Insurers are well aware of the typical bad faith scenario in third-party claims. Counsel for a claimant sends a demand for policy limits to the insurer in the hope that the insurer does not accept within a time limit specified in the demand. For one reason or another, the insurer does not accept within the allotted time frame, the claimant declares the policy limits to be open and, following a verdict well in excess of the policy limits, the claimant takes an assignment of the bad faith claim from the insured and sues the insurer.

Insurers understandably despise these types of claims and, as a practical matter, if unable to prevail on summary judgment, will settle them. They fear, with justification, that a jury will focus on the claimant’s injuries and the insurer’s deep pockets without regard to the merits of the actual claim for bad faith. With those parameters in mind, the claimant need only raise a question of fact as to the insurer’s bad faith.

In most states, a policy-limit demand is a condition for bad faith liability. See American Guarantee & Liability Ins. Co. v. U.S. Fidelity & Guar. Co., 668 F.3d 991 (8th Cir. 2012) (applying Missouri law); Yorkshire Ins. Co. v. Seger, 279 S.W.3d 755, 768 (Tex. App. 2007); Little Princess Express Cab Corp. v. American Transit Ins. Co., 785 N.Y.Supp. 2d 430 (N.Y.App. Div. 2004); Chandler v. American Fire & Cas. Co., 879 N.E.2d 396 (Ill. App. 2007); Tokio Marine v. Macready,803 F.Supp. 2d 193 (E.D.N.Y. 2011) (applying New York law); Pride Transp. v. Continental Cas. Co., 804 F.Supp. 2d 520 (N.D.Tex 2011) (applying Texas law); Phillips v. Bramlett, 288 S.W.3d 876 (Tex. 2009); Haddick ex rel. Griffith v. Valor Ins., 763 N.E.2d 299 (Ill. 2001); Fulton v. Woodford, 545 P.2d 979 (Ariz. App. 1976); CBLPath, Inc. v. Lexington Ins. Co., 900 N.Y.S. 2d 462 (N.Y.App. Div. 2010); Ortega-Maldonado v. Allstate Ins. Co., 519 F.Supp. 2d 981 (D.Minn. 2007) (applying Minn. law). Other states go the other way, holding that the insurers’ conduct as a whole is subject to examination, regardless of a policy-limit demand. See ACCC Ins. Co. v. Carter, 621 F.Supp. 2d 1279 (N.D.Ga. 2009) (applying Georgia law); Alexander Mfg., Inc. Employee Stock Ownership & Trust v. Illinois Union Ins. Co., 688 F.Supp. 2d 1170 (Dist. Or. 2010) (applying Oregon law).

The Ninth Circuit Court of Appeals recently held that California law does not require that a bad faith claim be predicated on the insurer’s rejection of a claimant’s settlement demand. See Du v. Allstate Ins. Co., Case No. 10-56422 (9th Cir. June 11, 2012). Instead, the court held that an insurer has an affirmative duty to initiate settlement negotiations and make a settlement offer where liability is reasonably clear. Thus, even in the absence of a settlement demand, an insurer may be liable for a bad faith claim. Examining California cases, the court focused on a California statute addressing unfair claims settlement practices. See Cal. Ins. Code § 790.03(h). That section addresses unfair claims settlement practices in the context of the Insurance Unfair Trade Practices Act. While California courts do not allow a private right of action under that Act, the Ninth Circuit held that a violation of section 790.03(h) can serve as evidence that an insurer breached the implied covenant of good faith and fair dealing and acted in bad faith. See Moradi-Shalal v. Fireman’s Fund Ins. Cos., 250 Cal. Rptr. 116 (Cal. 1988) (no private right of action under California Unfair Insurance Trade Practices Act).

Section 790.03(h)(5) specifically identifies as an “unfair claims settlement practice,” “[n]ot attempting in good faith to effectuate prompt, fair, and equitable settlement of claims in which liability has become reasonably clear.” The court held this language required an insurer to not only accept, but to also make reasonable settlement offers once liability has become reasonably clear. Section 790.03(h)(5) was taken directly from the NAIC Unfair Trade Practices Model Act, Section 4(D), which has been adopted by most states. Therefore, in jurisdictions that have not directly addressed the issue of whether an insurer can face bad faith liability in the absence of a settlement demand, insurers should be cautious of waiting for the underlying claimant to make a settlement demand within policy limits before initiating settlement discussions.