By John J. Pappas
This is one of a series of articles under the by line "Butler Pappas on Bad Faith" originally published in Mealey's Litigation Report: Insurance Bad Faith, Vol. 13, #18, p. 23 (January 18, 2000). © Copyright Butler Pappas 2000.
I. The Gathering Storm
For over one hundred years the appraisal clause has been efficiently resolvingdisputes between insured and insurer over the amount of the claim.(1) There is, however,a disconcerting trend of invoking appraisal in an attempt to circumvent the terms andconditions of the insurance contract, conceal fraud, and "create" evidence of "bad faith."(2) This paper warns of the calamity and complexities that will occur if this issue is notproperly addressed by insurers, insureds, and the courts.
II. Engagement
An insured submits a $10 million claim for windstorm damage and simultaneouslydemands appraisal. How should the insurer respond? What can the insurer do? Maythe insurer invoke its "right" to an Examination Under Oath? May the insurer invoke its "right" to obtain the insured's documents? May the insurer invoke its "right" to a SwornStatement in Proof of Loss? May the insurer pursue investigation of the claim throughthe terms and conditions of the insurance contract, or must the insurer go through theappraisal process, specifically, the appraisal panel?(3) Most courts seem to uphold aninsurer's contractual rights and enforce an insured's obligations under the insurancecontract. In fact, for an insurer not to proceed through contract, but rather solely throughthe appraisal process, may result in a waiver of these rights.
Assume the insurer conducts a thorough investigation and concludes that the claim is fraudulent. Specifically, the insurer concludes that $5 million of actual damagesare caused by flood and, therefore, excluded from its coverage. The other $5 million isintentionally inflated by 400% - - that is, the covered windstorm damage does not exceed$1 million. Assume the insurer has reached this conclusion fifteen days before theappraisal panel is scheduled to meet. What is the insurer to do? Should the insurer relyon a "Reservation of Rights" letter and proceed with appraisal? Should the insurer denythe claim? Should the insurer pay the $1 million it concedes it would otherwise have paidits insured? Should the insurer refuse to proceed with appraisal? Should the insurer filea Complaint for Declaratory Judgment?(4) Logic dictates that if the insurer believes theinsurance contract is void then it should not, in fact cannot, acquiesce to any furtherpayment or appraisal. Once again, to do so would invite waiver and estoppel arguments.
III. Conflict, Consensus, and Contradiction
Assume the insurer has reserved all rights, denied the claim, and even obtaineda stipulation from the insured that going forward with appraisal will not estop the insurerfrom asserting any of its reasons for denial of the claim. Alternatively, a court compelsappraisal. An appraisal occurs.
Traditionally, the process is as follows. The insured appoints as its appraiser, theinsured's own public adjuster, contractor, or estimator. The insurer, in turn, appoints its own independent adjuster, contractor, or estimator. Although each is independent, eachis far from impartial.(5) They are advocates. Some may even argue each is an agent fortheir "client" (a foreshadowing of evidentiary concerns). These two advocates gettogether and attempt to agree on as much as possible. To the extent there isdisagreement, if the appraisers or parties cannot agree upon an umpire, the court ispetitioned to appoint one. The umpire is neither an appraiser nor an advocate for eitherparty, but rather someone who on an item-by-item basis chooses one or the other untilthe claim is fully decided upon. That is the way appraisal was designed to proceed.(6) Because an insurer should have already paid its insured whatever it believes it owed(presuming no coverage or forfeiture issues), appraisal should only benefit the insured. Apparently, insurers justify such a process upon the rationale it is less expensive andless risky than litigation. For an increasing number of claims, this rationale may no longerring true.
Some states have held that an appraisal clause is an agreement to arbitrate andthus the governing arbitration laws and rules apply.(7) If taken literally, such a processwould result in three arbitrators of equal standing who are not only independent, butimpartial as well. In fact, it would be a breach of their duties as arbitrators to have anyex parte communications with any of the parties. This arbitration panel is intended to actmore like a quasi-judicial proceeding of three judges or three jurors in which evidence ispresented and a formal hearing is held. Although there are positives and negatives toboth the traditional "appraisal" process and this "arbitration" process, a commondenominator is what we call "the politics of three."
Whether appraisal or arbitration, there are three voters, each with an equal vote. An award only requires two of the three signatures. By definition, one is always morefavorable to the insured, while another is always more favorable to the insurer. That is,one advocates a high number, and the other advocates a low number. The thirdparticipant is somewhere in between, or, more typically, simply indifferent. Whathappens?
Assume appraiser number one argues that the covered damages are $10 million,while appraiser number two argues that these damages do not exceed $1 million. Assume the umpire believes that appraiser number two ($1 million) is probably right. Does the umpire sign-off on a $1 million award without obtaining the signature ofappraiser number one? Possibly, but not likely. On the other hand, if the umpirebelieved that appraiser number one ($10 million) was probably right, would the two ofthem sign-off on a $10 million award? Again, possibly, but not likely.
What is likely to happen is that the umpire, looking to avoid conflict, and seekingconsensus and credibility, goes to appraiser number one and says: "I am going to sign-offon appraiser number two's proposal of $1 million, unless you agree to sign-off on acompromise of $5.5 million." Devoid of an actual choice, appraiser number one agrees. The umpire then goes to appraiser number two and says: "I am going to sign-off on a$7.5 million award unless you agree to sign-off on a $5.5 million award." Devoid ofchoice, appraiser number two agrees. All three sign-off on an appraisal award of $5.5million, notwithstanding the fact that not one believes that is the actual covered damage. Such a process is frightening, especially when one considers the potentialconsequences.
IV. Catch 22
The insurer is faced with a $5.5 million appraisal award signed by all three"independent" arbitrators, including the one chosen by the insurer. Yet the claim hasalready been denied and the policy declared void because, in part, the insurer contendsthat the covered damages do not exceed $1 million. May the insurer litigate and try thebreach of contract case? May the insurer be found to owe less than the amount of theappraisal award? May the insurer still argue that the insured's $10 million claim wasintentionally inflated and thus the insured forfeits its rights to any insurance proceeds,including those awarded in appraisal? May the insurer argue that the insured's claim wasintentionally inflated by $9 million, or is the insurer limited to arguing "only" a $4.5 millioninflation? May the insured argue its $10 million claim is still true and accurate? Mayeither party introduce the appraisal award as evidence? Are the appraisers or arbitratorswitnesses? Are they expert witnesses? Are any of the appraisers or arbitrators considered agents of either party and thus their conduct (e.g., signing the award) ortestimony is imputed to their respective "client?" What would be the arguments, and bywhom, if the appraisal award had been $9 million? What would have been thearguments if the appraisal award had been $1 million? We have been unable to find anypublished decisions directly addressing these evidentiary issues in a post-appraisalinsurance contract trial.
The insurer denied the claim in part because it determined that at least $5 millionwas caused by flood and, therefore, excluded from coverage. May the insurer still arguethis at trial?(8) Does the appraisal award preclude such argument? If such argument isallowed at trial, may the insured introduce the appraisal process and the appraisers asevidence to the contrary? The headache most courts believe they are medicating bycompelling appraisal before the coverage and forfeiture issues are resolved is now backas a migraine.
V. The Ultimatum
Upon receipt of the $5.5 million appraisal award, the insured writes its insurer thefollowing:
Dear Gentlemen:
Enclosed is a copy of the $5.5 million appraisal awardsigned by all three appraisers, including your own. Pursuantto your own appraisal clause, and the judgment of thesethree independent experts, the amount of covered damagesexceeds your evaluation by $4.5 million, or 450%. How canyou, an expert in insurance, be wrong by $4.5 million?
Nevertheless, if you pay me this award, plus interest,and reasonable attorney's fees, within the next ten days, I willexecute a full release of any and all claims. If not, however,I will sue you for a breach of contract, fraud, and "bad faith." Obviously, I will seek punitive damages in order to deter youfrom continuing such wrongful conduct with others.
Sincerely yours,
Your Insured
Although the insurer is confident that the actual covered damages do not exceed $1million, does it matter? How does the insurer explain its $1 million dollar evaluation inlight of the "unanimous" appraisal award of $4.5 million more? If the appraisers testify,what will they actually say? No doubt at least one will testify that he was "forced" to signfor $4.5 million lower than he thought the insured was entitled. What will the "umpire"say? Will he have any competent expertise on the amount of damages, or will he admitthat the process was political and resulted in a compromise to achieve at least theperception of consensus?
What happens if the insurer chooses not to settle? Assume the "bad faith" isbifurcated and stayed. A jury returns a verdict finding no forfeiture, yet agreeing with theinsurer that the covered damages are "only" $1 million - - at best a bittersweet result forthe insurer who must pay $4.5 million more as a result of the appraisal award. Does theinsured still have a "bad faith" claim due to the insurer's refusal to pay that award a yearearlier? Does the insured have a "bad faith" claim due to the insurer's failure to pay the$1 million a year earlier? Here we have the appraisal award, a political compromise,used as evidence of both covered damages and "bad faith." Obviously, this is far beyondits intended purpose - - to resolve dollar disputes.
What would happen if the jury's award was for the full amount of the appraisalaward of $5.5 million? How do you evaluate the insurer's defense to the "bad faith" claimthen? What is the insurer's defense - - "the politics of three?" The insured rebuts: "Sowhat, the $5.5 million is determined by the terms of the contract you, the insurer, wrote.How can you excuse your failure to pay based upon a refusal to accept the resultmandated by your own contract? What would you, the insurer, be arguing if the appraisalaward was $1 million or less?" Implied is the cornerstone of American Jurisprudence:"What is good for the goose is good for the gander."
If the jury "awards" $5.5 million or more, the insurer could expect to receiveanother demand letter from the insured, this time including a substantial figure forpunitive damages. In fact, such a letter would probably be sent even if the jury agreeswith the insurer on the amount of covered damages, as long as it does not find aforfeiture.
VI. Carcasses and Contagion
The effects of an appraisal award on the contract litigation can be calamitous. Thechoices, however, appear clear. One option is to allow everything into evidence and letthe parties and their counsel argue and explain. This would include appraisers, umpires,and arbitrators as witnesses and, more than likely, as experts. One or more of them mayactually be deemed agents of either the insured or the insurer and thus their conduct andtestimony be considered that of their "client." The parties may have to present expertson the appraisal process. The contract case will become, in large part, a trial of theappraisal itself. Ironically, the process that was intended to reduce the expense andburden upon the judicial process will actually increase that burden, and, additionally,dramatically complicate it.
The second option is to allow none of it into evidence. The appraisal award actssolely as a contractual ceiling as a matter of law and nothing else. The case is triedbefore the jury as if there never was an appraisal or appraisal award. Anyinconsistencies between the appraisal award and the verdict can be resolved by the courtpost-verdict as a matter of law (presumably with the benefit of an interrogatory verdictform already completed by the jury). This option is consistent with the public policyobjectives initially envisioned by the appraisal clause, and will reduce the complexity ofthe judicial process. This option may, however, deny a party's "right" to presentotherwise admissible evidence. Of course, this latter issue would not be present if theexistence and enforceability of the contract itself was determined before the remedy - -that is if the contract case was resolved before the appraisal award.(9)
The third option is for insurers to rewrite the appraisal provision. This can betailored to a particular jurisdiction and a particular line of coverage. However, onecommon element should be a clear statement that - - "appraisal cannot be invoked ifthere are any coverage or forfeiture issues." Hopefully, this would mean when appraisalis properly invoked, the result is final, and there cannot be a subsequent trial on contractresulting in the above-described confusion.
There is a fourth option. Insurers can eliminate the appraisal clause from theirinsurance contracts. If the insured and the insurer agree to submit the claim to appraisalor arbitration, they may still do so.
VII. Conclusion
It is most revealing about the present state of our dispute resolution system thatsomething as benign as an "appraisal" clause can actually become the ultimatebattleground. A battleground where, paradoxically, issues of coverage and fraud aredecided without even addressing them, and the "victor" proclaims either "bad faith" or"fraud." Such a process and result runs counter to any definition of justice.
Endnotes
1. See Hanover Fire Ins. Co. v. Lewis, 28 Fla. 209, 10 So. 297 (Fla. 1891) (a provision for arbitratinga disputed amount constitutes an appraisal agreement, rather than an arbitration agreement).
2. See Palozie v. State Farm Mut. Auto. Ins. Co., No. 96-0021, 1996 U.S. Dist. LEXIS 20720 (D. Ariz.Dec. 2, 1996) (the manner that an insurer conducts an appraisal, the conduct of the insurer at theappraisal, and which party prevails at the appraisal are factors relevant to an insured's bad faithclaim); Wailua Assocs. v. Aetna Cas. & Sur. Co., 27 F. Supp. 2d 1211 (D. Haw. 1998) (indicia of badfaith include unreasonable delay from the time the claim is submitted until the initiation of theappraisal, from the time between confirmation of the award and payment, and for the amount of timeduring the appraisal itself); Appalachian Ins. Co. v. Rivcom Corp., 130 Cal. App. 3d 818 (Cal. Ct.App. 1982) (amount of an appraisal award is evidence of an insurer's bad faith, or lack thereof).
3. See United States Fidelity & Guar. Co. v. Romay, No. 98-648, 1999 Fla. App. LEXIS 11560 (Fla. 3dDCA Aug. 25, 1999) (an insured must comply with the policy's post-loss conditions to compelappraisal); Pando v. United States Fidelity & Guar. Co., No. 97-2978, 1998 U.S. Dist. LEXIS 11941(S.D. Fla. June 29, 1998) (applying Florida law) (the insured must comply with the post-lossobligations imposed by the policy of insurance before the insurer is required to submit to appraisal);Llaguno v. ARI Mut. Ins. Co., 719 So. 2d 311 (Fla. 3d DCA 1998) (the only condition precedent toappraisal is submission of a Sworn Statement in Proof of Loss).
4. See Paradise Plaza Condo. Ass'n v. Reinsurance Corp., 685 So. 2d 937 (Fla. 3d DCA 1996) (theorder in which the issues of damages and coverage are to be determined should be left within thesound discretion of the trial judge).
5. See Rios v. Tri-State Ins. Co., 714 So. 2d 547 (Fla. 3d DCA 1998) (the term "independent" meansthe appraiser must be unaffiliated with the appointing party; however, an appraiser may still beindependent even if the appraiser is to receive a contingency fee percentage of the award).
6. See Liberty Mut. Fire Ins. Co. v. Hernandez, 735 So. 2d 587 (Fla. 3d DCA 1999) ("[a]lthoughappraisal clauses are treated as arbitration clauses for most purposes, the two processes are notidentical . . . the [appraisal] clause contemplates inspection and valuation by each appraiserindividually, not a trial-type hearing . . .;" therefore, the umpire need not be a lawyer as required bystate arbitration rules); Casualty Indem. Exch. v. Yother, 439 So. 2d 77 (Ala. 1983) (appraisal doesnot constitute arbitration); Roumel v. Niagra Fire Ins. Co., 225 A.2d 658 (D.C. 1966) (appraisal isonly a method of determining amount of loss, does not determine other issues such as liability andcoverage, and is conclusive proof of the damages involved); Eberhardt v. Georgia Farm BureauMut. Ins. Co., 477 S.E.2d 907 (Ga. Ct. App. 1996) (appraisal is not arbitration); Atlas Constr. Co. v.Indiana Ins. Co., 309 N.E.2d 810 (Ind. Ct. App. 1974) (appraisal is not arbitration); Hartford Fire Ins.Co. v. Jones, 108 So. 2d 571 (Miss. 1959) (appraisal is not arbitration); Elberon Bathing Co. v.Ambassador Ins. Co., 389 A.2d 439 (N.J. 1978) (appraisal is not arbitration); In re Delmar Box Co.,127 N.E.2d 808 (N.Y. 1955) (appraisal is not arbitration); PHC v. North Carolina Farm Bureau Mut.Ins. Co., 501 S.E.2d 701 (N.C. Ct. App. 1998) (appraisal is not arbitration); Minot Town & Countryv. Fireman's Fund Ins. Co., 587 N.W.2d 189 (N.D. 1998) (appraisal is not arbitration); In re Appraisalof Certain Fire Losses, 120 N.E.2d 592 (Ohio Ct. App. 1954) (appraisal is not arbitration); StandardFire Ins. Co. v. Fraiman, 514 S.W.2d 343 (Tex. Ct. App.1974) (appraisal is not arbitration); Smithsonv. United States Fidelity & Guar. Co., 411 S.E.2d 850 (W.Va. 1991) (appraisal is not arbitration).
7. See Meineke v. Twin City Fire Ins. Co., 892 P.2d 1365 (Ariz. Ct. App. 1994) (appraisal is arbitration); Appalachian Ins. Co. v. Rivcom Corp., 130 Cal. App. 3d 818 (Cal. Ct. App. 1982)(appraisal isarbitration); Germano v. Preferred Mut. Ins. Co., No. CV95328064, 1996 Conn. Super. LEXIS 1334(Conn. Super. Ct. May 24, 1996) (appraisal is arbitration); Closser v. Penn Mut. Fire Ins. Co., 457A. 2d 1081 (Del. 1983) (appraisal is arbitration); Hoenstine v. State Farm Fire & Cas. Co., 736 So.2d 761 (Fla. 5th DCA 1999) (arbitration rules govern appraisal); Florida Select Ins. Co. v. Keelean,No. 98-02466, 1999 Fla. App. LEXIS 3082 (Fla. 2d DCA Mar. 17, 1999) (appraisal clause is abinding arbitration agreement); Christiansen v. First Ins. Co., 967 P.2d 639 (Haw. Ct. App. 1998)(appraisal is arbitration); Beard v. Mount Carroll Mut. Fire Ins. Co., 561 N.E.2d 116 (Ill. App. Ct.1990) (appraisal is arbitration); Friday v. Trinity Universal, 939 P.2d 869 (Kan. 1997) (appraisal isarbitration); Brethren Mut. Ins. Co. v. Conrad, 458 A.2d 880 (Md. Ct. Spec. App. 1983) (appraisalis arbitration); Vesledahl Farms v. Rain & Hail Ins. Serv., C2-96-1049, 1996 Minn. App. LEXIS 1424(Minn. Ct. App. Dec. 17, 1996) (appraisal is arbitration); Silverman v. Fireman's Fund Am. Ins. Co.,604 P.2d 805 (Nev. 1980) (appraisal is arbitration); Riley v. Farmers Fire Ins. Co., 735 A.2d 124 (Pa.1999) (appraisal is arbitration); Waradzin v. Aetna Cas. and Sur. Co., 570 A.2d 649 (R.I. 1990)(appraisal is arbitration).
8. See State Farm Fire & Cas. Co. v. Licea, 685 So. 2d 1285 (Fla. 1996) (appraisal clause requiresan assessment of the amount of loss which "necessarily" includes a determination as to whetherthe cause of loss is covered or excluded).
9. But see Opar v. Allstate Ins. Co., No. 99-182, 1999 Fla. App. LEXIS 15748 (Fla. 1st DCA Dec. 1,1999).