Insurers Beware: Defending Bad Faith Claim May Lead to Waiver of Privileged Communications

by Cozen O'Connor
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On July 27, 2016, the United States District Court for South Carolina ordered an insurer to turn over its privileged communications. The Court explained that the insurer waived the protections afforded under the attorney-client privilege and work product doctrine by asserting it acted in good faith in the defense of its insured. See State Farm Fire & Casualty Co., et al. v. Admiral Ins. Co., 2016 WL 4051271 (D. S.C. July 25, 2016). While this is a district court opinion and may be subject to appeal, insurers should still be cognizant of the issue.

James McElveen filed suit after he was seriously injured during a fraternity hazing event hosted by Maurice Robinson and Phi Beta Sigma Fraternity. Robinson tendered the suit for defense and indemnification to Phi Beta’s insurer, Admiral Insurance Company. Admiral denied coverage. Robinson’s homeowners’ insurer, State Farm Fire & Casualty Company, provided him a defense. Admiral settled McElveen’s claims against Phi Beta and others prior to trial, leaving Robinson as the lone defendant. The case was tried and verdict was entered against Robinson. State Farm ultimately settled the judgment for $975,000.

State Farm then filed suit against Admiral for a declaratory judgment that Admiral must reimburse State Farm for the settlement and all fees and costs incurred in the underlying defense. State Farm alleged that Robinson was entitled to a defense and indemnification under the Phi Beta policy, and that Admiral acted in bad faith in denying coverage. Part of the damages claimed by State Farm included damages for the emotional distress and humiliation Robinson allegedly sustained from the media attention related to the trial.

Admiral countersued State Farm for bad faith. State Farm apparently had the opportunity to settle the case within its policy limits of $300,000 prior to trial. Admiral alleged that State Farm’s wrongful refusal to settle caused Robinson’s claimed emotional distress damages in having to go to trial. In answering the counterclaim’s allegations, State Farm admitted it owed Robinson a duty to act in good faith and asserted “it did so.”

Admiral sought discovery related to State Farm’s decision not to settle, and its communications with Robinson discussing the consequences. State Farm objected that the information sought was protected by the attorney-client privilege, work product doctrine, and common interest doctrine.  Although the Court agreed, it nonetheless ordered State Farm to produce the requested information.  The Court, relying on a South Carolina district court case involving an insurer’s communications with its own counsel, explained that by asserting that it did act in good faith in handling the claims asserted against Robinson, State Farm put its communications with Robinson at issue and therefore waived the attorney-client privilege and work product protections.  In other words, the court held that the insurer could not use the substance of the communications with its insured as both a sword (we acted in good faith) and a shield (but we are not going to tell you what we said to our insured).

So what does this mean? How can an insurer defend against bad faith allegations and protect its privileged communications? Potentially, the insurer should maintain communications with the insured separate from communications that include the insurer’s counsel.  The Court’s ruling indicates that an insurer must proceed with caution, at least in South Carolina.

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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