It is settled law in California that an insurer denying or delaying the payment of policy benefits due to the existence of a genuine dispute with its insured as to the existence of coverage liability or the amount of the insured's coverage claim is not liable in bad faith even though it might be liable for breach of contract. See Fraley v. Allstate Ins. Co., 81 Cal. App. 4th 1282 (2000).

 

A California appeals court, in Chateau Chamberay Homeowners Ass'n v. Associated Intern. Ins. Co., 90 Cal. App. 4th 335 (2001), extended the “genuine dispute doctrine” to a factual claims dispute. Fraud, by definition, is a factual dispute. The insured claimed he had a covered loss while the insurer, from investigation, believed it established that the claim presented by the insured was false and fraudulent.

 

The court found that Associated International was entitled to summary judgment based on a genuine dispute concerning facts and stated the following:

 

Although an insurer's bad faith is ordinarily a question of fact to be determined by a jury by considering the evidence of motive, intent and state of mind, “[t]he question becomes one of law…when, because there are no conflicting inferences, reasonable minds could not differ. [Citations.]” Walbrook Ins. Co. v. Liberty Mutual Ins. Co., 5 Cal. App. 4th 1445, 1454,1455 (1992). We are not called upon to determine whether AIIC's view as to the proper outcome of the adjustment process was correct. It is only necessary for us to determine that, in light of the record as a whole, its position with respect to the disputed points was reasonable or that AIIC had proper cause to assert the positions that it did. (Emphasis added.)

 

In Guebara v. Allstate Ins. Co., 237 F. 3d 987 (9th Cir. 2001), Allstate alleged, based on its investigation, that Guebara had attempted fraud. The Ninth Circuit Court of Appeal held the following:

 

The genuine dispute in this case was not purely factual. The genuine dispute as to the contents claims was based on factual evidence—three expert opinions, inconsistent testimony by Guebara and her witnesses, and desperate financial circumstances. The genuine dispute as to the structure claim, however, was based on the fraud language in the policy and on an unsettled issue in California insurance law.

 

The “genuine dispute” defense has been adopted across the U.S.

 

The essence of the question as to whether the dispute is merely contractual or whether there are tortious elements justifying an award of punitive damages depends first on whether there is proof of bad faith and whether the proof is sufficient for the jury to conclude that there was conduct that is outrageous because of the defendant's evil motive or his reckless indifference to the rights of others. See Restatement (Second) Torts, Sec. 909(2) (1979), as quoted and applied in Horton v. Union Light, Heat and Power Co., 690 S.W. 2d 382 (Ky. 1985); Federal Kemper Ins. Co. v. Hornback, 711 S.W. 2d 844 (Ky. 1986);. First Nat. Bank of Louisville v. Lustig, 96 F. 3d 1554 (5th Cir. 1996), applying Kentucky law.

 

In California, the genuine dispute rule does not relieve an insurer from its obligation to thoroughly and fairly investigate, process, and evaluate the insured's claim. A genuine dispute exists only where the insurer's position is maintained in good faith and on reasonable grounds. The California Supreme Court stated, “In this connection, we find potentially misleading the statements in some decisions to the effect that under the genuine dispute rule bad faith cannot be established where the insurer's withholding of benefits 'is reasonable or is based on a legitimate dispute as to the insurer's liability.'” [Century Surety Co. v. Polisso 139 Cal.App.4th 922 (2006)].

 

The courts in Tomaselli v. Transamerica Ins. Co., 25 Cal.App.4th 1269 (1994) and Chateau Chamberay Homeowners Ass'n. v. Associated Intern. Ins. Co., 90 Cal.App.4th (2001) used the terminology “if reasonable or if based on a legitimate dispute.” Likewise, the court in Wilson v. 21st Century Ins. Co., 171 P.3d 1082 (Cal. 2007) stated, “In the insurance bad faith context, a dispute is not 'legitimate' unless it is founded on a basis that is reasonable under all the circumstances.”

 

In Idaho and Wisconsin an insured may recover in tort where its insurer unreasonably and in bad faith denies or withholds payment of a valid claim. [Roper v. State Farm Mut. Auto. Ins. Co., 958 P. 2d 1145 (Idaho 1998); White v. Unigard Mut. Ins. Co., 730 P. 2d 1014 (Idaho 1986)]. In addition, an insured asserting a claim of bad faith must show that the claim was not fairly debatable, that the denial or failure to pay was not the result of a good faith mistake, and that the resulting harm is not fully compensable by contract damages. [Simper v. Farm Bureau Mut. Ins. Co. of Idaho, 974 P. 2d 1100 (Idaho 1999); Lucas v. State Farm Fire & Cas. Co., 963 P. 2d 357 (Idaho 1998); Anderson v. Farmers Ins. Co. of Idaho, 947 P. 2d 1003 (Idaho 1997)]

 

An insurer does not act in bad faith if it challenges the validity of a “fairly debatable” claim. When a claim is fairly debatable, the insurer is entitled to dispute the claim and will not be deemed liable for failure to pay the claim. [Greene v. Truck Ins. Exchange, 753 P. 2d 274 (Idaho Ct. App. 1988)]. In Drake v. Milwaukee Mut. Ins. Co., 236 N.W. 2d 204 (Wis. 1974) the court found that the insurer is entitled to debate a fairly debatable claim, whether the debate concerns a matter of fact or law.

 

Kentucky allows two ways for a claim to be fairly debatable: (1) the issue is one of first impression in Kentucky, and authorities from other jurisdictions support the insurer's position; and (2) a dispute over relevant facts related to coverage exists. [Empire Fire & Marine Ins. Co. v. Simpsonville Wrecker Serv., Inc., 880 S.W. 2d 886 (Ky. Ct. App. 1994)].

 

In Prieto v. Paul Revere Life Ins. Co., 354 F.3d 1005 (9th Cir. 2004), the court, applying Arizona law, affirmed a partial summary judgment for the insurer on bad faith and punitive damages, holding as follows:

 

In Zilisch v. State Farm Mut. Auto Ins. Co., 995 P.2d 276 (Ariz. 2000), the Arizona Supreme Court changed its approach…finding that while fair debatability is a necessary condition to avoid a claim of bad faith, it is not always a sufficient condition. The appropriate inquiry is whether there is sufficient evidence from which reasonable jurors could conclude that in the investigation, evaluation, and processing of the claim, the insurer acted unreasonably and either knew or was conscious of the fact that its conduct was unreasonable. (Emphasis added.)

 

Iowa also sets up the “fairly debatable” standard as a defense to the tort of bad faith.

 

The Iowa Supreme Court first recognized the intentional tort of first-party bad faith in Dolan v. Aid Ins. Co., 431 N.W. 2d 790 (Iowa 1988). The court explained that when “a claim is fairly debatable,” the insurer is entitled to debate it, whether the debate concerns a matter of fact or law.

 

In Florida, the court in John J. Jerue Truck Broker v. Insurance Co. of North America, 646 So. 2d 780 (Fla. App. 1994) refused to adopt the “fairly debatable” standard but concluded that the trial court considering a charge of tortious bad faith conduct by an insurer must “consider all of the circumstances involved in the denial of coverage in evaluating an insurer's liability for bad faith.”

 

The Florida Court of Appeal directed the trial court to apply the following standards:

 

(1) the insurer's effort to resolve promptly the coverage issues or otherwise limit any potential prejudice to the insured;

(2) the substance of the coverage disputes or the weight of the legal authority on the coverage issue; and

(3) the insurer's diligence or thoroughness in investigating the facts specifically pertinent to coverage.

 

Applying Colorado law, the court in Marathon Ashland Pipe Line LLC v. Maryland Cas. Co., 243 F. 3d 1232 (10th Cir. 2001) stated, “Bad faith claims are a species of tort law, not of contract law. They constitute a violation of the insurer's separate, non-contractual, 'duty to process claims fairly and in good faith.'” Under Wyoming law, the court in McCullough v. Golden Rule Ins. Co., 789 P. 2d 855 (Wyo. 1990) said that a bad faith claim is an independent tort action based on the theory that insurers owe a duty of good faith to policyholders not to unreasonably deny a claim for benefits under the policy.

 

It is the duty of a claims person who decides that a loss or defense must be denied to collect sufficient evidence that will establish that the denial of the claim was “fairly debatable.” The evidence must be clear and unambiguous so that a trier of fact (a judge or jury) would conclude that a reasonable and prudent insurer would have made the same decision.

 

In North Dakota, the Supreme Court stated the following in Fetch v. Quam, 623 N.W. 2d 357 (N.D. 2001):

The district court held, as a matter of law, an insurance company is not guilty of bad faith for denying a claim when the claim is fairly debatable or if there is a reasonable basis for denying the claim or delaying payment. The court found that over the years American Hardware had made offers of settlement in line with the verdict. In addition, the court determined Fetch did not present any information suggesting American Hardware improperly denied coverage, investigated in bad faith, or fraudulently induced Fetch to delay filing a motion for default judgment against Guam; moreover, the trial court noted, those arguments were anticipated by American Hardware and effectively refuted.

 

The North Dakota Supreme Court stated clearly and unambiguously that “an insurer does not act in bad faith by reasonably refusing to settle a claim, which is fairly debatable as to liability, for amounts demanded by an insured which are not supported by facts regarding damages.” In Hanson v. Cincinnati Life Ins. Co., 571 N.W. 2d 363 (N.D. 1997), the court defined the test for bad faith as whether the insurer acts unreasonably in handling an insured's claim.

 

The Alabama Supreme Court in State Farm Fire & Cas. Co. v. Slade, 747 So. 2d 293 (Ala. 1999) stated the standard in the negative as “when the claim is not fairly debatable, refusal to pay will be bad faith and, under appropriate facts, give rise to an action for tortious refusal to honor the claim.”

The court further said that when a claim is “fairly debatable,” the insurer is entitled to debate it, whether the debate concerns a matter of fact or law.

 

Bad faith in Alabama is not simply bad judgment or negligence. To prove bad faith the insured must show a dishonest purpose and a breach of a known duty, that is, the duty of good faith and fair dealing, through some motive of self-interest or ill will.

 

The court in First Nat. Bank of Louisville v. Lustig, 96 F. 3d 1554 (5th Cir., 1996) applying Kentucky law, stated the rule as follows:

 

[I]t is clear that an insurer may challenge a claim which is fairly debatable on its law or facts… At the Conclusion of the coverage phase of the trial, the jury determined that coverage existed. On appeal, the parties do not dispute that the Sureties are obligated to pay the claim under the terms of the policy and, therefore, the parties do not contest the first factor under the bad faith analysis. … The second factor, whether FNBL proved that the Sureties lacked a reasonable basis in law or fact for denying this claim, is disputed. Under this factor, if a genuine issue exists as to either questions of law or fact, FNBL's claim is considered fairly debatable and the bad faith tort claim may not be maintained.

 

Although coverage was found under a banker's bond, the court concluded there was no bad faith and that the dispute was “fairly debatable” because Kentucky had not yet defined “manifest intent” and because of the lack of certainty in this case concerning whether manifest intent was based on the subjective intent of the bank officer or the objective result of his conduct. The court held that the sureties possessed a legally debatable basis for denying FNBL's claim and a factual basis upon which to contest FNBL's claim based on the bank officer's refusal to admit to intending to harm the bank.

 

The court in McGilvray v. Farmers New World Life Ins. Co., 28 P. 3d 380 (Idaho 2001) found that a suit for bad faith must fail because there was no contract in effect at the time of the putative insured's death.

 

In Duir v. John Alden Life Ins. Co., 754 F. 2d 245 (7th Cir. 1985), the court applied the “fairly debatable” measure to a bad faith claim and, applying Wisconsin law, stated the following:

 

In order to prove a claim of bad faith, an insured must show: (1) the absence of any reasonable basis by the insurer for denying the benefits of the policy to the insured; and (2) the insurer's knowledge or reckless disregard of the lack of a reasonable basis for denying the claim. Id. at 691, 271 N.W. 2d at 376. A court must determine whether a reasonable insurer under the particular circumstances would have denied or delayed payment of a claim as well as whether the insurer recklessly disregarded a lack of a reasonable basis for the insurer's denial of a claim or proof submitted by the insured. Benke v. Mukwonago-Vernon Mutual Insurance Co., 110 Wis. 2d 356, 362, 329 N.W. 2d 243, 246-47 (Ct. App. 1982)…However, when an insurer exercises its duty of ordinary care and reasonable diligence in investigating and evaluating claims and determines that a claim is “fairly debatable,” the insurer is entitled to debate and/or litigate the claim if it feels that there is a question of law or fact which must be decided before the insurer, in good faith, is required to pay. Id. at 693, 271 N.W. 2d at 377; Benke v. Mukwonago-Vernon, 110 Wis. 2d at 364-65, 329 N.W .2d at 248. (Emphasis added.)

 

Applying Alabama law in State Farm Fire and Cas. Co. v. Balmer, 891 F.2d 874 (11th Cir. 1990), the court held as follows:

 

[H]owever recklessly an insurer conducts its investigation, a bad faith claim cannot succeed where the insurer had an arguably lawful basis for denying the claim. “When a claim is 'fairly debatable,' the insurer is entitled to debate it, whether the debate concerns a matter of fact or law.” National Sec. Fire & Casualty Co. v. Bowen, 417 So. 2d 179, 183 (Ala. 1982) (Citation omitted.) A debatable reason for denying a claim is “an arguable reason, one that is open to dispute or question.“ Id. If the evidence offered by the insured “fails to eliminate any arguable reason for denying payment, any fairly debatable reason on a matter of fact or a matter of law, he cannot recover under the tort of 'bad faith refusal.'” Id. at 185. Whether the insurer had such an arguable basis for denial is judged as of the time the decision to deny is made. See National Savings Life Ins. Co. v. Dutton, 419 So. 2d 1357, 1362 (Ala. 1982). (Emphasis added.)

 

The court found that State Farm's investigation was far from ideal. State Farm did not use purchase verification forms or sift the debris to verify the contents destroyed in the fire. There was also evidence suggesting that State Farm failed to follow in-house rules concerning the investigation of fire losses and failed to perform all of the steps in a proper fire investigation. Regardless, the court found that Alabama law is clear that despite the imperfections of State Farm's investigation, the existence of a debatable reason for denying the claim at the time the claim was denied defeats a bad faith failure to pay a claim.

 

The basis of the denial by State Farm was related to the possible misrepresentation of contents in the Balmers' claim. The Balmers represented via sworn statements that the contents destroyed in the fire had a total value of $159,000 and that within a year before the fire more than $23,000 of these contents was purchased and more than $9,000 was received as gifts. The Balmers' tax returns for the two years preceding the fire reported their annual income as falling between $6,000 and $10,000. A report by two State Farm representatives who visited the site of the house the day after the fire indicated that there appeared to be a small amount of contents for a two-story house. A State Farm special investigator learned that the Balmers were over $50,000 in arrears on loans and mortgages secured by the farm property. That information was found to be sufficient to conclude that the decision to deny the claim was fairly debatable and the insured could not maintain a bad faith cause of action.

 

The Washington Supreme Court in Ellwein v. Hartford Accident And Indemnity Co., 15 P. 3d 640 (Wash. 2001) held that the “fairly debatable” standard for determining bad faith, as it is commonly called, is followed in the vast majority of jurisdictions. In Washington the “fairly debatable” standard is a simple matter of fairness. All persons, including insurance companies, should have the right to their day in court. The price of losing a trial should not be millions of dollars in punitive damages. The national trend permitting dismissal of bad faith claims as a matter of law coincides with an increased willingness on the part of courts to use summary judgment as a means to curtail the unwarranted consumption of public and private resources in lawsuits that seek wealth rather than indemnity.

 

Ellwein was overruled by Smith v. Safeco Ins. Co., 78 P.3d 1274 (Wash, 2003). The court held that the “insurer's assertion of reasonable basis for its denial of coverage did not entitle it to summary judgment on insured's bad faith claim against it, although insurer argued that it was entitled to summary judgment unless its policyholder could prove bad faith as a matter of law.”

 

In Van Holt v. Liberty Mut. Fire Ins. Co., 163 F. 3d 161 (3d Cir. 1998) the court found there was no bad faith and the claim was “fairly debatable” as a matter of law because evidence existed that the insured presented a claim for items already paid for in a previous claim for loss under a flood policy and that they overstated the amount of their claim. Similarly, in Pace v. Insurance Co. of North America, 838 F. 2d 572 (1st Cir. 1988), the court found that a marine insurer raised a “fairly debatable” issue when it denied a claim for the sinking of a vessel when it concluded that the vessel was not seaworthy because it sank in calm seas. Although the jury found for the vessel on the hull policy, no recovery was allowed on the bad faith claim.

 

The Idaho Supreme Court weakened the “fairly debatable” or “genuine dispute” defense in Lucas v. State Farm Fire and Cas. Co., 963 P. 2d 357 (Idaho 1998) when it held that there was a genuine issue of fact to be determined at trial as to whether the basis for the denial was “fairly debatable.” Justice Trout, in the dissent, opined,

 

There is no reasonable reading of the facts in this case that State Farm intentionally or unreasonably denied payment. It has challenged the obligation to pay based upon significant medical evidence. If it is wrong, it has a contractual obligation to pay the claim and pay attorney fees to its insured. But there is no factual basis for a bad faith claim.

 

In Zilisch v. State Farm Mut. Auto. Ins. Co., 977 P. 2d 134 (Ariz. App. – Div. 1 1998) the court adopted the “fairly debatable” standard and held that State Farm was not liable to Zilisch in tort because the value of the claim was fairly debatable as to the value of the plaintiff's injuries. The decision was vacated by Zilisch v. State Farm Mut. Auto. Ins. Co., 995 P.2d 276 (Ariz. 2000). The court held that “(1) while fair debatability is a necessary condition to avoid a claim of bad faith, it is not always a sufficient condition, and (2) whether insurer knowingly acted unreasonably regarding insured's claim is a jury question.”

 

The Wisconsin Supreme Court in Danner v. Auto-Owners Ins., 629 N.W. 2d 159 (Wis. 2001) found that the liability of an underinsured motorist was not “fairly debatable”—nor was the value of the injuries—and affirmed a bad faith judgment.

 

The Iowa Supreme Court, in Sampson v. American Standard Ins. Co., 582 N.W. 2d 146 (Iowa 1998), concluded that the issue of fair debatability could be determined as a matter of law by the court and need not always be a defense that must be determined by the jury when there is sufficient evidence available to support the decision made by the insurer—in this case the fact that the plaintiff had received treatment for the alleged injury before the accident—as one that was “fairly debatable.” If fairly debatable, a bad faith case cannot be maintained.

 

In Freidline v. Shelby Ins. Co., 774 N.E.2d 37 (Ind. 2002), the Indiana Supreme Court, faced with a denial of a claim under the absolute pollution exclusion that was found not to apply, determined that there was insufficient evidence to maintain an action for bad faith and stated the following:

 

The scope of the pollution exclusion is an evolving area of law, subject to differing interpretations. The pollution exclusion is one of the most frequently litigated exceptions found in a staple insurance industry product—the comprehensive general liability policy. Tri-Town Corp., 863 F. Supp. at 38; see also Madison Constr. Co., 735 A.2d at 106. This is also evident in the trial court's grant of summary judgment in favor of Shelby. After considering Kiger, Seymour, and Summit, the trial court found that the pollution exclusion in Shelby's general liability policy “does not appear ambiguous.” R. at 311. Inasmuch as we find there is a rational basis for Shelby's actions, and Shelby supports its position with good faith legal argument, the Freidlines have failed to establish by clear and convincing evidence that Shelby breached its duty to act in good faith. Thus, the trial court correctly entered summary judgment in favor of Shelby on this issue.

 

Insurers must recognize, of course, that trial courts review the actions of an insurer when deciding a bad faith claim with 20/20 hindsight. Therefore, the evidence available to the insurer to call into play the “fairly debatable” measure of good faith or the “genuine dispute doctrine” must be overwhelming.

 

Before an insurer can be found liable in tort for its delay or denial in the payment of policy benefits, it must be shown that the insurer acted unreasonably or without proper cause. CalFarm Ins. Co. v. Krusiewicz, 131 Cal. App.4th 273 (2005) illustrates this principle. The Krusiewiczes sued CalFarm, not as its insureds but because CalFarm failed to pay a judgment they secured against CalFarm's insured, Laynescape, Inc., which had constructed retaining walls on the Krusiewiczes' property. Laynescape failed to properly seal the retaining walls, permitting water to permeate the walls and damage the walls' exterior paint. Laynescape did not paint the retaining walls. CalFarm insured Laynescape under a policy covering damage to the paint, but containing a standard provision excluding from coverage the cost to repair the insured's faulty or defective work. The court said the following:

 

The mistaken [or erroneous] withholding of policy benefits, if reasonable or if based on a legitimate dispute as to the insurer's liability under California law, does not expose the insurer to bad faith liability.” Without more, such a denial of benefits is merely a breach of contract. Moreover, the reasonableness of the insurer's decisions and actions must be evaluated as of the time that they were made; the evaluation cannot fairly be made in the light of subsequent events that may provide evidence of the insurer's errors. Thus, before an insurer can be found to have acted tortuously (i.e., in bad faith), for its delay or denial in the payment of policy benefits, it must be shown that the insurer acted unreasonably or without proper cause. However, when there is a genuine issue as to the insurer's liability under the policy for the claim asserted by the insured, there can be no bad faith liability imposed on the insurer for advancing its side of that dispute.

 

Therefore, if the conduct of the insurer in denying coverage was objectively reasonable, its subjective intent is irrelevant. See Morris v. Paul Revere Life Ins. Co., 109 Cal. App.4th 966 (2003).

 

When the issue of the insurer's objective reasonableness depends on an analysis of legal precedent, reasonableness is a legal issue. The court found that CalFarm acted reasonably because case law was not clear on the issue raised by the claim, whether it owed for the wall or just the paint. CalFarm, the court concluded, could make an objectively reasonable determination that the costs of removing and replacing the backfilled dirt and landscaping came within the policy's “own work” exclusion because those costs were necessary to repair Laynescape's defective work in failing to apply the correct number of coats of sealant. The trial court and the dissenting justice disagreed.

 

As this case illustrates, even though the reasonableness of actions of an insurer may have a factual basis, reasonable minds can differ on the meaning of a “genuine dispute.” It is imperative, therefore, when an insurer anticipates using the “genuine dispute” defense, to seek the advice and counsel of an expert as back-up for its refusal to indemnify an insured. The expert can be an engineer, a claims expert, a fraud expert, or some other professional on whose advice the insurer can rely.

 

In Anderson v. State Farm Mut. Auto. Ins. Co., 416 F.3d 1143 (10th Cir. 2005), State Farm made a decision to deny coverage. Although the decision was correct under the law at the time the decision was made, by the time it reached the circuit court, it was incorrect. The court held that actions taken in reasonable reliance on existing case law cannot constitute bad faith because such conduct is not unreasonable. The court concluded, “A decision to award coverage benefits pursuant to retroactive application of a judicial decision does not mean that the prior disclosures and representations of the insurer based on the previously understood state of the law constitute bad faith.”

 

In Rios v. Scottsdale Ins. Co., 119 Cal. App.4th 1020 (2004), the Scottsdale policy—a named peril policy—provided no coverage for theft. The claim presented by Rios was for theft. The court concluded that there was no coverage potential under the policy and therefore, there could be no bad faith.