Erie Ins. Co. v. Hickman by Smith

Decision Date27 October 1993
Docket NumberNo. 29S02-9310-CV-1180,29S02-9310-CV-1180
Citation622 N.E.2d 515
CourtIndiana Supreme Court
PartiesERIE INSURANCE COMPANY, Appellant, (Defendant Below) v. Ramona HICKMAN, by her Next Friend Nancy SMITH, and Nancy Smith, Individually, Appellee. (Plaintiffs Below)

KRAHULIK, Justice.

We grant transfer to reaffirm the existence of a duty that an insurer deal in good faith with its insured, and to recognize a cause of action in tort for the breach of that duty.

In this case, Ramona Hickman and Nancy Smith (Plaintiffs-Appellees below) filed a first-party claim against Erie Insurance Company (Defendant-Appellant below). Plaintiffs sought a recovery for the breach of an insurance contract and for punitive damages because Erie denied their claims. Judgment was entered on the jury's verdict awarding both compensatory and punitive damages. Erie appealed the award of punitive damages on the grounds that there was insufficient evidence.

In the original appeal, a majority of the Court of Appeals reversed the award of punitive damage. Erie Ins. Co. v. Hickman (1991), Ind.App., 580 N.E.2d 320. We granted transfer and remanded for reconsideration because the Court of Appeals applied an erroneous standard of review. Erie Ins. Co. v. Hickman (1992), Ind., 605 N.E.2d 161. On remand, the Court of Appeals again reversed the award of punitive damages on the grounds that punitive damages were not recoverable in a breach of contract action. Erie Ins. Co. v. Hickman (1993), Ind.App., 610 N.E.2d 283. Plaintiffs seek transfer from that decision.

The basis for the second reversal of the punitive damage award in the Court of Appeals was our decision in Miller Brewing Co. v. Best Beers of Bloomington, Inc. (1993), Ind., 608 N.E.2d 975. In Best Beers, we held that to recover punitive damages in a lawsuit founded upon a breach of contract, the plaintiff must plead and prove the existence of an independent tort of the kind for which Indiana law recognizes that punitive damages may be awarded. Id. at 984. Our intent in Best Beers was to prohibit the recovery of punitive damages, which is a tort remedy, where no tort had been established.

Before our decision in Best Beers, dicta in Vernon Fire & Cas. Ins. Co. v. Sharp (1976), 264 Ind. 599, 608, 349 N.E.2d 173, 180, suggested that it was appropriate for an insured to recover punitive damages from an insurer when the insurer's breach of the insurance contract was accompanied by a serious wrong, tortious in nature. Thereafter, Indiana courts declined to recognize the existence of a separate tort remedy where an insurer failed to act in good faith because Vernon Fire allowed the substantial equivalent. See, e.g., Liberty Mutual Ins. Co. v. Parkinson (1985), Ind.App., 487 N.E.2d 162, 165, where the court wrote that "[d]ue to our development of this special contractual remedy which affords the insured a more generous measure of damages, we have found no reason to adopt bad faith as an independent tort in this State, and we see no need to adopt such an action now."

Our decision in Best Beers eliminated this "special contractual remedy." However, the contract at issue in Best Beers did not involve insurance and, as a result, we did not address the question of whether a tort remedy was available to an insured when the insurer fails to fulfill duties imposed upon it by law.

It is axiomatic that tort obligations arise, not from an agreement between the parties, but by operation of law. Webb v. Jarvis, (1991), Ind., 575 N.E.2d 992, 995; Peru Heating Co. v. Lenhart (1911), 48 Ind.App. 319, 326, 95 N.E. 680, 683 ("a tort denotes an injury inflicted otherwise than by a mere breach of contract; ... a tort is one's disturbance of another in rights which the law has created, either in the absence of contract or in consequence of a relation which a contract has established between the parties.") Indiana law has long recognized that there is a legal duty implied in all insurance contracts that the insurer deal in good faith with its insured. Vernon Fire, 264 Ind. at 609, 349 N.E.2d at 181; Wedzeb Enterprises v. Aetna Life & Cas. Co. (1991), Ind.App., 570 N.E.2d 60, 63; Liberty Mutual v. Parkinson, 487 N.E.2d at 164. Whether breach of this duty constitutes a tort involves a judicial balancing of three factors: (1) the relationship between the parties, (2) the reasonable foreseeability of harm to the person injured, and (3) public policy concerns. Webb v. Jarvis, 575 N.E.2d at 995.

Clearly, a relationship exists between an insurer and its insured because they are in privity of contract. However, the existence of a contract, standing alone, does not give rise to the required "special relationship" to support imposition of a tort duty. Rather, it is the unique character of the insurance contract which supports the conclusion that there is a "special relationship." This contractual relationship is at times a traditional arms-length dealing between two parties, as in the initial purchase of a policy, but is also at times one of a fiduciary nature, see, e.g., Richey v. Chappell (1992), Ind., 594 N.E.2d 443, 447 (statements from the insured to the insurer concerning an occurrence which may be made the basis of a claim by a third party are privileged from disclosure by the attorney-client privilege), and, at other times, an adversarial one, as here in the context of a first-party claim. Easily foreseeable is the harm that proximately results to an insured, who has a valid claim and is in need of insurance proceeds after a loss, if good faith is not exercised in determining whether to honor that claim. See, e.g., Vernon Fire, 264 Ind. at 609, 349 N.E.2d at 181. Given the sui generis nature of insurance contracts, then, we conclude that it is in society's interest that there be fair play between insurer and insured. These factors, coupled with our return to the rule of no punitive damages in contract cases, leads us to conclude that recognition of a cause of action for the tortious breach of an insurer's duty to deal with its insured in good faith is appropriate. 1

We need not determine the precise extent of that duty today. 2 However, we make these general observations. The obligation of good faith and fair dealing with respect to the discharge of the insurer's contractual obligation includes the obligation to refrain from (1) making an unfounded refusal to pay policy proceeds; (2) causing an unfounded delay in making payment; (3) deceiving the insured; and (4) exercising any unfair advantage to pressure an insured into a settlement of his claim. Neither do we need to decide the precise nature and extent of damages recoverable in such an action. In tort, all damages directly traceable to the wrong and arising without an intervening agency are recoverable. Symon v. Burger (1988), Ind.App., 528 N.E.2d 850, 852. By contrast, the measure of damages in a contract action is limited to those actually suffered as a result of the breach which are reasonably assumed to have been within the contemplation of the parties at the time the contract was formed. Indiana & Mich. Elec. Co. v. Terre Haute Industries, Inc. (1987), Ind.App., 507 N.E.2d 588, 601; Indiana University v. Indiana Bonding & Surety Co. (1981), Ind.App., 416 N.E.2d 1275, 1288. Nonetheless, in most instances, tort damages for the breach of the duty to exercise good faith will likely be coterminous with those recoverable in a breach of contract action.

We also note that this new cause of action does not arise every time an insurance claim is erroneously denied. For example, a good faith dispute about the amount of a valid claim or about whether the insured has a valid claim at all will not supply the grounds for a recovery in tort for the breach of the obligation to exercise good faith. This is so even if it is ultimately determined that the insurer breached its contract. That insurance companies may, in good faith, dispute claims, has long been the rule in Indiana. Vernon Fire, 264 Ind. at 609-10, 349 N.E.2d at 181; Indiana Ins. Co. v. Plummer Power Mower (1992), Ind.App., 590 N.E.2d 1085, 1093; CIGNA-INA/Aetna v. Hagerman-Shambaugh (1985), Ind.App., 473 N.E.2d 1033, 1036; Town & Country Mutual Ins. Co. v. Hunter (1984), Ind.App., 472 N.E.2d 1265, 1268; Hoosier Ins. Co. v. Mangino (1981), Ind.App., 419 N.E.2d 978, 982; First Fed. Sav. and Loan Assoc. v. Mudgett (1979), Ind.App., 397 N.E.2d 1002, 1008. As the Court wrote in Vernon Fire:

It is evident that the exercise of [the right to disagree as to the amount of recovery] may directly result in the intentional infliction of temporal damage, including the damage of interference with an insured's business (which an insured will undoubtedly consider to be oppressive). The infliction of this damage has generally been regarded as privileged, and not compensable, for the simple reason that it is worth more to society than it costs, i.e., the insurer is permitted to dispute its liability in good faith because of the prohibitive social costs of a rule which would make claims nondisputable.

264 Ind. at 609-10, 349 N.E.2d at 181. Similarly, the lack of diligent investigation alone is not sufficient to support an award. See Continental Cas. Co. v. Novy (1982), Ind.App., 437 N.E.2d 1338. On the other hand, for example, an insurer which denies liability knowing that there is no rational, principled basis for doing so has breached its duty. See, e.g., Town & Country Mutual, 472 N.E.2d at 1268; Hoosier Ins. Co. v. Mangino, 419 N.E.2d at 983.

Thus, an insured who believes that an insurance claim has been wrongly denied may have available two distinct legal theories, one in...

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