Insured Cannot Bring Bad Faith Allegation When Coverage “Fairly Debatable”

The United States District Court for Minnesota, applying Minnesota law, has affirmed a magistrate judge’s decision denying an insured’s motion to amend its complaint to add a claim for bad faith. Fishbowl Solutions v. Hanover Ins. Co., 2022 WL 1462697 (D. Minn. May 9, 2022). Applying de novo review, the court agreed that the coverage question was “fairly debatable” and held that the insured failed to demonstrate the insurer knew it lacked a reasonable basis to deny the insured’s claim, an essential element of a bad faith claim under Minnesota law.

The insured accounting firm purchased a Technology Professional Liability Policy for the period from July 17, 2019 to July 17, 2020. In November 2019, a fraudster obtained access to a Fishbowl accountant’s email and created a code that intercepted emails sent by customers to the accountant. The fraudster then replied to the emails, directing customers to pay outstanding invoice amounts to the fraudster’s bank account. 

The carrier denied coverage, giving rise to coverage litigation regarding whether the conduct at issue resulted in “an actual impairment or denial of service of ‘business operations.’” 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.’” The parties’ arguments centered on whether the fraudster’s interception of the accountant’s emails impaired business operations. The insured argued that the interception impaired its ability to collect payment and communicate with customers – activities it claimed were business operations. The carrier contended that the “invoice manipulation” only interrupted the insured’s ability to collect invoices that it was already owed, whereas business operations were those activities that would impair an insured’s ability to earn income. 

During the coverage action, the insured moved to amend its complaint to add a cause for bad faith. The magistrate judge concluded that the insurer’s coverage position was sufficiently well-grounded as to give rise to “reasonable disagreement” such that the coverage issue was “fairly debatable.” Further, the magistrate judge determined that the insured was unable to demonstrate the mens rea element of the statute – that the insurer knew there was no reasonable basis to deny coverage or acted in reckless disregard in so denying coverage. After the motion was denied, the insured objected to the ruling.  

Reviewing the question de novo, the district court concurred with the magistrate judge’s determination that the proposed amendment would be futile because the claim would not survive a motion to dismiss. The relevant Minnesota statute required that the insured demonstrate two elements to establish bad faith: (1) that there was no reasonable basis for the insurer denying coverage; and (2) that the insurer actually knew there was no reasonable basis for denial or acted recklessly in denying benefits. 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.” In considering the insured’s objection to the ruling, the court concluded that the insured was unable to meet this standard, noting that, while the policyholder’s coverage position might ultimately be correct, the viability of a bad faith claim turns on whether the insurer’s interpretation of the policy language “creates reasonable disagreement” between the parties’ respective positions. Because the court determined the proposed amendment could not overcome these hurdles, it overruled the insured’s objection and affirmed the magistrate judge’s determination. 

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