Claims for bad faith breach of insurance contract can arise in first-party and third-partyi contexts. This article will address the former. First-party bad faith cases involve an insurance company refusing to make or delaying payments owed directly to its insured under a first-party policy such as life, health, disability, property, fire, or no-fault auto insurance. ii In essence, the insurer’s actions expose the insured to being personally liable for the monetary obligations underlying the insured’s claims.
Underlying Contract Theory Giving Rise to Tort of Bad Faith
Every contract in Colorado contains an implied duty of good faith and fair dealing.iii In most contractual relationships, a breach of this duty will only result in damages for breach of contract and will not give rise to tort liability.iv However, insurance contracts are unlike ordinary bilateral contracts.v
First, the motivation for entering into an insurance contract is different.vi Insureds enter into insurance contracts for the financial security obtained by protecting themselves from unforeseen calamities and for peace of mind, rather than to secure commercial advantage.vii
Second, there is a disparity of bargaining power between the insurer and the insured. Because the insured cannot obtain materially different coverage elsewhere, insurance policies are generally not the result of bargaining.viii
Due to the special nature of the insurance contract and the relationship which exists between the insurer and the insured, an insurer’s breach of the duty of good faith and fair dealing gives rise to a separate cause of action arising in tort.ix The basis for tort liability is the insurer’s conduct in unreasonably refusing to pay a claim and failing to act in good faith, not the insured’s ultimate financial liability.x Therefore, the fact an insurer eventually pays an insured’s claims will not prevent the insured from filing suit against the insurer based on its conduct prior to the time of payment.
The Usual Claims for Relief
The cause of action for bad faith sounds in tort although it is the insurance contract from which the tort duty arises. Duty in insurance bad faith is grounded upon the special nature of the insurance contract and the relationship which exists between the insurer and the insured. An insured typically brings four claims for relief, or any combination within the four, when commencing a first-party insurance bad faith action. They are: 1) common law bad faith, 2) statutory bad faith, 3) declaratory judgment, and 4) breach of contract.
For first-party common law bad faith claims, there is a codified two-part test: 1) was conduct by the insurer unreasonable, and 2) did the insurer know the conduct was unreasonable, or did it recklessly disregard facts demonstrating the conduct was unreasonable.xi
A different standard of care exists with respect to claims brought under statutory authority, which is: an insurer’s delay or denial was unreasonable if the insurer delayed or denied authorizing payment of a covered benefit without a reasonable basis for that action.xii Importantly, Colorado’s bad faith statute provides a remedy in addition to, not in lieu of, common law bad faith.
An action for a declaratory judgment is appropriately used to settle and to afford relief from uncertainty and insecurity with respect to rights, status, and other legal relations.xiii To have standing to bring a declaratory judgment action, plaintiff must assert a legal basis on which a claim for relief can be grounded. Plaintiff must allege an injury in fact to a legally protected or cognizable interest.xiv Indirect and incidental pecuniary injury is insufficient to confer standing.xv It calls not for an advisory opinion upon a hypothetical basis, but for an adjudication of present right upon established facts.xvi Accordingly, a trial court may not provide declaratory relief to plaintiff who attempts to litigate the question of the limits of an alleged tortfeasor’s insurance coverage prior to judgment against the tortfeasor.xvii
To recover on a breach of contract claim for relief, plaintiff would have to prove 1) the existence of a contract; 2) he or she performed his or her duties under the contract (or that he or she was justified in failing to do so); 3) defendant failed to perform the contract; and 4) there are resulting damages.xviii
Recoverable Damages Under Colorado Law
Colorado’s bad faith statute allows first-party claimants to recover if the insurer delayed or denied authorizing payment of a covered benefit without a reasonable basis for the action.xix The damages recoverable on a statutory claim are limited to reasonable attorneys’ fees, court costs, and “two times the covered benefit.” Importantly, “two times the covered benefit” does not mean two times total damages, it is two times the applicable policy limit. The award to be made to the prevailing claimant is not the damages suffered by claimant caused by the delay in the payment of the benefit, but rather two times the covered benefit the payment of which was unreasonably delayed or denied.
When plaintiff seeks to recover compensatory damages in a bad faith claim, those damages may include the amount of any excess judgment and compensation for any other injuries suffered, including certain attorney fees, interest on the wrongfully withheld funds, and emotional distress.xx Emotional distress damages in bad faith cases can only be awarded upon a showing of substantial property or economic loss and is a question of law.xxi
If warranted by the evidence, damages may also be recovered for lost earnings, loss of future earnings, and diminished earning capacity.xxii An insured may recover compensatory damages for damage to the insured’s credit caused by the judgment against the insured being recorded where the insurer has unreasonably denied coverage or refused to settle.xxiii Recoverable noneconomic compensatory damages may include damages for emotional distress, pain and suffering, inconvenience, fear and anxiety, and impairment of the quality of life.xxiv Prejudgment interest at nine percent compounded annually is recoverable on the compensatory damages awarded in an insurance bad faith claim.xxv
Where an insured’s claim is for breach of contract, noneconomic damages are available only to first-party claimants who can prove by clear and convincing evidence the insurer “willfully and wantonly” breached the insurance contract.xxvi Where the insurer properly denies coverage, the insured’s bad faith claim must fail if the only claimed damages flowed from the denial of coverage.
Where a liability insurer offers in settlement of a claim an amount less than its internal estimated exposure, this does not establish damages resulting from the insurer’s alleged bad faith failure to settle, nor does it constitute an admission of liability.xxvii A “consent to settle” clause does not necessarily preclude a bad faith claim as a matter of law.xxviii
Statute of Limitations
The tort of bad faith is governed by a two-year statute of limitations.xxix A claim for bad faith breach of the duty to indemnify does not accrue until the insurer refuses to pay a claim arising a settlement or judgment.xxx With respect to first-party claims for unreasonable delay or denial of benefits, the statute of limitations begins to run when the insured knew, or reasonably should have known, of his injury, as distinct from damages, and its cause.xxxi Damages do not have to be known before a claim may accrue.xxxii
An example can be found in Vanderloop v. Progressive Casualty Insurance Co.,xxxiii where plaintiff alleged the insurer wrongfully failed to settle with a third party within policy limits. Judgment was rendered in the underlying negligence action, and because the insurer failed to settle within the policy limits, plaintiff was exposed to excess liability.xxxiv The court found the bad faith claim did not accrue until final judgment in the underlying negligence case established plaintiff’s excess liability.xxxv However, the court distinguished the alleged bad faith conduct in Vanderloop—failure to settle, which required a judgment with excess liability to create the injury necessary for accrual—from one where the alleged bad faith conduct was an insurer’s refusal to provide insurance coverage.xxxvi Where the bad faith conduct alleged was refusal to provide insurance coverage, the court specifically noted an insurer’s duty of good faith can be breached before judgment in the underlying case is rendered.xxxvii
Bad faith litigation is largely fact specific, so each case must be evaluated carefully at its inception to identify applicable Colorado law, potential exposures, and to ensure proper defenses are asserted. The aim of this article was not to exhaust every potential scenario, but to provide an overview of the likely claims, elements necessary to prove each, potential damages, and statute of limitations considerations.
i While not being addressed in this article, for the purpose of comparison, third-party bad faith arises when an insurance company acts unreasonably in investigating, defending, or settling a claim brought by a third person against its insured under a liability policy. Farmers Group, Inc. v. Williams, 805 P.2d 419, 421 (Colo.1991); John H. Bauman, Emotional Distress Damages and the Tort of Insurance Bad Faith, 46 Drake L.Rev. 717, 746-47 (1998). The insurance company’s duty of good faith and fair dealing extends only to the insured, not to the third-party. Lazar v. Riggs, 79 P.3d 105, 107 (Colo.2003). In the third-party context, an insurance company stands in a position of trust with regard to its insured; a quasi-fiduciary relationship exists between the insurer and the insured. Farmers Group, Inc. v. Trimble, 691 P.2d 1138, 1141 (Colo.1984).
ii Williams, 805 P.2d at 421; Bauman, supra, at 739.
iii Cary v. United of Omaha Life Ins. Co., 68 P.3d 462, 466 (Colo.2003).
v Id.; Huizar v. Allstate Ins. Co., 952 P.2d 342, 344 (Colo.1998).
vi Trimble, 691 P.2d at 1141.
vii Cary, 68 P.3d at 467; Trimble, 691 P.2d at 1141.
viii Huizar, 952 P.2d at 344.
ix Cary, 68 P.3d at 466 (citing Trimble, 691 P.2d at 1141).
x Trimble, 691 P.2d at 1142.
xi C.R.S. § 10-3-1113; Colo. Jury Instr., 4th Civil 25:2; Colo. Jury Instr., 4th Civil 25:3 and 25:4 (defining “unreasonable conduct of parties” and “reckless disregard,” respectively).
xii C.R.S. §§ 10-3-1115 and 10-3-1116; Peden v. State Farm Mutual Automobile Insurance Company, 841 F.3d 887 (10th Cir. 2016).
xiii C.R.S. § 13-51-101, et. seq.
xiv Board of County Comm’rs, La Plata County v. Bowen/Edwards Assocs., 830 P.2d 1045 (Colo.1992); Wimberly v. Ettenberg, 194 Colo. 163 (1977).
xv Ettenberg, 194 Colo. at 168.
xvi Aetna Life Ins. Co. v. Haworth, 300 U.S. 227, 242, 57 S.Ct. 461, 465, 81 L.Ed. 617 (1937).
xvii Farmers Ins. Exch. v. Dist. Court for Fourth Judicial Dist., 862 P.2d 944, 949 (Colo. 1993).
xviii W. Distrib. Co. v. Diodosio, 841 P.2d 1053, 1058 (Colo.1992).
xix C.R.S. § 10-3-1116(1).
xx Goodson v. American Standard Insurance Co. of Wisconsin, 89 P.3d 409 (Colo. 2004); Ballow v. PHICO Insurance Co., 878 P.2d 672 (Colo. 1994) (noting, however, that damages awarded cannot place insured in a more advantageous position than he would have been in had insurer’s misconduct never occurred); Bernhard v. Farmers Insurance Exchange, 885 P.2d 265 (Colo. App. 1994), aff’d on other grounds, 915 P.2d 1285 (Colo. 1996); Colo. Jury Instr., 4th Civil 25:6.
xxi Goodson, 89 P.3d at 414.
xxii Munoz v. State Farm Mutual Automobile Insurance Co., 968 P.2d 126 (Colo. App. 1998); see Colo. Jury Instr., 4th Civil 25:9 and 6:1.
xxiii Nunn v. Mid-Century Insurance Co., 244 P.3d 116 (Colo. 2010).
xxiv Goodson, 89 P.3d 409.
xxv Herod v. Colorado Farm Bureau Mutual Insurance Co., 928 P.2d 834 (Colo. App. 1996).
xxvi C.R.S. § 13-21-102.5(6)(a)(I)(B).
xxvii Signature Development Companies, Inc. v. Royal Insurance Co. of America, 230 F.3d 1215 (10th Cir. 2000).
xxviii Bankr. Estate of Morris v. COPIC Ins. Co., 192 P.3d 519, 526 (Colo. App. 2008)
xxix C.R.S. § 13–80–102(1).
xxx Daugherty v. Allstate Insurance Co., 55 P.3d 224 (Coo. App.), cert. denied (2002).
xxxi Brodeur v. American Home Assurance Co., 169 P.3d 139, 147 n. 8 (Colo. 2007).
xxxii Id. (citing Section 13-80-108(1), C.R.S.); Dove v. Delgado, 808 P.2d 1270 (Colo. 1991).
xxxiii 769 F.Supp. 1172 (D.Colo.1991).
xxxiv Id. at 1175.