So-called “reverse bad faith” is a double-edged sword for Coverage Opinions. On one hand, it is an issue that does not arise too often. And CO seeks to focus on cases that could have wide impact. On the other hand, because reverse bad faith does not come about every day, its uniqueness makes it an attractive case for CO. Uniqueness wins out.

In State Auto Property and Casualty Ins. Co. v. Hargis, No. 13-5020 (6th Cir. May 6, 2015), the Sixth Circuit Court of Appeals provided a detailed discussion of “reverse bad faith.” Bottom line -- the court held that a common law tort claim by an insurer, against an insured, for reverse bad faith, is not recognized under Kentucky law. In fact, the Hargis court also observed that it is “not aware of any jurisdiction that has recognized a cause of action for reverse bad faith.”

Hargis arose out of a fire claim under a homeowner’s policy. Lori Hargis’s home, located in Henderson, Kentucky, was insured by State Auto under a homeowner’s policy. The home burned to the ground. Hargis filed an insurance claim for approximately $866,000. State Auto paid the claim and subsequently commenced an action to declare the policy void, alleging that Hargis caused or conspired to cause the fire and falsely inflated the property loss resulting from the fire.

Hargis asserted counterclaims against State Auto for breach of contract and bad faith under Kentucky common law, the Kentucky Consumer Protection Act and the Kentucky Unfair Claims Settlement Practices Act. State Auto’s investigation eventually led to Hargis’s admission that she had solicited a friend to burn down her house to collect the insurance proceeds. Hargis pleaded guilty and was sentenced to 60 months in prison and ordered to pay restitution to State Auto.

After the indictment was returned against Hargis, State Auto moved for partial summary judgment and Hargis’s bad faith claims were dismissed. State Auto also filed an amended complaint that added a statutory claim for damages for insurance fraud and a common law tort claim, under Kentucky law, for reverse bad faith. State Auto’s argument, in support of reverse bad faith, was that “there is a strong public policy against allowing insureds to profit from their own wrongdoing while simultaneously subjecting insurers to inordinate increased costs for investigation, defense, and litigation.”

The District Court rejected the insurer’s claim for reverse bad faith. The Sixth Circuit agreed. At the outset, the court noted that State Auto cited no Kentucky case that has adopted a claim, by an insurer, for reverse bad faith against an insured. Further, the court stated that it was “not aware of any jurisdiction that has recognized a cause of action for reverse bad faith.”

Despite State Auto’s inability to point to any decisions in Kentucky (or elsewhere) that have recognized a common law claim for reverse bad faith, “State Auto argue[d] that there was no reason to conclude the Kentucky Supreme Court would not decide to allow tort recovery ( i.e., compensatory and punitive damages) for an insured’s bad faith since the implied covenant of good faith and fair dealing imposes contractual obligations on both parties. That is, State Auto contends, it is ‘unjust’ for Kentucky law to allow Hargis to assert a common law tort claim for bad faith without having to face the threat of a reciprocal tort claim for reverse bad faith.”

Nonetheless, for a host of reasons, the Sixth Circuit predicted that the Kentucky Supreme Court would reject State Auto’s invitation to adopt a common law tort claim for reverse bad faith by an insured. These were as follows:

• The reasons articulated by the Kentucky Supreme Court in recognizing first-party common law bad faith. Namely, that a fiduciary relationship existed between the insurer and its insured.

• A prior rejection, by the Kentucky Supreme Court, of an insurance company’s challenge to the fact that the Kentucky Unfair Claims Settlement Practices Act affords rights and remedies to an insured but provides no reciprocal rights or remedies to insurers.

• The standards for proving a claim of bad faith.

• The availability of other remedies for the damages incurred as a result of an insured’s fraud under Kentucky law. More specifically, the court explained: “State Auto repeatedly returns to the theme that it is ‘unjust’ for Kentucky law to allow Hargis to escape the consequences of her intentionally fraudulent conduct. But, she plainly did not. Her fraudulent conduct resulted in a civil judgment against her for all of the damages incurred by State Auto and subjected her to incarceration and an order of restitution to State Auto. The criminal conviction simplified State Auto’s proofs by establishing both breach of contract and the statutory claim for insurance fraud. . . . Further, even if the prosecution had not gone forward, there is no suggestion that State Auto could not have brought a common law claim for fraud. Finally, to the extent that State Auto claims that the threat of punitive damages is necessary to deter such fraudulent conduct, it is hard to imagine that a possible claim for reverse bad faith would be a deterrent if the threat of criminal prosecution was not.”

• The absence of support in other jurisdictions for reverse bad faith.

What I found most interesting was the court’s observation that it was “not aware of any jurisdiction that has recognized a cause of action for reverse bad faith.” Is that really the case?