Can There Be <i>Implicit Waiver</i> of Attorney-Client Privilege in Insurance Bad Faith Actions? South Carolina Supreme Court Answers That QuestionIn June, the South Carolina Supreme Court addressed waiver of the attorney-client privilege in bad faith refusal to provide coverage cases and found that, under South Carolina law, an insurer that asserts its subjective understanding of the law, as informed by counsel, as a defense to a bad faith claim may implicitly waive the privilege with respect to those attorney-client communications.

In In re Mt. Hawley Insurance Company, the insured sued its excess commercial liability insurer, Mt. Hawley Insurance Company, for bad faith after Mt. Hawley refused to defend the insured in a construction defect action. As a defense, Mt. Hawley asserted that it acted in good faith. The insured sought discovery into the reasons why Mt. Hawley denied coverage. Mt. Hawley claimed that certain portions of the requested discovery included communications that were protected by the attorney-client privilege, and after finding that the insured had made a prima facie showing of bad faith, the United States District Court for the District of South Carolina ordered that the documents be produced for an in camera review. In response, Mt. Hawley sought a writ of mandamus from the Court of Appeals for the Fourth Circuit to vacate the district court’s order. The Fourth Circuit certified the following question to the South Carolina Supreme Court: “Does South Carolina law support application of the ‘at issue’ exception to attorney-client privilege such that a party may waive the privilege by denying liability in its answer?”

The South Carolina Supreme Court quickly disposed of the question certified by the Fourth Circuit, answering the question in the negative and finding that the mere denial of liability or assertion of good faith in a bad faith cause of action does not waive the attorney-client privilege. The court, however, did decide to fully analyze the issue of when the attorney-client privilege is placed “at issue” and thereby potentially waived in a bad faith case, in part because the parties asserted that the certified question did not accurately reflect the posture of the case below.

In determining the proper framework to be used when presented with this issue, the South Carolina Supreme Court noted the varying approaches other jurisdictions have taken when determining whether the attorney-client privilege is waived in a bad faith action. The court noted that the minority approach takes the most restrictive view of the use of the attorney-client privilege and found that the privilege does not extend to communications in furtherance of a crime or tort, including an insurance claim for bad faith. On the opposite end of the spectrum, the court noted that other courts have rejected the idea of an implied waiver of the attorney-client privilege and found that the privilege exists absent a direct, express reliance by the client on the privileged communication in making out its claim or defense.

Opting for a more middle-ground approach, the South Carolina Supreme Court adopted the framework created in Arizona in State Farm Mutual Automobile Insurance Co. v. Lee. Under that approach, the attorney-client privilege may be implicitly waived on a factual, case-by-case determination where (1) the insurer defends a bad faith claim on the basis of its subjective and allegedly reasonable understanding of the law and (2) that understanding necessarily involves what the insurer learned from its counsel. In addition to the two requirements announced in Lee, the South Carolina Supreme Court also adopted a third requirement: The party seeking waiver of the attorney-client privilege must also make a prima facie showing of bad faith in order for the privilege to be waived.

Notably, the court’s opinion does not change the analysis used when an insurer asserts its objective reading of the policy at issue as a defense to a bad faith claim. Nevertheless, despite the fact that the South Carolina Supreme Court provided an extra layer of protection for insurers asserting a subjective understanding of the law as a defense in bad faith actions, insurers and counsel should be aware of this new ruling and of the risk of implicit waiver of the attorney-client privilege. This risk should be kept in mind both when attorneys are communicating with their clients throughout the claims handling process and when formulating defenses to bad faith claims.

South Carolina Supreme Court Says “No” to Binding Non-Signatories to Arbitration ClauseThe Supreme Court of South Carolina recently determined that non-signatory insureds could not be compelled to arbitrate their claims under an arbitration clause in an agency agreement where the insureds did not obtain a direct benefit from that agreement.

In Wilson v. Willis,  the court considered 14 lawsuits that had been filed against an agent, the insurance broker who hired her, their insurance agency (Southern Risk Insurance), and six insurers for which their office sold policies. Twelve of the suits were filed by insureds who were customers of the agent, and two lawsuits were filed by other insurance agents (collectively, petitioners) who were in competition with the defendant agent and Southern Risk Insurance. The suits asserted various causes of action, including violations of the Unfair Trade Practices Act, and claimed that the broker, Southern Risk Insurance, and the insurers failed to prevent their agent from defrauding the insureds and stifling competition in the local insurance market.

Approximately one year into the lawsuit, three of the insurers filed motions to compel arbitration and dismiss the suits. Those insurers argued that a 2010 agency agreement they had signed with Southern Risk Insurance contained an arbitration provision and that petitioners were third-party beneficiaries to that agreement. The insurers argued that the petitioners were bound by the arbitration clause, which required arbitration of “any dispute or disagreement [that arose] in connection with the interpretation of th[e] [a]greement, its performance or nonperformance, its termination, the figures and calculations used or any nonpayment of accounts,” and were equitably estopped from asserting their non-signatory status, because any claims asserted by petitioners were based upon duties that would not exist but for the 2010 agency agreement.

The trial court denied the motion to compel arbitration, and the court of appeals reversed, finding that the petitioners were equitably estopped from asserting their non-signatory status. In reversing, the court of appeals relied on the direct benefits test it had articulated in Pearson v. Hilton Head Hospital. Under that test, a non-signatory to an agreement containing an arbitration clause will be bound by that clause if the non-signatory receives a direct benefit from the agreement that contains the clause. In other words, under the direct benefits test, a non-signatory cannot assert his or her non-signatory status under an agreement containing an arbitration clause while simultaneously maintaining that other aspects of that agreement apply to his or her benefit. The court of appeals held that, because the petitioners’ claims arose out of duties created by the 2010 agency agreement and the relationship the agreement created between the insurers and Southern Risk Insurance, they were equitably estopped from asserting their non-signatory status.

On de novo review, the Supreme Court of South Carolina reversed, finding that the arbitration clause was not enforceable against the petitioners. The court emphasized the distinction between direct benefits and indirect benefits, explaining that a direct benefit is one that flows directly from the agreement containing the arbitration clause. On the other hand, an indirect benefit is one where a non-signatory exploits the contractual relationship created by the agreement, rather than the agreement itself. The court noted that the petitioners were unaware of the 2010 agency agreement until the insurers filed their motions to compel arbitration, the petitioners had not asserted a claim for breach of contract, and there was no evidence that the petitioners had knowingly exploited or received a direct benefit from the agency agreement itself. Therefore, any benefit the petitioners gained from the agency agreement was indirect, and they could not be compelled to arbitrate their claims under a theory of equitable estoppel under South Carolina law.

As state courts continue to grapple with the circumstances in which an arbitration clause may be enforced against a non-signatory, insurers seeking to enforce arbitration clauses in such a manner should take extra precaution to make the intention to include non-signatories clear, such as including explicit language in agency agreements that the arbitration clause applies to all third-party beneficiaries of the agreement and informing the insureds that any claims they have related to their policies may be subject to arbitration pursuant to an agency agreement.

We all know how prevalent bad faith claims are. It seems like almost every case involving disputed policy benefits includes one. Many have no merit and should be disposed of on summary judgment. The rest, however, arguably have at least some degree of legitimacy. While it may not seem that difficult to identify those that present significant exposure, the large verdicts we continue to see suggest otherwise. So how can insurers distinguish between a garden-variety bad faith claim with, at most, low six-figure exposure versus one that could result in a multimillion-dollar verdict?

First, it’s important to recognize that insurers instinctively evaluate cases based on factors that are insurer-centric: What is the amount of policy benefits? What are the terms of the policy? Did the company make the right decision? What kind of witness will the corporate representative(s) make? What will it cost to defend the case? These questions are familiar to all of us—and rightfully so. They are particularly useful for evaluating a breach of contract claim, or even a bad faith claim prior to summary judgment. However, they have less relevance once it becomes clear that the bad faith claim will be submitted to a jury. Good plaintiffs’ lawyers rely on different factors when evaluating a case: How sympathetic is the plaintiff? How badly did the plaintiff need the benefits? Has the plaintiff changed his or her position based on the denial? Did the insurer give the plaintiff the runaround? Does the basis for denial resonate with an average person? Is there evidence indicating the insurer was more concerned about the financial impact of the coverage decision than processing the claim correctly? The answers to these questions often provide the most reliable indication of whether the jury may render a headline-grabbing verdict.

$25.5 Million Oklahoma Verdict: Jackpot Justice or Case StudyA good example is the recent $25.5 million verdict in Oklahoma against Aetna. The case involved the 2014 denial of health insurance coverage for a specific cancer treatment on the basis that it was experimental. The plaintiff, Orrana Cunningham, who died in May 2015, suffered from stage 4 nasopharyngeal cancer near her brain stem. Her doctors at M.D. Anderson recommended proton beam therapy, a targeted form of radiation that could pinpoint her tumor without the potential for blindness or other side effects of standard radiation. After Aetna denied coverage for this treatment, Cunningham and her husband Ron, a retired Oklahoma City firefighter, mortgaged their dream home to pay for the $92,000 therapy. They also started a GoFundMe page.

At trial, plaintiff’s counsel presented evidence that Medicare covers proton beam therapy and that insurers often cover it for an array of pediatric cancer patients. He also presented evidence that Aetna did not carefully review the claim. For example, Aetna’s medical director testified that he sometimes reviewed up to 80 claims per day. At the same time, Aetna’s counsel told the jury that Aetna was proud of how the claim was handled. The jury disagreed. It concluded that Aetna recklessly disregarded the duty it owed to Ms. Cunningham, rendering a verdict for $15.5 million in mental anguish damages and $10 million in punitive damages.

Reviewing the factors noted above, the risk of a large verdict was obvious. The plaintiff was sympathetic. She and her husband badly needed the benefits. They had to mortgage their house as a result of the denial and ask their friends for money. And the jury didn’t buy the basis for the denial, finding instead that the insurer was more concerned about its profits than carefully administering Ms. Cunningham’s claim.

Bad faith claims are so prevalent, it is easy to become desensitized to the risk they pose.  Nevertheless, once summary judgment has been denied, these claims can present significant exposure for insurers. The factors listed above that are considered by both insurers’ and insureds’ attorneys will help you decide when to fight and when to write a check.

The Bradley team will continue to monitor and report on significant bad faith developments.