Insured Cannot Amend Complaint to Add Bad Faith Claim Where Coverage Issue is “Debatable”

Applying Minnesota law, the United States District Court for the District of Minnesota has denied an insured’s motion to amend its coverage litigation complaint to add a claim for bad faith, holding that coverage under the policy was “fairly debatable” and that the insured failed to demonstrate that the insurer knew it lacked a reasonable basis to deny the insured’s claim. Fishbowl Solutions Inc. v. Hanover Ins. Co., 2022 WL 1037083 (D. Minn. Apr. 6, 2022).

An insured software company was caught in a fraudulent scheme by which a fraudster obtained the email account information of one of the company’s accountants. The fraudster intercepted emails sent by customers to the accountant, such that the accountant never saw those messages. Instead, the fraudster replied to the emails, directing customers to pay outstanding invoice amounts to the fraudster’s bank account. The insured sought coverage for its losses under its technology E&O policy’s coverage grant for cyber business interruption. The policy afforded coverage for “actual loss of ‘business income’ and ‘extra expense’ incurred by you . . . directly resulting from a ‘data breach’ . . . which results in an actual impairment or denial of service of ‘business operations.’” “Business operations” was defined as “usual and regular business activities.”

After the insurer denied coverage, the insured company filed a breach of contract suit against the insurer. The insured thereafter moved for leave to amend the complaint to add a claim for bad faith on the grounds that the insurer lacked a reasonable basis for denying coverage. The court denied the motion to amend after finding that the bad faith claim would not survive a motion to dismiss. The Minnesota statute governing bad faith claims requires that the insured demonstrate two elements: 1) that there was no reasonable basis for the insurer to deny coverage, and 2) that the insurer actually knew there was no reasonable basis for the denial or acted in reckless disregard. Further, under this statue, “when a claim is fairly debatable, the insurer is entitled to debate it, whether the debate concerns a matter of fact or law.”

The court found that the insured was unable to meet this standard, noting that while its coverage position may ultimately be correct, the insurer’s coverage position was tenable enough to “create[] reasonable disagreement” between the parties’ respective positions. The parties’ arguments centered on whether the fraudster’s interception of the accountant’s emails impaired “business operations” as defined by the policy. The insured argued the interception impaired its ability to collect payment and communicate with customers – activities it claimed were business operations. The insurer argued that the “invoice manipulation” only interrupted the insured’s ability to collect invoices it was already owed, whereas “business operations” were those activities that would impair an insured’s ability to earn income. The court found that the insurer’s argument was sufficient to create “reasonable disagreement” such that the coverage issue was “fairly debatable.” The court further held that the insured was unable to demonstrate that the insurer knew there was no reasonable basis to deny coverage or acted in reckless disregard by so denying coverage.

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