Page 1 of 7 Minnesota's First-Party Bad Faith Statute: Where Are We After Five Years? 11/1/2013 Shanda K. Pearson Five years ago, with the passage of the first-party bad faith statute, Minnesota entered into a new era. Minnesota Statutes 604.18, the statute that permits insureds to bring first-party bad faith claims and potentially recover extracontractual damages against their insurers, went into effect on August 1, 2008. Prior to that date, Minnesota did not recognize bad faith claims in the first-party context; insureds could seek recovery for bad faith only in the third-party context for an insurer s wrongful failure to settle a claim. The policyholder bar was pleased with the new first-party statute, believing that large verdicts would curb abuses. The insurance industry, on the other hand, was concerned that the floodgates would open, leading to a myriad of meritless cases. Five years later, it s a good time to see what actually happened. Friday, November 01, 2013 by: Shanda K. Pearson Section: Features/Substantive Law Print Send Share When passed, Minn. Stat. 604.18 was viewed by many as a compromise between policyholder and insurer groups. Five years later, the general consensus seems to be that the number of claims under the statute, at least those that are successful, has remained relatively low. Some policyholders posit that this is because the standards and procedural thresholds for pursuing a claim are just too high.1 In contrast, insurers would likely conclude that the low number of claims and fewer number of victories are evidence that the industry deals with its policyholders appropriately. Regardless of what the numbers are or mean, in the appropriate case, Minn. Stat. 604.18 provides an opportunity for redress for insureds and poses potentially significant penalties for insurers when bad faith conduct is established. The Claims to Which 604.18 Applies Minn. Stat. 604.18 permits bad faith claims related to claims handling and settlement of claims under firstparty insurance policies. First-party policies typically require an insurer to pay proceeds directly to the insured when there is a loss under the policy. Minnesotans who have had the unfortunate luck to be in the path of some of this summer s hail storms are likely familiar with first-party property damage coverage. In addition to homeowners and other property damage policies, underinsured motorist (UIM), and disability policies, among others, are considered first-party coverage. There are, however, some types of first-party claims specifically excepted from the statute. First, Minn. Stat. 604.18 does not apply to claims resolved or confirmed by arbitration or appraisal. (subd. 4(c)). This may have had the unintended effect of increasing the number of first-party claims, particularly in the UIM area, being arbitrated. In addition, the statute does not apply to workers compensation insurance, health insurance, political subdivisions providing self-insurance, or the Minnesota Joint Underwriting Association, among several other specifically delineated exceptions. (subd. 1(a)). Ms. Pearson is a shareholder with the Bassford Remele law firm. A majority of her practice is focused on insurance coverage matters. She is a member of the MSBA, the Minnesota Defense Lawyers Association, and the Defense Research Institute s Insurance Law Committee. Only an Insured Can Assert a First-Party Bad Faith Claim Only an individual or entity that qualifies as an insured under the first-party policy in question can assert a claim under Minn. Stat. 604.18. (subd. 1(b)). Accordingly, a person or entity claiming third-party beneficiary status under an insurance policy cannot make a claim under the statute. In addition, a first-party bad faith claim cannot be assigned, which is something that often occurs in the context of third-party bad faith claims.2 (subd. 4(e)). The Statutory Standard for First-Party Bad Faith Minn. Stat. 604.18 sets the standard that applies to first-party bad faith claims. Under subdivision 2, an insurer may be liable for bad faith if the insured can establish that the insurer had no reasonable basis for denying the benefits owed under the policy and, second, that the insurer knew of, or acted in reckless disregard of, the lack of a reasonable basis for denying the benefits.3 As discussed below, Minnesota courts have provided some guidance as to what a reasonable basis is.

Page 2 of 7 Evidence That Cannot be Used to Establish Bad Faith Minn. Stat. 604.18 provides that certain evidence is inadmissible to establish a bad faith claim. (subd. 4(d)). This includes rules and standards set forth in Minnesota Statutes chapters 59A to 79A, which regulate insurance transactions in Minnesota. For example, Minnesota s Unfair Claims Settlement Practices Act, codified at Minnesota Statutes section 72A.20, sets forth standards of conduct for insurers and claimshandling practices the legislature determined to be deceptive and otherwise unfair. These standards, however, are not admissible as standards of care in a first-party bad faith claim. (subd. 4(d)(4)). The Process The procedure for bringing a first-party bad faith claim is similar to the procedure, with which many litigants are already familiar, applicable to punitive damages. An insured s complaint seeking benefits under a firstparty policy may not initially plead bad faith. (subd. 4(a)). Rather, the insured must move to amend the complaint to add the bad faith claim. The motion must be accompanied by one or more affidavits showing the factual basis for the motion. In contrast to a punitive damages motion, however, 604.18 specifically provides that the insurer may submit opposing affidavits. If the court finds prima facie evidence in support of the motion, the court may grant the insured s motion. Available Remedies Minn. Stat. 604.18, subd. 3, provides that a court may award what the statute refers to as taxable costs to the insured if it is determined that bad faith occurred. The amount of taxable costs available to an insured is the lesser of: (1) one-half of the proceeds awarded that are in excess of an amount offered by the insurer at least 10 days before trial begins; or (2) $250,000. The meaning of proceeds awarded may be subject to debate. Insureds may argue that the term refers to the amount of damages awarded by the fact finder, while insurers will likely maintain that proceeds awarded refers to the proceeds available under the insurance policy. There could be a significant difference in the amount awarded under the potentially differing interpretations. As an example, if the jury on a UIM claim awards $360,000 (after collateral offsets) and the insurer offered $60,000 of a $100,000 limit, the taxable cost would be $20,000 (one-half of the remaining policy limit) under one interpretation, and $150,000 (one-half of the difference between the offer of $60,000 and the net jury award of $360,000 after offsets) under the other. In addition, an insured may receive up to $100,000 in reasonable attorney fees incurred to establish bad faith. The fees must be separately accounted for and cannot be duplicative of the fees expended in pursuit of the proceeds on behalf of the insured under the insurance policy. Punitive damages are not available for a violation of 604.18. (subd. 3(b)). The Statute s Effective Date Minn. Stat. 604.18 was effective August 1, 2008, and applies to causes of action for conduct that occurs on or after that date. Insureds have argued that an insurer s subsequent conduct, after an initial denial, can bring a potential bad faith claim within the effective date of the statute. For example, in Crawford v. State Farm,4 the insurer denied benefits under its policies in 2004.The insured argued that the insurer engaged in continuing conduct after August 1, 2008, by making settlement offers that were less than the amount ultimately awarded by a jury in 2011. The court of appeals held that the insurer s initial denial of benefits controlled, and denied the insured s motion to amend.5 Guidance Provided by Minnesota Courts While there are still few appellate court decisions interpreting Minn. Stat. 604.18, the Minnesota Court of Appeals and Minnesota s federal district court have provided guidance on the standard that will be used to analyze first-party bad faith claims. Because the statute is still relatively new, district court decisions also

Page 3 of 7 provide helpful insight about issues central to first-party bad faith claims. The Fairly Debatable Standard Will Likely Apply The standard for bad faith conduct set forth in Minn. Stat. 604.18 considers whether the insurer had a reasonable basis for denying benefits owed. Minnesota courts have applied, and will likely adopt, the fairly debatable standard to evaluate whether a denial of benefits is reasonable. This standard has been adopted by Wisconsin courts, and because the standard set forth in 604.18 is similar to Wisconsin s first-party bad faith law, many speculated that Minnesota courts would look to Wisconsin courts for guidance.6 In Friedberg v. Chubb and Son, Inc., 7 the Minnesota federal district court undertook a two-pronged analysis utilized by the majority of jurisdictions adopting the fairly debatable standard. Under that analysis, the court will first consider whether a reasonable insurer would have denied or delayed payment of the claim under the facts of the particular case. This is an objective analysis that takes into account such things as whether the insurer properly investigated the claim and analyzed the investigation results. The insurer s conduct is measured against what a reasonable insurer would have done under similar circumstances. Thus, to establish this prong parties may need to offer expert testimony from, for instance, a claims representative or other insurance industry personnel regarding claims handling norms in the insurance industry. The second prong of the fairly debatable standard asks: (1) whether the insurer knew of a lack of a reasonable basis for denying the benefits, or (2) whether the insurer acted in reckless disregard of the lack of a reasonable basis to deny benefits. This is a subjective analysis that turns on what the insurer knew and when. The Friedberg case provides a good illustration of how courts apply the fairly debatable standard at least the first prong of the two-pronged analysis to both factual and legal issues relevant to a denial of benefits. Friedberg concerned a loss for water intrusion damage to a home. The residence at issue was covered by a Chubb policy that contained exclusions for rot, fungi and mold, as well as construction defects. After receiving notice of the claim, Chubb sent out an adjuster and expert to inspect the home. They observed significant water intrusion causing rot, mold and damage to the home s wood framing and ultimately determined that the damage was primarily attributable to faulty construction and gradual deterioration (which was not covered by the policy) as opposed to a single event such as a storm (which likely would have been covered by the policy). Based on the investigation and its analysis of the policy, Chubb denied coverage. The insureds disputed the denial and sought to amend their complaint seeking benefits under the policy to assert a bad faith claim against Chubb. The court denied the motion to amend in part because it concluded that Chubb conducted a thorough investigation and denied a claim that was fairly debatable on both factual and legal grounds. The court noted that while a jury may ultimately determine that the investigator and others were wrong in determining that the damage at issue was caused by faulty workmanship excluded by the policy, Chubb had a reasonable factual basis for its decision to deny the benefits. There was also a question regarding whether Chubb took an unreasonable position in how it construed the policy at issue. The policy exclusions on which Chubb relied contained ensuing loss provisions that the policyholders argued revived any coverage otherwise excluded.8 The court determined that there were conflicting decisions in Minnesota regarding whether a policy s ensuing loss provisions provide coverage under the circumstances in the Friedberg case. Ultimately, the court held that Chubb s position about how the ensuing loss provisions applied was, at minimum, fairly debatable, and precluded a finding of bad faith. Because the court determined Chubb s conduct was reasonable, it did not specifically address the second prong of the bad faith test. Since Friedberg, two unpublished Minnesota Court of Appeals panels also applied, but did not specifically adopt, the fairly debatable standard to first-party bad faith claims: Homestead Hills Homeowner Assoc. v. Am. Family Mut. Ins. Co.9 and Northern Nat l Bank v. North Star Mut. Ins. Co.10 Some Minnesota district court judges, even before these decisions were issued, had already applied the fairly debatable standard when assessing bad faith claims under 604.18.11 Thus, while there will likely be more uniformity among district courts, these cases may not result in a significant shift from the way a number of bad faith cases have

Page 4 of 7 been analyzed in the district court. Bad Faith and Good Faith Conduct Application of the fairly debatable standard means that so long as an insurer conducts a reasonable investigation, analyzes the results of that investigation, and can point to a reasonable factual and legal basis for the denial of benefits even if there is contrary evidence that was considered the insurer s decision will probably not constitute bad faith under Minn. Stat. 604.18. The cases referenced in the previous section, as well as a number of district court decisions, provide examples as to what type of conduct by an insurer does, and does not, rise to a level of bad faith. For instance, a number of district court cases in the UIM context indicate that if the insured had a pre-existing condition that led to a dispute as to causation, or if there is a report from an independent medical examination (IME) that disagrees with the extent of the insured s claimed injuries, an insured will likely have an uphill battle to establish bad faith conduct. In Espinoza v. Progressive Northern Insurance Co.12 the court denied the plaintiff insured s motion to amend to include a claim for first-party bad faith where two IMEs of the insured reported no objective findings to support the insured s complaints. In a more recent decision, a district court determined a UIM claim was fairly debatable as a matter of law where an IME concluded that an insured s knee injury was not caused by the motor vehicle accident at issue and so denied the plaintiff s motion to add a claim for first-party bad faith.13 A mere gap in the amounts demanded by the insured and offered by the insurer is probably unlikely to sustain a first-party bad faith claim. In Davis v. Grinnell Mutual Reinsurance Company,14 the Minnesota federal district court granted summary judgment on a plaintiff s bad faith claim, rejecting the insured s argument that the gap (approximately $200,000) between the insurer s tendered coverage and what the insured asserted he should be paid was enough to allow his 604.18 claim to proceed.15 In contrast, a court will likely allow an insured to seek taxable costs for bad faith when an insurer has no factual or legal basis for a denial, or, under some circumstances, takes an unreasonable time to investigate a claim. For instance, in Lobbins v. Allstate Insurance Co.,16 an insurer evaluating a UIM claim refused to concede on issues of fault, liability and the extent of the insured s damages even though there was no evidence to the contrary. In that case, the insurer (1) refused to admit fault even though the insured was a passenger on a bus hit by a drunk driver; (2) refused to admit the insured met the $4,000 tort threshold even though it had paid out $20,000 in no-fault benefits; and (3) apparently ignored two IME reports concluding the insured sustained permanent injuries caused by the accident. Even though the insurer had offered some money to settle the case, the court concluded that the insured, under those facts, could amend her complaint to seek taxable costs for bad faith.17 A Minnesota district court has also allowed a bad faith claim to go forward where the insurer withheld payment of undisputedly covered claims pending resolution of a coverage dispute regarding other, potentially uncovered, claims. In King s Cove Marina v. St. Paul Mercury Insurance Co.,18 an insured provided documentation of a number of costs related to debris removal and demolition following a windstorm. The insurer s adjuster acknowledged that some, but not all, of the costs were undisputedly covered under the policy at issue. The insurer refused, without giving any explanation, to pay anything on the claim until the dispute regarding the potentially uncovered portion of the claim was resolved. The court determined that the insurer s conduct was sufficient to grant the plaintiff s motion to amend his complaint to add a bad faith claim (but did not determine if bad faith actually occurred). While the existence of bad faith involves a fact intensive inquiry made on a case-by-case basis, the above examples provide guidance as to how the courts have applied the statute under certain factual scenarios. Questions that Remain Unanswered There are a number of unanswered questions regarding Minn. Stat. 604.18 that Minnesota appellate courts have not yet had an opportunity to address. Again, district court decisions provide guidance on these issues.

Page 5 of 7 How Much Deference to Give to Competing Affidavits As explained above, an insured must submit prima facie evidence of bad faith to prevail on a motion to amend to seek taxable costs for bad faith, but Minn. Stat. 604.18 specifically provides that insurers may submit affidavits showing there is no factual basis for the motion. Thus, the question is whether a court must give deference to the affidavits submitted by the insured when deciding a motion to amend. One school of thought is that since the statute requires prima facie evidence, only the insured s affidavits are entitled to deference. This is the approach taken by the Anoka County District Court inturner v. American Family Mutual Insurance Co.19 Of course, others would argue that because the legislature specifically permits the insurer to submit opposing affidavits, courts should be allowed to give some, if not equal, weight to them. In Herbert v. State Farm,20 the district court denied an insured s motion to assert a bad faith claim after considering opposing affidavits from the insurer. The court reasoned that [b]y including language in the Bad Faith Statute regarding how the motion to amend must be defended it appears... that the Court is to give at least equal weight to Defendant s responsive affidavits. Minnesota s appellate courts have yet to specifically address this issue. Whether Liability for Bad Faith Is Determined by the Court or Jury Minn. Stat. 604.18, subd. 4(b) provides that [a]n award of taxable costs under this section shall be determined by the court in a proceeding subsequent to any determination by a fact finder of the amount an insured is entitled to under the policy. This provision is subject to two interpretations. First, that the court, in a subsequent proceeding, decides both liability for bad faith and the amount of taxable costs awarded. The statute could, on the other hand, be interpreted to mean that the jury decides whether there was bad faith and the court then determines the amount of taxable costs awarded. Although Minnesota s appellate courts have not considered the issue, there are state and federal district court decisions that seem to indicate courts are interpreting the statute to mean that the court is to determine both issues after trial of the underlying case.21 Timing and Scope on Discovery on Bad Faith Issues Disagreements about the timing and scope of permissible discovery can arise between parties involved in a case where an insured is considering a bad faith claim, or where the court has allowed the insured to amend the complaint to assert a bad faith claim. This is a potentially significant issue because insurer documents that might be relevant to a bad faith claim are of the type not generally relevant to, and often prepared in anticipation and during the course of, the litigation of the underlying claim. Insureds, however, often argue that discovery of such information is extremely valuable and oftentimes necessary to support a motion to amend or to ultimately establish that bad faith conduct occurred. A district court s decisions in an early bad faith case may provide some guidance regarding relevant considerations that need to be balanced when deciding discovery-related disputes. In Hiner v. Allstate Insurance Co.,22 the insurer sought a protective order when an insured in a UIM claim requested the claim file related to his own claim as well as claims files involving similar Minnesota claims during the previous five years. Over the insurer s objections that the requested files were irrelevant, inadmissible, and protected by the work product doctrine, the court ultimately agreed with the insured that his own claims file was relevant to determine whether there was a reasonable basis for the insurer to deny him UIM benefits. The court granted the insurer s motion regarding the other requested claims files, holding that [e]vidence of defendant s handling of other claims is neither relevant to the facts in [the plaintiff-insured s] circumstances nor the elements contained in section 604.18 subdivision 2. 23 In addition to providing guidance regarding what might and might not be discoverable when bad faith is alleged, the court s ruling also highlights for insurers the importance of properly documenting in the claims file the investigation and analysis on which a denial of benefits is based. Presumably to avoid the issues raised in the Hiner case, at least one district court has ordered, upon granting an insured s motion to amend the complaint to assert a bad faith claim, that discovery on bad faith issues was to be stayed until after the trial of the underlying case. The court explained this was done to eliminate

Page 6 of 7 any prejudice that might otherwise have arisen as a result of the granting of this motion to amend. 24 Stay Tuned In the five years since Minn. Stat. 604.18 went into effect, Minnesota s appellate courts have had only a few opportunities to apply the statute and address issues arguably left unclear by the statutory language. But stay tuned; it is only a matter of time until additional issues find their way to the appellate courts. Until then, federal and state district court decisions will provide guidance to insurers and insureds alike regarding the type of conduct that could lead to a viable first-party bad faith claim under the statute and how certain aspects of the statute will ultimately be interpreted. 1 Brenden Tupa, Insurance Bad-Faith Statute is a Bad Joke, Minnesota Lawyer (Feb. 8, 2013). 2 Third-party bad faith claims involve the insurer s breach of a policy written to protect the insured from liability claims made by third parties (i.e. a commercial general liability or an automobile liability policy). 3 Of note, Minn. Stat. 604.18, subd. 2(c) specifically provides that an insurer cannot be held to have acted in bad faith when the insurer conducts or cooperates with a timely arson or fraud investigation. 4 Crawford v. State Farm Mut. Ins. Co., 2012 WL 6554434 (Minn. Ct. App. Dec. 17, 2012). 5 See alsohiner v. Allstate Ins. Co., 2010 WL 2717796 (Hennepin Cty. Dist. Ct. Jan. 25, 2010) (holding same). 6 See Anderson v. Cont l Ins. Co., 271 N.W.2d 368 (Wis. 1978). 7 Friedberg v. Chubb & Son, Inc., 800 F. Supp. 2d 1020 (D. Minn. 2011). 8 For instance, the policy s construction defect exclusion barred coverage for loss caused by construction defects but stated the policy insured ensuing covered loss unless another exclusion applied. 9 Homestead Hills Homeowner Ass n v. Am. Family Mut. Ins. Co., 2012 WL 5896829 (Minn. Ct. App. Nov. 26, 2012) (holding insured could not pursue taxable costs for bad faith because hail damage claim was fairly debatable ). 10 N. Nat l Bank v. N. Star Mut. Ins. Co., 2012 WL 4052835 (Minn. Ct. App. Sept. 17, 2012), rev. denied (Minn. Nov. 27, 2012). 11 See, e.g., Auto-Owners Ins. Co. v. Second Chance Inv., LLC, No. 27-CV-10-15620 (Hennepin Cty. Dist. Ct. Apr. 11, 2011); Gades v. Allstate Prop. Cas. Claims Serv., No. 27-CV-07-22561 (Hennepin Cty. Dist. Ct. Sept. 30, 2008). 12 Espinoza v. Progressive N. Ins. Co., No. 27-CV-09-2719 (Hennepin Cty. Dist. Ct. Dec. 24, 2009). 13 Utke v. Am. Family Mut. Ins. Co., 2012 WL 7070503 (Ramsey Cty. Dist. Ct. Feb. 6, 2012). 14 Davis v. Grinnell Mut. Reinsurance Co., 2010 WL 5464915 (D. Minn. Dec. 30, 2010). 15 See alsoespinoza, No. 27-CV-09-2719 (denying motion to amend where the insured solely relied on an allegedly insufficient settlement offer to support his motion). 16 Lobbins v. Allstate Ins. Co., No. 27-CV-08-5218 (Hennepin Cty. Dist. Ct. Dec. 30, 2008). 17 See also Fahey v. R & L Carriers, Inc., No. 19HA-CV-08-1096 (Dakota Cty. Dist. Ct. Aug. 7, 2009) (granting motion to amend where three and one-half years passed between an accident and an insurer s offer on a UIM claim under what was ultimately determined to be a $25,000 policy in a case involving what the court described as a horrendous accident where the Minnesota State Patrol put 100 percent fault on the other driver and an IME doctor attributed at least 40 percent of over $100,000 of medical bills to the collision). 18 King s Cove Marina, LLC v. St. Paul Mercury Ins. Co., No. 19HA-CV-09-2118 (Dakota Cty. Dist. Ct. June 2, 2009). 19 Turner v. Am. Family Mut. Ins. Co., No. 02-CV-08-8364 (Anoka Cty. Dist. Ct. Mar. 19, 2009) ( While [the insurer s] affidavit questions the factual basis of Plaintiff s claims, this is not the time to resolve those disputes. ). 20 Herbert v. State Farm Mut. Auto. Ins. Co., No. 19-C3-07-10672 (Dakota County Dist. Ct. Jan. 23, 2009). 21 See, e.g., Hackbard v. State Farm Fire and Cas. Co., 2013 WL 375543 (D. Minn. Jan. 31, 2013) (noting the court decided that any claim for taxable costs would be decided by the court after the conclusion of a jury trial of the underlying claim); Bernstrom v. American Family Mut. Auto. Ins. Co., No. 35-CV-09-5 (Kittson County Dist. Ct. Dec. 21, 2010). 22 Hiner v. Allstate Ins. Co., No. 27-CV-09-7021 (Hennepin Cty. Dist. Ct. July 30, 2009). 23 See also, Hiner, supra note 22 (permitting depositions of claims handler and Rule 30.02(f) witness to

Page 7 of 7 go forward with limitations). 24 Greseth v. N. Star Mut. Ins. Co., No. 78-CV-08-268 (Traverse Cty. Dist. Ct. May 14, 2009).