By Larry Rocheford and Michelle Kuhl
As we know, the Minnesota Supreme Court heard oral arguments in Peterson vs. Western National Mutual Insurance Company on January 6, 2020. That Minnesota Supreme Court decision concerned Minnesota’s new bad faith statute: Minn. Stat. § 604.18. In essence, in that third-party action a UIM claim was brought against Western National, it went to verdict and following the verdict there was an award of bad faith damages. This will be the first Minnesota Supreme Court decision that truly interprets this new bad faith statute.
Our interpretation of the oral arguments was that there will likely be a split decision in favor of the Plaintiff and against Western National.
We await that important decision as it will likely give us guidance on how bad faith claims are to be handled in the future. Our best guess is that the decision will be issued sometime this summer, although there is no deadline in which the Court must issue its decisions. It was noted that Western National may have erred in not appealing the Court’s order allowing amendment to the Complaint and the addition of the bad faith claims. Chief Justice Gildea suggested an oral argument that this may not have been a case where bad faith should have even been added.
On April 21, 2020, United States District Court Judge Pat Schiltz filed his Findings of Fact, Conclusions of Law, and Order for Judgment in Selective Insurance v. Sela, Case No. 16‐CV‐4077 (PJS/BRT).
Sela owned a large home on Lake Minnetonka. His home was damaged in a June 2010 and in a June 2015 hail storm. At the time of the 2010 hail storm Sela was insured by Lexington Insurance and Lexington paid Sela $510,000 for his property damage. In the 2015 hail storm, Sela was insured with Selective Insurance Company. Selective asked Sela what repairs he completed after the 2010 hail storm. Sela advised Selective what he repaired and what he had not repaired and provided documentation as to repairs following the 2010 hail storm and before the 2015 occurrence.
Following its investigation, Selective alleged Sela willfully misrepresented the extent to which he repaired his home following the 2010 hail storm and denied indemnification. Sela counterclaimed for breach of contract, alleged he did not commit fraud and alleged that Selective was required to indemnify him for the loss Sela sustained from the 2015 hail storm. After a week-long jury trial, the jury found for Sela and determined damages to be in excess of $493,000. The matter was before the trial judge on Sela’s counterclaim for bad faith under Minn. Stat. § 604.18. On this counterclaim, the Court conducted a bench trial. The 66-page order was the Court’s Findings and Conclusions following the bench trial.
Findings of Fact
Sela’s property which included a home, garage, pool house and gazebo clad in part in copper, were extensively damaged by a June 2010 hail storm. Because he was in federal prison serving sentences for fraud and tax offenses, Sela did not immediately submit a claim to Lexington Insurance following the June 2010 property damage. Eventually he submitted a property claim to Lexington under his replacement cost policy.
Judge Schiltz explained the difference between replacement cost coverage and actual cash value of a loss. The actual cash value is always owed. If the insured actually replaces the building within a certain amount of time, it may recover the difference between replacement cost and ACV (i.e. the hold-back). Following the 2010 hail storm and claim, Lexington paid Sela the ACV of his damaged property. Sela never repaired anything. He never sought the difference between the replacement cost and the ACV. In not repairing the building, Sela would have pocketed the ACV payment and would have saved Lexington Insurance money as it was not forced to pay any of the holdback under the replacement cost portion of the policy. During the claim process for the 2010 claim with Lexington Insurance, Sela chose to move his insurance to Selective Insurance. Before Selective insured the Sela property, it examined his property and elected to issue a homeowners policy. Sela was insured with Selective at the time of the 2015 hail storm. In addition, following the 2010 hail storm, because Sela is in the Roofing business, he repaired some parts of the home with the proceeds provided by Lexington and chose not to repair other parts.
Following the 2015 hail storm, Selective’s independent appraiser examined the damage to the Sela home and described it as a “catastrophic claim”. When Selective received that information, it fired the independent adjuster.
About three weeks after firing the independent adjuster who said Sela had catastrophic damages from the 2015 hail storm, Selective assigned two of its employees to inspect Sela’s property. In the course of their inspection, they met with Sela and Sela advised as follows:
- The exterior of the home had been completely redone 5 or 6 years earlier.
- The property had sustained property damage in the 2010 hail storm.
- Lexington Insurance indemnified Sela for damage from the 2010 hail storm.
- Gutters had been replaced following the 2010 hail storm and claim.
- Sela pointed out where the repairs had been made to gutters and copper flashing and onto the roof tile system.
- Sela pointed out various items that had not been repaired but were damaged in the 2010 hail storm.
- Selective was fully advised that some of the damage from the 2010 hail storm had been repaired and some of the damage had not been repaired.
- Sela later submitted photographs to Selective Insurance marking parts of the property that had not been repaired from the 2010 hail storm.
A Selective employee was to calculate Sela’s damages and settle the claim. He noted that Sela sustained significant loss as a result of the 2015 hail storm but never calculated the amount of that loss as Selective assigned its special investigation unit to get involved in the case.
Shortly after Sela submitted his claim to Selective following the 2015 hail storm, Selective received an anonymous letter that accused Sela of the following:
- That Sela was a criminal and a convicted felon.
- That Sela previously submitted a similar insurance claim on the property and received over $585,000.
- That the 2010 damage to Sela’s property had not been caused by weather but had been caused by Sela directing his employees to intentionally ding and damage his property so he could collect homeowner’s insurance proceeds.
- The anonymous letter further provided that none of the damage from 2010 had been repaired.
- Selective decided to investigate the fraud allegations made in the anonymous letter. Selective assigned a special investigation unit employee to check out the allegations. The fraud allegations from the anonymous letter, overwhelmingly, proved to be false. The investigation showed that Sela was up front about damage telling Selective when there was damaged caused by a worker and when there was damage caused by the 2010 and 2015 hail storms. The anonymous letter’s contents quickly proved unreliable.
- Under the law, Sela had no obligation to use the Lexington Insurance settlement from the 2010 hail storm to repair the premises. He could pocket all the proceeds.
First Prong of Minnesota’s Bad Faith Statute
According to Judge Schiltz the first prong of Minnesota’s bad faith statute is objective: Whether the insurer had a reasonable basis to deny benefits under the circumstances.
Expert testimony regarding what a reasonable insurer would have done is not necessary unless the issue is so esoteric that jurors cannot form a valid judgment as to whether the insurer’s conduct was reasonable.
Judge Schiltz cited many Wisconsin cases indicating that an expert on a bad faith claim is not necessary as the area was well within a jurors’ ordinary experience and expert testimony was not necessary.
Judge Schiltz determined that Selective did not have a reasonable basis to deny Sela’s claim. Selective’s burden was to prove that Sela lied. Here, it was evident that Selective failed to prove any lie on the part of Sela. Sela never claimed that following the 2010 hail storm damage and payment by Lexington Insurance that he spent the entire $510,000 repairing his home. He conceded he only spent $215,000. Sela never misrepresented what was damaged and what he repaired following the 2010 storm and Lexington payment.
Selective failed to properly investigate the damage from the 2015 loss, failed to provide its forensic expert with all of the information pertinent to that loss and relied on irrelevant and untrue information that was harmful to Sela. Judge Schiltz concluded that Selective did not have a reasonable basis for concluding that Sela committed fraud.
Second Prong of Minnesota’s Bad Faith Statute
The second prong of Minnesota’s bad faith statute is subjective: Whether the insurer denied benefits while knowing of, or acting in reckless disregard of, the lack of a reasonable basis.
On this subjective prong, the burden was to show that Selective acted with reckless disregard of the lack of a reasonable basis for denying Sela’s claim. It was evident that Selective’s assigned adjuster testified that he did no fraud investigation, nothing to confirm statements Sela allegedly made and nothing to show Sela committed fraud or told a lie. Selective’s adjusters denied Sela’s claim without any reasonable basis. Selective’s SIU investigator’s entire investigation missed the point. Selective’s SIU investigator kept insisting that Sela prove how he managed to repair all of the damage caused by the 2010 hail storm spending only $215,000 when Sela never claimed that he repaired all the damage.
Selective’s SIU investigator claims she was unable to confirm the validity of Sela’s invoices for repairs following the 2010 hail storm yet Sela was able to produce witnesses confirming their validity. Selective did nothing with its forensic expert or its SIU investigator to determine if Sela had committed a lie or had committed fraud. In essence, Selective’s conduct in investigating the 2015 loss was reckless. When the case was tried, Selective tried to rely on Sela’s statements never raised when Sela’s claim was denied to support its position that Sela committed fraud. None of the information relied upon by Selective to deny Sela’s claim support a denial. Further, Sela secretly recorded his conversation with Selective’s claim personnel. It contradicted some of the statements made by Selective’s claims personnel.
The Court stated as follows:
Any reasonable insurer that denied its insured hundreds of thousands of dollars of indemnification on the basis of fraud would have no difficulty identifying (1) who made that decision and (2) the fraudulent statements on which the decision is based.
Here, Selective could not name a person who made the decision to deny a claim for fraud and Selective could not identify the fraudulent statements on which the claim denial was based. Selective had no reasonable basis to deny Sela’s claim
Minnesota’s bad faith statute allows the insured who has proven bad faith taxable costs which include “an amount equal to one half the proceeds awarded that are in excess of an amount offered by the insurer at least 10 days before the trial begins or $250,000, whichever is less citing Minn. Stat. § 604.18, subd. 3(a)(1). The Court found that Sela was entitled to taxable costs amounting to half the ACV verdict plus an additional $100,000 in reasonable attorneys’ fees. In addition, if Sela expended sums to complete repairs he may be entitled to some of the replacement cost holdback and may be entitled to additional taxable costs.
There was also a section in the 66-page order regarding the interest calculation on prejudgment interest. It is worth reading, however, it is not germane to Minnesota’s bad faith statute.
We are still waiting to hear from the Minnesota Supreme Court on Minnesota’s bad faith statute, Peterson vs. Western National. We do have this trial court decision from United States District Court Judge Schiltz. Based on Judge Schiltz’s Order in the Sela case, two prongs ought to give us some guidance as follows:
- Objectively, was there an absence of a reasonable basis for denying benefits of the insurance policy; and
- Subjectively, did the insurer know of the lack of a reasonable basis for denying the benefits of the insurance policy or did the insurer act in reckless disregard of the lack of a reasonable basis for denying the insurance benefits.
The first prong of this test is simple. The first-party insurer must create a reasonable basis for denying benefits of the insurance policy. When presented with the first-party claim the insurer must determine liability and damages. It must promptly investigate those elements of the claim and evaluate whether the benefits are owed. If the insurer provides a reasonable basis to deny benefits of the insurance policy, it should be protected and the bad faith statute should not be of concern.
For example, and hypothetically, when a first-party UIM carrier receives a Malmin notice, it is on notice that a liability case has been asserted and likely commenced. At that time, the UIM carrier must investigate the liability facts and the damages to determine if UIM benefits will be owed. In a UIM case, that means the causal negligence of the party, tort threshold, damages, subrogation interests and collateral sources all need to be investigated. After that investigation is complete, the UIM carrier should be able to make a determination as to whether UIM benefits may be owed under the insurance policy.
By the time a Schmidt notice is interposed in a UIM case, the UIM carrier should have determined the size of the underlying case and should be able to determine whether it wants to substitute its own check to preserve subrogation rights against the allegedly at fault and underinsured driver. That evaluation necessarily involves determining the size of the Plaintiff’s claim.
The second prong of the test to determine whether the bad faith statute applies is subjective. One needs to determine if the insurer knew of the lack of a reasonable basis or acted in reckless disregard of the lack of a reasonable basis. Again, hypothetically, the question would be whether the insurer knew there was a lack of a reasonable basis for denying UIM benefits or, alternatively, denied UIM benefits in reckless disregard for a lack of a reasonable basis. This second prong is subjective. It literally asks what the insurer knew, should have known and how it acted with that knowledge or disregard of that knowledge.
Although not an express prong under the bad faith statute, Judge Schiltz’s order makes clear the importance of being able to identify a specific person who made the decision to deny the claim. That person will be the focus in determining whether the insurer had a reasonable basis to deny the claim and knew of or acted in reckless disregard of the lack of a reasonable basis. Throughout the order finding bad faith against Selective in the Sela decision, it was evident that Selective’s attorney and Selective personnel acted in concert and disregarded certain information, but no one took responsibility for making the decision to deny benefits of the insurance policy. There was no “captain of the ship” who said benefits are to be denied because of some reasonable basis.
Judge Schiltz expressed concern that the attorney representing Selective may have been the one who made the decision. That would be problematic because the Rules of Professional Conduct prohibit a lawyer from serving as an advocate at a trial in which the lawyer is likely to be a necessary witness.
A best practice would be a process by which insurer representative is designated to be the decision maker. That person must evaluate the basis for denying benefits and must be able to state why that reasonable basis justifies denying benefits under an insurance policy. And, as to the second, subjective prong, that decision maker must know the reasonable basis for denying insurance benefits and that decision maker must be acting in accord with the reasonable basis. If the decision maker knows there is no reasonable basis for denying insurance benefits or is reckless, does not know the basis for denying benefits under an insurance policy, which is bad faith.