In late 2007, the Washington Supreme Court held that (1) an insurer’s issuance of a subpoena to and ex parte written communications with an arbitrator in an underlying claim constituted bad faith; and (2) the insurer did not rebut the presumption of harm that arose from that bad faith finding. Mutual of Enumclaw Ins. Co. v. Dan Paulson Construction, Inc., 169 P.3d 1 (Wash. 2007).
In Paulson, homeowners brought arbitration proceedings against a construction company alleging construction defects. The company tendered the defense of the arbitration to its general liability insurer, which agreed to provide a defense subject to a reservation of rights. Because the policy excluded coverage for the construction company’s own work, but provided coverage for work performed by the company’s subcontractors, the insurer sought to ascertain which of the homeowners’ claims, if any, were covered. To that end, the insurer attempted to participate in the arbitration hearing in the underlying dispute. However, the insurer did not formally move to intervene and did not ask the arbitrator for permission to attend, and its informal requests to participate were denied by the insured.
Prior to the commencement of the arbitration, the insurer filed a declaratory judgment action and issued a subpoena to the arbitrator. The insurer also sent a cover letter to the arbitrator explaining the coverage issues, which the courts later characterized as ex parte communications with the arbitrator. The insurer scheduled the arbitrator’s deposition after the arbitration was concluded and requested documents concerning the arbitration.
The homeowners prevailed at arbitration and accepted an assignment of the contractor’s claims against the insurer in return for agreeing not to execute the arbitration award against the contractor. When the insurer proceeded to file a second declaratory judgment action seeking a declaration of non-coverage, the homeowners counterclaimed for breach of contract and bad faith, premising their bad faith claim in part upon the insurers’ action vis-a-vis the arbitration.
On summary judgment, the trial court held that the insurer had acted in bad faith when it interfered in the arbitration proceeding, but that it had successfully rebutted the presumption of harm. The state Court of Appeals reversed, holding that the insurer had not acted in bad faith because the insurer “had a reasonable need to know the elements of a potential damage award.” The appeals court also held that the insurer had rebutted the presumption of harm.
On appeal to the state Supreme Court, the court held that the insurer’s conduct did constitute bad faith. In reaching its holding, the court found that the issuance of the subpoena and mailing of the cover letter to the arbitrator breached the insurer’s duty to refrain from engaging in any unreasonable, frivolous, or unfounded action which would demonstrate a greater concern for the insurer’s monetary interest than for the insured’s financial risk. The court also concluded that the insurer did not rebut the presumption of harm because it was impossible to predict what course the arbitration might have taken but for the insurer’s bad faith conduct.