§ 4.2 Insurer's Wrongful Refusal to Defend: Breach of Contract or Tort?
In 1961, the Supreme Court issued its opinion in Miles v. State Farm,9 in which the insured had caused a car wreck and injured her daughter-in-law, a passenger in the vehicle. The daughter-in-law offered to settle with the liability insurer for $5,000, the policy limit. However, the liability policy contained an exclusion for injuries to resident relatives of the insured.10 Initially after the wreck, the insured informed the insurer that the daughter-in-law had been living with her at the time of the wreck, and based on the resident-relative exclusion, the insurer denied coverage and declined to settle the daughter-in-law's claim.11
As it turned out, however, the daughter-in-law had not technically been living with the insured at the time of the wreck. The daughter-in-law received her mail and kept her clothing at another address. While she often stayed at the insured's home, she did not reside there. The insured had incorrectly informed the insurer to the contrary without understanding the meaning or importance of the issue of residency.12
The daughter-in-law ultimately obtained a $12,500 judgment against the insured. The daughter-in-law then brought suit, "as a third-party beneficiary," against the insurer for its $5,000 policy limit, which the insurer refused to tender because of the resident-relative exclusion. The jury in that case determined that the daughter-in-law had not been a resident relative and found in favor of the daughter-in-law.13 After the insurer paid its $5,000 limit to daughter-in-law, the insured filed an action against the insurer for the excess judgment of $7,500.14
The insured couched her claim against the insurer as sounding in tort for negligence and bad faith. In essence, the insured claimed that if the insurer had reasonably investigated the resident-relative issue, then it would have discovered that the daughter-in-law had not been a resident relative, accepted coverage, defended the claim, and settled the daughter-in-law's claim for an amount within the $5,000 coverage.15
The Supreme Court acknowledged the Tyger River doctrine and the insurer's duty "to act in good faith" and "exercise reasonable care" when defending its insured. The Court also observed that an unreasonable refusal to settle within policy limits when there is an opportunity to do so will "render [the insurer] liable in tort to the insured for the amount of the judgment against him in excess of the policy limit."16 Importantly, however, the Court continued as follows:
But this is not such a case. State Farm never assumed or undertook to control the defense of [the daughter-in-law's] action against [the insured] or to determine whether or not a compromise settlement of [the daughter-in-law's] claim should be made. On the contrary it expressly and unequivocally denied coverage; and the issue here is whether from the record before us, viewed in the light most favorable to the plaintiff's case, it may reasonably be inferred that its denial of coverage was without substantial basis and therefore not in good faith. We agree with the trial judge that the evidence furnishes not the slightest basis for such conclusion.17
The Court went on to summarize several cases from other jurisdictions involving entry of an excess judgment against the insured after the insurer's denial of coverage, refusal to defend, and declination of an opportunity to settle within limits. The courts in those other cases had found, under the facts of those cases, that the insurers there had not committed bad faith in denying coverage, as they each had a substantial factual basis for taking that position. Each carrier having ultimately been incorrect in its coverage position had amounted to a breach of contract, but not an act of bad faith.18 Likewise, the Court in Miles found that State Farm had reasonably relied on the statement of its insured about the residency issue, and thus the Court found that the insurer had not acted in bad faith in conducting its investigation of the claim.19
Notably, the Miles Court did not address whether the insured would have been able to recover the excess judgment pursuant to a cause of action for breach of contract. Moreover, the Court did not hold that there could be no set of facts in which an insurer's unreasonably denying coverage and refusing to defend or settle could support a claim of insurance bad faith in tort. Rather, the Court simply held that under the facts before it, there was no bad faith in State Farm's refusal to accept coverage and assume the defense. The Court did not address whether, if the facts...
