Taylor v. State Farm Mut. Auto. Ins. Co., CV-94-0505-PR

CourtSupreme Court of Arizona
Writing for the CourtFELDMAN; ZLAKET, V.C.J., and MOELLER
Citation185 Ariz. 174,913 P.2d 1092
PartiesBobby Sid TAYLOR, Plaintiff-Appellant/Cross-Appellee, v. STATE FARM MUTUAL AUTOMOBILE INSURANCE COMPANY, an Illinois corporation, Defendant-Appellee/Cross-Appellant.
Docket NumberNo. CV-94-0505-PR,CV-94-0505-PR
Decision Date11 April 1996

FELDMAN, Chief Justice.

Bobby Sid Taylor sought this court's review of a court of appeals' opinion holding that his bad faith claim against State Farm Mutual Insurance Company ("State Farm") was barred by the statute of limitations. See Taylor v. State Farm Mut. Auto. Ins. Co., 182 Ariz. 39, 893 P.2d 39 (1994) ("Taylor II "). We granted review to determine the date of accrual of a cause of action for bad faith refusal to settle a liability claim against the insured, and whether such a claim is governed by a contract or tort statute of limitations. 1 We have jurisdiction pursuant to Ariz. Const. art. VI, § 5(3), and Ariz.R.Civ.App.P. 23.


This is the second appeal to this court arising out of an automobile accident that occurred some nineteen years ago, on April 9, 1977, when Bobby Sid Taylor negligently injured Anne Ring and James Rivers. The facts of that accident are set forth in Ring v. Taylor, 141 Ariz. 56, 685 P.2d 121 (App.1984) ("Ring I "). Ring, her husband, and Rivers filed personal injury actions against Taylor.

Taylor was insured by State Farm under a policy carrying a liability limit of $50,000. State Farm designated attorney Hofmann to defend Taylor in the personal injury action. Taylor personally retained attorney Randall, who filed a counterclaim against Ring. Although Ring and Rivers agreed to settle by accepting the policy limit, State Farm refused. The case went to trial, and on March 30, 1981, the jury returned a verdict against Taylor, awarding Rivers and Ring $1.3 million each, and Ring's husband $21,500 for loss of consortium. These verdicts exceeded Taylor's liability coverage by more than $2.6 million. Without filing a supersedeas bond or obtaining an order staying execution, State Farm appealed; the court of appeals affirmed the judgment in March 1984, and this court denied review. Id.

While that case was on appeal, Ring attempted to garnish any bad faith claim Taylor might have against State Farm for the latter's failure to settle within the policy limits. Because Taylor had not assigned his bad faith action to Ring, the court of appeals dismissed the proceeding and quashed Ring's writ of garnishment. Ring v. State Farm Mut. Auto. Ins. Co., 147 Ariz. 32, 708 P.2d 457 (App.1985) ("Ring II "). In June 1985, State Farm settled with Ring.

On July 17, 1985, Taylor sued State Farm for bad faith based on the excess judgment in favor of Rivers resulting from State Farm's refusal to settle Rivers' claim within Taylor's $50,000 policy limits. On June 17, 1987, a jury returned a verdict in favor of Taylor and against State Farm for $2.1 million compensatory damages and $300,000 in attorneys' fees. State Farm again appealed, and on September 17, 1987, the court of appeals held that Taylor's claim against State Farm was barred under the terms of a prior release between the parties. Taylor v. State Farm Mut. Auto Ins. Co., No. 1 CA-CV 9908 (1991) (mem. dec.). 2 This court vacated that decision on June 10, 1993, holding that "extrinsic evidence supported Taylor's contention that the release language was not intended to release his bad faith claim," leaving intact the jury's verdict in favor of Taylor on the release issue. Taylor v. State Farm Mut. Auto. Ins. Co., 175 Ariz. 148, 158-59, 854 P.2d 1134, 1144-45 (1993) ("Taylor I "). We remanded to the court of appeals to address the remaining issues. Id. The court of appeals again reversed the judgment for Taylor, this time on statute of limitations grounds. The court held that the two-year statute of limitations applied to Taylor's bad faith claim and that the action accrued in March 1981, at the time the excess verdict was rendered. Taylor II, 182 Ariz. at 46, 893 P.2d at 46. That opinion is the subject of this review proceeding.

A. Are bad faith claims governed by a tort or a contract statute of limitations?

Bad faith actions against insurers usually fall into the category of "first-party" or "third-party" actions, depending on the type of coverage at issue. Clearwater v. State Farm Mut. Auto. Ins. Co., 164 Ariz. 256, 258, 792 P.2d 719, 721 (1990). An action alleging that the insurer acted in bad faith in its duty to indemnify or protect the insured from third-party claims is governed by a third-party claims analysis, regardless of whether the insured or the third party sues the insurer. Id. In contrast, first-party actions arise out of a direct obligation by which the carrier contracts to pay benefits directly to the insured (or a beneficiary) for losses incurred by either. Id.; see also Department of Ins. Rules, Art. 8, R4-14-801(B)(4), (10) (defining first- and third-party claimants). Because Taylor's action finds fault with State Farm's failure to protect Taylor from Rivers' claim, the third-party analysis applies.

A cause of action for bad faith refusal to settle was recognized by this court as a valid third-party claim in Farmers Ins. Exch. v. Henderson, 82 Ariz. 335, 338, 313 P.2d 404, 405-06 (1957). The cause of action stems from the duty of good faith and fair dealing, which is derived from the underlying contractual relationship and is implied in all contracts. Rawlings v. Apodaca, 151 Ariz. 149, 154, 726 P.2d 565, 570 (1986); Wagenseller v. Scottsdale Memorial Hospital, 147 Ariz. 370, 383, 710 P.2d 1025, 1038 (1985). The duty of good faith requires that neither party act in a manner that would damage the rights of the other party to receive the benefits flowing from the underlying contractual relationship. Rawlings, 151 Ariz. at 153-54, 726 P.2d at 569-70; Wagenseller, 147 Ariz. at 383, 710 P.2d at 1038.

Although the underlying contract provides the basis for a bad faith action, this court has recognized the insurance carrier's breach of the duty of good faith as a tort. Noble v. National Am. Life Ins. Co., 128 Ariz. 188, 189, 624 P.2d 866, 867 (1981). Moreover, the court of appeals has applied the tort statute of limitations to bad faith claims. Ness v. Western Sec. Life Ins. Co., 174 Ariz. 497, 500, 851 P.2d 122, 125 (App.1992). 3 California has expressly recognized that a liability insurer's breach of the duty of good faith when considering a settlement with a third-party claimant is a tort. Crisci v. Security Ins. Co., 66 Cal.2d 425, 58 Cal.Rptr. 13, 426 P.2d 173 (1967). This court, however, has never decided as a contested issue which statute of limitations applies to an action for bad faith failure to settle. Due to the nature of the underlying dispute in a third-party failure-to-settle claim, and the historical development of bad faith law, we believe the tort statute of limitations is appropriate.

In Rawlings, this court was asked to decide for the first time whether the covenant of good faith and fair dealing in a first-party claim sounded in tort or contract. In constructing the appropriate framework, we noted that the insurance relationship is unique from that of other contracts because it is "characterized by elements of public interest, adhesion, and fiduciary responsibility." 151 Ariz. at 158, 726 P.2d at 574. The insured receives intangible benefits from the relationship, such as peace of mind and the knowledge that the carrier will give equal consideration in all matters to the insured's interests. Id. at 157, 726 P.2d at 573. When the carrier fails to deliver these non-commercial benefits, contract damages are seldom adequate. Id. at 159, 726 P.2d at 575. Moreover, because the insured may be injured when the insurer manipulates its bargaining power to its own advantage, the insurer may breach its duty of good faith without actually breaching express covenants in the contract. Likewise, the insurer may breach an express covenant without breaching the implied covenant of good faith and fair dealing. Id. at 157-60, 726 P.2d at 573-76. We noted this distinction in Rawlings and stated that

in special contractual relationships, when one party intentionally breaches the implied covenant of good faith and fair dealing, and when contract remedies serve only to encourage such conduct, it is appropriate to permit the damaged party to maintain an action in tort and to recover tort damages.

Id. at 160, 726 P.2d at 576.

Taylor acknowledges that Rawlings allowed a first-party bad faith claim to proceed in tort but urges that it notes a lack of consensus on the nature of bad faith claims. We recognize the almost even split in jurisdictions regarding which rubric best fits bad faith claims and that bad faith actions contain characteristics of both tort and contract. However, we believe the Rawlings' rationale is especially applicable to third-party cases like the one before us because the relationship between the parties, rather than any express contractual provisions, begets the cause of action. 4 Here, Taylor purchased insurance from State Farm to obtain protection that could exist only if State Farm would in good faith defend any covered claims made against him. By implication, State Farm necessarily had a duty to consider settling. Henderson, 82 Ariz. at 341, 313 P.2d at 408. Because Taylor's injury resulted from State Farm's failure to give equal consideration to his interests when refusing to settle...

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