Iowa Supreme Court Says Bad-Faith Claim Barred by Claim Preclusion

January 8, 2016 | Kristine A. Tidgren

The Iowa Supreme Court issued an opinion today that may change the way many cases against insurance companies are tried. Because insurance coverage and farming operations go hand in hand, agricultural law attorneys should pay attention to Villarreal v. United Fire and Casualty Co.* and its implications.

The case gave the Iowa Supreme Court its first opportunity to decide whether a breach-of-contract verdict in favor of an insured (against the insurer) precludes a subsequent action for first-party bad faith, at least where the bad-faith claim is based on events that predate the filing of the breach-of-contract lawsuit. In a 6-3 decision, the Court ruled that it does. Consequently, the Court reversed a decision from the Iowa Court of Appeals and affirmed a district court judgment granting summary judgment to an insurer in a bad-faith case filed by a group of insureds. The insureds had not filed the bad-faith claim until after prevailing in a breach-of-contract action. The Court ruled that claim preclusion barred the bad-faith action.

The insureds were owners of a restaurant that was severely damaged in a fire. The owners filed a claim under their commercial property insurance policy, but the insurer largely denied the claim. The insureds filed a breach-of-contract action against the insurer, and the jury returned verdicts in favor of the insureds in an amount totaling $236,902. The insurer paid the judgment, including interests and costs.

The insureds then filed a bad-faith action against the insurer, alleging that the insurer had "no objective basis for denying or failing to make payment on the [building and personal property] insurance claims."

The trial court granted the insurer's motion for summary judgment, ruling that the bad-faith action was barred by claim preclusion. The trial court specifically found that the breach-of-contract and bad-faith claims arose from the same fire loss and the insurer's refusal to pay the claim. Both claims, the court continued, depended upon the proper amount that the insurer should have paid under its policy. The trial court also noted that, if the breach-of-contract and bad-faith claims were filed together, the bad-faith claim could have been bifurcated from the breach-of-contract case to prevent prejudice in the breach-of-contract action.

The Iowa Court of Appeals, in a 2-1 decision, reversed. The Court of Appeals ruled that the bad faith action was not barred by claim preclusion.

On appeal, the Iowa Supreme Court disagreed. In its 6-3 majority opinion, the Court ruled that a "first-party bad faith claim based on denial of insurance benefits without a reasonable basis ordinarily arises out of the same transactions as a breach-of-contract claim for denial of those same benefits. This means a final judgment in the breach-of-contract case would bar the bringing of a subsequent, separate bad-faith lawsuit." The Court went on to say that any "potential prejudice from introducing evidence relevant only to the insurer's bad faith can be resolved by bifurcating the trial into a breach-of-contract phase and a bad-faith phase."

Recognizing that this was a case of first impression in Iowa, the Court analyzed several cases from other jurisdictions in reaching its conclusion. It specifically looked to jurisdictions that, like Iowa, apply the transactional test from section 24 of the Restatement (Second) of Judgments in analyzing claim preclusion. The Court concluded:

Perfect identify of evidence is not the standard in Iowa for whether claim preclusion applies. To the contrary, the Restatement makes clear that "a substantial overlap" of proofs and witnesses "ordinarily" leads to claim preclusion, and even the absence of such overlap is not fatal to claim preclusion.

The Court was careful to point out that its holding did not extend to cases where the bad-faith claim was based on conduct that occurred after the breach-of-contract case was filed. That, the Court stated, would be a "different kettle of fish."

The dissenting justices were concerned that the majority opinion did not "present the entire picture." The dissent noted that it was not until the trial on the breach-of-contract issue that the adjuster responsible for evaluating the insureds' claim offered what the dissent characterized as "extraordinary trial testimony." The adjuster testified at trial that she had no idea what the actual value of the destroyed property was. She had not sought to obtain an appraisal of that property. The dissent noted that this was "powerful evidence that could be marshalled in support of a bad-faith claim." The dissenting justices did not agree that the majority's approach would achieve efficiency. Rather, the dissent urged, "Certainly little will be achieved, and much may in fact be lost, by the majority's departure from this court's long line of same-claim, same-evidence precedents. The holding does, however, deny the plaintiff his day in court on this potentially valid bad-faith claim, no question about that."

For its part, the majority stressed that in this case, the insureds had a basis for alleging bad faith when they filed their original suit, as well as ample time thereafter to amend that suit to add the bad-faith claim. The Court stated that this was not a situation where the bad-faith claim could not have been asserted in the original case.

In response to the concern that their holding might lead to a routine inclusion of bad-faith counts in suits for insurance recoveries, the Court reminded attorneys that they are always bound by the rules of professional responsibility requiring all claims to be "well grounded in fact." "Counsel," the Court continued, "should be able to make a preliminary assessment [on the question of whether the denial of the claim lacked an objectively reasonable basis] before a breach of contract action is filed or, if need be, soon thereafter." The Court stressed that theirs was not a "lone ranger" decision. Many other jurisdictions, the Court stated, "treat the breach of contract claim and the bad faith claim as flowing from one transaction for claim preclusion purposes."

Iowa attorneys should take heed.

*Villarreal v. United Fire and Casualty Co., No. 14-0298 (Iowa Jan. 8, 2016).