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Considering the Clash Between Good Faith and Bad Faith.

Looking at MD. Ins. v. Head Indus. Coatings, 906 S.W.2d 218 (Tex.App. -- Texarkana 1995) on appeal to the Texas Supreme Court in the historical context.


Union Bankers Ins. Co. v. Shelton, 889 S.W.2d 278, nicely highlights the lack of a union between the two sides of the Texas Supreme Court when it comes to the duty of good faith and fair dealing. Who would have thought this would be the direction signaled so long ago in Arnold v. National County Mutual Fire Insurance Co., 725 S.W.2d 165 (Tex. 1987) and Vail v. Texas Farm Bureau Mut. Ins. Co., 754 S.W.2d 129 (Tex. 1988) .

MD. Ins. v. Head Indus. Coatings ("Maryland"), builds on that decision in an entirely different way, providing a chance at harmonizing the two sides of the issue by applying one to statutory remedies and the other to the common law.

Two different worlds

The problem in the recent series of cases that culminates with Maryland is that there are two different torts being discussed: first, breach of the duty of good faith and fair dealing and second, bad faith.

First, the Duty of Good Faith and Fair Dealing

The duty of good faith and fair dealing is the fiduciary duty owed between those in special relationships. It is the duty owed by one partner to another. The duty of a corporation's officers to the corporation. The duty owed by a lawyer to a client and the duty owed by a Trustee to the beneficiaries of a trust.

In the "old" Texas jurisprudence, the violation of this duty was known as "fiduciary fraud" and a violation was assumed whenever the fiduciary in the relationship profited at the expense of others. Critically, the burden of proof was on the fiduciary.

The edge of this doctrine is shown in Employers Casualty Company v. Tilley, 496 S.W.2d 552, 562 (Tex. 1973).

The law "speaks to the fiduciary relationship between a lawyer and his client . . ." "recites that the lawyer's professional judgment is to be used solely for the benefit of his client and that no conflicting interest shall dilute such loyalty."

Thus there was in Texas a general rule that where equity imposes a confidential or fiduciary relationship, and one of the parties to the relationship obtains an advantage over the other, a presumption of unfairness arises. In such a case, it is the burden of the party obtaining the advantage to show that he acted fairly, and that he fully informed the other party of all material facts relating to the transaction. Thus the frightening Texas Bank & Trust Company v. Moore, 595 S.W.2d 507, 509 (Tex. 1980), and see Scott v. Weaver, 2 S.W.2d 870 (Tex.Civ.App.--Austin 1927, writ dism'd).

And all of this rests on rather old foundations in Texas law. E.g. Johnson v. Peckham, 132 Tex. 148, 120 S.W.2d 786, 120 ALR 720 (1938) at 120 S.W.2d 788 [stating that exceptions should not creep in]

"When persons enter into fiduciary relations each consents, as a matter of law, to have his conduct towards the other measured by the standards of the finer loyalties exacted by courts of equity. That is a sound rule and should not be whittled down by exceptions. If the existence of strained relations should be suffered to work an exception, then a designing fiduciary could easily bring about such relationships to set the stage for a sharp bargain."

The original Arnold case was decided with this specific intent in mind. In fact it is this line of precedent that caused William Kilgarlin, in his Overview of Good Faith and Fair Dealing, May 1988, at D-15 to write:

"It should be noted that in Arnold, the term 'bad faith' is not utilized. Arnold very carefully characterizes the action as being one of breach of a duty of good faith and fair dealing."

But, Bad Faith

Bad faith also has a Texas history. In the "old" days (a hundred years ago or so) it was also known under the titles of Oppression and Malice. E.g. International & G.N. v. Garcia, 7 S.W. 802, 804 (Tex. 1888). Somewhere past gross negligence, it generally applied to the abuse of sharecroppers and others who were relatively powerless and who had been grossly mistreated.

For bad faith there was a standard of proof similar to the old "box of band aids" on the oil rig test. Rather than the tortfeasor being forced to prove innocence (as is the case in fiduciary fraud cases), the injured party had to basically disprove any alternative reason for the abusive behavior. Cf Bolton v. Stewart, 191 S.W.2d 798, 803-804 (Tex.Civ.App. -- Fort Worth 1945, no writ).

The most modern equivalent in Texas is wrongful discharge. After all, you can fire someone without any reason, just not for the wrong reason.

This basically means that the plaintiff cannot recover. As 889 S.W.2d 278 at 286-288 reflects, "some evidence (287) vs any proof of a reasonable basis (287-288) -- is a return to the "there wasn't a complete disregard for the health and safety of the men on that oil rig, they had a box of band aids on it" approach that used to rule the law of gross negligence. For more, see National Union Fire Ins. Co. v. Dominguez, 873 S.W.2d 373, 376-77 (Tex. 1994).

The Commercial Law Complication

While tort attorneys (on both sides) have been creating and redefining ancient causes of action in modern names and pleading, the legislature and the commercial law bar have not been quiet. The commercial setting has its own law of "good faith" with (more or less) pure contract remedies and a burden of proof somewhere in the middle of the two tort positions. The legislature, with Vail's gloss, has also produced a DTPA statutory basis.

Beginning with the commercial law, citing an "ancient" case: Riley v. First State Bank, 469 S.W.2d 812, 816 (Tex.Civ. App. -- Amarillo 1976, writ ref'd n.r.e.):

"'Good Faith' is defined in Sec. 1.201(19) to mean 'honesty in fact in the conduct or transaction concerned.' The test is not diligence or negligence; and it is immaterial that appellee may have had notice of such facts as would put a reasonably prudent person on inquiry which would lead to discovery, unless appellee had actual knowledge of facts and circumstances that would amount to bad faith."

And Christian v. First. Nat. Bank of Weatherford, 731 S.W.2d 832, 842-843 (Tex.Civ.App.--Fort Worth 1975, writ ref'd n.r.e).

"Comment 6 to Section 9.504 repeats that the Code's general obligation of good faith (Section 1.203) is imposed upon these parties. Section 9.507(a) states that if the collateral has been disposed of without compliance with the Uniform Commercial Code, the debtor may recover for any losses sustained as a result of this wrongful disposition."

As for Vail and the DTPA, that is the heart of the Maryland opinion -- which stands as a challenge and a harmony.

Basically, Maryland states that under the DTPA good faith applies. Away from the DTPA, bad faith applies. The issue is complicated by Maryland's not accepting 21.21 incorporation of 21.21-2 and a wondrously outraged dissent.

The Problem

As any attorney can guess, both tort standards lend themselves to some substantial abuse. Further, Texas' third standard that the legislature enacted and that applies in certain situations is not any clearer.

Basically, if one treats an insurance company as a true fiduciary involved in a special relationship, it is almost impossible for the insurance company to carry the burden of proof. Having consulted for the defense in several cases where the insurers were attempting to prevent any breach of the duty, it is close to impossible to conduct business as usual.

Every denied claim requires the same precautions and steps that accompany a corporate officer selling goods to his or her corporation or a trustee buying a portion of the property of a trust. cf Trevino v. Brookhill Capital Resources, 782 S.W.2d 279, 281-282 (Tex.App. -- Houston [1st Dist.] 1989, writ denied.). Basically, under this standard it is impossible to deny most claims at a cost less than just paying them.

On the other hand, when litigating for the plaintiff (which I also do), the "reasonable basis to challenge a claim" and "as a matter of law" position (footnote 1 of the concurring dissent at Union Bankers, 287) makes it basically impossible for a plaintiff to prevail without a showing of actual malice.

This position leads to a great deal of injustice. Consider if your partner converted (did not share) substantial income and then said "well, I thought I had a good reason." You would feel rather appalled if the Court sided with him or her as a matter of law.

This is especially true if the litigation could be expected to take years and run thousands of hours and only three or four thousand dollars were at stake.

In fact, I had the privilege of being involved in a case where a company that routinely denied all claims (albeit, they always had a good excuse) was finally brought to heel -- but only after they had cheated scores of people with "good reason." As a result, I know that abuse is not only possible, but certain to occur under the "bad faith" standard.

A Middle Ground or Both Grounds?

There is a middle ground that occurs because of the growth in the measure of the law.

When the cases began, there was no pre-judgment interest. Mental anguish required an intentional tort and a physical manifestation. Attorneys fees were recovered only via punitive damages (still an important element of punitive damages proof in some jurisdictions).

Now all of these elements can be recovered.

The only real problem a plaintiff faces in obtaining "fair compensation" is the inherent risk and delay of the judicial system compounded by the changing possibilities of a Supreme Court which has adopted two very different standards and two very different torts as the law of Texas.

The middle ground is to impose the "good faith" standard of proof, but to limit it by commercial style damages.

That is, as to "commercial fiduciaries," if a payment is withheld, the fiduciary has the burden of proof as to fairness. Otherwise, the Plaintiff recovers all "normal" damages (direct and consequential, including emotional distress, credit damage and attorneys fees, together with prejudgment interest).

However, punitive damages apply only in cases where gross negligence, intent or malice can be shown. (Reviving Transport and giving it a clear application).

By going to the commercial law, the commercial fiduciary duty would place insurance contracts in the same realm as other commercial transactions where a duty of good faith and fair dealing applies. This allows the standard to be applied that consumers expect when they buy insurance (e.g. "Get Met, It Pays" surely doesn't mean to most -- "unless we have a good excuse"). At the same time, by applying it only in commercial and quasi- commercial situations, a wholesale dilution of the general duties of fiduciaries is prevented.

The alternative is to follow Maryland and to have both positions be the law. Under the DTPA an insurer owes a fiduciary duty of good faith and fair dealing.

The insurer has the burden of proof, and is liable for tripled damages and attorneys fees.

If the protected party wants more in the way of punitive damages (with due regard for the regular statutory modifications of punitive damages), they must show the equivalent of actual malice and intent to harm.

The law in Texas needs to draw back from the edge. Reaching a union of the laws offered in Union Bankers and Maryland would allow that to happen.

The split is clearly illustrated in Union Bankers. The choice of how to rectify and whether to rectify now (rather than later) is clearly presented in Maryland (not to mention an interesting invitation to revisit Employers v. Block and all of the collateral issues).

Now is the time.

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Copyright 1998, 1999, 2000 Stephen R. Marsh

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