The Current Status Of Bad-Faith Claims Involving Insurance

Published date17 August 2021
Subject MatterCorporate/Commercial Law, Insurance, Contracts and Commercial Law, Insurance Laws and Products
Law FirmCollins Einhorn Farrell
AuthorLynn B. Sholander

Introduction - Three Theories

The availability of causes of action under Michigan law premised on an insurer's bad faith has generated significant confusion for several decades. This confusion is likely due, in part, to differences in the law between state jurisdictions. In order to fully understand the types of claims that are viable under Michigan law, it is necessary to demarcate the most common types of potential claims and track Michigan cases considering their application. This piece will focus on the three most common categories of "bad-faith claims" and summarize whether each type of claim is viable in Michigan.

Breach of contract. First, this article will explore, and dedicate the greatest length to, the viability of claims based on an insurer's "bad-faith breach of contract." Concisely stated, Michigan does not recognize a cause of action for bad-faith breach of contract. Rather, in order to recover tort damages, such as mental distress damages, related to an insurer's conduct in conjunction with the execution of its duties under an in-Insurance policy, the insurer must breach a tortious duty that is wholly separate and independent from the breach of contract.

Failure to pay a claim. The second, and often related, category of bad-claims consists of claims based on an insurer's bad-faith failure to pay an insurance claim submitted by its insured. In Michigan, an insured may not bring an independent cause of action based on his or her insurer's bad-faith failure to timely pay his or her claim. However, an insured may be entitled to recover penalty interest in the amount prescribed by MCL 500.2006 (in cases implicating the Michigan Uniform Trade Practices Act ("UTPA")) or MCL 500.3142 (in cases involving no-fault personal protection insurance benefits).

Michigan courts and federal courts applying Michigan law have repeatedly recognized that a plaintiff may not maintain an action in tort arising from the breach of a contractual duty. Failure to settle a liability claim. The third category of claims discussed in this article includes bad-faith claims in the context of liability insurance. In short, Michigan law recognizes an insured's cause of action against his liability insurer for bad-faith refusal to settle a claim against the insured. It also recognizes a cause of action brought by an excess liability insurer against the primary liability insurer based on the primary insurer's bad-faith handling of a suit or settlement that results in a judgment in excess of the primary insurance policy limit.

Michigan Rejects a Cause of Action for Bad-Faith Breach of an Insurance Contract

Confusion often surrounds whether a claimant may assert a cause of action for bad-faith breach of an insurance contract in Michigan. Much of this uncertainty arises from the fact that an insurer has a general obligation to act in good faith or use ordinary care in performing its duties under an insurance contract. This obligation arises out of - and is not independent of - the contract.1 In short, Michigan courts and federal courts applying Michigan law have repeatedly recognized that a plaintiff may not maintain an action in tort arising from the breach of a contractual duty.2 Correspondingly, the Michigan Supreme Court and the Michigan Court of Appeals have refused to recognize an actionable, independent tort based on an insurer's bad-faith breach of an insurance contract.3

The underlying rationale of this rule is that a plaintiff may not claim tort damages for the mere non-performance of contractual duties. Additionally, Michigan courts have reasoned that bad-faith claims are inappropriate in the context of Michigan no-fault insurance given the comprehensive scheme in place under the no-fault act that includes penalties for an insurer's failure to timely pay an insurance claim, which are discussed are discussed later in this article.4

Consistent with these principles, the Michigan Supreme Court expressly recognized in Kewin v Massachusetts Mutual Life Insurance Company that when a party breaches an insurance contract, damages are limited "to the monetary value of the contract had the breaching party fully performed under it."5 Exemplary damages that do not arise naturally from the breach of the insurance policy are generally not recoverable.6 The reasoning supporting this rule is that insurance contracts are commercial in nature, in that they constitute "agreements to pay a sum of money upon the occurrence of a specified event."7 The court explained:

In the commercial contract situation, unlike the tort and marriage contract actions, the injury which arises upon a breach is a financial one, susceptible of accurate pecuniary estimation. The wrong suffered by the plaintiff is the same, whether the breaching party acts with a completely innocent motive or in bad faith.8(emphasis added)

However, Kewin and subsequent cases have recognized a caveat to this rule, which applies in cases where a party violates a duty separate from its contractual duties:

Cases recognizing a right to maintain an action in tort arising out of a breach of contract by the defendant[] generally involve a separate and distinct duty imposed by law for the benefit of the plaintiff that provides a right to maintain an action without regard to whether there was a contractual relationship between the plaintiff and the defendant.9

On several occasions, the Michigan Supreme Court has delineated the proper means of determining whether a plaintiff may raise a tort claim in a situation where a contractual agreement exists between the parties. For example, in Loweke v Ann Arbor Ceiling & Partition Co, LLC,10 the court explained:

[I]n determining whether an action in tort will lie, Fultz [v Union-Commerce Assoc, 470 Mich 460, 462; 683 NW2d 587 (2004),] recast the test to focus on whether any legal duty independent of the contract existed. Notably, in requiring courts to focus on whether a defendant owed a legal duty to the plaintiff, Fultz directed courts to utilize the " 'separate and distinct' definition of misfeasance." . . . [The focus is] on whether a legal duty independent of a contract existed, rather than whether defendant's conduct was separate and distinct from the tasks required by the contract or whether the hazard was contemplated by the contract.

Similarly, the Michigan Supreme Court explained the distinction as follows in Hart v Ludwig11:

We have simply the violation of a promise to perform the agreement. The only duty, other than that voluntarily assumed in the contract to which the defendant was subject, was his duty to perform his promise in a careful and skillful manner without risk of harm to others, the violation of which is not alleged. What we are left with is defendant's failure to complete his contracted-for performance. This is not a duty imposed by the law upon all, the violation of which gives rise to a tort action, but a duty arising out of the intentions of the parties themselves and owed only to those specific individuals to whom the promise runs. A tort action will not lie.12

Likewise, in Kewin, the court recognized this distinction as a basis for its refusal to recognize a tort consisting of the bad-faith breach of an insurance contract, holding that "absent allegation and proof of tortious conduct existing independent of the breach, exemplary damages may not be awarded in common-law actions brought for breach of a commercial contract."13

Numerous other Michigan cases have recognized that a plaintiff generally may not recover damages for emotional distress or anguish, or any other exemplary damages, for the breach of an...

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