Will the “Bad Faith Setup” defense take hold in Missouri?
Mar. 2015  |  Bad Faith Update  |  Vol. 1 Iss. 5

“Bad Faith Setup”
As a Defense to an Insurer's
Failure to Settle?

Recently a federal judge sitting in the Eastern District of Pennsylvania allowed an insurer to proceed to take various depositions in order to discover evidence to support the insurer’s “Bad Faith Setup” and Reverse Bad Faith defense.

Dietz & Watson, Inc. v. Liberty Mutual Ins. Co.

Underlying Action
The underlying claim arose after Javier Fernandez was injured in a work place accident and filed suit against Deitz & Watson, Inc. (D&W). D&W’s insurer, Liberty Mutual, provided a defense while reserving the right to disclaim coverage for any punitive damages. Eventually, the claim settled for $2.5 million, with Liberty Mutual funding $1.75 million of the settlement and D&W paying the remaining $750,000 balance. 

In addition, Mr. Fernandez and D&W agreed that Mr. Fernandez’s counsel in the underlying action would represent D&W in any bad faith action against Liberty Mutual and that Mr. Fernandez would receive the first $250,000 of any recovery in the bad faith action. Finally, at the time of the settlement, Mr. Fernandez withdrew any claim for punitive damages.

Bad Faith Action
Following the settlement of the Underlying Action, D&W filed an action against Liberty Mutual for failing to engage in good faith settlement negotiations and requiring D&W to fund part of the settlement by refusing to offer more than $1.75 million to resolve the claim. Liberty Mutual countered the action by asserting that D&W claim was barred by unclean hands as D&W had colluded with Mr. Fernandez and his attorneys in the underlying action. Liberty Mutual based this defense on Mr. Fernandez dropping his punitive damage claims immediately before the settlement (to create the appearance that D&W contributed to the settlement of covered claims), that D&W is now represented by Mr. Fernandez’s counsel and that Mr. Fernandez will receive the first $250,000 of any recovery in the bad faith action.

Liberty moved to take the depositions of Mr. Fernandez, Mr. Fernandez’s counsel in the Underlying Action (now D&W’s counsel) and filed a motion to compel such discovery. In granting Liberty Mutual’s motion, the Court stated that Pennsylvania “applies the duty to act in good faith to each party to an insurance contract, including the insured.” In allowing underlying as well as current counsel to be deposed it appears the Pennsylvania Eastern District will now put an emphasis on the insured’s and claimant’s actions in “setting up” an insurer for bad faith rather than focusing on the insurer’s actions in failing to resolve claims.

Finally, the Eastern District of Pennsylvania decision is in stark contrast to decisions handed down in Cox v. Cont’l Cas. Co., 2014 U.S. Dist. LEXIS 68081 (W.D.Wash. May 16, 2014) and Home Indem. Co. v. Lane Powell Moss & Miller, 43 F.3d 1322 (9th Cir. 1994) which seem to reject outright the notion that a “Bad Faith Setup” is a defense to a bad faith action against an insurer.  

In Missouri fraud and collusion are often pled by insurers as affirmative defenses to bad faith claims. Carriers unfamiliar with Missouri law often mistake the insured’s legitimate efforts to protect themselves, particularly in the face of a coverage denial, with collusion. It is equally important that counsel for the claimant and insured know the safe harbors so that the insurer’s conduct in handling liability claims is the focal point for the reviewing court. Only time will tell whether Dietz & Watson decision and the “Bad Faith Setup” defense will take hold in Missouri.

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Kirk's practice focuses on significant plaintiff’s personal injury and wrongful death claims in the areas of products and premises liability, general aviation, and insurance bad faith litigation.
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