A few weeks ago, I blogged about an insured’s actions during the adjustment of a claim and how an insured’s actions may become the insurance company’s defenses to bad faith actions. Insurance companies also defend themselves against bad faith allegations by proving the insurer’s “good faith” reliance on the advice of competent counsel.1

In property insurance claims, coverage counsel may make an early appearance on behalf of the insurance company during the adjustment period of an open claim. These are often attorneys oversee the claims process, for take examinations under oaths, and request documents to investigate claims.

In certain instances, insurance companies have used the defense that they relied upon the advice of counsel to fight alleged bad faith. In Melorich Builders, Inc. v. Superior Court,2 the court explained that in order to have a proper defense to bad faith, the insurance company must show that:

  1. the insurer’s acts were in good faith reliance upon the advice of its counsel and thus the insurance company and its representatives believed it acted in a manner necessary to protect the company’s interests;
  2. the insurer was not so knowledgeable as to the legal standard involved that it knew the advice of its counsel was incorrect or erroneous;
  3. the insurance company fully disclosed all relevant facts to its counsel;
  4. the insurer was willing to reconsider, and act appropriately when the insurer determined the advice of counsel was not correct.

Although it is not common for insurance companies to point their finger at their own counsel, placing the blame upon the advice of counsel may eliminate punitive damages in a large majority of cases. The lack of knowledge that the insurance company was doing something wrong is likely to prevent a finding of “oppression, fraud or malice,” which is required under California Civil Code Section 3294 for punitive awards.

But, an insurance company cannot hide behind advice from counsel when it knew the advice was incorrect. Most insurance companies have developed a method for adjusting cases and know the boundaries of each state’s laws. Exposing a claims file and showing the insurance company’s method of adjusting regardless of its advice from its counsel may be the key to proving bad faith when advice of counsel is asserted.

1 State Farm Mut. Auto Ins. Co. v. Sup. Ct. (1991) 228 Cal. App. 3d 721.
2 Melorich Builders, Inc. v. Sup. Ct. (1984) 160 Cal. App. 3d 931.