South Bend / Mishawaka, IN – An insurer denies a claim and the court agrees there is no coverage under the policy. Case closed. Or is it? Can the insured still pursue a tort claim for bad faith against the insurer? The Indiana Court of Appeals has held that an insured’s tort claim for bad faith can survive, even if the claim for bad faith in contract has been denied. Klepper v. ACE American Ins. Co., 999 N.E.2d 86, 98-99 (Ind. Ct. App. 2013). In a case involving the combination of alcohol, mold, and bad faith, the Indiana Court of Appeals refused to dismiss a tort claim alleging bad faith, even though the Court held the insured was not entitled to coverage under the terms of the insurance contract. Id.

I. The Case: Klepper v. ACE American Insurance Company

In Klepper v. ACE American Ins. Co., Pernod USA was an owner and operator of a distillery in Lawrenceburg, Indiana from January 2002 to June 2007. XL insured Pernod from 2001-2003, and by Ace from 2003-2004. Pernod’s policy with ACE included a “legally obligated to pay” provision within its terms. Under this provision, ACE was required to pay the sums that the insured became legally obligated to pay as damages from bodily injury or property damage for which the insurance applied. Additionally, the ACE Policy also included a “voluntary payment” provision which held that no insured was to voluntarily make a payment, assume any obligation, or incur an expense, other than for first aid or at the insured’s own cost, without the consent of ACE.

Pernod distilled alcohol. During the distillation process, ethanol was dispersed into the air, causing mold to grow on nearby buildings. Klepper, a nearby property owner, brought a class action in 2005 on behalf of himself and similarly situated property owners who were damaged by the mold. The Class alleged nuisance, negligence, trespass, and illegal dumping.

Pernod filed a claim with ACE in 2005, but ACE mistakenly misclassified the claim as “an underage drinking claim” and closed the file. It wasn’t until 2007 that ACE was informed they had misclassified the claim and that Pernod’s prior insurer, XL, had been providing Pernod a defense against the Class Action. XL demanded contribution from ACE for the costs of Pernod’s defense. ACE agreed to contribute 49% of the defense costs under a full reservation of rights.

During the first attempted mediation, Pernod requested ACE contribute $1mm toward a settlement agreement. ACE refused and offered to contribute only $250,000. ACE left a second mediation early. The Class, XL, and Pernod reached a settlement agreement at the second mediation session. The agreement would require a total of $5.2mm to be paid to the Class. Pernod was to contribute $1.2mm, XL was to contribute $1mm to a common fund for immediate use and benefit for the Class, and the remaining $3mm was to be collected from ACE to the extent that the damages were covered by Pernod’s insurance policy.

In May of 2009 the Class filed an amended complaint which included a claim for declaratory judgment regarding the coverage under the ACE Policy for the damages sought by the Class. Thereafter, the Class released Pernod and XL from any claims upon receipt of the $2.2mm payment owed by the two. Pernod assigned their rights as to the declaratory judgment over to the Class.

In December 2010, the Class again filed an amended complaint asking the court to declare that up to $3mm could be collected from ACE under the terms of the Policy. The complaint also alleged bad faith and unfair claims handling on behalf of ACE. The case was assigned a special master in August of 2012. The special master concluded that ACE had honored it obligations and that as a matter of law, Pernod breached its obligation by entering the settlement agreement without the consent of ACE. The special master also found Pernod had assigned their rights to the Class, and the Class would have to deal with the consequences. Id. at 90. The trial court entered and adopted the special master’s report and stayed all remaining issues. Id. The Class and Ace both appealed the decision. Id.

On appeal, ACE argued that the insurance contract’s “legally obligated to pay provision” only obligated the policy to cover claims for damages for which Pernod was found liable. ACE contended that since the settlement agreement released Pernod from liability, Pernod was no longer legally liable for the damages amounting to $3mm. Thus, ACE alleged they were no longer liable for the claims. Moreover, ACE also relied on the voluntary payment clause and stated that because Pernod settled the Class’s claims without their consent, the voluntary payment provision precluded coverage.
The Class argued that ACE should not be able to avoid coverage upon the “legally obligated to pay provision” nor the “voluntary payment provision”. The Class argued that the issue involved a balancing of competing rights between the insured’s right to protect itself when the insurer leaves it facing a large potential liability versus the right of the insurer to protect itself from an unreasonable settlement.

The Court affirmed the trial court and held ACE did not breach the insurance agreement. Id. at 96. The Court found ACE had negotiated the settlement in good faith because there was a valid question of whether the emissions damages even qualified under the policy. Id. at 96. The Court also noted that ACE at no point abandoned Pernod, because Pernod had a defense to the claims at all times, even if it was not provided by ACE. Id. Additionally, the Court stated ACE provided nearly half of the funds for Pernod’s defense when it became aware of the claim. Id.

As for the language of the policy, the Court held that based upon precedent, they could not simply remove the “voluntary payment” and “legally obligated to pay” provisions from the contract. Id. at 97. Thus, as these provisions were valid portions of the contract, ACE could rely on them in denying an obligation to pay for the damages to the Class under the policy. Id at 96-97.

This case is a curious one because of the Court’s decision regarding the claim of bad faith. The Court allowed Pernod to move forward with the claim for bad faith, even though the Court concluded ACE owed Pernod no coverage. Id. at 98-99. The Court found that while the bad faith claim that was based in contract was resolved upon the Court’s holding of no coverage, the Class could still proceed with their tort claim for bad faith. Id. In supporting its decision, the Court cited Indiana law holding that an insured’s bad faith claim can be based on the insurer’s manner of handling the claim. Id. at 98.

II. Implications of the Decision

Historically, Indiana courts required that a plaintiff bringing a bad faith claim must show ill will by the insurer, and that the insurer denied coverage wrongfully. Foster v. State Farm Fire & Cas. Co., 2011 U.S. Dist. LEXIS 92218 (N.D. Ind. Aug. 17, 2011) (holding that in order for a plaintiff to prove than an insurance company committed the tort of bad faith in Indiana, a plaintiff must establish that his claim was underpaid or wrongfully denied in the first place, and that as a general proposition, a finding of bad faith requires evidence of a state of mind reflecting dishonest purpose, moral obliquity, furtive design, or ill will). However, it should be noted that the Indiana Supreme Court has previously held that a good faith dispute concerning coverage does not automatically preclude a punitive damages claim for bad faith when coverage was denied. Monroe Guaranty Insurance Co. v. Magwerks Corporation, 829 N.E.2d 968, 970 (Ind. 2005). Based on Monroe, an argument can be made that the Klepper decision should not be so surprising. However, a holding like that in Klepper where the Court found ACE correctly denied coverage, yet a tort based bad-faith claim remained viable certainly has the potential for widespread implication. And, it certainly seems to be a departure from previous Indiana bad faith rulings – specifically, the requirement that a plaintiff show that an insurer wrongfully denied coverage.

Based upon Klepper, an insurer can correctly deny coverage to an individual, but still face damages for bad faith and fair dealing. If an insurer disputes a claim and it is determined that the policy does not apply to that particular matter, is the insurer still really the insurer? For example, suppose Joe Smith was in a car accident and his car was a complete loss. When Joe was involved in the accident, he was transporting a $2,000 television in the back of the car, but it was crushed in the collision. Joe asserts the television is covered under the car insurance, but the insurer denies that the television is covered. In disputing the claim, the court finds that the insurer in fact had explicitly stated in their policy they were not liable for separate items damaged in a motor vehicle accident. Thus, the insurer never was the actual insurer of the television. Yet, throughout the matter the insurer had dragged its feet hoping the insured would drop the matter and simply give up. Based on the Klepper decision, the insurer can still face damages in a tort based bad faith claim for dragging its feet on the television matter, even though they never were contractually bound to cover the television.

While the television matter is fictional, it raises questions with real world implications. With the Klepper decision on the books, what is going to stop insured individuals from seeking indemnity from their insurance company on matters they know are unlikely to be covered? By doing so, if the insurance company handles the matter in any way that unduly delays payment, attempts to deceive the insured, or pressures them into a settlement– they can be held liable for that conduct.

Another question that arises from Klepper involves the alleged damages. What damages does the Class (after assignment of the claim from Pernod) have? The bad faith claim allowed to proceed would be based in tort. As with any tort claim, the Class would need to show damages in order to recover. And, without compensatory damages, there can be no punitive damages. Erie Ins. Co. v. Hickman, 622 N.E.2d 515, 523 (Ind. 1993). The Klepper decision does not include specific allegations so we really do not know what damages the Class may have, and the Court did not explain how the Class could actually frame their bad faith claim.

All in all, the decision in Klepper is likely to bring about change in the law of bad faith and in the manner that an insurer handles policy claims. While the law of bad faith has become commonplace in insurance disputes, it is likely to become even more widespread, as a door has been opened for insured individuals to make a claim for bad faith, even when no coverage existed. Little law has arisen as to the Court’s decision in Klepper, but with a gaping hole for insured individuals to now jump through, it is only a matter of time before Klepper becomes a commonplace decision cited in the briefs of individuals claiming bad faith against their insurers.

Footnote: This article was published on October 8, 2014 by Indiana Lawyer.