The Issue of Bad Faith in Pre-Litigation Coverage 

A major issue facing insurance companies in disputes with their insureds is bad faith.  This can be an especially fraught question once it has become clear that the insured had knowledge of a situation giving rise to a claim prior to applying for coverage.  In these situations, insurance companies can be caught in the compromising position of having to defend an insured while also protecting their own rights.   The challenge for insurance companies is to retain their rights, without opening themselves to claims of bad faith.

Recently, the district court of Connecticut granted an insurance company’s motion for summary judgment dismissing the insured’s claims of bad faith.  The facts of the case and the steps taken by the insurance company prior to moving for declaratory judgment were instrumental in leaving the court no choice but to dismiss claims of bad faith as against it.

Admiral Insurance Co. v. Versailles Medical Spa LLC et al.,

In the matter of Admiral Insurance Co. v. Versailles Medical Spa LLC et al., case number 3:20-cv-00568, U.S. District Court for the District of Connecticut, the court granted Admiral Insurance Co.’s (hereinafter as “Admiral”) partial motion for summary judgment dismissing Versailles Medical Spa LLC’s (hereinafter as the “Spa”) four counter claims as against Admiral for bad faith.

Facts of the Case

In the underlying action, the spa’s client (hereinafter as the “Client”) alleged a treatment she received at the spa caused burns to her legs.  One month after the treatment, in September 2016, the client allegedly wrote an email to the spa stating that the treatment she received burned her legs.  There was, however, an issue of material fact as to whether this email was sent to, and received by, the spa.  Thereafter, the client met with a spa employee to discuss her allegedly botched treatment.

In May 2017, the spa applied to Admiral to renew its professional liability insurance.  As part of the application, it responded no claims had been filed against the spa or any of its employed.  Based upon the information in the application, Admiral issued a renewed professional liability policy (hereinafter as the “policy”).

The policy defined a “claim” as “a written demand for money or services by any Insured resulting from a Professional Incident . . .”[i]  Further, the policy’s “Insuring Agreement” required a claim first be made during the policy period in order to fall within the policy’s coverage.  Third, the policy carved out several exclusions, including a “prior knowledge” exclusion (the “Prior Knowledge Exclusion”), which absolves Admiral of liability for any “[c]laim . . . of which the person signing the Application for this Policy . . . was aware prior to the effective date of this Policy.”[ii]

The client filed the underlying action on January 4, 2019.  The Spa sought defense from Admiral under the terms of the policy.  Admiral initially disclaimed coverage and stated that they would not pay for defense costs.  The spa again demanded coverage through counsel, so Admiral withdrew its original disclaimer, retained defense counsel, and issued a complete reservation of rights.  Admiral then brought the instant declaratory action.  The spa answered and asserted four counterclaims of bad faith as against Admiral.

The parties eventually moved for summary judgment.  Admiral sought partial summary judgment for the spa’s four counts of bad faith for:

(1) litigating the instant action;

(2) failing to properly investigate the coverage Claim;

(3) failing to properly defend the underlying case; and

(4) failing to defend and indemnify the Spa for …[the Client]’s later claim that she injured her forehead during …[the same session].[iii]

Holding

On the first counterclaim for bad faith in litigating this action, the court granted Admiral summary judgment on the basis the spa was not denied a defense in the underlying action.  Admiral continued to provide the spa with a defense through the retained counsel, albeit subject to a reservation of rights.  By continuing to provide defense through counsel, Admiral’s engagement in a declaratory judgment action was proper.  Indeed, the court stated Admiral was taking the ordinary course of business.

On the second counterclaim for failure to investigate the coverage case, the court held that the policy provides Admiral with the decision of whether to investigate.  The spa’s claim that Admiral acted in bad faith by not investigating the claim was therefore not supported by the policy.  The spa was not guaranteed the benefit of an investigation; therefore, they could not maintain an action for failure to investigate as against Admiral.

On the third counterclaim for bad faith failure to defend the underlying case, the spa argued that Admiral did not properly instruct the spa’s counsel with the most effective strategy.  The court reiterated Connecticut precedent that attorneys retained by an insurance company are only allegiant to the client, not the insurance company.  Here, the spa and not Admiral was the defense counsel’s client, and therefore Admiral had no ability to direct the spa’s defense.

On the final counterclaim, that Admiral acted in bad faith specifically related to the client’s action regarding damages to her forehead, the court held that, much like the first counterclaim, a jury could not find that Admiral acted in bad faith or deprived the spa of defense.  Further, even though the client’s alleged forehead injury did not appear in either of her emails, they were still “Related Claims” pursuant to the policy.  Therefore, the court granted Admiral summary judgment on this claim.

Takeaway

This is a significant win for insurance companies doing business in Connecticut because it provides a pre-litigation roadmap for effectively handling insureds who misrepresent certain facts in their applications.  In the instant matter, Admiral was successful because they took the “prudent if not ordinary course”[iv] according to the court.  They provided their insured with defense counsel, and only once defense counsel was retained under a reservation of rights did Admiral initiate a declaratory judgment action.  This strategy ultimately led to a successful defeat of the insured’s claims of bad faith and a major win for all insurance companies in Connecticut.

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Sources

[i] Admiral Ins. Co. v. Versailles Med. Spa, citing Pl.’s 56(a)2 Stmt. ¶ 19; Defs.’ 56(a)1 Stmt, CIVIL 3:20-CV-0568 (JCH), 2 (D. Conn. Oct. 25, 2022)

[ii] Admiral Insurance Co. v. Versailles Medical Spa LLC et al., case number 3:20-cv-00568, U.S. District Court for the District of Connecticut

[iii] Id. at 6.

[iv] Id