Insurance Co. of North America v. Citizensbank of Thomasville

• Decision Date: 25 April 1986
• Parties: INSURANCE COMPANY OF NORTH AMERICA v. CITIZENSBANK OF THOMASVILLE 83-1416.
• Court: Alabama Supreme Court

Page 880

491 So.2d 880

INSURANCE COMPANY OF NORTH AMERICA v. CITIZENSBANK OF THOMASVILLE

83-1416.

Supreme Court of Alabama.

April 25, 1986.

Rehearing Denied June 13, 1986.

Robert L. Williams and Robert D. Norman of Norman, Fitzpatrick & Wood, Birmingham, for appellant.

Richard T. Dorman and James H. Frost of Johnstone, Adams, Howard, Bailey & Gorman, Mobile, and Wyman O. Gilmore, Grove Hill, for appellee.

TORBERT, Chief Justice.

This is an appeal by the Insurance Company of North America ("INA") from a judgment in favor of Citizensbank of Thomasville based on a jury verdict finding a bad faith refusal to pay an insurance claim.

Prior to Citizensbank's opening in August 1975, it obtained a banker's blanket bond from INA. The bond included fidelity coverage for fraudulent or dishonest acts of the officers and employees of the Bank. On June 9, 1977, an amendatory rider was added which defined "dishonest or fraudulent acts" to mean acts committed by an employee with the manifest intent to cause the insured to sustain a loss and to obtain financial benefit for the employee or another intended person.

This case stems from the actions of Thomas Branch, the president and chief executive officer of Citizensbank from its opening until June of 1978. Branch was replaced on June 15, 1978, by Eldon Scott, who thereafter filed, on behalf of the Bank, nine proof of loss forms with INA claiming that losses suffered by Citizensbank were the result of fraudulent and dishonest acts by Thomas Branch. These alleged acts included embezzlement of insurance commissions, making fraudulent loans, inside dealing, fraudulent nondisclosure, and submission of intentionally misleading documents. Branch subsequently pleaded guilty to charges of embezzlement and was convicted and put on probation under a suspended sentence in both state court and federal court proceedings.

A brief synopsis of the losses claimed by Citizensbank is as follows:

A. Green Group--Loans to GBW Industries, Inc., a corporation owned by the Green brothers, resulted in a $108,171.45 claimed loss, and in addition, overdrafts in the amount of $46,870.30 from January 5, 1978, to May 4, 1978, and overdrafts in the amount of $48,127.67 from May 5, 1978, to June 3, 1978. GBW Industries, Inc., filed for bankruptcy on May 5, 1978.

B. Ott Group--A loan guaranteed by the Small Business Administration resulted in a claimed loss of $93,662.57, and other loans to the Ott family resulted in claimed losses of $113,811.73. Branch was indicted and convicted of a crime in regard to the S.B.A. loan.

C. Automobile Loans--Richard Hall and Billy Strickland, directors of Citizensbank, each owned an automobile dealership and each had an agreement with the Bank to finance the automobiles for his customers. The Bank claimed a loss of $77,231.42 on the Hall loans and $30,990.26 on the Strickland loans.

D. Direct Claims Against Tom Branch--The Bank claimed Branch embezzled $4,134.51, representing commissions on credit life insurance sold by the Bank. Branch was indicted for this embezzlement, pleaded guilty, and was placed on probation. Also, a loan made to Branch, in violation of Code 1975, §§ 5-6-25, -26, -29 (repealed), resulted in a claimed loss of $6,373.29.

INA never formally denied any of the claims, but Citizensbank filed this lawsuit on February 5, 1981, to avoid a 24-month contractual bar for bringing suit on the bond, and claimed a "de facto denial." The complaint asked for $606,000 on the contract claim and $2,000,000 on the bad faith claim.

At trial, Citizensbank was able to introduce evidence of only $454,658.34 of contract claim losses. On June 15, 1984, a jury awarded Citizensbank $290,431.77 on the breach of contract count and $866,930.01 on the bad faith count. INA's motion for JNOV or, in the alternative, a new trial was subsequently denied. INA paid the amount of the breach of contract judgment but initiated this appeal from the judgment against it for bad faith and the denial of its motion for JNOV or a new trial.

To recover under a theory of bad faith in Alabama, a plaintiff has a "heavy burden" to prove each element of bad faith. National Savings Life Ins. Co. v. Dutton, 419 So.2d 1357, 1361 (Ala.1982). The elements which must be proved are as follows:

" '(a) an insurance contract between the parties and a breach thereof by the defendant;

" '(b) an intentional refusal to pay the insured's claim;

" '(c) the absence of any reasonably legitimate or arguable reason for that refusal (the absence of a debatable reason);

" '(d) the insurer's actual knowledge of the absence of any legitimate or arguable reason;

" '(e) if the intentional failure to determine the existence of a lawful basis is relied upon, the plaintiff must prove the insurer's intentional failure to determine whether there is a legitimate or arguable reason to refuse to pay the claim.' "

Mueller v. Hartford Ins. Co. of Alabama, 475 So.2d 554, 556 (Ala.1985), quoting National Security Fire & Cas. Co. v. Bowen, 417 So.2d 179, 183 (Ala.1982); Dutton, 419 So.2d at 1361.

The test in Alabama for a finding of bad faith is recognized as a "two-tier" test. The first tier of the test "establishes that the tort of bad faith refusal to honor a direct claim arises when there exists no lawful basis for the refusal coupled with actual knowledge of that fact." Gulf Atlantic Life Ins. Co. v. Barnes, 405 So.2d 916, 924 (Ala.1981).

The second tier of the test involves an "intentional failure to determine whether or not there was any lawful basis for refusal," or, in other words, "whether a claim was properly investigated and whether the results of the investigation were subjected to a cognitive evaluation and review." Barnes, supra.

In the case at bar, both tiers of the two-tier test are being forcefully argued. The appellant, INA, argues that the first tier of the test is not met because the jury only awarded a portion of the contract claim, and therefore that a lawful basis, or at least a debatable reason, must have existed for the refusal of the entire amount being claimed. Furthermore, INA argues that the claims were properly investigated, INA having hired a CPA to perform the investigation and the investigation having entailed over 400 hours of work and the compilation of a 17-volume report.

On the other hand, the appellee, Citizensbank, argues that INA never had a lawful basis for refusing the claims, and that the fact that Thomas Branch was indicted and was found guilty in regard to two of the claims clearly shows the absence of a lawful basis for refusal. Furthermore, Citizensbank argues that the investigation by INA was inadequate and was merely preparation for trial, and that the investigation was designed solely to support its own position. See, Barnes, supra.

I

The evidence in this case shows that the insurance claims filed by Citizensbank were based on a number of banking transactions. The record indicates that these transactions were financially complex and involved a large number of parties and bank documents. Moreover, the transactions were the products of approximately three years of a bank's continuous daily business operations.

The evidence shows that Citizensbank first gave notice of possible losses to INA on September 9, 1978. The actual date of discovery of all of these losses was stipulated to be February 6, 1979. At that time, Citizensbank began its process of evaluating its own losses and preparing proofs of loss to be filed with INA. On April 11, 1979, Citizensbank filed its first proofs of loss with INA, along with notice that more proofs would be forthcoming. Approximately eight months later, on December 5, 1979, Citizensbank filed its final proofs of loss with INA, along with a supplement to its first filings.

The next 14 months were spent by INA in its investigation and evaluation of the claims filed by Citizensbank. Testimony indicated that INA was in the process of preparing a response to these claims when this lawsuit was filed on February 5, 1981 and a constructive denial was alleged by Citizensbank.

In Dutton, supra, we attempted to set forth a workable test for the tort of bad faith refusal to pay. There, we stated:

"In the normal case in order for a plaintiff to make out a prima facie case of bad faith refusal to pay an insurance claim, the proof offered must show that the plaintiff is entitled to a directed verdict on the contract claim and, thus, entitled to recover on the contract claim as a matter of law. Ordinarily, if the evidence produced by either side creates a fact issue with regard to the validity of the claim and, thus, the legitimacy of the denial thereof, the tort claim must fail and should not be submitted to the jury."

Dutton, 419 So.2d at 1362. However, because the decision of the insurance company to deny a claim under an insurance policy must be judged by what was before it at the time the decision was made, Federated Guaranty Life Ins. Co. v. Wilkins, 435 So.2d 10, 13 (Ala.1983); Dutton, 419 So.2d at 1362, and because many things may have happened between the time the denial was made and the time the case came to trial, the Dutton test may be restated to provide as follows: In the ordinary case, in order for the plaintiff to recover on a bad faith claim, the plaintiff must show that if the contract claim had been tried on the date of the denial, the plaintiff would have been entitled to a directed verdict; i.e., information received by the insurer after the date of the denial is irrelevant to the determination of whether the insurer denied at that date in bad faith. Although no express denial was ever made by INA in this case, we will consider that a constructive denial occurred at the end of the 24-month limitation set in the terms of the bond for filing suit to recover under the bond. Therefore, we must examine what was before INA at the time of the constructive denial.

On the date of the constructive denial, INA had in its possession the...