The Pennsylvania Supreme Court Clarifies the Standard That Courts Must Use When Considering Claims Made for Insurance Bad Faith Under 42 Pa.C.S. § 8371

Nearly twenty years after implementation of Pennsylvania’s insurance bad faith statute, the Pennsylvania Supreme Court has finally settled the confusion that developed among the lower courts regarding exactly what constitutes the test for bad faith. Proof of a motive of “self-interest or “ill-will” on the part of an insurer is not required but may be probative of whether the insurer knew or recklessly disregarded its lack of a reasonable basis in denying a claim.

It has long been Pennsylvania law that an insurance company’s transactions with its insureds should be performed with the “utmost fair dealing.” Fedas v. Ins. Co. of Pa., 151 A. 285, 286 (Pa. 1930). However, no private cause of action existed for policyholders when their insurance company did not fulfill that duty beyond breach of the insurance contract.

In 1981, in D’Ambrosio v. Pa. Nat’l Mut. Cas. Ins. Co., 431 A.2d 966 (Pa. 1981), an insured argued before the Pennsylvania Supreme Court that it should adopt a private cause of action for first-party bad faith, such as one that was adopted in California. The court declined to do so. Instead, it openly invited the Pennsylvania Legislature to enact such a law that would provide a private cause of action for insurance bad faith.

Roughly ten years later, in 1990, the legislature accepted the Supreme Court’s invitation and enacted 42 Pa.C.S. § 8371. This statute provides a private cause of action for policyholders who feel their insurers have handled their first-party claims in bad faith. If the court finds the insurer has acted as such, it can levy interest, court costs, attorneys’ fees and punitive damages against the insurer. What the statute lacks, however, is a definition of what exactly would be considered “bad faith.” Without a definition, it was up to the courts to fashion a standard.

The first significant definition of bad faith by a Pennsylvania appellate court came from the Pennsylvania Superior Court decision in Terletsky v. Prudential Prop. & Cas. Ins. Co., 649 A.2d 680 (Pa.Super. 1994). In that decision, the Superior Court defined “bad faith” as: “[a]ny frivolous or unfounded refusal to pay proceeds of a policy.” It further outlined a two-pronged test that an insured must demonstrate, with clear and convincing evidence, that the insurer: “(1) did not have a reasonable basis for denying benefits under the policy; and (2) defendant knew or recklessly disregarded its lack of reasonable basis in denying the claim.” The Superior Court further stated that, “[f]or purposes of an action against an insurer for failure to pay a claim, such conduct imports a dishonest purpose and means a breach of a known duty (i.e., good faith and fair dealing), through some motive of self-interest or ill will; mere negligence is not bad faith.”

Courts interpreted the Terletsky standard as requiring not just the two prongs of the test, but also requiring evidence of a motive of ill will and self-interest to succeed on a claim for bad faith. Many trial courts dismissed actions based on this interpretation. See, Wiedinmyer v. Harleysville Mut. Ins., 42 Pa. D. & C. 4th 204, 217 (C.P. Montg. Aug. 5, 1999) (“There appears in the record no evidence of ill will or dishonest purpose in defendant’s conclusion that payment could not be made upon plaintiff’s claim . . . “); Universal Teleservices Ariz., Ltd. Liab. Co. v. Zurich Am. Ins. Co., 2004 Phila. Ct. Com. Pl. LEXIS 88, at *18 (C.P. Phila. Mar. 4, 2004) (“The bad faith statute addresses only whether insurers acted recklessly or with ill will in a particular case, here no such evidence was presented.”); Fleeger v. United States Auto. Ass’n, 43 Pa. D. & C. 5th 408, 426 (C.P. Lawrence Dec. 29, 2014) (“The plaintiffs have not presented any evidence that the defendant’s denial of the claim demonstrated an improper purpose on its behalf and there is no evidence that it breached a known duty motivated by self-interest or ill will.”).

Confusion developed when the Superior Court issued its ruling in Greene v. United Servs. Auto. Ass’n, 936 A.2d 1178 (Pa.Super. Ct. 2007). It held that a “motive of self-interest or ill will” was not required for a finding of bad faith but was probative of whether the insurer “knew or recklessly disregarded its lack of reasonable basis in denying the claim.”

The confusion created by the Greene decision was clearly evident in the Rancosky case, beginning at the trial court level. Despite the Greene case, the trial court in Rancosky found in favor of the insurer after a bench trial because Rancosky failed to prove that the insurer had acted out of “some motive of self-interest or ill will.” Rancosky v. Wash. Nat’l Ins. Co., 2014 Pa. Dist. & Cnty. Dec. LEXIS 9954 (C.P. Washington Dec. 1, 2014).

On appeal, the Superior Court adopted the Greens court’s interpretation. It held that a “motive of self-interest or ill will” was not required and reversed the trial court. Rancosky v. Wash. Nat’l Ins. Co., 130 A.3d 79 (Pa.Super. 2015).

Given this confusion, not only among the courts in Rancosky but among the lower courts in general, the Pennsylvania Supreme Court accepted the Rancosky case and considered, for the first time, the elements of a first-party bad faith insurance claim under § 8371. Specifically, it considered whether a motive of self-interest or ill will is a third prong to the Terletsky test for bad faith. The Supreme Court stated that “[a]n ill-will level of culpability would limit recovery in any bad faith claim to the most egregious instances only where the plaintiff uncovers some sort of ‘smoking gun’ evidence indicating personal animus towards the insured,” and that “[s]uch a construction could functionally write bad faith under Section 8371 out of the law altogether.” Therefore, the Supreme Court upheld the two-pronged Terletsky test and clarified that evidence of an insurer’s “motive of self-interest or ill will” is merely probative of the second prong of the test. The Supreme Court, however, reiterated that mere negligence is not bad faith.

In what is arguably dicta, the Supreme Court dismissed arguments that a higher standard than the two-pronged Terletsky test is required for bad faith claims seeking punitive damages and stated that § 8371 put punitive damages on the “same footing as other categories of damages.” There were no dissenting opinions to the majority opinion. However, Justice Saylor warned, in his concurring opinion, that trial courts must be mindful of the constitutional limitations placed on punitive damage awards by the Due Process Clause of the Fourteenth Amendment of the United States Constitution, as interpreted by the United States Supreme Court.

After Rancosky, it is anticipated that the plaintiffs’ bar will argue that the Supreme Court has “lowered the bar” for bad faith claims. Thus, an accompanying increase in bad faith counts may be added to standard breach of contract cases where, previously, bad faith claims might not have been brought. However, it is vital to keep in mind that negligence does not—and has never—constituted bad faith, and Rancosky does not suggest otherwise. As a practice note, it is paramount that counsel for insurers be aware of the dicta in Rancosky, regarding the potentially lower standard for punitive damages, and evaluate and prepare their cases accordingly.

*Christopher is an associate in our Harrisburg, Pennsylvania office. He can be reached at 717.651.3708 or cwwoodward@mdwcg.com.

_{Defense Digest, Vol. 24, No. 2, June 2018. Defense Digest is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. ATTORNEY ADVERTISING pursuant to New York RPC 7.1. © 2018 Marshall Dennehey Warner Coleman & Goggin. All Rights Reserved. This article may not be reprinted without the express written permission of our firm. For reprints, contact tamontemuro@mdwcg.com.}