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March 2013

Court Restricts Insurers' Ability to Assert Privilege in First-Party Bad-Faith Suits

In Cedell v. Farmers Ins. Co. of Wash., No. 85366-5, in which the insured sued Farmers Insurance Company of Washington following a fire loss, alleging bad-faith claims handling practices, the Washington Supreme Court significantly restricted an insurer’s ability to assert the attorney-client privilege in first-party bad-faith lawsuits. The Washington Supreme Court held that there is a presumption of no attorney-client privilege in a first-party bad-faith claims handling lawsuit and that the attorney-client privilege will be deemed waived if the trial court finds a basis for the bad-faith claim to proceed after an in camera review of the allegedly privileged materials.

The insurer may overcome the presumption by showing that its attorney was “not engaged in the quasi-fiduciary tasks of investigating and evaluating or processing the claim, but instead in providing the insurer with counsel as to its own potential liability; for example, whether or not coverage exists under the law.” The court recommended that insurers maintain separate files when an attorney acts in more than one role so as not to comingle different functions. 

Once the insurer establishes that its attorney only provided a coverage opinion, the insurer is entitled to an in camera review of the claims file and to the redaction of communications from counsel that reflect the mental impressions of the attorney to the insurer, “unless those mental impressions are directly at issue in its quasi-fiduciary responsibilities to its insured.” If the court finds that the attorney-client privilege applies after the in camera inspection, the court must address any exceptions to the attorney-client privilege. One such exception is the “civil fraud” exception. 

Under the “civil fraud” exception, the attorney-client privilege does not protect communications between an insurer and its attorney when the communications are about committing fraud. Washington courts also have held that “if an insurer engages in bad faith in an attempt to defeat a meritorious claim, bad faith is tantamount to civil fraud.” Escalante v. Sentry Ins. Co., 49 Wn. App. 375, 743 P.2d 832 (1987), overruled on other grounds by Ellwein v. Hartford Accident & Indem. Co., 142 Wn.2d 766, 15 P.3d 640 (2001), overruled by Smith v. Safeco Ins. Co., 150 Wn.2d 478, 78 P.3d 1274 (2003).

The Cedell court set forth a two-step analysis that must be undertaken when the insured asserts the “civil fraud” exception:

First, upon a showing that a reasonable person would have a reasonable belief that an act of bad faith has occurred, the trial court will perform an in camera review of the claimed privileged materials. Second, after in camera review and upon a finding there is a foundation to permit a claim of bad faith to proceed, the attorney-client privilege shall be deemed to be waived. 

In Cedell, Farmers retained outside counsel to provide coverage advice. But the record revealed Farmers’ outside counsel also assisted in the claim investigation by taking sworn statements from the insured and a witness, and in adjusting the claim by negotiating directly with the insured. Because Farmers’ outside counsel performed claims handling functions, the case was remanded for evaluation under the new test.

The Washington Supreme Court’s 5-4 holding applies to “first party insurance claims by insured’s claiming bad faith in the handling and processing of claims, other than UIM claims.” However, because most coverage actions will involve allegations of bad-faith claims handling, the presumption will often apply. Plaintiffs asserting bad faith in the third-party context also may seek application of these rules. Thus, coverage counsel should limit their involvement to providing the coverage opinion, and should not engage in activities related to investigating, adjusting or processing claims. If coverage counsel performs both activities, the claim file should be maintained separately.

Click here for the opinion. 

This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the Washington Supreme Court. These events would render the opinion unavailable for use as legal authority in Washington state courts.

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Jordan S. Altura