17 Aug Review of Tennessee Bad Faith Law
Written by: Karl Braun
In January, 2021, District Judge, Aleta Trauger, issued a comprehensive and well-reasoned memorandum and order in the case of For Senior Help v. Westchester Fire Insurance Company, 515 F. Supp. 3d 787 (M.D. Tenn. 2021). In her lengthy analysis, Judge Trauger skillfully navigated a complex landscape of coverage issues under Tennessee law. For coverage practitioners in Tennessee it is a “must read” in terms of its precision in analyzing the interplay among definitions, endorsements and exclusions overlapping within a Miscellaneous Professional Liability Policy (the “Policy”) issued to a franchisor company. The opinion also addressed issues of bankruptcy in the context of an attempted assignment of a cause of action against the insurer for alleged bad faith failure to settle. While the breadth of the opinion exceeds the scope of this note, some important aspects of Tennessee law were clarified therein and merit comment.
Specifically, Judge Trauger addressed the applicability of T.C.A. 56-7-105(a) in allowing additional liability for an insurer’s bad faith refusal to pay a claim. She also offered important judicial guidance with regard to an insurer’s potential liability for alleged bad faith failure to settle claims against its insured. Finally, she confirmed that, under Tennessee law, a cause of action for an insurer’s bad faith failure to settle is not assignable. The underlying professional liability policy was issued to a franchisor of non-emergency transport services, Medex. Medex was sued by one of its franchisees, For Senior Help (“FSH”). FSH paid Medex a franchise fee, an additional fee in exchange for an Area Development Agreement (“ADA”) and an operations fee in exchange for a variety of support services that were to be provided by Medex as franchisor.
FSH pursued claims against Medex alleging, inter alia, that Medex had failed to provide the franchise support services for which FSH continued to pay certain operations fees and royalties. FSH also alleged that Medex had breached the franchise agreement and intentionally misrepresented the “outsourced operations support” that would be provided through oral representations, promotional materials, brochures and statements made before and after the signing of the franchise agreement. Medex counterclaimed alleging that FSH had breached the franchise agreement first and misused its trademark.
The franchise agreement contained an arbitration clause, and the parties went to arbitration. An arbitration award in excess of 1.4 million was entered against Medex for breach of the franchise agreement and the ADA, as well as against Medex and its principals (jointly and severally) for misrepresentation, fraudulent inducement and violating the Tennessee Consumer Protection Act. Medex looked to its insurer, Westchester Fire Insurance (“Westchester”) but Westchester denied coverage reserving all rights and defenses under the Policy. Medex filed for Chapter 11 bankruptcy relief shortly thereafter.
By Order, the bankruptcy court assigned the Policy and all claims under the Policy to FSH. FSH, “stepping into the shoes of Medex,” filed the instant action in the Middle District of Tennessee against Westchester. FSH asserted claims for (1) breach of the Policy related only to Westchester’s refusal to pay the judgment against Medex for breach of contract and attorneys fees and costs; (2) bad faith refusal to pay that portion of the Judgment attributable to breach of contract, attorney fees, and the arbitrations costs, in violation of T.C.A. 56-7-105; and (3) common law bad faith failure to settle within policy limits. FSH did not dispute that the portion of the Judgment attributable to fraud, misrepresentation, and TCPA claims was not covered by the Policy. The case was initially before Judge William L. Campbell who recused himself after the bankruptcy trustee moved to intervene as of right. Prior to recusal, Judge Campbell denied Westchester’s motion for summary judgment stating that the claims for breach of contract, attorney fees and arbitration costs were covered by the Policy. Judge Campbell did not reach the merits of the bad faith claims. Judge Trauger stepped in to hear the parties’ cross-motions for partial summary judgment on the bad faith claims. She addressed specific issues under Tennessee law related to alleged bad faith failure to pay claims, and alleged bad faith failure to settle within policy limits as set forth more fully below.
(1) Bad Faith Refusal to Pay a Claim
Interestingly, FSH asserted a claim of bad faith refusal to pay a claim, in violation of T.C.A. 56-7-105(a), however, it conceded that “…Tennessee courts have unambiguously held that T.C.A. 56-7-105(a) ‘applies only to that class of written contracts, which written contracts themselves bear interest from the time they become due.’” As such, the Court granted Westchester’s motion for summary judgment with regard to this claim. However, the Court also observed that there was some uncertainty potentially raised by the 2003 Tennessee Supreme Court case of Gaston v. Tenn. Farmers Mut. Ins. Co., 120 S.W.3d 815 (Tenn. 2003) involving T.C.A. 56-7-105(a) as applied to liability insurance coverage for injuries sustained in an automobile accident.
The Court noted that the case of Tenn. Farmers Mut. Ins. Co. v. Cherry, 213 Tenn. 391, 374 S.W.2d 371, 372 (1964) (which had been subsequently cited at least three times, the most recent being over 20 years ago) had never been expressly overruled by the Tennessee Supreme Court. Cherry held that T.C.A. 56-7-105(a) applies to “life insurance, fire insurance and accident insurance policies since these types of insurance policies would bear interest from the time they became due, regardless of whether judgment was recovered on them or not. It does not apply to liability insurance policies pursuant to which an insurance company agrees to pay, on behalf of the insured and within specified limits, all sums which the insured shall become legally obligated to pay as such damages to a third party.” [emphasis added] Gaston’s holding was clearly contrary to Cherry and, while not expressly overruling Cherry, Judge Trauger warned that Gaston “calls into question the continuing validity of Cherry.”
(2) Claim for Bad Faith Failure to Settle Within Policy Limits
FSH also asserted a claim for bad faith failure to settle within policy limits. The Court began by citing well-established law in Tennessee (as set forth in Johnson v. Tenn. Farmers Mut. Ins. Co., 205 S.W.3d 365,370 (Tenn. 2006)) that “…an insurer having exclusive control over the investigation and settlement of a claim may be held liable to its insured for an amount in excess of its policy limits if as a result of bad faith, it fails to effect a settlement within policy limits…” The Court went on to expound that “bad faith refusal to settle” “…is defined, in part, as an insurer’s disregard or demonstrable indifference toward the interests of its insured…” The Court also cited the commonly cited test of whether the “…facts tend to show a willingness on the part of the insurer to gamble with the insured’s money in an attempt to save its own money or any intentional disregard of the financial interests of the plaintiff in the hope of escaping full liability imposed upon it by its policy…” Such indifference by the insurer may be proven circumstantially and the insurer’s conduct will be subject to close scrutiny as a result of the potential conflict of interest between the insurer and the insured.
Important guidance for insurers provided by the Court is as follows: “…the manner in which the insurer investigates the case has an important bearing upon the question of bad faith in refusing or failing to settle the claim. Ordinary care and diligence in investigation require the insurer to investigate the claim to such an extent that it can exercise an honest judgment regarding whether the claim should be settled…mere negligence is not sufficient to impose liability for failure to settle…” Id. at 801. “Moreover, an insurer’s mistaken judgment is not bad faith if it was made honestly and followed an investigation performed with ordinary care and diligence…” Id. The Court then cited evidence provided by Westchester through affidavit testimony that “…it made repeated efforts to settle, even prior to the arbitration, that the discovery leading up to the arbitration revealed that FSH could not quantify the damages specifically related to breach of contract, and that FSH refused to back away from its demand of $650,000, insisted that Medex and its principals personally pay some portion of settlement, and failed to respond to Westchester’s last offer of $100,000…” The Court then held that, “…if a jury believes the version of events presented by Westchester, the jury could reasonably find Westchester did not act in bad faith during the settlement negotiations and that the failure to reach a settlement resulted from the plaintiff’s intransigence rather than from bad faith on the part of Westchester…” [emphasis added]
The Court also clarified and confirmed a sometimes confusing context within which T.C.A. 56-7-1051 is referenced. The Court cited Leverette v. Tennessee Farmers Mutual Insurance Co., No. M20011-00264-COA-R3CV, 2013 WL 817230 (Tenn. Ct. App. Mar. 4, 2013) and distinguished between claims for “…an insurer’s bad faith refusal to pay on a policy…” and claims “…by an insured against its insurer for bad faith failure to settle…” [emphasis added]. In Leverette, the insurance company initially declined to defend and declined coverage of the claims in a lawsuit against the insured’s minor child based on a policy exclusion. As a result of the insurance company’s failure to defend, the injured party obtained a $1 million default judgment against the minor. The minor’s parents and the injured party then jointly filed suit against the insurance company for breach of contract and bad faith. The trial court granted summary judgment to the plaintiffs on the issue of coverage holding that the exclusion relied upon by the insurer did not apply and the other claims went to trial. The jury awarded the plaintiffs compensatory and punitive damages on the “bad faith claim.”
Judge Trauger went on to observe that, on appeal in Leverette, the court vacated the holding of liability for bad faith “since the statutory cause of action was not pleaded…” The plaintiff in Leverette had not properly pleaded T.C.A. 56-7-105 with regard to the insurer’s bad faith failure to pay the claim. The court in Leverette clarified that “This court has held that Tennessee does not recognize the tort of bad faith in suits between an insured and her insurer where the actions complained of are covered by the bad faith penalty statute…” and cited Chandler v. Prudential Ins. Co., 715 S.W.2d 615 (Tenn. Ct. App. 1986). When the plaintiff in Leverette responded that Chandler was no longer good law in light of Johnson (cited above), the court concluded that Johnson addressed only a common law claim of bad faith refusal to settle as opposed to bad faith failure to pay a claim. The court differentiated between refusing to pay a claim (triggering T.C.A. 56-7-105) and bad faith refusal to settle within policy limits. The difference rests with whether the insurer has “already acknowledged coverage and liability and has undertaken to provide a defense for the insured in suits or actions by third parties…” In Leverette, the insurer did not even provide a defense.
Westchester consequently raised as a defense, its reservation of rights and argued that it never acknowledged liability so that it should not be liable for bad faith under Leverette. Judge Trauger, however, noted that Westchester did not dispute that it undertook a defense in this case but emphasized that it did so with a reservation of rights. She pointed out that, “…In this case, by undertaking a defense, Westchester also assumed a duty to explore, in good faith, the possibility of settlement within claim limits and its client’s best interests…” “…In other words, irrespective of Westchester’s reservation of rights, it appears to have had exclusive control over the investigation and settlement of FSH’s claim against Medex…” “…By providing a defense, it incurred a duty to negotiate settlement in good faith as an integral part of that defense, and it may be held liable if it failed to do so…”
That being said, as set forth above, the Court stated that if a jury believed Westchester’s account of the events, it could find that “…Westchester did not act in bad faith during the settlement negotiations and that the failure to reach a settlement resulted from the plaintiff’s intransigence rather than from bad faith on the part of Westchester…” In Tennessee, whether an insurer has a duty to defend is governed by the “four corners of the complaint…” Travelers Indem. Co. of America v. Moore & Associates, Inc., 216 S.W.3d 302 (Tenn. 2007). “The duty to defend is broader that the duty to indemnify because the duty to defend is based on the facts alleged, while the duty to indemnify is based upon the facts found by the trier of fact. Any doubt as to whether the claimant has stated a cause of action within the coverage of the policy is resolved in favor of the insured when determining whether the liability insurer owes a duty to defend.” Id.
In light of the decision in For Senior Help, and the broad duty to defend in Tennessee, insurers should be fully aware of their duties upon providing a defense to their insureds. As stated by Judge Trauger, “…by providing a defense, [they incur] a duty to negotiate settlement in good faith as an integral part of that defense and [they] may be held liable if [they fail] to do so.”
(1) T.C.A. 56-7-105(a) provides as follows: (a) The insurance companies of this state, and foreign insurance companies and other persons or corporations doing an insurance or fidelity bonding business in this state, in all cases when a loss occurs and they refuse to pay the loss within sixty (60) days after a demand has been made by the holder of the policy or fidelity bond on which the loss occurred, shall be liable to pay the holder of the policy or fidelity bond, in addition to the loss and interest on the bond, a sum not exceeding twenty-five percent (25%) on the liability for the loss; provided, that it is made to appear to the court or jury trying the case that the refusal to pay the loss was not in good faith, and that the failure to pay inflicted additional expense, loss, or injury including attorney fees upon the holder of the policy or fidelity bond; and provided, further, that the additional liability, within the limit prescribed, shall, in the discretion of the court or jury trying the case, be measured by the additional expense, loss, and injury including attorney fees thus entailed. [emphasis added]