From Property Insurance Coverage Law Blog, Merlin Law Group:
In a recent case in Tennessee, homeowners suffered a fire loss and filed a claim with their insurance company, Anpac.1 The insurance company investigated the loss and found that the homeowners intentionally set the fire and denied coverage. It then filed a declaratory judgment action. The homeowners filed counterclaims for breach of contract, unfair claims practices and bad faith. They alleged that the insurance company ignored evidence that showed they did not set the fire. In Tennessee, a statute allows insureds to seek a penalty of up to 25% of the total liability where a claim is denied in bad faith.2 When an insurance company refuses to pay a claim within 60 days of a demand, it must pay an additional 25% if the refusal was not in good faith and caused the insureds additional damages.
Insurers have a duty to act in good faith and no law or statute indicates this is severed by litigation. The trial court looked to rulings from appellate courts in other states: Kentucky Supreme Court (holding that duties of fair dealing did not end after litigation commenced,3 and an insurer’s refusal to settle after liability became clear is basis of bad faith4); Supreme Court of California (litigation did not terminate the duty of good faith because it did not end the contractual relationship5); Montana Supreme Court (insurers duty of fair dealing and not to withhold payment of valid claims does not end when a Complaint is filed6); Arizona Court of Appeals (failure of insurer to investigate while declaratory judgment action was pending could be basis of breach of good faith7); and the Georgia Court of Appeals (litigation does not end duty to reasonably investigate8).
After reviewing holdings in these jurisdictions, the court found that the insurance company had a good faith duty to consider evidence that came to light during the litigation, and if that evidence made clear that the homeowner did not destroy their home and that they were due payment under the policy, it should have paid their claims.