Usually, when there is no coverage, there can be no bad faith for not paying the claim. But in Advantage Buildings & Exteriors, Inc., v. Mid-Continent Casualty Company, Missouri's Court of Appeals found that Mid-Continent could be liable for failing to pay the claim because it failed to provide its insured with a timely reservation of rights letter.
Advantage was sued in 2008 for construction defects. Mid-Continent told Advantage it was investigating coverage, reserving its rights under the policy and would let Advantage know of its determination. A few weeks later, Mid-Continent told Advantage it was accepting the defense of the case under a reservation of rights. Despite being told that its insured would likely be found liable and face millions in claims, Mid-Continent determined the most that was insured was about $50,000 -- but did not tell its insured this. Mid-Continent failed to respond to settlement demands, and then, 2 years later and a few days before trial, told the insured why the majority of the claims were not covered. Advantage made a deal with the plaintiff. In a declaratory judgment action, it was determined that Mid-Continent's coverage position was correct -- most of the claims were not covered. But the bad faith claim went to trial, and Mid-Continent was hit for $3M in actual damages and $2M in punitive damages.
Mid-Continent said there could be no bad faith because it defended the case and told Advantage it was reserving its rights and doing a coverage analysis. But this was not a "proper" reservation of rights. A "proper" reservation of rights must be both clear and timely, and the insured must fully understand the insurer's position. "Defending an action with knowledge of non-coverage under a policy of liability insurance without a proper and effective reservation of rights in place will preclude the insurer from later denying liability due to non-coverage." There is a duty of good faith to settle claims against an insured.
The elements to prove such a claim of bad faith failure to settle are:
(1) the liability insurer has assumed control over negotiation, settlement, and legal proceedings brought against the insured; (2) the insured has demanded that the insurer settle the claim brought against the insured; (3) the insurer refuses to settle the claim within the liability limits of the policy; and (4) in so refusing, the insurer acts in bad faith, rather than negligently.
The judgment was reversed because of bad jury instructions, and the matter remanded for a new trial on actual and punitive damages.