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Bad Faith Policy Limit Demand

In the Insurance Bad Faith litigation world there are important distinctions between a potential first and third party potential bad faith.

Third Party Insurance

Generally, in each insurance liability policy, California law implies a covenant of good faith and fair dealing that obligates the insurance company to make reasonable efforts to settle a third party's lawsuit against the insured. If the insurer breaches the implied covenant by unreasonably refusing to settle the third party suit, the insured may sue the insurer in tort to recover damages proximately caused by the insurer's breach." PPG Industries, Inc. v. Transamerica Ins. Co. (1999) 20 Cal.4th 310, 312

General, an injured party is neither a party to nor an intended beneficiary of an insurance contract until such time as the injured party has obtained a judgment against the insured. Therefore, an injured party has no action against an insurance company for breach of the implied covenant of good faith and fair dealing based upon the insurer’s refusal to settle a claim. Murphy v. Allstate Ins. Co. (1976) 17 Cal.3d.937, 941. Although the Unfair Claims Settlement Practices Act under Insurance Code sections 790, et seq., requires an insurance company “to attempt in good faith to effectuate prompt, fair and equitable settlement of claims in which liability has become reasonably clear,” no private action is created from that statute. Moradi-Shalal v. Fireman’s Fund Ins. Cos. (1988) 46 Cal.3d.287, 313. Bad faith may only be actionable by the injured party against the third party insurer if:

  1. There is an excess judgment,
  2. There was a reasonable basis to settle within policy limits after a demand was made,
  3. The insurer refused to settle within limits, and
  4. The tortfeasors assigns his benefits and rights under their policy to pursue the bad faith claim.

An insured's claim for bad faith based on an alleged wrongful refusal to settle first requires proof the third party made a reasonable offer to settle the claims against the insured for an amount within the policy limits. This first element can be satisfied if:

  1. Its terms are clear enough to have created an enforceable contract resolving all claims had it been accepted by the insurer,
  2. All of the third party claimants have joined in the demand,
  3. It provides for a complete release of all insureds and
  4. The time provided for acceptance did not deprive the insurer of an adequate opportunity to investigate and evaluate its insured's exposure.

Coe v. State Farm Mut. Auto. Ins. Co. (1977) 66 Cal.App.3d 981, 992-993; Strauss v. Farmers Ins. Exchange (1994) 26 Cal.App.4th 1017, 1021; Critz v. Farmers Ins. Group (1964) 230 Cal.App.2d 788, 798. Plainly stated, a claim for bad faith based on an alleged wrongful refusal to settle also requires proof the insurer unreasonably failed to accept an otherwise reasonable offer within the time specified by the third party for acceptance. However, when a liability insurer timely tenders its "full policy limits" in an attempt to effectuate a reasonable settlement of its insured's liability, the insurer has acted in good faith as a matter of law because "by offering the policy limits in exchange for a release, the insurer has done all within its power to effect a settlement." (Lehto v. Allstate Ins. Co. (1994) 31 Cal.App.4th 60,

First Party Insurance

By contrast, first party claims can give rise to claims for insurance bad faith based upon breach of contract and breach of the implied covenant of good faith and fair dealing. The standard utilized (whether third party by assignment or first party) examines the reasonableness of the insurer's conduct, and mere errors by an insurer in discharging its obligations to its insured. Brandt v. Superior Court (1985) 37 Cal.3d 813. Therefore, erroneous denial of a claim does not alone support tort liability unless it is found to have withheld benefits unreasonably.


When a claim is based on the insurer's bad faith, alleging either the insurer unreasonably refused to pay policy benefits or did not conduct an adequate investigation, the ultimate test is whether the insurer's conduct was unreasonable under all of the circumstances. Chateau Chamberay Homeowners Assn. v. Associated Internat. Ins. Co. (2001) 90 Cal.App.4th 335, 346. Only then is there a plausible argument of opening a third party insurer to an excess judgment potentially subject to the assignment of bad faith.

Certainly, not all lawsuits that result in an excess judgment are bad faith lawsuits. The critical question to a bad faith lawsuit lies in what the insurer could and should have done to settle the case within policy limits.

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