A Delaware court has thrown a small blanket of precedent over the smoldering embers of claims by some insureds with large deductibles that their insurance company is guilty of bad faith if it does not attempt to subrogate and recover the insured’s deductible.
On August 2, 2020, Praveen Patel’s house located at 403 Derby Way, Wilmington, Delaware, sustained fire damage caused by a fire originating from a neighboring property located at 401 Derby Way, Wilmington, Delaware. Plaintiffs’ homeowner’s policy with State Farm Fire and Casualty Company carried dwelling coverage of $1,450,900.00 with a 5% deductible amounting to $72,545.00. Under the policy, State Farm reserves the right to seek subrogation. The Recovery language in the policy read as follows:
If any insured to or for whom we make payment under this policy has rights to recover damages from another, those rights are transferred to us to the extent of our payment. That insured must do everything necessary to secure our rights and must do nothing after loss to impair them. However, before a loss, an insured may waive in writing all rights of recovery against any person.
Following the fire, State Farm made significant fire damage claim payments to Patel, who was then required to pay the first $72,545. Patel believed that the cause of the fire was due to the negligence of the neighbor and insisted that State Farm subrogate. However, there was a problem—at the time of the fire, State Farm insured both Plaintiffs’ property and the neighbor’s property where the fire originated. As you might imagine, State Farm opted not to pursue subrogation against the neighbor, and Patel filed suit arguing State Farm breached the implied covenant of good faith and fair dealing (i.e., “bad faith”) by (1) failing to “explain the severity of the deductible” and (2) failing to “seek reimbursement from the policy of the neighbors.” Patel also argued that State Farm acted in a self-interested manner when it failed to seek subrogation from the neighbor because State Farm insured the 401 property as well.
It should be noted that nothing prevented the insured from pursing his own negligence action against the neighbor, incurring the hefty costs of experts and litigation. But Patel chose not to.
State Farm filed a Motion for Summary Judgment, claiming it did not breach the implied covenant because it was not required to explain the deductible to its insured and the policy does not require State Farm to seek subrogation. Because the suit was one for bad faith, the court explained that one of the integral components of an insurance contract is that all parties to the contract act in “good faith.” This implied covenant is “best understood as a way of implying terms in the agreement, whether employed to analyze unanticipated developments, or to fill gaps in the contract’s provisions.” However, the implied covenant cannot be used to circumvent the parties’ agreements or create a “free-flowing duty… unattached to the underlying legal document.” The implied covenant requires “a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits” of the bargain. It added, “parties are liable for breaching the covenant when their conduct frustrates the overarching purpose of the contract by taking advantage of their position to control implementation of the agreement’s terms.” The implied covenant will not be applied in contexts where the parties’ agreement includes the requisite terms in the agreement.
The Superior Court granted State Farm’s summary judgment, stating that the policy includes a provision addressing subrogation and State Farm reserved the right to subrogate. However, the subrogation clause allows State Farm to exercise its right to seek recovery of the Plaintiffs’ deductible through subrogation but does not require them to.
Interesting to the author of this article is the fact that the court made no mention of the anti-subrogation rule or its applicability to this case. The Anti-Subrogation Rule (“ASR”) is a common law defense to subrogation. It states that a subrogated insurance company standing in the shoes of its insured cannot bring a subrogation action against or sue its own insured. Sometimes as the “suing your own insured” defense, the ASR was originally developed based on the logical premise that because the carrier stands in the shoes of it’s insured, it would essentially be suing itself. The implication in this case would be that if it subrogated, State Farm would be suing its own insured (the neighbor).
However, in Delaware, the ASR insurer has no right of subrogation against an insured, co-insured, or a wrongdoer who is an insured under the same policy. Lexington Ins. Co. v. Raboin, 712 A.2d 1011 (Del. 1998). If a joint tortfeasor is protected from subrogation because of the ASR, and other joint tortfeasors who are not protected by the ASR are sued by the insurer, the unprotected joint tortfeasors can sue the protected joint tortfeasor for contribution. Great American Assur. Co. v. Fisher Controls Intern., Inc., 2003 WL 21901094 (2003) (unpublished); Firemen’s Ins. Co. of Washington, D.C. v. Fire-Free Chimney Sweeps, Inc., 2010 WL 1268158 (2010) (unpublished).
In Fisher Controls Intern., Inc., Great American Assurance Company paid damages for a fire that broke out at a refinery during a renovation project. Great American sued several subcontractors alleging that they negligently started the fire. They dropped the suit against one of the subcontractors after determining that it was an insured under the Great American policy and, therefore, protected by the ASR. Several of the other subcontractors then sue the dismissed subcontractor for indemnification or contribution. The court ruled that although the ASR protected the insured subcontractor from a direct action by Great American, precedent indicates that it could still be sued for contribution or indemnification by the joint tortfeasors.
Whether or not the ASR would have prevented State Farm from suing the neighbor in subrogation, State Farm chose not to do so, and the court said that was their choice. Not all states have spoke out on the “duty” to subrogate as much as the “right” to subrogate. The most noise in this area is coming from the workers’ compensation industry, where a subrogation success creates a significant favorable effect on an employer’s experience modifier and can result in reduced insurance premiums in the future. Failure to subrogate results in the opposite.
Corporate decision-makers and corporate counsel should make it their business to see that workers’ compensation subrogation is made a priority, that their business is given proper credit for successful subrogation recoveries, and that these recoveries are reflected in experience modifiers which control how large of a premium the insured will be responsible for paying in the coming years. Loss control programs attack loss frequency and are a worthy goal in connection with any business or insurance program. However, risk management must be taken a step further. It is the insured’s responsibility to insist that subrogation potential is being investigated and is being actively and competently acted on. After a successful subrogation venture, it then becomes the insured’s obligation to see that they are given proper credit for those subrogation recoveries, which might otherwise be lost in the confusing and obfuscated world of experience rating.
For subrogation questions involving whether and when to subrogate property and casualty, as well as workers’ compensation insurance claims, contact Lee Wickert at leewickert@mwl-law.com.
