Bad Faith Breach of Contract by First-Party Insurers
![handle is hein.journals/legstud25 and id is 409 raw text is: BAD FAITH BREACH OF CONTRACT BY
FIRST-PARTY INSURERS
ALAN 0. SYKES*
ABSTRACT
Insurers may at times exploit the delay inherent in the civil litigation process
to induce needy insureds to settle for less than the amount that the contract
promises. The prospect of extracontractual remedies for such bad faith at the
end of the litigation process can make these tactics unprofitable and thus serve
a potentially valuable function. But the remedy may be worse than the problem,
as the courts seem to find bad faith on the part of insurers who have genuine and
reasonable disputes with their policyholders over the terms of the policy or over
factual issues essential to the insured's right to recover. The ability of the courts
to identify opportunistic behavior accurately is thus in doubt, and the possibility
arises that bad faith doctrine in first-party cases does little to police misconduct
while doing much to cause uneconomic increases in the premiums that policyhold-
ers must pay.
CONTRACTS usually include an implied covenant of good faith and fair
dealing.' A failure by a party to act in good faith may thus lead to a
breach of contract action regardless of the express terms of the contract.
A failure to act in good faith may also constitute a tort.2
In many commercial settings, actions based on breach of the obligation
to act in good faith are exceedingly rare. But in the insurance industry,
the importance of the bad faith action has become profound. De-
pending on the jurisdiction, the type of insurance and the alleged failing
of the insurer, an insurer who acts in bad faith may incur liability not
only for damages owing under the policy but also for uncovered economic
losses of the insured, the insured's emotional distress damages and attor-
* Professor of Law, University of Chicago, The Law School. I have received useful
comments from David Friedman, Louis Kaplow, and Steven Shavell, from the participants
in law and economics workshops at Harvard University and the University of Michigan,
and from a thoughtful referee. I thank the Scaife and the Bradley Foundations for financial
support.
1 See E. Allan Farnsworth, Contracts § 7.16 (1990); Restatement (Second) of Contracts
§ 205; U.C.C. § 1-203.
2 See Dan Dobbs, Robert Keeton, David Owen, & W. Page Keeton, Prosser and Keeton
on Torts § 92 (1988).
[Journal of Legal Studies, vol. XXV (June 1996)]
© 1996 by The University of Chicago. All rights reserved. 0047-2530/96/2502-0005$01.50](ViewImageLocal?handle=hein.journals/legstud25&div=20&collection=journals&method=preview&ext=.png&size=3)
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