruiz court eviscerated any distinctions between first and third-party bad faith actions for discovery purposes. Id. at 1128. The court reasoned that Section 625.144 did not distinguish between third and first-party actions, and thus, the court had no basis for applying different discovery rules to substantively identical causes of action. Id. Accordingly, the court held, “[A]ll materials, including documents, memoranda, and letters, contained in the underlying claim and related litigation file material that was created up to and including the date of resolution of the underlying disputed matter and pertain in any way to coverage, benefits, liability, or damages, should also be produced in a first-party bad faith action.” Id. at 1129-30. Notably, the court further held that materials prepared after the resolution of the underlying dispute would be subject to production upon a showing of good cause or pursuant to an order of the court following in camera inspection. Id. at 1130.

Although the insurer in Ruiz claimed protection only under the work-product doctrine and the court did not expressly address attorney-client privilege, the decision's broad description of discoverable documents in first-party bad faith actions has been interpreted to find a per se waiver of attorney-client privilege in bad faith actions. See, e.g., Lender v. Geico Gen. Ins. Co., No. 09-22303-CIV, 2010 WL 3743812, at *2-3 (S.D. Fla. Sept. 22, 2010); Mayfair House Assoc., Inc. v. QBE Ins. Corp., No. 09-80359-CIV, 2010 WL 472827, at 3-4 (S.D. Fla. Feb. 5, 2010) (“[I]n Ruiz, the Florida Supreme Court effectively eliminated the attorney-client privilege as a discovery shield in bad faith insurance litigation between an insured and its insurance company with respect to all materials generated prior to resolution of the underlying disputed matter.”); Adega v. State Farm Fire & Cas. Ins. Co., No. 07-20796-CIV, 2008 WL 1009719, at *2 (S.D. Fla. 2008 Apr. 9, 2008); Nowak v. Lexington Ins. Co., 464 F.Supp.2d 1241, 1245-47 (S.D. Fla. 2006). But see XL Specialty Ins. Co. v. Aircraft Holdings, LLC, 929 So.2d 578, 583 (Fla. 1st DCA 2006) (holding Ruiz limited to work-product protections and not applicable to attorney-client privilege because Ruiz court did not expressly recede from prior holding that attorney-client privilege applies to bad faith actions).

Although the court in Adega found that it was bound to interpret Ruiz to apply per se waiver of attorney-client privilege in a bad faith action, it did so “begrudgingly.” Adega at *2. The court stated, “While the Florida courts have discussed, at length, the discovery that should be permitted in a bad faith case, there has been precious little analysis of the sanctity of the attorney-client privilege ' a cornerstone of the entire judicial/legal system in this country.” Id.

Balance of Interests

Other courts have also balanced the competing interests of insurers and insureds in bad faith claims by applying a rebuttable presumption to the waiver of attorney-client privilege in a bad faith claim. This analysis rests on whether the documents were created primarily for business versus legal purposes. See Lindley v. Life Investors Ins. Co. Am., 267 F.R.D. 382, 389-400 (N.D. Okl. 2010). Although it may be practically difficult to distinguish the line between business and legal purposes, at the very least, such analysis recognizes a nuanced approach to attorney-client privilege issues. The court in Lindley correctly observed, “[T]here are often no clear answers to privilege issues to the fact-dependent case by case analysis required. This is particularly true on the context of insurance bad faith claims.” Id. at 389.

Even some jurisdictions that have extended the crime fraud exception to bad faith insurance actions recognize the fact-dependent nature of privilege waiver. Under Ohio Rev. Code Section 2317.02(A)(2), Ohio's legislature has codified an exception to attorney-client privilege specifically applicable to insurers:

An attorney, concerning a communication made to the attorney by a client in that relationship or the attorney's advice to a client, except that if the client is an insurance company, the attorney may be compelled to testify, subject to an in camera inspection by a court, about communications made by the client to the attorney or by the attorney to the client that are related to the attorney's aiding or furthering an ongoing or future commission of bad faith by the client, if the party seeking disclosure of the communications has made a prima facie showing of bad faith, fraud, or criminal misconduct by the client.

ORC ' 2317.02(A)(2); see also Hutchinson v. Farm Family Cas. Ins. Co., 867 A.2d 1, 6-7 (Conn. 2005) (holding civil fraud exception should be extended to claims of bad faith against insurers but the same threshold evidentiary requirements for obtaining in camera review when civil fraud has been alleged shall apply when bad faith has been alleged). Although ORC ' 2317.02(A)(2) is broader than the holding in Cedell, the statute appears to recognize the importance of a nuanced approach to privilege issues by purposefully requiring an in camera inspection by the court. See In re Prof. Direct Ins. Co., 578 F.3d 432, 441 n.7 (6th Cir. 2009) (noting the explanatory note for the statute purposely modified the common law established to provide for judicial review regarding the privilege).

Conclusion

The tension between these principles likely will continue. While eviscerating the privilege may assist the insureds in pending cases, the long-term effect could be anti-consumer. If the insurer's analyses and considerations are subject to discovery, insurers will not receive the candid views that otherwise might support settlement.

Lewis E. Hassett, a member of this newsletter's Board of Editors, is a partner with Morris, Manning & Martin, LLP and is the co-chair of the firm's Insurance/Reinsurance Practice Group. He may be reached at [email protected] or 404-504-7762. Cindy Chang is a member of the firm's Insurance/Reinsurance Practice Group and may be reached at [email protected] or 202-842-1081.

This article addresses conflicting court decisions on the extent to which an insured's allegations of insurer bad faith eviscerate the insurer's attorney-client privilege. Not surprisingly, insureds argue that an allegation of bad faith is sufficient to waive the privilege, while insurers argue that an insurer's right to invoke the privilege should be revocable only under the same crime fraud exception applicable outside the insurer bad faith context.

The applicable rule can affect not only the outcome in the bad faith case itself, but also the insurer's incentives and ability to obtain candid legal advice in assessing coverage. Court decisions on the subject are mixed, and some are discussed below.

Attorney-Client Privilege Waived Only When Fraud Exception Applies

Recently, the Washington Court of Appeals addressed the issue in the first-party context. In Cedell v. Farmers Ins. Co. of Washington, Case No. 38921-5-II (Wash. App. Div. 2 Aug. 3, 2010), the court held that bad faith allegations alone, even if supported by some evidence, do not eviscerate an insurer's right to attorney-client privilege. Rather, the insured must establish fraud.

In Cedell, the insured filed a bad faith action against his insurer after the insurer had not settled his claim stemming from an accidental fire at his home over a year after the incident. During the course of discovery, the insured sent interrogatories and requested documents including the case file on the insured's claim. The insurer produced heavily redacted documents, withheld documents and refused to respond to interrogatories on the basis of attorney-client privilege and work product protection. After finding that the facts of the case were adequate to support a good faith belief the insurer engaged in wrongful conduct, the trial court conducted an in camera review of the redacted documents. The court ordered the insurer to produce the insured's entire claims file including all attorney-client privileged and work product documents.

On appeal, the court rejected the insured's argument that insurers have no attorney-client privilege rights in a first-party bad faith claim simply because information about the insurer's handling of the claim is central to the bad faith allegations. See also W. Va. ex rel. Allstate Ins. Co. v. Madden , 601 S.E.2d 25, 34, 36-37 (W. Va. 2004) (holding filing a first-party bad faith claim action alone does not automatically waive the insurer's attorney-client privilege, but a crime fraud exception may overcome the privilege); cf. City of Myrtle Beach v. United Nat'l Ins. Co., No. 4:08-1183-TLW-SVH, 2010 WL 3420044, at *5 (D. S.C. Aug. 27, 2010) (finding no per se waiver upon allegations of bad faith, but waiver occurs when insurer voluntary injects facts relating to attorney-client privilege in its answer and asserted defenses); Dion v. Nationwide Mut. Ins. Co. , 185 F.R.D. 288, 294-95 (D. Mont. 1998) (finding that first-party bad faith allegations do not automatically waive insurer's attorney-client privilege). Instead, the Washington Court of Appeals held that insurers do not lose attorney-client privilege protection unless an otherwise recognized exception, such as fraud, applies.

Importantly, the Cedell court distinguished between a prima facie showing of fraud versus a showing of bad faith. Although the trial court had found sufficient facts to support a finding of bad faith, it had not made sufficient findings to support fraud. See also U.S. v. Zolin , 491 U.S. 554, 574 (1989) (holding that a party seeking to establish the crime fraud exception must present evidence sufficient to support a reasonable belief that in camera review of the documents may yield evidence of fraud). Accordingly, without a factual basis for finding fraud, the Court of Appeals held that the trial court abused its discretion by ordering an in camera review of the evidence and ordering disclosure and production of the privileged information.

Per Se Waiver of Attorney-Client Privilege

Other courts have been less protective of the privilege. For example, the Florida Supreme Court's decision in Allstate Indemnity Company v. Ruiz , 899 So.2d 1121, 1131 (Fla. 2005), has paved the way for the broadest unconditional waiver of attorney-client privilege in bad faith actions in Florida. In Ruiz, pursuant to the statutory right for bad faith actions under Fla. Stat. 625.144, the insured brought a bad faith action against his insurer after it denied coverage for an accident claim involving an automobile that the insurer's agent incorrectly removed from the insured's policy prior to the accident.

Florida's courts had long recognized that insurers are obligated to produce “all materials, including documents, memoranda and letters, contained in the insurance company's file, up to and including the date of judgment in the original litigation” in third-party bad faith actions. See Id. at 1126-27, quoting Stone v. Travelers Ins. Co. , 326 So.2d 241, 243 (Fla. 3d DCA 1976). In contrast, courts had not applied the per se waiver consistently in first-party bad faith actions because a fiduciary relationship does not exist between the insurer and insured in first-party actions. See Id. at 1126-27, quoting Stone v. Travelers Ins. Co. , 326 So.2d 241, 243 (Fla. 3d DCA 1976).

Receding from its prior decision in Kujawa v. Manhattan National Life Insurance Company , 541 So.2d 1168, 1169 (Fla. 1989), the Ruiz court eviscerated any distinctions between first and third-party bad faith actions for discovery purposes. Id. at 1128. The court reasoned that Section 625.144 did not distinguish between third and first-party actions, and thus, the court had no basis for applying different discovery rules to substantively identical causes of action. Id. Accordingly, the court held, “[A]ll materials, including documents, memoranda, and letters, contained in the underlying claim and related litigation file material that was created up to and including the date of resolution of the underlying disputed matter and pertain in any way to coverage, benefits, liability, or damages, should also be produced in a first-party bad faith action.” Id. at 1129-30. Notably, the court further held that materials prepared after the resolution of the underlying dispute would be subject to production upon a showing of good cause or pursuant to an order of the court following in camera inspection. Id. at 1130.

Although the insurer in Ruiz claimed protection only under the work-product doctrine and the court did not expressly address attorney-client privilege, the decision's broad description of discoverable documents in first-party bad faith actions has been interpreted to find a per se waiver of attorney-client privilege in bad faith actions. See, e.g., Lender v. Geico Gen. Ins. Co., No. 09-22303-CIV, 2010 WL 3743812, at *2-3 (S.D. Fla. Sept. 22, 2010); Mayfair House Assoc., Inc. v. QBE Ins. Corp., No. 09-80359-CIV, 2010 WL 472827, at 3-4 (S.D. Fla. Feb. 5, 2010) (“[I]n Ruiz, the Florida Supreme Court effectively eliminated the attorney-client privilege as a discovery shield in bad faith insurance litigation between an insured and its insurance company with respect to all materials generated prior to resolution of the underlying disputed matter.”); Adega v. State Farm Fire & Cas. Ins. Co., No. 07-20796-CIV, 2008 WL 1009719, at *2 (S.D. Fla. 2008 Apr. 9, 2008); Nowak v. Lexington Ins. Co. , 464 F.Supp.2d 1241, 1245-47 (S.D. Fla. 2006). But see XL Specialty Ins. Co. v. Aircraft Holdings, LLC, 929 So.2d 578, 583 (Fla. 1st DCA 2006) (holding Ruiz limited to work-product protections and not applicable to attorney-client privilege because Ruiz court did not expressly recede from prior holding that attorney-client privilege applies to bad faith actions).

Although the court in Adega found that it was bound to interpret Ruiz to apply per se waiver of attorney-client privilege in a bad faith action, it did so “begrudgingly.” Adega at *2. The court stated, “While the Florida courts have discussed, at length, the discovery that should be permitted in a bad faith case, there has been precious little analysis of the sanctity of the attorney-client privilege ' a cornerstone of the entire judicial/legal system in this country.” Id.

Balance of Interests

Other courts have also balanced the competing interests of insurers and insureds in bad faith claims by applying a rebuttable presumption to the waiver of attorney-client privilege in a bad faith claim. This analysis rests on whether the documents were created primarily for business versus legal purposes. See Lindley v. Life Investors Ins. Co. Am. , 267 F.R.D. 382, 389-400 (N.D. Okl. 2010). Although it may be practically difficult to distinguish the line between business and legal purposes, at the very least, such analysis recognizes a nuanced approach to attorney-client privilege issues. The court in Lindley correctly observed, “[T]here are often no clear answers to privilege issues to the fact-dependent case by case analysis required. This is particularly true on the context of insurance bad faith claims.” Id. at 389.

Even some jurisdictions that have extended the crime fraud exception to bad faith insurance actions recognize the fact-dependent nature of privilege waiver. Under Ohio Rev. Code Section 2317.02(A)(2), Ohio's legislature has codified an exception to attorney-client privilege specifically applicable to insurers:

An attorney, concerning a communication made to the attorney by a client in that relationship or the attorney's advice to a client, except that if the client is an insurance company, the attorney may be compelled to testify, subject to an in camera inspection by a court, about communications made by the client to the attorney or by the attorney to the client that are related to the attorney's aiding or furthering an ongoing or future commission of bad faith by the client, if the party seeking disclosure of the communications has made a prima facie showing of bad faith, fraud, or criminal misconduct by the client.

ORC ' 2317.02(A)(2); see also Hutchinson v. Farm Family Cas. Ins. Co. , 867 A.2d 1, 6-7 (Conn. 2005) (holding civil fraud exception should be extended to claims of bad faith against insurers but the same threshold evidentiary requirements for obtaining in camera review when civil fraud has been alleged shall apply when bad faith has been alleged). Although ORC ' 2317.02(A)(2) is broader than the holding in Cedell, the statute appears to recognize the importance of a nuanced approach to privilege issues by purposefully requiring an in camera inspection by the court. See In re Prof. Direct Ins. Co., 578 F.3d 432, 441 n.7 (6th Cir. 2009) (noting the explanatory note for the statute purposely modified the common law established to provide for judicial review regarding the privilege).

Conclusion

The tension between these principles likely will continue. While eviscerating the privilege may assist the insureds in pending cases, the long-term effect could be anti-consumer. If the insurer's analyses and considerations are subject to discovery, insurers will not receive the candid views that otherwise might support settlement.

Lewis E. Hassett, a member of this newsletter's Board of Editors, is a partner with Morris, Manning & Martin, LLP and is the co-chair of the firm's Insurance/Reinsurance Practice Group. He may be reached at [email protected] or 404-504-7762. Cindy Chang is a member of the firm's Insurance/Reinsurance Practice Group and may be reached at [email protected] or 202-842-1081.