Bad Faith Insurance Claims And Attorney-Client Privilege

The South Carolina Supreme Court punts back to the United States Court of Appeals for the Fourth Circuit

We are presented with a certified question from the United States Court of Appeals for the Fourth Circuit. The underlying case is an insurance bad faith action against an insurance company for its failure to defend its insured in a construction defect action. The insured settled the construction defect action and brought a bad faith tort action. When the insurer asserted it acted in good faith in denying coverage, the insured sought to discover the reasons why the insurer denied coverage. According to the insurer, the discovery requests included communications protected by the attorney-client relationship. The federal district court reviewed the parties’ respective positions, determined the insured had established a prima facie case of bad faith, and ordered the questioned documents to be submitted to the court for an in camera inspection. The insurer then sought a writ of mandamus from the Fourth Circuit to vacate the district court’s order regarding the discovery dispute. In turn, the Fourth Circuit certified the following question to this 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 parties, especially the insured, assert the certified question does not accurately represent the correct posture of the case. In fact, the insured concedes the narrow question presented requires an answer in the negative. We agree, for we find little authority for the untenable proposition that the mere denial of liability in a pleading constitutes a waiver of the attorney-client privilege. For the reasons set forth below, we elect to analyze the issue narrowly in the limited context of a bad faith action against an insurer. We are constrained to answer the certified question as follows: “No, denying liability and/or asserting good faith in the answer does not, standing alone, place the privileged communications ‘at issue’ in the case.”

The court describes the facts of the claim

Because the certified question necessarily involves a determination of the circumstances under which a communication otherwise protected by the attorney-client privilege is discoverable under South Carolina law, we will examine the law generally and set forth the proper framework to be applied in South Carolina in a tort action by an insured against the insurer for bad faith refusal to provide coverage.

And sets out general principles of attorney-client privilege. 

With this general background, we turn to the three approaches to the waiver of the attorney-client privilege.

Bad faith claims against an insurer

This Court has not previously been tasked with harmonizing attorney-client privilege and insurance bad faith law. As the Supreme Court of Washington noted, insurance bad faith claims place in tension three valued principles: on the one side, the attorney-client privilege; and on the other side, the importance of broad discovery and holding insurance companies accountable for their bad acts. See Cedell v. Farmers Ins. Co. of Wash., 295 P.3d 239, 245–46 (Wash. 2013) (en banc). As mentioned previously, there are three broad approaches jurisdictions take to resolve this tension. Bertelsen, 796 N.W.2d at 702 n.6; Restatement (Third) of the Law Governing Lawyers § 80 Reporter’s Note cmt. b. We acknowledge that none of the various approaches is without legitimate criticisms.

First, a “substantial minority” of jurisdictions have broadened the crime-fraud exception to the attorney-client privilege and found the privilege does not extend to any communications in furtherance of any crime or tort, including bad faith insurance claims. These jurisdictions have typically found the entire pre-denial claim file discoverable.

Rejected by the court as this places only “nominal value” on the privilege

Second, and on the other extreme, other jurisdictions have upheld the attorney client privilege absent direct, express reliance on a privileged communication by a client in making out his claim or defense. Such jurisdictions reject the suggestion of an implied waiver of the attorney-client privilege. We reject this approach as well, as it fails to balance the attorney-client privilege with any competing policy considerations.

The winner

Third, some jurisdictions take a middle-ground approach and find the answer depends on a case-by-case analysis of the facts. This is the general approach we adopt when determining if the attorney-client privilege has been waived in a tort action against an insurer for bad faith refusal to deny coverage.

We find the case of State Farm Mutual Automobile Insurance Co. v. Lee from the Supreme Court of Arizona instructive…

In finding the Lee framework instructive, we emphasize the sanctity of the attorney-client privilege. In this regard, a client does not waive the privilege simply by bringing or defending a lawsuit. We adopt the Lee framework in a tort action against an insurer for bad faith refusal to provide coverage, and we impose the additional requirement that the party seeking waiver of the attorney-client privilege make a prima facie showing of bad faith.

“[B]etween Scylla and Charybdis”

Insurance bad faith actions necessarily bring into conflict the competing policy considerations of protecting the attorney-client privilege and promoting broad discovery to facilitate the truth-seeking function of our justice system. In balancing these considerations, we find the Lee framework is the most consistent with South Carolina’s policy of strictly construing the attorney-client privilege and requiring waiver to be “distinct and unequivocal.” See Thompson, 329 S.C. at 76–77, 495 S.E.2d at 439; Doster, 276 S.C. at 651, 284 S.E.2d at 219. This case-bycase approach accounts for and fairly distributes the risks and benefits of the various competing public policies. We therefore answer the certified question from the United States Court of Appeals for the Fourth Circuit by holding that a denial of bad faith and/or the assertion of good faith in the answer does not, standing alone, place a privileged communication “at issue” in a case such that the attorney-client privilege is waived.

(Mike Frisch)