In State Farm Fire & Casualty Co. v. Robert Charles Justus (Case No. 47913-3-II), the Washington Court of Appeals (Division II) ruled on three important issues for insurers relating to bad faith actions. The first issue pertains to bad faith actions following a covenant judgment between the insured and the claimant. The court ruled that an insurer may challenge aspects of liability that the trial court declined to address when approving the covenant judgment as “reasonable.” Second, the court found that an intentional shooting was not rendered “negligent” merely because the insured mistakenly believed that the law permitted him to do it. Third, the court ruled that where the insured assigns his rights under the policy to the claimant, the claimant may obtain privileged materials in the insurer’s claim file, even if the insured refuses to waive the privilege.

The insured, William Morgan, confronted intruders on his property who were attempting to steal some metal pipes. The insured — an experienced and expert marksman — then pointed his gun at the intruders, who attempted to drive away in their truck. The insured then fired nine shots at the truck, causing the truck to crash and inflicting fatal injuries on the passenger. He then pointed his gun at the driver, Robert Justus, and ordered him to lie on the ground until police arrived.

The setup in this case will be familiar to anyone who has handled claims in Washington. Justus filed suit against Morgan more than two years after the incident, which was after the expiration of the statute of limitations that applied to the relevant intentional torts. It may seem obvious that this case involved only intentional acts. But in the surrealistic realm of Washington insurance law, nothing is ever obvious. In a contrived attempt to reach Morgan’s umbrella policy with State Farm, Justus asserted a claim for “negligent” wrongful detention.

State Farm defended Morgan under a reservation of rights. Ultimately, however, Morgan and Justus agreed to a stipulated judgment coupled with a covenant not to execute that judgment against Morgan and an assignment of Morgan’s rights against State Farm for “bad faith” (the basis for the bad faith claim was not specified in the opinion). Under Washington law, the trial court was then required to find the settlement to be “reasonable” before it could be enforced against State Farm in a subsequent bad faith action. State Farm contested the reasonableness of the settlement, on the basis that the statute of limitations barred any intentional tort claim, and the negligence claim was not supported by the facts. The trial court skirted the issue, noting that State Farm already had filed a declaratory judgment action and that Justus’s action was viable to the extent any negligence-based claim “is later found” to be valid. In a previous decision, the Court of Appeals upheld the reasonableness finding.

In the bad faith action, State Farm again argued that the facts did not support any negligence claim and, therefore, Morgan’s liability was a sham. Justus argued that State Farm was collaterally estopped from contesting Morgan’s liability once the court approved the settlement as reasonable. The bad faith trial court sided with State Farm, and the Court of Appeals agreed. The Court of Appeals held that an insurer “will not be bound to findings and conclusions concerning liability if the insurer attempted to challenge the liability findings, and the trial court failed to adjudicate the merits of the substantive claims.”

Justus argued in favor of reasonableness on the basis that there was some chance liability was real, trying to capture the courts' preference not to second-guess settlements, so reasonableness is usually found even when, as here, the claims are rather dubious. Then, in the bad faith action, the plaintiff argues that the liability was conclusively established by the reasonableness finding. When successful, this strategy effectively precludes the insurer from ever challenging a sham settlement, particularly where (as here) those conclusively established facts also bar coverage. The Justus holding provides insurers with a potential path out of this trap: insurers can insist that the first court either rule that the settlement is unreasonable or decline to make any substantive findings on the issues that undercut liability.

On the actual issue of Morgan’s liability, the trial court found that the facts did not support a negligence claim. Again, the Court of Appeals agreed. Justus argued that Morgan’s actions were negligent because he mistakenly believed he could lawfully exercise force against Justus and detain him. The court rejected this argument because Morgan intended both the action itself (pointing the gun) and the desired consequences (to control and detain Justus). Therefore, there was no negligence, and Justus’s claims were time-barred.

Nevertheless, Justus’s bad faith claims were allowed to proceed based on an unspecified theory of “procedural” bad faith. In the course of that bad faith phase, Justus sought discovery of State Farm’s claim file. State Farm withheld much of the file due to Morgan’s attorney-client privilege. Despite the fact that Morgan had agreed to provide reasonable cooperation to Justus, Morgan refused to waive the attorney-client privilege. Nevertheless, Justus sought production and/or an in camera review under Cedell v. Farmers Ins. Co. of Wash., 176 Wn.2d 686 (2013). In Cedell, the Washington Supreme Court held that an insurer’s claim file is presumptively not privileged as against the insured unless the insurer can show that the attorney was providing counsel as to the insurer’s potential liability, such as whether coverage exists. The trial court refused to compel production of the claim file to Justus because regardless of whether the insurer was entitled to assert the privilege, the insured in this case (Morgan) had not waived the privilege. The court advised that if Justus felt that Morgan was violating the settlement agreement, his remedy was to sue Morgan for enforcement of the agreement. Due to the resulting lack of evidence, summary judgment was granted to State Farm.

On this point, the Court of Appeals disagreed with the trial court. The court reasoned that “denying Justus, who stands in the shoes of the Morgans, the rights to the claim file he would have under Cedell is contrary to the central purposes of discovery highlighted in Cedell.” Therefore, the Court of Appeals extended Cedell to requests for production of a claim file by a third party who has been assigned a first-party insured’s rights.

Thus, while it is best to avoid a covenant judgment situation in Washington, Justus helps insurers navigate that process once it has begun. Justus also sets an outside limit on the manufacture of negligence claims out of clearly intentional conduct. However, Washington courts continue to scrutinize claims of attorney-client privilege to resist responding to discovery requests.