Insurer Could Face Bad Faith Liability Even Though It Has No Duty To Defend

Applying Utah law, the United States District Court for the District of Utah held that an insurer could potentially face bad faith liability even though the insurer had no duty to defend the insured against an underlying lawsuit. Travelers Prop. Cas. Co. of Am. v. Fed. Recovery Serv., Inc., 2016 WL 156453 (D. Utah Jan. 12, 2016).

The insureds, related businesses providing processing, storage, transmission, and other handling of electronic data for their customers, were hired by an owner/operator of fitness centers to manage payments and automatic debits for its customers. A dispute between the owner/operator and the insureds later ensued, and the owner/operator alleged that the insureds failed to provide certain customer information “until [the owner/operator] satisfied several vague demands for significant compensation.” The insureds provided notice to the insurer of the owner/operator’s lawsuit, but the insurer advised the insureds not to provide notice until the lawsuit was served on the insureds. When the lawsuit was served on the insureds, the insureds tendered it to the insurer, which denied coverage under a “Technology Errors and Omissions Liability” policy providing coverage for “any error, omission or negligent act,” and sought a judicial determination that no coverage was available for the lawsuit.

In a prior decision, the court had held that the insurer had no duty to defend the lawsuit because it alleged that the insureds knowingly withheld information, which was not an “error, omission, or negligence.”

In this most recent decision, the court held that the insureds could not re-litigate the issue of whether the insurer had a duty to defend the lawsuit brought by the owner/operator. The court determined that the insurer had no duty to defend based on the policy and complaint, and the court held that, under Utah law, the insureds could not use extrinsic evidence to show a duty to defend because the policy provided that the insurer’s duty to defend depended solely on the allegation in the suit. Because there was no duty to defend, the court held that the insurer did not breach any fiduciary duty owed to the insureds.

The court also held that it could not determine as a matter of law that the insurer did not breach the policy’s implied covenant of good faith and fair dealing. Even though the court held that the insurer had no duty to defend the lawsuit, it held that the insurer could face bad faith liability because it required the insured to receive service of the lawsuit before tendering the claim for coverage and allegedly did not “diligently investigate, fairly evaluate, and promptly and reasonably communicate” with the insured. However, the court held that the insurer could not face bad faith liability for any actions “root[ed]” in the denial of coverage or for threatening to seek reimbursement of defense costs paid under a reservation of rights while litigating coverage for the lawsuit.

Wiley Executive Summary

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