Federal PA Court Permits “Bad Faith Set-Up” as a Defense to Insured’s Bad Faith Claim

by Nelson Brown & Co.

A Pennsylvania federal court recently allowed an insurer to plead “bad faith set-up” as a defense to, or “avoidance” of, a bad faith cause of action. The plaintiffs in Shannon v. New York Central Mutual Insurance Company who were injured by the insured alleged that the insurer’s refusal to pay policy limits on behalf of its insured in a timely manner amounted to bad faith and sought punitive damages under Pennsylvania’s bad faith statute. (The plaintiffs acquired standing to bring the action against the insurer by assignment from the insured).

In its answer, the insurer responded that the cause for delay was not bad faith. It was due to the plaintiffs’ own actions in “creating pretexts and manufacturing conditions under which the main goal was not to settle the underlying matter at fair and reasonable value, but rather to manufacture the very bad faith claim the [plaintiffs] now [make].”

New York Central Mutual described the plaintiffs’ conduct as a “bad faith set-up,” which included making a settlement demand with an unreasonably quick deadline to accept and withholding necessary documentation making it impossible for the insurer to evaluate the claim before the lapse of the demand. The insurer claimed that by engaging in such conduct to allege bad faith, the plaintiffs purposefully put themselves in a position to collect punitive damages that dwarf the policy’s $25,000 limit of liability and far exceed the reasonable value of the injury. Although the insurer eventually offered policy limits upon the completion of its claim evaluation, the plaintiffs rejected the offer on grounds that they had already “incurred the time and expense of written discovery and depositions.”

The plaintiffs moved to strike these allegations from the answer, arguing that “bad faith set-up” is not a recognized affirmative defense. The U.S. District Court for the Middle District of Pennsylvania sided with the insurer reasoning that most of the insurer’s allegations of a “bad faith set-up” were “reasonably related” to its defense against the bad faith claim under FRCP 8(c), which sets forth the pleading rules. While the court refrained from discussing the merits and viability of such a defense under Pennsylvania law, it nevertheless ruled that if the allegations of a “bad faith set-up” were proven, it would assist in establishing an “avoidance” of the bad faith claim.

Notably, the court did strike certain portions of the insurer’s “bad faith set-up” defense for vagueness because those portions referred to violations of unspecified state and federal criminal statutes and did not satisfy the “fair notice” requirement of the federal pleading rules.

There is some case law already recognizing an insurer’s right to bring a claim against its insured for the breach of the duty of good faith and fair dealing, i.e. the so-called “reverse bad faith” claim, Garvey v. National Grange Mut. Ins. Co., 167 f.R.D. 391 (E.D. Pa. 1996). This recent decision green-lights a novel approach to combating a common practice of claimants who engage in “bad faith set-up” tactics for the sole purpose of obtaining punitive damages. In light of this decision, insurers would be prudent to maintaining good records and documentation of communications with claimants, especially with regards to settlement offers and timing.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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