Insurance Companies Entitled to Attorney-Client Privilege in Bad Faith Actions

On August 3, 2010, Division II of the Washington Court of Appeals held that allegations that an insurer acted in bad faith are not sufficient to defeat attorney-client privilege. Rather, the plaintiff must show an exception, such as the fraud exception. Moreover, this exception requires a showing of actual fraud, not just bad faith. Cedell v. Farmers Ins. Co., No. 38921-5-II, __ Wn. App.__, __P.2d__ (2010).

Farmers Insurance Company of Washington (“Farmers”) insured Bruce Cedell. After his home was damaged by fire, Cedell made a first party claim under his Farmers policy. The trial court found that the fire department and the fire cause investigator hired by Farmers determined that the cause of the fire was accidental. However, for reasons not explained in the appellate decision, Farmers considered the claim “suspicious.” At some point, Farmers hired an attorney to provide coverage advice regarding Cedell’s claim.

A year after the fire, Cedell filed an insurance bad faith lawsuit against Farmers. In response to discovery requests, Farmers withheld and redacted information based upon attorney-client privilege and the work product doctrine. Cedell then filed a motion to compel arguing that attorney-client privilege and work product did not apply in bad faith litigation.

The trial court determined that in-camera review of the documents withheld was appropriate because (1) Farmers made a one-time offer of $30,000 with an acceptance period that fell when its coverage counsel was out of town; (2) Farmers threatened to deny Cedell coverage without explanation; and (3) the damage to the house was eventually determined to be far more than Farmers’ $30,000 offer. After conducting in-camera review, the trial court held that attorney-client privilege and work product did not apply, and ordered Farmers to produce all documents withheld and/or redacted based on attorney-client privilege and work product, imposed sanctions, and awarded attorney fees for Farmers’ failure to provide the information.

Division II granted Farmers’ motion for discretionary review. The Court of Appeals held that in the first party context insurance companies are entitled to attorney-client privilege despite allegations of bad faith. In addition, “[a]n insurance company does not lose attorney-client privilege protection simply because its litigation opponent raises an issue where advice of counsel may be relevant.”

Next, the court of appeals noted that “[t]he elements of bad faith and fraud are . . . separate and distinct,” and explained that although Farmers’ conduct may have constituted a violation of insurance regulations, the evidence was not adequate to support a finding of fraud. Accordingly, the court reversed and remanded holding that the trial court had abused its discretion in conducting an in-camera review and that discovery sanctions were inappropriate.