Why it matters: Recognizing the “conflicting policy concerns,” a federal court judge in South Carolina nevertheless ruled that an insurer affirmatively waived both the attorney-client and work product protections from disclosure because it raised a defense that its coverage of denial was reasonable. The policyholder ultimately was hit with a $55 million judgment and sued the insurer, alleging claims of bad faith failure to settle. In its affirmative defenses to the complaint, the insurer argued that it had a reasonable basis to deny coverage in the underlying litigation. In response, the policyholder sought discovery to test that defense and issued a subpoena to the insurer’s coverage counsel, seeking disclosure of communications prior to the commencement of the litigation. The court rejected the insurer’s objections to such discovery with respect to attorney-client privilege, holding that “insurers’ thoughts and knowledge are at the center of a claim for bad faith.” Thus, “where an insurer in a bad faith claim asserts an affirmative defense that it acted reasonably and in good faith, the insurer puts at issue the evidence it had before it at the time it denied the claim, including communications with counsel relevant to its state of mind and directly pertains to its “thoughts and knowledge.” With respect to work product, the court ordered disclosure relying on the exception to such protections because the policyholder had no other means to discover the relevant facts.

Detailed discussion: In December 2010, the East Bridge Lofts Property Owners Association sued Creekstone Builders and related parties over a renovation performed on its condominium buildings. When Creekstone requested defense in the suit from Crum & Forster Specialty Insurance Co. pursuant to multiple commercial general liability policies, the insurer filed a declaratory judgment action seeking an order that it was not obligated to defend, indemnify, or provide liability coverage to the policyholder.

Meanwhile, the parties in the underlying litigation conducted a mediation session prior to trial. Although the insurer attended the mediation, it otherwise did not participate in the case. At trial, a jury awarded East Bridge $55 million.

Alleging bad faith failure to settle, Creekstone and East Bridge sued Crum & Forster, contending that the insurer “failed to make a meaningful offer” in the underlying litigation. Crum & Forster responded that it had a reasonable basis for denying the claim.

The plaintiffs then issued a subpoena to the insurer’s coverage counsel requesting his entire file for the time period beginning October 1, 2012, and ending June 19, 2014, regarding the insurance policies issued by Crum & Forster and pertaining to the underlying litigation.

In its motion to quash the subpoena and motion for a protective order, Crum & Forster argued that the requested communications were protected by both the attorney client privilege and work product protection.

But U.S. District Judge Richard M. Gergel found otherwise.

Courts must broadly construe rules enabling discovery and narrowly construe limitations on discovery, he said, and in South Carolina, the party asserting the privilege must establish lack of waiver.

Although the court acknowledged that determining “whether a communication has been put ‘at issue’ in a bad faith action is particularly nettlesome,” implicating conflicting policies, “[n]evertheless, ‘[a]n insurer’s thoughts and knowledge are at the center of a claim for bad faith,’ and the basis for the insurer’s evaluation of a claim is highly relevant—if not essential—to proving those ‘thoughts and knowledge.’ ”

Therefore, “where an insurer in a bad faith claim asserts as an affirmative defense that it acted reasonably and in good faith, the insurer puts at issue the evidence it had before it at the time it denied the claim, including communications with counsel relevant to its state of mind,” Judge Gergel wrote.

In the case at hand, the insurer retained its lawyer to provide legal advice on insurance coverage matters, including responding to correspondence from counsel for the Creekstone entities raising questions as to coverage matters.

“Defendant has asserted as an affirmative defense that it ‘had a reasonable basis for’ its decision to deny coverage,” the court said. “On this evidence, the Court finds that [Crum & Forster] has failed to establish a lack of waiver of the attorney-client privilege for at least part of the time period to which the subpoena applies.”

The judge set the relevant time period for the waiver from October 2012—when Crum & Forster first responded to the notice of the underlying lawsuit—until April 10, 2014, the day the insurer denied coverage for Creekstone.

Turning to work product, Judge Gergel again found that the insurer waived its protection for the relevant time period, rejecting Crum & Forster’s contention that it ended sooner when coverage litigation was anticipated.

The plaintiffs “have presented evidence that many of the documents asserted to be work product may be discoverable,” the court said. “First, the documents prepared by [counsel] to aid Defendant’s coverage determination are likely not prepared in ‘anticipation of litigation.’ Further, because the insurer’s thoughts and knowledge are central to Plaintiffs’ bad faith claim, these documents are likely to be the only method by which Plaintiffs may prove their claim.”

Evidence arising after a coverage denial period is irrelevant to the question of an insurer’s pre-denial conduct, the court noted, so the waiver was inapplicable after the denial occurred.

Crum & Forster also requested that the court exclude privileged communications it accidentally provided to the plaintiffs as part of an earlier discovery request, which it sought to pull back pursuant to Federal Rule of Civil Procedure 502. But the correspondence—e-mails between the carrier and its former coverage counsel dated July 23, 2013, through August 1, 2013—was similarly not privileged, Judge Gergel said.

“For the same reasons that [the subsequent counsel’s] files are not fully protected by attorney-client privilege and the work-product privilege, the Court finds that the correspondence at issue here is not privileged,” the court wrote. “The information contained in [the e-mails] reflects [the attorney’s] legal advice to Defendant on coverage matters, provided prior to Defendant’s decision to deny coverage. Defendant has asserted an affirmative defense that it ‘had a reasonable basis for’ its decision to deny coverage. Accordingly, the Court concludes that the attorney-client privilege and the work-product privilege do not apply to this correspondence, and, therefore, there is no basis to exclude it.”

Crum & Forster has already filed a motion for reconsideration in the case.

To read the order in East Bridge Lofts Property Owners Assoc. v. Crum & Forster Specialty Insurance Co., click here.