State Farm Fire & Cas. Co. v. Nicholson

• Decision Date: 21 July 1989
• Docket Number: No. S-2303,S-2303
• Citation: 777 P.2d 1152
• Parties: STATE FARM FIRE & CASUALTY COMPANY, Appellant, v. David G. NICHOLSON and Doreen C. Nicholson, husband and wife, Appellees.
• Court: Alaska Supreme Court

Page 1152

777 P.2d 1152

58 USLW 2115

STATE FARM FIRE & CASUALTY COMPANY, Appellant, v. David G. NICHOLSON and Doreen C. Nicholson, husband and wife, Appellees.

No. S-2303.

Supreme Court of Alaska.

July 21, 1989.

Rehearing Denied Aug. 24, 1989.

Kenneth P. Jacobus, Hughes, Thorsness, Gantz, Powell & Brundin, Anchorage, for appellant.

Ralph B. Cushman, Anchorage, for appellees.

Before MATTHEWS, C.J., and RABINOWITZ, BURKE, COMPTON and MOORE, JJ.

OPINION

MOORE, Justice.

David and Noreen Nicholson sued State Farm Fire & Casualty Company for unreasonably and willfully breaching its duty to act in good faith. The Nicholsons alleged that State Farm did not promptly settle a claim under their homeowner's policy. The jury returned a special verdict in favor of the Nicholsons, awarding $105,700 in compensatory damages and $7,500 in punitive damages. On appeal, we address whether the breach of the implied covenant of good faith and fair dealing in "first-party" insurance cases is a tort, thereby possibly justifying an award of punitive damages, and whether the award of prejudgment interest was appropriate.

I.

In 1981, the Nicholsons purchased homeowner's insurance from State Farm, covering their residence at 1841 Early View Drive in Anchorage. In the event the Nicholsons suffered a loss that was covered, the policy obligated State Farm "to place the insured back in the situation they were in prior to the loss."

In February, 1983 a water main belonging to Central Alaska Utilities, Inc. broke. The water main was buried eight feet underground and ran beside the Nicholson house and other houses in the subdivision. The escaping water caused the soil underneath the house to erode and settle. More than a year later, on March 27, 1984, the Nicholsons first contacted State Farm to report the loss. On April 6, 1984 Vere Hotchkiss, claims adjuster for State Farm, made an initial on-premise inspection, and returned again on April 11, 1984 with an engineer to conduct another inspection. Relying on the Franklin & Allen engineering report issued on April 13, 1984, which stated two possibilities for the loss i.e. water alone or permafrost and earth settling, State Farm denied coverage on April 22, 1984, because its policy contained an exclusion for broad water damage and damage caused by earth movement. Furthermore, the Franklin & Allen report recommended that the Nicholson house be observed during the winter of 1984-1985 to determine if any more settling would occur. Another consulting engineering report agreed with the Franklin & Allen report that a problem with the Nicholson house was permafrost degradation.

In the meantime, State Farm agreed to cover the Nicholsons' next door neighbor for the same loss. On June 14, 1984 State Farm now agreed to extend coverage to the Nicholsons for their loss and requested them to obtain property appraisals. On August 15, 1984 a general contractor J.B. White, Inc. inspected the premises and declined to give a repair estimate to the Nicholsons until a soil survey was performed. In September 1984, Shannon & Wilson drilled two test holes and issued two reports to the Nicholsons on October 23 and December 3, 1984. During the winter of 1985 engineers took perimeter levels around the house twice a month until March 11, 1985. During this time the Nicholsons experienced electrical and structural problems in their house. They were upset with the delay in fixing their house.

On May 29, 1985, a new State Farm adjuster, Roberta Halcro contacted the Nicholsons and requested they contact David Chapman of Pac-Rim Construction Services to provide an estimate for the repair of the house by either demolition or replacement. The Pac-Rim repair report was issued on June 14, 1985 and both repair estimates exceeded $163,000, well in excess of the policy limits of $113,264.

State Farm then obtained an appraisal of the property with improvements as of September 24, 1985 for $98,200, and offered to pay that amount plus additional reimbursement for repair or replacement costs up to the policy limits. The offer was made on October 9, 1985. The Nicholsons rejected this offer and filed suit against State Farm on October 17, 1985. ¹

At trial in March 1987, State Farm offered testimony from several witnesses that the adjustment of this claim was highly unusual, difficult, and complex. The Nicholsons offered testimony from Robert Lowe, as an expert independent claim adjuster, that State Farm's delay in deciding coverage and settlement of the claim was unreasonable and outrageous.

II.

State Farm argues that the tort of bad faith handling of insurance claims should only be recognized in the context of liability claims, also known as third-party claims, ² and not in first-party cases, in which an insured seeks coverage for losses he or she incurred. ³ The Nicholsons argue that Alaska should recognize the tort of bad faith in first-party as well as third-party cases.

The tort of bad faith in the insurance context can be traced to the covenant of good faith and fair dealing, a contractual duty implied in all insurance policies. W. Shernoff, supra note 1, § 2.01. Jurisdictions differ in their treatment of a breach of the implied covenant of good faith and fair dealing in the insurance context. Some jurisdictions characterize the cause of action as merely a breach of contract; others characterize the cause of action as a tort in third-party cases but not first-party cases; still others characterize the cause of action as a tort in both first-party and third-party cases. Id. §§ 2.01-2.02 (and cases cited therein); see also 15A R. Anderson, Couch Cyclopedia of Insurance Law § 58.3 (1983).

Courts first recognized the tort of bad faith in third-party cases. W. Shernoff, supra note 1, § 1.07, at 1-24 to 1-25. The California Supreme Court was the first to apply the tort of bad faith to first-party cases. See Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 108 Cal.Rptr. 480, 510 P.2d 1032 (1973). In Gruenberg, after fire damaged the insured's restaurant, the insured sought to recover his loss pursuant to a fire policy. After the insurer denied liability under the policy, the insured sued for the tort of bad faith. The court extended its prior holdings, which recognized the tort of bad faith in third-party cases, ⁴ to the first-party case before it. Id., 108 Cal.Rptr. at 485-86, 510 P.2d at 1037-38. The court reasoned that, in third-party cases,

we considered the duty of the insurer to act in good faith and fairly in handling the claims of third persons against the insured, described as a "duty to accept reasonable settlements"; in the case before us we consider the duty of an insurer to act in good faith and fairly in handling the claim of an insured, namely a duty not to withhold unreasonably payments due under a policy. These are merely two different aspects of the same duty. That responsibility is not the requirement mandated by the terms of the policy itself--to defend, settle, or pay. It is the obligation, deemed to be imposed by the law, under which the insurer must act fairly and in good faith in discharging its contractual responsibilities. Where in so doing, it fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing.

Id. at 1037 (emphasis in original).

Since Gruenberg, a great number of other jurisdictions have recognized the tort of bad faith in first-party cases. ⁵

In Noble v. National American Life Insurance Co., 128 Ariz. 188, 624 P.2d 866, 867-68 (Ariz.1981), the Arizona Supreme Court, in following Gruenberg, noted:

We are persuaded that there are sound reasons for recognizing the rule announced in Gruenberg. The special nature of an insurance contract has been recognized by courts and legislatures for many years.... An insurance policy is not obtained for commercial advantage; it is obtained as protection against calamity. In securing the reasonable expectations of the insured under the insurance policy there is usually an unequal bargaining position between the insured and the insurance company.... Often the insured is in an especially vulnerable economic position when such a casualty loss occurs. The whole purpose of insurance is defeated if an insurance company can refuse or fail, without justification, to pay a valid claim. We have determined that it is reasonable to conclude that there is a legal duty implied in an insurance contract that the insurance company must act in good faith in dealing with its insured on a claim, and a violation of that duty of good faith is a tort.

(Citations omitted). ⁶ In White v. Unigard Mutual Insurance Co., 112 Idaho 94, 730 P.2d 1014 (1986), the Idaho Supreme Court raised an additional policy justification for holding that the breach of the covenant of good faith and fair dealing sounds in tort:

An action in tort provides a remedy for harm done to insureds though no breach of an express contractual covenant has occurred and where contract damages fail to adequately compensate insureds.... [T]he requirement that contract damages be foreseeable at the time of contracting, in some cases would bar recovery for damages proximately caused by the insurer's bad faith. The measurement of recoverable damages in tort is not limited to those foreseeable at the time of the tortious act; rather they include "[a] reasonable amount which will compensate plaintiff for all actual detriment proximately caused by the defendant's wrongful conduct."

Id., 730 P.2d at 1017-18 (citations omitted). The Texas Supreme Court discussed both justifications in its decision to recognize a common-law cause of action for breach of the duty of good faith and fair dealing:

In the insurance context a special relationship arises out of the parties' unequal bargaining power and the nature of...