Insurer's denial of defense based on unsettled law was bad faith

By Stephanie L. Peppard

A liability insurer may be liable for bad faith if it relies on a split in legal authority in refusing to defend a policyholder, the Washington Supreme Court has held.

In American Best Food, Inc. v. Alea London, Ltd., 168 Wn.2d 398 (Mar. 18, 2010), American Best Food operated the Cafe Arizona nightclub. Two bar patrons, George Antonio and Michael Dorsey, became involved in an altercation. Security guards escorted Antonio out of the building but later let him return to the bar. He confronted Dorsey again. This time, security escorted both men outside. Antonio then pulled a gun and shot Dorsey. Dorsey struggled to the alcove of the bar, and security guards took him back inside. The club’s owner ordered the security guards to remove Dorsey from the club, and according to Dorsey, they “dumped him on the sidewalk.”

Dorsey later sued Cafe Arizona, alleging that it failed to protect him against criminal conduct, despite the club’s history of violence and its awareness of Antonio's propensities. He alleged that the security personnel worsened his injuries by dumping him on the sidewalk after he had been shot.

Cafe Arizona tendered the defense of the action to its insurer, Alea London, Ltd. The insured’s counsel and Alea exchanged letters that argued over whether the policy exclusion for injuries “arising out of” assault or battery applied, even though the complaint alleged additional injuries that the insured’s negligence had caused after the assault had occurred. Alea asserted that under more than 20 years of Washington case law, the phrase “arising out of” broadens the exclusion and encompasses any occurrence with a causal connection to the excluded assault and battery. According to Alea, but for the excluded assault, Dorsey would have no negligence claim. Cafe Arizona cited a federal decision from Texas in which a tavern owner’s failure to render aid to an injured patron was covered despite a similar assault-and-battery exclusion in the policy.

Cafe Arizona sued Alea for breach of contract, bad faith, and violation of the Washington Consumer Protection Act (CPA). On cross-motions for summary judgment, the trial court dismissed the action. Cafe Arizona appealed. The Court of Appeals reversed in part, holding that Alea had breached its duty to defend and that the trial court should not have dismissed the bad-faith claim on summary judgment. The Court of Appeals affirmed the dismissal of Cafe Arizona’s CPA claim. Alea sought review by the Washington Supreme Court, which accepted review.

The Supreme Court noted that no Washington decision had decided whether an assault-and-battery exclusion also excluded coverage for post-assault negligence. The Court reviewed the split in non-Washington cases on the question. The Court chose to follow the rationale of non-Washington courts that had held that “arising out of” in an assault-and-battery exclusion did not apply to, and therefore did not defeat coverage for, allegations of post-assault negligence.

The lack of a controlling Washington decision on the subject also prompted the Supreme Court to hold that Alea should have given its insured the benefit of the doubt in deciding whether to defend, and that its failure to do so was unreasonable. The legal uncertainty whether Alea owed a duty to defend “works in favor of providing a defense to an insured,” the Court held, concluding that Alea had breached its duty to defend as a matter of law.

The Supreme Court went one step further and held that Alea’s refusal to defend was also bad faith as a matter of law. Historically, Washington courts have found bad faith only where the insurer’s conduct was unreasonable, frivolous, or unfounded. Alea therefore argued that its coverage position was one reasonable conclusion from the case law. The Court disagreed, holding that Alea should have provided a defense to Cafe Arizona because, under the split authorities from other states, it was arguable that it was legally entitled to a defense, and therefore should have resolved that question in favor of the insured.

Justice Susan Owens and three other justices dissented in part. Justice Owens agreed with the majority that as a matter of law, Alea owed Cafe Arizona a defense but disagreed that Alea’s conduct was bad faith as a matter of law. The duty to defend sounds in contract, but bad faith sounds in tort. Traditionally, Washington courts have found no bad faith if the insurer’s coverage denial was based on a reasonable interpretation of the policy. Justice Owens wrote, “I cannot conclude that Alea’s ... [coverage] determination, though incorrect, was unreasonable, frivolous, or unfounded in light of the existing case law.” Her dissent is consistent with the longstanding Washington rule that an insurer has a “right to be wrong.” That rule is now in doubt. Liability insurers in Washington should be concerned that this new case requires them to be entirely correct in denying a defense, because if they are wrong, a finding of bad faith is probable.

Around The Firm

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