The final opinion of a New York appellate court in National Union Fire Ins. Co. of Pittsburgh v. TransCanada Energy USA, Inc., 119 A.D.3d 492 (2014), is only three paragraphs long, but it raises a host of questions about how, or whether, insurers can continue to obtain confidential legal advice in the course of processing claims.

The issue in TransCanada was whether the plaintiff in a dispute over coverage for property damage and lost earnings could review pre-litigation communications between its insurers and their attorneys (among others).  The insurers claimed the communications were immune from discovery under the attorney-client privilege, the work product doctrine and the common interest privilege.  The appellate court ultimately affirmed a decision that ordered disclosure of most—but not all—of the materials in dispute.

The law that governs these issues in New York is still unsettled, and some courts do not appear to have considered all the potential consequences of the language in which they express it.  At the same time, but in a separate line of cases, New York’s courts have relaxed their previous hard line against recognizing the tort of insurance bad faith, allowing plaintiffs to pursue extracontractual damages based on alleged breaches of the covenant of good faith and fair dealing.  The dangers posed by the convergence of these two trends have not all been realized in theTransCanada case, but the case does illuminate many of the perils that lie ahead for insurers.

This article will discuss the two lines of cases that provide the legal background for the TransCanada decision.  A second article will discuss the ruling itself, and a final article will consider its implications in detail.

The Legal Background: Two Trains Running

On Track 1:  Privilege Issues

Lawyers often get involved in the investigation and processing of insurance claims.  When those claims end up in litigation—whether in a simple dispute over coverage or a claim for bad faith—the possible disclosure of lawyers’ communications raises complex tactical and legal issues.  In New York, the law that governs those issues has been made, for the most part, by intermediate appellate courts, and so it may fairly be regarded as still evolving.  Important questions remain unanswered, while some cases offer answers that are deeply problematic.

Work Product

New York’s Civil Practice Law and Rules protects both “attorney work product” and “trial preparation” materials prepared by non-lawyers.  N.Y. Civ. Prac. Law & R. §§ 3101(c) and (d).  In either case, the protection applies only to materials prepared “in anticipation of litigation.”  In re Bekins Storage Co., 460 N.Y.S.2d 684, 689 (N.Y. Sup. 1983) (“The New York legislative distinction between work product … and material prepared for litigation … did not remove the work product exemption from the litigation context”).

After an initial split, New York’s intermediate appellate courts coalesced around the view that an insurer does not “anticipate” litigation until the date on which it has made “a firm decision to reject the claim”—even if “the decision … may not have been conveyed to the insured on said date.”  Landmark Ins. Co. v. Beau Rivage Rest., 509 N.Y.S.2d 819 (2d Dep’t 1986).  Thereafter, courts observed that an insurer, having made a firm decision to deny a claim, is also “obligated to issue a disclaimer.” Bertalo’s Rest. Inc. v. Exchange Ins. Co., 658 N.Y.S.2d 656 (2d Dep’t 1997).  Thus, the denial letter now generally serves as a marker for when work product protection first attaches; an insurer that has merely reserved its rights, for example, does not yet “anticipate litigation.”  Bonbard v. Amica Mut. Ins. Co., 783 N.Y.S.2d 85 (2d Dep’t 2004).   But details remain to be worked out.  What happens, for example, if an insurer decides conditionally that it will disclaim coverage, but only if a pending scientific analysis establishes a defense?

Attorney-Client Privilege

The work product analysis has also influenced other issues.  In New York, as in most other jurisdictions, the attorney-client privilege protects communications that are “primarily or predominantly of a legal character.”  Rossi v. Blue Cross & Blue Shield of Greater N.Y., 73 N.Y.2d 588, 594 (1989).  In the context of an insurance claim, this requires courts to distinguish between communications “of a legal character” and those that further “the regular business of an insurance company.”  Nicastro v. N.Y. Central Mut. Fire Ins. Co., 985 N.Y.S.2d 806 (4th Dep’t 2014).  Claims investigation is part of that regular business; consequently, communications with lawyers about the investigation of a claim are not necessarily legal in character.  E.g.Geneva Mortgage Corp. v. Certain Underwriters at Lloyd’s, London, 14 Misc.3d 1233(A) (N.Y. Sup. Ct. 2006) (“Merely because such an investigation was undertaken by attorneys will not cloak the reports and communications with privilege”).  Deciding whether to pay or deny a claim is also part of an insurer’s “regular business,” – and courts have used that fact, too, to reject claims of privilege:  “[T]he payment or rejection of claims is a part of the regular business of an insurance company.  Consequently, reports which aid … in the process of deciding which of the two actions to pursue are made in the regular course of business” and are not privileged.  Millen Inds., Inc. v. American Mut. Liab. Ins. Co., 324 N.Y.S. 2d 930 (1st Dep’t 1971).

These cases decided questions of privilege on the basis of the “character” (or, at least, the subject matter) of the communications at issue.  But in Bertalo’ssupra, the Appellate Division for the Second Department took a different approach.  Citing the Beau Rivage case (which dealt with the work product doctrine) as authority that an insurer does not anticipate litigation before it decides to deny a claim, the Bertalo’s opinion stated that “communications which occurred before the date … the [insurer] had reasonable grounds to reject the claim … are not immune from discovery”—meaning that they are not protected by the attorney-client privilege.  658 N.Y.S.2d at 659.  Without any explanation, the court essentially held that a communication with a lawyer which takes place before an insurer anticipates litigation cannot be legal in character.

Language to that effect (and similarly without analysis) continues to appear in Appellate Division decisions.  E.g.,Melworm v. Encompass Indemn. Co., 977 N.Y.S.2d 321 (2d Dep’t 2013) (“Reports prepared by … attorneys before the decision is made to pay or reject a claim are … not privileged and are discoverable”).  But it is not universal.  InNicastrosupra, the Fourth Department observed that even communications about an investigation may be privileged:  “The critical inquiry is whether, viewing the lawyer’s communication in its full content and context, it was made in order to render legal advice.”  985 N.Y.S.2d at 808.  Where an attorney is asked to “advise [an insurer] of its legal responsibilities,” at least some courts hold that the advice is legal in character, even if it relates to the decision about whether to deny a claim.  Id.  See also Reliance Ins. Co. v. American Lintex Corp., 2001 WL 604080, at *2 (S.D.N.Y. June 1, 2001) (“legal advice regarding the extent … to which the … claim was covered by the … policy” was privileged); This is clearly the law in other states.  E.g.Cedell v. Farmers Ins. Co., 176 Wash.2d 686 (2013) (privilege will apply if the attorney was “providing the insurer with counsel as to its own potential liability; for example, whether … coverage exists under the law”).

Common Interest

Another unsettled matter concerns the precise contours of the so-called “common interest doctrine” or “common interest privilege.”  This doctrine permits the disclosure to a third party, without waiver, of privileged communications—if the disclosure is made for the purpose of furthering an interest that the client and the third party have in common.  For the doctrine to apply, the parties’ “common interest” must be “identical, not similar,” and it must be “legal, not solely commercial.”  Bank of American, N.A. v. Terra Nova Ins. Co. Ltd., 211 F.Supp.2d 493, 496 (S.D.N.Y. 2002).

New York’s highest court, the Court of Appeals, has expressly recognized the common interest privilege only  in criminal cases, and only in the context of communications about a common defense to a pending prosecution.  E.g., People v. Osorio, 550 N.Y.S.2d 612 (N.Y. 1989).  In Parisi v. Leppard, 660 N.Y.S.2d 307 (N.Y. Sup. Ct. 1997), a Nassau County trial court extended the doctrine to civil litigation, but, given the narrow limits in which the Court of Appeals had ruled, it held that the doctrine applied only to communications that were “made in contemplation of legal action by or against” the parties involved.

Following Parisi, other trial courts expressly adopted the requirement that common interest communications be made in “anticipation of litigation.”  E.g.Aetna Cas. & Surety Co. v. Certain Underwriters at Lloyd’s London, 676 N.Y.S.2d 727 (N.Y. Sup. Ct. 1998), aff’d, 692 N.Y.S.2d 384 (1st Dep’t 1999).  (The opinion affirming this decision did not address the litigation requirement.)  But only one appellate court—the Appellate Division for the Second Department—has followed suit.  Hyatt v. State of Cal. Franchise Tax Board, 962 N.Y.S.2d 282 (2d Dep’t 2013); Hudson Valley Marine, Inc. v. Town of Cortlandt, 816 N.Y.S.2d 183 (2d Dep’t 2006).  In the First Department (which includes Manhattan), the Appellate Division has expressed only the rule that the communication “must have been … primarily or predominantly of a legal rather than a commercial nature.”  U.S. Bank National Assoc. v. APP International Finance Co., 823 N.Y.S.2d 361 (1st Dep’t 2006) (emphasis in original). That is how the common interest doctrine works in other jurisdictions.  E.g.O’Boyle v. Borough of Longport, 94 A.3d 299, 310 (N.J. 2014) (privilege applies to parties with “a common interest in a litigated or non-litigated matter”).

On Track 2:  Extracontractual Liability for Bad Faith

New York law governing insurers’ exposure for the way they handle claims has also been changing.  The traditional view held that “there is no separate cause of action in tort for an insurer’s bad faith failure to perform its obligations under an insurance contract.”  E.g.Burkhart, Wexler & Hirschberg, LLP v. Liberty Ins. Underwriters, 859 N.Y.S.2d 901 (N.Y. Sup. Ct. 2008) (citation omitted), aff’d, 875 N.Y.S.2d 590 (2d Dep’t 2009).  More recent decisions hold that insurers may sometimes be subject to extracontractual liability, in the form of consequential damages for breach of the covenant of good faith and fair dealing that is implied by law into every insurance contract.  See, e.g.Kings Infiniti Inc. v. Zurich American Ins. Co., 43 Misc.3d 1207(A) (N.Y. Sup. Ct. 2014).

The newer approach gained traction with the decision of a 5-2 majority of the Court of Appeals in Bi-Economy Market, Inc. v. Harleysville Ins. Co. of N.Y., 10 N.Y.3d 187 (2008), and a companion case, Panasia Estates, Inc. v. Hudson Ins. Co., 10 N.Y.3d 200 (2008).  Bi-Economy held that policyholders may recover consequential damages for breach of the covenant of good faith, so long as those damages were “reasonably contemplated” at the time of contracting, in light of “what liability the [insurer] fairly may be supposed to have assumed consciously, or to havewarranted the [policyholder] reasonably to suppose that it assumed, when the contract was made.”

Since Bi-Economy, a number of New York trial courts have permitted claims that are hard to distinguish from the first-party bad faith suits common in other jurisdictions.  E.g.Mutual Association of Administrators v. National Union Fire Ins. Co. of Pittsburgh, PA, 2012 WL 4752439 (N.Y. Sup. Ct. Sept. 17, 2012) (in a suit based on a liability insurer’s having decided, allegedly in bad faith, not to pay defense costs after the policyholder refused a settlement, the court denied the insurer’s motion for summary judgment on the policyholder’s claim that the financial burden of the defense had caused it to go out of business);  Schlachter, Stumbar, Parks & Salk, LLP v. OneBeacon Ins. Co., 2011 WL 6756971 (N.D.N.Y. 2011) (because “it was foreseeable that Plaintiffs would suffer the loss of peace of mind as a result of [defendant liability insurer’s] breach” of duty to defend, which was allegedly committed in bad faith, “Plaintiffs are entitled to … consequential damages” for that “loss”); Savino v. The Hartford, 886 N.Y.S.2d 69 (N.Y. Sup. Ct. 2009) (where an automobile insurer allegedly decided in bad faith not to pay for one medical procedure, and this decision allegedly prevented the policyholder from obtaining a second one, the court denied a motion to dismiss claims seeking extracontracual damages for pain and suffering and other non-economic losses); Rodriguez v. Allstate Ins. Co., 931 N.Y.S.2d 462 (Sup. Ct. 2011) (in a suit based on an automobile insurer’s alleged bad faith failure to pay for a stolen car, the court declined to dismiss an additional claim for car payments the policyholder made while unable to use the vehicle); Grinshpun v. Travelers Cas. Co. of Conn., 23 Misc.3d 1111(A) (N.Y. Sup. Ct. 2009) (declining to dismiss a claim for the legal costs incurred by a policyholder while seeking to enforce a claim for underinsured motorist coverage).

Waiting at the Station: The Big Bad Faith Claim

As important as these two sets of developments are, it is just as important that their emergence has been essentially independent.  For the most part, New York’s courts have not had to consider the significance of their holdings about confidentiality in the context of high-stakes disputes over how an insurer has handled a novel or complex claim.  As a result, the tools that the courts have created may be ill-suited for the problems that are now almost certain to arise.