82 Hawai'i 120, Best Place, Inc. v. Penn America Ins. Co.

• Decision Date: 05 June 1996
• Docket Number: No. 16065,16065
• Citation: 920 P.2d 334,82 Hawaii 120
• Parties: 82 Hawai'i 120 The BEST PLACE, INC., a Hawai'i corporation, Plaintiff-Appellant/Cross-Appellee, v. PENN AMERICA INSURANCE COMPANY, a foreign corporation, Defendant-Appellee/Cross-Appellant, and John Does 1 through 10; Doe Partnership, Corporation and/or Other Entities 1 through 20, Defendants.
• Court: Hawaii Supreme Court

Page 334

920 P.2d 334

82 Hawai'i 120

The BEST PLACE, INC., a Hawai'i corporation Plaintiff-Appellant/Cross-Appellee, v. PENN AMERICA INSURANCE COMPANY, a foreign corporation Defendant-Appellee/Cross-Appellant and John Does 1 through 10; Doe Partnership, Corporation and/or Other Entities 1 through 20, Defendants.

No. 16065.

Supreme Court of Hawai'i.

June 5, 1996.

As Amended June 21, 1996.

Michael R. Goodheart of Goodheart and Tady, on the briefs, Woodland Hills, CA, for plaintiff-appellant/cross-appellee.

Chuck T. Narikiyo, Chad P. Love and Myles T. Yamamoto of Love & Yamamoto, on the briefs, Honolulu, for defendant-appellant/cross-appellant.

Before MOON, C.J., LEVINSON, NAKAYAMA and RAMIL, JJ., and BURNS, Intermediate Court of Appeals Chief Judge, in place of KLEIN, J., Recused.

NAKAYAMA, Justice.

This appeal and cross-appeal arise from a complaint filed by the plaintiff-appellant/cross-appellee The Best Place, Inc. (Best Place) against its insurer, the defendant-appellee/cross-appellant Penn America Insurance Company (Penn). The complaint alleged the following two counts: (1) breach of contract; and (2) tortious breach of the implied covenant of good faith and fair dealing (the tort of bad faith). Prior to trial, both parties filed various motions in limine. Arguing that Hawai'i does not recognize the tort of bad faith in the insurance context, Penn moved to exclude all evidence, testimony, argument, or comment on the issue of tortious bad faith and/or punitive damages. Penn also moved to exclude, inter alia, evidence of a settlement offer. Best Place moved: (1) to exclude certain evidence based on (a) waiver, (b) estoppel, and (c) Hawai'i Rules of Evidence (HRE) 403; and (2) for default and sanctions against Penn.

The circuit court granted Penn's motion to exclude all evidence dealing with the tort of bad faith, as well as Penn's motions to exclude evidence of the settlement offer. The circuit court also granted Best Place's two pretrial motions. Best Place, with leave of court, filed an interlocutory appeal pursuant to Hawai'i Revised Statutes (HRS) § 641-1(b) (1993), ¹ and Penn filed a cross-appeal.

The primary issue in this appeal is whether Hawai'i recognizes the tort of bad faith refusal to pay a valid claim submitted by an insured under a policy of insurance. For the reasons set forth below, we vacate the circuit court order granting Penn's motion in limine regarding tortious bad faith and hold that Hawai'i recognizes the tort of bad faith in the first-party insurance context.

I. BACKGROUND

In 1986-87, Best Place operated a bar/nightclub in Waikiki. Best Place insured the nightclub against fire under a policy issued in 1987 by Penn. Approximately four months after Penn issued the policy to Best Place, a fire broke out and destroyed the nightclub. Police and fire officials concluded that arson was the cause of the fire.

An investigation by Penn into the nightclub's finances revealed that the nightclub lost money each and every month it was in operation. Furthermore, Penn discovered that, although many of the nightclub's bills were unpaid, the manager and majority stockholder of the nightclub, Sara Hernandez, paid the fire insurance premium with a cashier's check three days prior to the fire.

After the fire, Best Place demanded payment on the insurance policy from Penn. However, because the circumstances surrounding the fire were suspect, Penn insisted that Hernandez submit to an examination under oath. In addition, Penn required that Best Place submit a complete "Proof of Loss" form as mandated under the policy, and requested other documents relevant to Penn's evaluation of the claim. Hernandez failed to submit to an examination under oath and did not turn over the requested documents. Consequently, Penn refused to act on Best Place's demand for payment on the fire insurance policy.

Best Place thereafter retained an attorney. On February 3, 1988, February 19, 1988, and March 23, 1988, the attorney sent letters to Penn's attorney seeking to ascertain the basis of Penn's prior requests, as well as an explanation for non-payment of Best Place's claim. No further communication transpired between the parties, and, on June 20, 1988, Best Place filed a complaint against Penn alleging: (1) breach of contract; and (2) tortious breach of the implied covenant of good faith and fair dealing. Prior to trial, both parties filed a number of motions in limine. Following the circuit court's ruling on these motions, Best Place took an interlocutory appeal pursuant to HRS § 641-1(b). Penn filed a cross-appeal challenging the circuit court's evidentiary rulings. ²

II. STANDARD OF REVIEW

The primary issue on appeal, i.e., whether Hawai'i recognizes the tort of bad faith, is a question of law. Questions of law are reviewable de novo under the right/wrong standard of review. State v. Baranco, 77 Hawai'i 351, 355, 884 P.2d 729, 733 (1994). The other issues on appeal will be discussed in their respective sections.

III. DISCUSSION

A. Implied Covenant of Good Faith and Fair Dealing

Historically, the duty of good faith and fair dealing was implied in contracts with conditions of satisfaction, e.g., a contract for the painting of a portrait or for the supply of materials. ³ However, every contract contains an implied covenant of good faith and fair dealing that neither party will do anything that will deprive the other of the benefits of the agreement. Comunale v. Traders & Gen. Ins. Co., 50 Cal.2d 654, 328 P.2d 198, 200 (1958); Wagenseller v. Scottsdale Memorial Hospital, 147 Ariz. 370, 383, 710 P.2d 1025, 1038 (1985); Kerrigan v. City of Boston, 361 Mass. 24, 278 N.E.2d 387, 393 (1972). But see English v. Fischer, 660 S.W.2d 521, 522 (Tex.1983) (concluding that there is no covenant of good faith and fair dealing implied in every contract).

In the insurance context, courts first recognized the duty of good faith and fair dealing where the issue was whether a liability insurer wrongfully refused to settle a third-party claim. ⁴ The early case of Brassil v. Maryland Casualty Co., 210 N.Y. 235, 104 N.E. 622 (1914), recognized the principle that the obligation of good faith and fair dealing underlies all written agreements and that a breach of this obligation is a breach of contract. In Brassil, the New York Court of Appeals stated:

[T]here is a contractual obligation of universal force which underlies all written agreements. It is the obligation of good faith in carrying out what is written....

[The insured's] rights ... go deeper than the mere surface of the contract written for him [or her] by the [insurer]. Its stipulations imposed obligations based upon those principles of fair dealing which enter into every contract.

Brassil, 104 N.E. at 624. The court then held that the insurer breached its contractual obligation of good faith when it unreasonably failed to settle a third-party settlement offer. Id.

In Hilker v. Western Automobile Ins. Co., 204 Wis. 1, 231 N.W. 257, 259-60 (1930), aff'd on reh'g, 204 Wis. 1, 235 N.W. 413 (1931), the Supreme Court of Wisconsin, citing Brassil, supra, set forth the following rationale for imposing liability upon an insurer who refused to settle a third-party claim within policy limits:

In view of the fact that these contracts of insurance are prepared by the company and not prescribed by law, the tendency of the decisions has been to extend, rather than to circumscribe, the field of liability on the part of the company and to hold that the rights of the insured 'go deeper than the mere surface of the contract written for him by the defendant. Its stipulations imposed obligations based upon those principles of fair dealing which enter into every contract.' Brassil, 104 N.E. at 624, L.R.A. 1915A, 629, 632. The covenant of good faith and fair dealing, of course, is not limited to insurance contracts.

The cornerstone of the decisions in Brassil and Hilker is that, in every contract, there is an implied covenant of good faith and fair dealing.

The obligation to deal in good faith is now a well-established principle of contract law. Restatement (Second) Contracts § 205 (1979) provides that "[e]very contract imposes upon each party a duty of good faith and fair dealing in its performance and its enforcement." In Hawai'i Leasing v. Klein, 5 Haw.App. 450, 456, 698 P.2d 309, 313 (1985), the Intermediate Court of Appeals (ICA) explicitly recognized that parties to a contract have a duty of good faith and fair dealing in performing contractual obligations. ⁵ We also note that the parties to all commercial contracts in this jurisdiction are subject to a statutory duty to perform in good faith. See HRS § 490:1-203 (1993) (providing that "[e]very contract or duty within this chapter imposes an obligation of good faith in its performance or enforcement.").

We now address the question of whether a breach of this duty in the insurance context gives rise to a bad faith cause of action.

B. Bad Faith Cause of Action for Insurer Misconduct

This court has never explicitly recognized a bad faith cause of action for insurer bad faith. Its recognition, however, is wholly consistent with the case law in this jurisdiction, as well as the statutory provisions dealing with insurer misconduct.

1. Case Law Dealing with Insurer Bad Faith

In Gossinger v. Association of Apartment Owners, 73 Haw. 412, 835 P.2d 627 (1992), in which we held that a mistake as to the nature and extent of an insured's injury was not a proper basis for the insured to rescind a release agreement, we quoted with approval the following language from Justice Spear's dissent in Williams v. Glash, 789 S.W.2d 261 (Tex.1990): "Insurers are now faced with a Hobson's choice. If they settle claims promptly, they are not protected from the later assertion of unknown claims. If they refuse to settle until all injuries are known, then they face potential liability under a bad faith claim." Gossinger, 73 Haw. at 424-25 n. 5, ...