ll Mexico and all state and federal district courts in Texas. I. The Pattern Jury Charge II. The Origins of the Duty

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1 ~ _ - - -~ :_ cc ~- -::: ==-_ - By Blair Dan~ VAN OssELAER & BucHANAN L.L.P. TEXAS PATTERN JURY CHARGE REVISIONS OVERDUE ON COMMON-LAW DUTY OF GOOD FAITH & FAIR DEALING The Texas Pattern Jury Charge's suggested question and instruction on the common-law duty of good faith and fair dealing has not changed in over a decade. Based on a close inspection of case law, the instruction dealing with an insurer's duty to investigate deserves a second look with an eye towards revision. I. The Pattern Jury Charge The Pattern Jury Charge ("PJC") has proposed the following question and instruction from 1998 through the most recent 2010 edition: The court found summary judgment evidence in favor of the insured under this standard, reversed the trial court judgment on the common-law duty, and remanded for further proceedings. 4 Significantly, in this finding, the court noted that there was sufficient evidence: to raise an issue of material fact that [the insurer] had no reasonable basis for its refusal to pay [the insured's] uninsured motorist claim and with actual knowledge of that, forced him to a trial on the accident before it would pay the claim. 5 An insurer fails to comply with its duty of good faith and fair dealing by- Failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim when the insurer's liability has become reasonably clear [or] Refusing to pay a claim without conducting a reasonable investigation of the claim [or] Canceling an insurance policy without a reasonable basis 1 The PJC arguably misstates the law. Specifically, the inclusion of an individual ground for bad faith liability for "[r]efusing to pay a claim without conducting a reasonable investigation of the claim'' is based on dicta and is not an independent basis for liability at common law. II. The Origins of the Duty In 1987, the Texas Supreme Court first held that the duty of good faith and fair dealing exists between an insurer and an insured in the context of uninsured motorist coverage in Arnold v. National County Mutual Fire Insurance Company. 2 The original iteration of the good-faith standard required a claimant to show "no reasonable basis for denial of a claim or delay in payment or a failure on the part of the insurer to determine whether there is any reasonable basis for the denial or delay." 3 The insurer had based its refusal to pay on an inexperienced lawyer's recommendations which were, in turn, based on "very weak" evidence. 6 The insurer then "failed to investigate the facts supporting the attorney's contentions." 7 Notably, Arnold does not state that the evidence showed a failure to investigate; rather, the evidence supporting reversal showed the insured "had no reasonable basis for its refusal to pay [the insured's] uninsured motorist claim." 8 The stated standard of "failure on the part of the insurer to determine whether there is any reasonable basis for the denial or delay'' in Arnold is, therefore, dicta. The next year, in Aranda v. Insurance Company of North America, the court applied the duty to workers' compensation insurers. 9 Aranda set out the standard as follows: A workers' compensation claimant who asserts that a carrier has breached the duty of good faith and fair dealing by refusing to pay or delaying payment of a claim must establish ( 1) the absence of a reasonable basis for denying or delaying payment of the benefits of the policy and (2) that the carrier knew or should have known that there was not a reasonable basis for denying the claim or delaying payment of the claim. 10 In clarification of Arnold, Aranda notes the requirement "that the carrier knew or should have known" there was no Blair Dancy is a partner with Van Osselaer & Buchanan LLP. He is a commercial trial lawyer with a focus on insurance disputes and has been recognized multiple times as a Rising Star by Law & Politics and Texas Monthly magazines. He is licensed in all state courts in New ll Mexico and all state and federal district courts in Texas.

2 reasonable basis for denying or delaying the claim. 11 The duty to investigate is subsumed in this element of the broader duty of good faith and fair dealing: The second element [of the duty] balances the right of an insurer to reject an invalid claim and the duty of the carrier to investigate and pay compensable claims. This element will be met by establishing that the carrier actually knew there was no reasonable basis to deny the claim or delay payment, or by establishing that the carrier, based on its duty to investigate, should have known that there was no reasonable basis for denial or delay. 12 Given this seeming inconsistency between Arnold and Aranda on the significance of an investigation, the PJC offered two competing instructions without recommending which should be used. 13 Ten years after Arnold, the court revised the standard in Universe Life Insurance Company v. Giles, though the requirement of a reasonable investigation was retained. 14 The Giles standard mirrors the actionable statutory standard adopted in 1995, "failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement of a claim with respect to which the insurer's liability has become reasonably clear." 15 Yet, Giles retained the Aranda modification that the duty arises when an insurer "should have known" liability was reasonably clear: The "reasonably clear" standard recasts the liability standard in positive terms, rather than the current negative formulation. Under this standard, an insurer will be liable if the insurer knew or should have known that it was reasonably clear that the claim was covered. 16 Potential confusion arose, however, with the court's footnote: An insurer will not escape liability merely by failing to investigate a claim so that it can contend that liability was never reasonably clear. Instead, we reaffirm that an insurance company may also breach its duty of good faith and fair dealing by failing to reasonably investigate a claim. 17 As in Arnold, this "investigatory" basis for bad faith in Giles is mere dicta. The insurer in Giles initially denied coverage for the claimant's heart bypass surgery on the premise that her heart condition pre-existed coverage and was therefore excluded. 18 After stating the revised standard for bad faith liability, the court held the evidence legally sufficient to support the judgment, under both old and new standards. 19 In addressing the sufficiency of this evidence, the court noted: From the medical records, it should have been reasonably clear to Universe that Giles's claim should be paid. Universe does not argue that the records were unreliable; to the contrary, Universe relied on them. Nor is there evidence of any need for further investigation after Giles's physicians wrote to Universe. 20 There was no issue of "reasonable investigation" in Giles. Accordingly, any statement that supports bad faith liability based solely on the investigation of a claim is, as in Arnold, mere dicta. The new Giles synthesized standard, including the duty to investigate, became the duty "to attempt in good faith to effectuate a prompt, fair, and equitable settlement when [the insurer knew or should have known that] the insurer's liability has become reasonably clear." 21 Simultaneously with Giles, the court issued State Farm Lloyds v. Nicolau in which it found legally sufficient evidence State Farm had not conducted a reasonable investigation of a homeowner's claim. 22 However, in Nicolau, the insurer had information showing liability had become reasonably dear by virtue of an engineering report supporting coverage that the insureds submitted to State Farm. 23 Nicolau does not stand for bad faith liability based solely on an inadequate investigation. A year after GilesandNicolau, in 1998, the PJC recommended the same jury question on the common-law duty of good faith and fair dealing as is in the current edition of the PJC. That proposed question has not been changed since III. The Seeming Outlier of Simmons and its Dissent Also in 1998, the Texas Supreme Court again addressed the duty in State Farm Fire & Casualty Company v. Simmons. 24 The dissents criticize the majority opinion, characterizing the majority opinion in such a way as being consistent with the 1998 PJC iteration of the duty: * * * The Simmonses, the Court holds, have met their burden of proof merely by showing that State Farm's investigation was deficient. The Court reasons that because the insurer, not the insured, is obliged to investigate a claim, an insured meets its burden of proof as to both the objective and subjective elements of bad faith liability by showing that the investigation was deficient in some respect. 25

3 While I agree that an insurer has a duty to investigate its insureds' claims, this duty can form the basis of bad-faith liability only if the plaintiff presents evidence that the insurer's breach of this duty results in denial of a claim that no reasonable insurer could have denied. The problem with the Court's analysis is that it does not link the duty to investigate to the objective element of the bad-faith tort-whether the insurer's liability is reasonably clear. 26 These critiques deserve closer analysis. In Simmons, homeowners made a fire claim with State Farm. 27 State Farm did a substandard job of investigating, eventually de~ying the clai~ "because the company reasonably believed that the S1mmonses had a strong financial motive to burn their home." 28 On appeal, "State Farm argue[d] that the deficiencies in its investigation [did] not support liability because the Simmonses have not identified any particular step that would have made State Farm's liability reasonably clear." 29 In rejecting that argument, the majority noted its legal sufficiency review showed "there was more than a scintilla of evidence that State Farm's investigation was materially deficient" to support the jury verdict. 30 To hold otherwise, the majority reasoned, would turn the duty to investigate on its head. 31 Upon closer scrutiny, the majority opinion rationale reflects that, in actuality, it did require a scintilla of evidence to support the "objective" element of bad faith liability, that is, that "a differently conducted investigation would have shown the claim to be reasonably clear." 32 Specifically, the majority noted: Based upon Hvasta's description of an insurer's obligations, the jury could have inferred that a reasonable insurer would have approached its insureds to resolve apparently conflicting information and would have eventually concluded that the insureds lacked a sufficient motive to commit arson. 33 This scintilla of evidence is in direct contravention to State Farm's trial position that it denied the claim "because the company reasonably believed that the Simmonses had a strong financial motive to burn their home." 34 Therefore, the majority found the "objective" element of the bad faith standard supported by legally sufficient evidence contrary to the dissents' criticisms on this point. The dissents appear to be based more on what suffices for legally sufficient evidence q than on what the legal standard is. Simmons does not stand l A The use of the concept "pretextual" was another way of saying that there must be some evidence that there was no reasonable basis for denying the claim or that liability was reasonably clear.35 for the proposition that breach of the duty to investigate, alone, can support common-law bad faith liability. Later that year, the court confirmed this reading of Simmons in Provident American Ins. Co. v. Castaneda: Our use of the term "pretextual" in Nicolau and Simmons did not mean that an insured is relieved from its burden of offering evidence that liability had become reasonably clear or that there was no reasonable basis for denying the claim. We did not redefine the common-law tort of bad faith... to include a mechanism by which a factfinder could conclude that the denial was pretextual even though there was a reasonable basis for denying the claim. The use of the concept "pretextual" was another way of saying that there must be some evidence that there was no reasonable basis for denying the claim or that liability was reasonably clear. 35 While the court's wording in these opinions is not overly exacting, a twoelement cause of action remained intact. IV The PJ C Recommendation Should Change. With this background, the PJC's iteration of the duty begs for a second look. The PJC's standard is not based on the common law, because there is no clear common-law standard set out in these cases for the duty to investigate and no holding on point that a failure to investigate-by itself-would support bad faith liability. ~eflecti?g this deficiency, the Committee bases its proposed mstrucnon on a statutory standard: [T]he duty of good faith and fair dealing with respect to failing to conduct a reasonable investigation has been recast in the statutory language of Tex. Ins. Code (a)(7) There is no Texas Supreme Court common-law: holding that sets out a separate, actionable duty in this context. Instead, the common law recognizes that a pretextual investigation, designed to avoid the discovery of evidence that would show when liability is reasonably clear, is relevant to this second element of th~ duty. 37 The PJC's question goes against this case law, turnmg the duty to investigate on its head. Instead of ~llowi~g ~or the potential for bad faith handling when an mvesnganon should have disclosed coverage, the PJC's question requires a bad-faith finding based on a substandard

4 investigation alone. V. Additional Precedent Supports the Two-Element Standard. The PJC's investigation standard is contrary to yet additional Texas Supreme Court precedent. 38 In Republic Insurance Company v. Stoker, the court addressed a common-law badfaith claim in the context of the denial of an uninsured motorist claim. 39 The insurer had denied the claim for the stated reason that the insured was more than fifty percent at fault. 40 The insurer did not mention an alternative ground for denial, that is, that there was no actual physical contact between the vehicles in question. 41 The insurer was entitled to summary judgment on the coverage issue under this alternative ground, leaving the issue of whether a claim for breach of the duty of good faith and fair dealing was viable despite an absence of coverage. The court held "there can be no claim for bad faith when an insurer has promptly denied a claim that is in fact not covered," leaving open a narrow, but undefined, possibility of liability for extreme conduct in the absence of coverage. 42 Six years after Stoker, the Texas Supreme Court clarified what does not qualify for exception to this Stoker rule. In American Motorists Insurance Company v. Podge, a workers' compensation claimant brought suit for breach of the duty of good faith and fair dealing, including allegations that the insurer "did not promptly and reasonably investigate her claim." 43 The court noted that the claimant's tort claims, "to the extent her complaints relate to claims for benefits on which she has never prevailed," were an improper attempt to circumvent the Workers' Compensation Commission's exclusive jurisdiction to handle those claims and otherwise did not "give rise to bad faith liability." 44 In citing Stoker, the court noted "the possibility that an insurer's denial of a claim it was not obliged to pay might nevertheless be in bad faith if its conduct were 'extreme,"' but also recognized that "[w]e cited no examples" of such possibilities in Stoker. 45 Yet, Podge expressly rejected the possibility that an unreasonable investigation alone could give rise to "bad faith liability. " 46 This decision re-confirmed that an unreasonable investigation is not the kind of "extreme" conduct, standing alone, that can give rise to tort liability. Nevertheless, the PJC instruction for bad faith liability could result in a verdict contrary to Stoker and Podge by hinging liability to only part of the standard for good faith and fair dealing: "Refusing to pay a claim without conducting a reasonable investigation of the claim." In Stoker, there was a refusal to pay based on a reason other than the reason ultimately used to deny coverage. Yet that action was not allowed to proceed. In Podge, the court rejected any unreasonable investigation duty insofar as the plaintiff's claim had not been determined in the plaintiff's favor before the Workers' Compensation Commission. The P]C instruction is not consistent with these prior opinions. VI. Conclusion To be consistent with Texas Supreme Court precedent, a model jury instruction on a bad faith claim should read: An insurer fails to comply with its duty of good faith and fair dealing by failing to attempt in good faith to effectuate a prompt, fair, and equitable settlement when the insurer knew, or should have known, that its liability has become reasonably clear. To the degree there is an issue as to whether a reasonable investigation was conducted, the following additional instruction may be appropriate: An insurer must reasonably investigate a claim. A failure to reasonably investigate a claim does not excuse an insurer from knowing whether its liability has become reasonably clear. Regardless of whether the PJ C recommended question and instructions change, trial lawyers may want to take a closer look at the PJC recommendations before submitting a proposed charge on the common-law duty of good faith and fair dealing. 1 See Texas Pattern Jury Charges-Business, Consumer, Insurance & Employment (1998, 2000, 2002, 2003, 2006, 2008, & ). Hereinafter, "PJ C." S.W.2d 165, 167 (Tex. 1987) ("We hold that such a duty of good faith and fair dealing exists."). While Stowers provided a basis for the finding of such a duty, see id. (citing G.A. Stowers Furniture Co. v. Am. Indem. Co., 15 S.W.2d 544, 548 (Tex. Comm'n App. 1929, holding approved)); nevertheless, "[a] Stowers claim is not a bad faith claim." Maryland Ins. Co. v. Head Indus. Coatings and Servs., Inc., 938 S.W.2d 27, 28 (Tex. 1996) (citing Am. Physicians Ins. Exch. v. Garcia, 876 S.W.2d 842, 847 (Tex. 1994)). 3 Arnold, 725 S.W.2d at 167 (emphasis added). 4!d. at !d. at !d. at !d. at See id. at See748 S.W.2d 210, (Tex. 1988) ("We, therefore, hold that there is a duty on the part of workers' compensation carriers to deal fairly and in good faith with injured employees in the processing of compensation claims.") (disapproving Fid. & Cas. Co. I( ofnew York v. Shubert, 646 S.W.2d 270 (Tex. App.-Tyler 1983, U

5 writ ref'd n.r.e.) and Cantu v. W Fire & Cas. Ins. Co., Ltd., 716 S.W2d 737 (Tex. App.-Corpus Christi 1986), writ ref'd n.r.e. per curiam, 723 S.W2d 668 (Tex.1987)). The Texas Supreme Court's overruling of Aranda in Texas Mutua/Insurance Company v. Ruttiger has no effect on this analysis, given Aranda discussed the general standard of good faith and fair dealing, but merely did so in the context of workers' compensation claims. See No , 2012 WL , *19 (Tex. June 22, 2012). 10 Id. at 213 (emphasis added). 11 Compare, 725 S.\V.2d at 167 with Aranda, 748 S.W2d at Id (emphasis added). 13 See PJC A (Arnold instruction) & B (Aranda instruction) (Sept. 1993). See also id. at comment "When to use-alternate submission" ("The Committee makes no attempt to specify the circumstances under which either instruction would be appropriate for submission."). 14 See Universe Life Ins. Co. v. Giles, 950 S.W2d 48, 56 & n.5 (Tex. 1997) S.W2d 48, 55 (Tex. 1997). 16 Id. at 56 (citingaranda) (footnote omitted; emphasis added). 17 Id. at 56 n.5 (citingarnold) (emphasis added). 18 Id. at Id. at Id. at See id.; see also State Farm Lloyds v. Nicolau, 951 S.W2d 444, 448 (Tex. 1997) ("We held in Giles [also issued today] that an insurer breaches its duty when the insurer fails to settle a claim if the insurer knew or should have known that it was reasonably clear that the claim was covered.") (emphasis added). 36 PJC 103.1, comment "Source of instruction" (italics added) (2010). See also PJC (1998) (citing Tex. Ins. Code art (IO)(a)(viii)). 37 See State Farm Lloyds v. Nicolau, 951 S.W2d 444, 448 (Tex. 1997) and discussion, supra. 38 See Am. Motorists Ins. Co. v. Podge, 63 S.W.3d 801 (Tex. 2001); Republic Ins. Co. v. Stoker, 903 S.W2d 338 (Tex. 1995) S.W2d at I d. 41 Id S.W2d at S.W3d 801, 804 (Tex. 2001). 44 Id at Id at Id. at ("Podge has also alleged generally-apart from her claim for temporary income benefits-that American Motorists did not promptly communicate with her and did not promptly and reasonably investigate her claim, but to the extent her complaints relate to claims for benefits on which she has never prevailed, nothing in her allegations shows American Motorists acted in a way that would give rise to bad faith liability."). The Texas Supreme Court's overruling of Aranda and disallowance of common-law claims related to workers compensation in Texas Mutua/Insurance Company v. Ruttiger, No , 2012 WL , *19 (Tex. June 22, 2012), is of no consequence to this analysis. The reasoning in Podge does not hinge on whether the cause of action exists, but rather on the proper scope of the tort. 22 Nicolau, 951 S.W2d at See id. at S.W.2d 42 (Tex. 1998). 25 Id at 49 (]. Hecht dissenting). 26 Jd. at 51 (J. Enoch dissenting). 27 Id. at Id. at Jd. at 47 (emphasis added) Jd. (emphasis added). 31 I d. 32 Contra id at 48 (dissent). 33 Id. at Id. at S.W2d 189, 198 (Tex. 1998) (emphasis added).