Dakota, Minnesota & Eastern Railroad v. Acuity

#24892, 24904-rev & aff in pt & rem-JENSEN, Circuit Judge
2009 SD 69

IN THE SUPREME COURT
OF THE
STATE OF SOUTH DAKOTA

* * * *

DAKOTA, MINNESOTA & EASTERN
RAILROAD CORPORATION, Plaintiff and Appellant,

v.

ACUITY, a Mutual Insurance Co.
f/k/a HERITAGE MUTUAL INSURANCE
COMPANY, d/b/a HERITAGE INSURANCE, Defendant and Appellee.

* * * *

APPEAL FROM THE CIRCUIT COURT
OF THE THIRD JUDICIAL CIRCUIT
BEADLE COUNTY, SOUTH DAKOTA

* * * *

HONORABLE ROBERT L. TIMM
Judge

* * * *

BRIAN J. DONAHOE
MEREDITH A. MOORE
WILLIAM D. SIMS of
Cutler & Donahoe, LLP Attorneys for plaintiff
Sioux Falls, South Dakota and appellant.

JENNIFER L. WOLLMAN
GARY P. THIMSEN of
Woods, Fuller, Shultz & Smith PC Attorneys for defendant
Sioux Falls, South Dakota and appellee.

* * * *

ARGUED
JANUARY 13, 2009

OPINION FILED 8/5/09
#24892, 24904

JENSEN, Circuit Judge

[¶1.] Dakota, Minnesota and Eastern Railroad (DM&E) filed this action

claiming that Acuity, f/k/a Heritage Mutual Insurance Co. (Acuity), engaged in bad

faith and vexatious failure to pay uninsured motorist (UM) benefits. DM&E

appeals the circuit court's entry of summary judgment on the claims. Acuity cross-

appeals the circuit court's discovery orders compelling Acuity's attorneys to give a

deposition in the case.

FACTUAL BACKGROUND

[¶2.] On July 28, 1998, DM&E employee Julian Olson (Olson) was seriously

injured in a motor vehicle accident while acting in the scope of his employment.

DM&E held a business automobile policy with Acuity, which provided liability and

UM coverage. Olson sued DM&E under the Federal Employer's Liability Act

(FELA) alleging negligent maintenance of the vehicle's Hy-Rail System. 1 Acuity

refused to defend the suit claiming the policy excluded coverage. On the final day of

the FELA trial, Olson and DM&E settled for an amount in excess of Acuity's policy

limits. Acuity did not participate in or contribute toward the settlement. There

was no judicial determination or admission of any fault by any party in the FELA

action.

[¶3.] DM&E subsequently brought a declaratory judgment action against

Acuity claiming that Acuity was obligated to defend and provide coverage for the

FELA action. The circuit court granted Acuity's motion for summary judgment

concluding that the policy exclusions were valid and barred coverage for Olson's

1. The Hy-Rail System is a device which is attached to the front end of a motor
vehicle allowing the vehicle to be driven on railroad tracks and public roads.
#24892, 24904

accident. This Court affirmed in DM&E v. Heritage Mut. Ins. Co., 2002 SD 7, 639

NW2d 513 (DM&E I).

[¶4.] While DM&E I was pending, DM&E filed a suit seeking UM benefits

under its policy with Acuity. The suit alleged that the negligence of an unidentified

and uninsured motorist was a cause of Olson's injuries, triggering the right to UM

benefits under the policy. Later, DM&E amended the complaint to add claims of

bad faith and vexatious failure to pay which are the subject of this appeal.

[¶5.] During discovery on the UM claim, DM&E obtained an insurance

coverage opinion dated August 1, 2000, from Acuity's attorney, Gary Thimsen

(Thimsen), to Tom Behrend (Behrend), an Acuity field claims manager. 2 Thimsen

noted that Olson was claiming a phantom vehicle had cut him off causing the

accident, which triggered a potential UM claim. Thimsen's letter asserted that the

policy afforded no coverage for the UM claim because "[n]o evidence has been

provided by an independent witness . . . to corroborate the facts of the accident as

[Olson] has related them." 3 The letter cited the accident report of a state trooper,

which noted the existence of knowledgeable witnesses. Thimsen's letter stated that

none of the individuals with knowledge had "come forward with information that

would verify [Olson's] story." Thimsen also noted the narrative from the accident

2. Thimsen's coverage opinion was written in response to a letter from Olson's
attorney on the FELA action putting Acuity on notice that Olson was seeking
UM benefits under DM&E's policy.

3. Thimsen referenced the portion of the UM policy requiring: "[i]f the hit-and-
run vehicle does not hit an insured, a covered auto, or a vehicle an insured is
occupying, the facts of the accident must be corroborated by competent
evidence provided by an independent and disinterested person and not by the
insured or any person occupying the same vehicle as the insured."
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report which stated: (1) Olson began passing a slower moving vehicle; (2) Olson

then drifted left, and overcorrected back to the right and then crossed both lanes of

traffic, entered the ditch and rolled.

[¶6.] The record shows that three independent witnesses gave statements to

DM&E shortly after the accident occurred in 1998. All three witnesses noted the

presence of an unusually slow-moving vehicle on the interstate traveling just in

front of Olson as he entered onto the highway. One of these witnesses stated her

belief that this vehicle caused the accident because it had come to a near stop in

front of Olson at the time that Olson was entering onto the interstate.

[¶7.] There was no evidence that Acuity considered these statements in

August 2000 or at any other time through September 2001 when DM&E filed the

UM claim. There was no showing that Acuity made any attempt during this time to

gather facts to assess the fault of Olson, the unidentified driver, or any other party.

Acuity did not interview Olson concerning the UM claim.

[¶8.] DM&E deposed Behrend on November 5, 2004, concerning Acuity's

investigation of the UM claim. The deposition transcript shows that Behrend knew

little about the investigation by Acuity even though he had sole responsibility for

the UM claim in-house. Behrend testified in his deposition that Thimsen and his

co-counsel exclusively handled the investigation and made the determination on the

UM claim.

Q: Did anyone interview someone from the DM&E
railroad in regard to the uninsured motorist claim?

A: In regard to the uninsured motorist claim, that
investigation was done by Gary Thimsen and Jennifer
Wollman.

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Q: When did that take place?

A: I believe it would have been in the summer of 2000,
May, June, somewhere in there.

Q: What triggered that investigation?

A: Receipt of possible underinsured or uninsured
motorist claim from Julian Olson's attorney . . . .

Q: And what did your investigation reveal?

A: My understanding is that there was no indication that
an uninsured motorist was causation of the accident.

Q: What was that based on?

A: Review by the attorneys of discovery documents.

Q: You said discovery documents. You mean lawsuit
discovery?

A: Correct.

Q: And what lawsuit was that?

A: The Julian Olson case versus DM&E.

Q: What specifically did they identify as establishing that
there was no indication that the uninsured motorist
caused the accident?

A: Well, I don't know if I can give you the details. From
what I understand, they looked at deposition transcripts
that were taken on the various parties.

Q: As we sit here today, could you point to any deposition
transcripts in particular that would be the basis for your
claim that the uninsured motorist did not cause the
accident?

A: No.

* * *

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Q: Who else would have knowledge of any investigation
that was undertaken by Acuity or Heritage Mutual in this
case?

* * *

A: That would just be me.

* * *

Q: Do you know whether they even investigated or
attempted to determine whether the unidentified driver
may have been at fault in the case?

A: I guess I couldn't really answer that.

Q: As I understand it, the information that you have in
regard to whatever happened in the actual accident itself
would have come from the attorneys that represent Acuity
and Heritage Mutual in this case, correct?

A: Correct.

Q: And is that a common practice for Heritage or Acuity
to rely on investigations of attorneys or information from
attorneys?

A: It is done periodically—is it done all the time, no. Is it
done periodically, yes.

Q: Periodically meaning about how often? Do you have
any—

A: Well, I couldn't really give you a percentage. You
know, it depends on the circumstances. This is – you
know, is an unusual circumstance, I guess you would do
it.

* * *

Q: Tell me about any issues that you think were
underinvestigated or failed – or DM&E or somebody else
failed to investigate about the accident?

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A: I guess I'd have to leave that to my attorneys to advise
whether or not they feel there was some lack of
investigation performed.

[¶9.] After Behrend's deposition, DM&E sought to depose Thimsen and

James Moore (Moore) 4 and issued subpoena duces tecums for documents in their

possession. DM&E moved to compel the discovery, which Acuity resisted and

moved to quash. The circuit court denied Acuity's motion to quash and granted

DM&E's motion to compel. Shortly before the circuit court ruled on the motions,

Acuity moved to bifurcate the bad faith claim from the UM claim. The bad faith

claim was bifurcated and informally stayed by the parties pending resolution of the

UM claim.

[¶10.] At the UM trial, Acuity did not contest that the damages exceeded the

UM policy limits. The sole issue was fault. The jury rendered a verdict in favor of

DM&E on the UM claim, finding that the unknown driver was negligent and the

cause of Olson's accident. This Court affirmed in DM&E v. Acuity, 2006 SD 72, 720

NW2d 655 (DM&E II).

[¶11.] After DM&E II was concluded, DM&E's counsel sent a letter to

Acuity's counsel requesting that substitute counsel be obtained for Acuity so that

the depositions of Thimsen and Moore could proceed consistent with the court's

prior order compelling their depositions. It is unclear from the record if Acuity

4. Attorney James Moore represented the manufacturer of the Hy-Rail device in
the separate federal products liability suit filed by Olson that was settled.
Moore is also a shareholder in the same firm as Thimsen, but there is no
showing that Moore had any involvement in representing Acuity or
investigating the UM claim.
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#24892, 24904

responded to this letter. Subsequently, Acuity's existing counsel filed a motion for

summary judgment.

[¶12.] At the trial level, DM&E asserted that fact issues existed for trial and

also argued that the summary judgment motion was premature until Acuity

obtained substitute counsel so that DM&E could take Thimsen's deposition

consistent with the circuit court's earlier order to compel the deposition. The circuit

court orally granted the motion for summary judgment without giving any

reasoning for its decision, or addressing DM&E's request to delay the motion to take

Thimsen's previously ordered deposition.

[¶13.] DM&E argues that issues of material fact exist regarding the

reasonableness of Acuity's denial of the UM claim, including Acuity's investigation.

DM&E also argues it should have been afforded an opportunity to develop these

issues by deposing Thimsen consistent with the court's prior order. Acuity asserts

that summary judgment was properly granted because the UM claim was fairly

debatable. Acuity cross appeals the circuit court's discovery rulings arguing that

the circuit court abused its discretion by granting DM&E's motion to compel and

denying Acuity's motion to quash the depositions and subpoenas.

STANDARD OF REVIEW

[¶14.] We review the circuit court's grant of summary judgment under a well-

established standard:

Summary judgment is authorized if the pleadings,
depositions, answers to interrogatories, and admissions
on file, together with the affidavits, if any, show that
there is no genuine issue as to any material fact, and that
the moving party is entitled to judgment as a matter of
law. We will affirm only when there are no genuine

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issues of material fact and the legal questions have been
correctly decided. All reasonable inferences drawn from
the facts must be viewed in favor of the non-moving party.
The burden is on the moving party to clearly show an
absence of any genuine issue of material fact and an
entitlement to judgment as a matter of law. Summary
judgment will be affirmed if there exists any basis which
would support the circuit court's ruling.

Schwaiger v. Avera Queen of Peace Health Servs., 2006 SD 44, ¶ 7, 714 NW2d 874,

877 (citation omitted) (emphasis in original). "The non-moving party, however,

cannot merely rest on its pleadings; it must point to specific facts which establish a

genuine, material issue for trial. Mere allegations are not sufficient to avoid

summary judgment." Id. ¶ 7, 714 NW2d at 878 (internal citations omitted).

ISSUE ONE

[¶15.] Whether the circuit court erred in granting Acuity's motion for
summary judgment on the bad faith and vexatious failure to
pay claims.

[¶16.] DM&E claims there are genuine issues of material fact concerning

Acuity's initial handling and denial of the UM claim. DM&E also argues that

questions of fact are created by Acuity's refusal to re-evaluate the UM claim, and in

its litigation tactics. We discuss both these claims by DM&E.

i. Acuity's Investigation and Initial Denial

[¶17.] Champion v. United States Fidelity & Guaranty Co., recognized a

cause of action for first-party bad faith. 399 NW2d 320, 324 (SD 1987). Champion

set forth the following test for bad faith, which has been reaffirmed by this Court on

numerous occasions:

[F]or proof of bad faith, there must be an absence of a
reasonable basis for denial of policy benefits [or failure to
comply with a duty under the insurance contract] and the

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knowledge or reckless disregard [of the lack] of a reasonable
basis for denial, implicit in that test is our conclusion that the
knowledge of the lack of a reasonable basis may be inferred and
imputed to an insurance company where there is a reckless
disregard of a lack of reasonable basis for denial or a reckless
indifference to facts or to proofs submitted by the insured.

Under these tests of the tort of bad faith, an insurance company,
however, may challenge claims which are fairly debatable and
will be found liable only where it has intentionally denied (or
failed to process or pay) a claim without a reasonable basis.

Walz v. Firemen's Fund Ins. Co., 1996 SD 135, ¶ 7, 556 NW2d 68, 70 (quoting

Champion, 399 NW2d at 324) (alterations in original).

[¶18.] Recently, this Court stated that "[f]irst-party bad faith . . . is an

intentional tort and typically occurs when an insurance company consciously

engages in wrongdoing during its processing or paying of policy benefits to its

insured." Hein v. Acuity, 2007 SD 40, ¶ 10, 731 NW2d 231, 235 (citations omitted)

(emphasis added). In the first-party context, "there exists a contractual

relationship, whereby the insurer has accepted a premium from its insured to

provide coverage.” Id. ¶ 13, 731 NW2d at 236. Because of the nature of this

relationship, "[w]e recognized in Julson that bad faith can extend to situations

beyond mere denial of policy benefits." Id. (citing Julson v. Federated Mut. Ins. Co.,

1997 SD 43, ¶ 6, 562 NW2d 117, 119).

[¶19.] Bad faith conduct may include the failure to conduct a reasonable

investigation concerning the claim. Walz, 1996 SD 135, ¶ 8, 556 NW2d at 70 (citing

Isaac v. State Farm Mut. Auto Ins. Co., 522 NW2d 752, 758 (SD 1994)). "The issue

is determined based upon the facts and law available to [the] [i]nsurer at the time it

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made the decision to deny coverage." Id. The question of whether an insurer has

acted in bad faith is generally a question of fact. Id.

[¶20.] Since Champion, we have recognized the right of an insurer to

challenge claims which are fairly debatable. If the claim is fairly debatable, then

the insurer has a reasonable basis to deny the claim:

If an insured's claim is fairly debatable either in fact or
law, an insurer cannot be said to have denied the claim in
bad faith. The fact that the insurer's position is
ultimately found to lack merit is not sufficient by itself to
establish that the insurer had a reasonable basis to deny
the claim. The focus is on the existence of a debatable
issue, not on which party was correct.

46A CJS Insurance § 1873 (2008).

[¶21.] The parties are sharply divided over whether the claim was fairly

debatable and when that determination should be made. Our case law requires

that the insurer's decision and actions must be reviewed "at the time it made the

decision to deny coverage." See Walz, 1996 SD 135, ¶ 8, 556 NW2d at 70. The

questions of whether the insurer's actions were unreasonable or whether the claim

was fairly debatable must be viewed at the time the insurer made the decision to

deny or litigate the claim, rather than pay it.

[¶22.] DM&E argues that Thimsen's opinion letter alone establishes a

genuine issue of material fact. DM&E reasons that Acuity failed to properly

investigate and evaluate the validity of the UM claim because of Thimsen's faulty

conclusion that there were no independent witnesses to corroborate the UM claim.

It posits that this creates an inference of bad faith for trial. DM&E also points to

Acuity's failure to re-evaluate its decision as it received additional facts supporting

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the UM claim. Acuity counters that it is entitled to summary judgment so long as

there was some defense of law or fact to the UM claim that made it fairly debatable,

regardless of the reasonableness of Acuity's investigation or handling of the claim.

[¶23.] Courts which apply the fairly debatable standard have held that the

adequacy of the investigation and consideration of the claim by the insurer is

relevant in determining whether a claim is fairly debatable. In Anderson v.

Continental Insurance Co., the Wisconsin Supreme Court stated:

It is appropriate, in applying the test, to determine
whether a claim was properly investigated and whether
the results of the investigation were subjected to a
reasonable evaluation and review. In the instant case,
insofar as the complaint alleges, the insurer and the other
defendants refused even to consider the nature and extent
of the plaintiffs' damages, and specifically rejected and
spurned the opportunity to evaluate and consider the
submitted proof of loss. The pleading of the plaintiffs was
sufficient in this respect.

271 NW2d 368, 377 (Wis 1978); see also Trinity Evangelical Lutheran Church &

School-Freistadt v. Tower Ins. Co., 661 NW2d 789, 796 (Wis 2003) ("[I]t is proper

when applying the bad faith test to determine whether a[n] [insurance] claim was

properly investigated and whether the results of the investigation were subjected to

a reasonable evaluation and review"); Skaling v. Aetna Ins. Co., 799 A2d 997, 1011

(RI 2002) ("The insurer's failure to conduct an appropriate and timely investigation

may subject the insurer to bad faith liability notwithstanding the merits of the

claim"); Farmland Mut. Ins. Co. v. Johnson, 36 SW3d 368, 376 (Ky 2000) ("whether

a claim or the amount . . . is fairly debatable is a question of fact for the jury and .

. . the fact of a disputed amount does not relieve the insurer of its duty to handle

the claim fairly"); Zilisch v. State Farm Mut. Auto. Ins. Co., 995 P2d 276, 280 (Ariz

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2000) ("The appropriate inquiry is whether there is sufficient evidence from which

reasonable jurors could conclude that in the investigation, evaluation, and

processing of the claim, the insurer acted unreasonably . . . ."); S.W. Energy Corp. v.

Continental Ins. Co., 974 P2d 1239, 1243 (Utah 1999) (affirming summary

judgment on a bad faith claim where the claim was fairly debatable and there was

nothing suggesting the insurer was dilatory or unreasonable in its investigation);

Dolan v. Aid Ins. Co., 431 NW2d 790, 794-95 (Iowa 1988) (citing Anderson for the

requirement that the test should be applied in the context of determining the

adequacy of the investigation, evaluation and review).

[¶24.] In this case, the facts suggest that the UM claim was denied because

Acuity concluded there were no independent witnesses to support Olson's claim

that the unidentified driver caused the accident. Based upon this apparent

erroneous conclusion, Acuity did not conduct any further investigation into the

accident. Acuity has provided no explanation of how or why it reached this

conclusion. Further, Acuity has not shown that it made attempts to interview the

insured, interview the eye-witnesses to the accident that it knew existed, or

investigate any of the actual facts of the accident.

[¶25.] The accident report reviewed by Thimsen was sketchy as to how the

accident occurred and did not contain any witness statements. While the report

does not specifically attribute fault to the unidentified driver, neither does it

exonerate the driver. Likewise, the report is inconclusive as to why Olson may

have appeared to overcorrect just as he was attempting to move around the

unidentified vehicle. Questions of fact exist as to whether Acuity failed to conduct a

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thorough investigation and subject the results of the investigation to "reasonable

evaluation and review." See Trinity Evangelical Lutheran Church & School-

Freistadt, 661 NW2d at 796.

[¶26.] Acuity's statement of material facts and its argument are devoid of

any mention of the investigation or analysis made by Acuity concerning the UM

claim at the time it denied the claim. Because of the meager investigation it is

unclear what facts were available to suggest the claim was fairly debatable at the

time Acuity denied the claim. On summary judgment, Acuity has the initial burden

to "clearly show an absence of any genuine issue of material fact and an entitlement

to judgment as a matter of law." Hahne v. Burr, 2005 SD 108, ¶ 6, 705 NW2d 867,

870-71 (citations omitted) (emphasis added). Further, all reasonable inferences

from the facts must be viewed in favor of DM&E. Id.

[¶27.] Acuity relies heavily on the fact that at both the summary judgment

and the directed verdict stages of the UM case, the circuit court determined that

fact questions existed as to fault. Acuity also cites the deposition of Olson's

attorney taken in December 2004. Olson's counsel testified that he believed the

UM claim was not as strong as other theories of liability against DM&E and the

manufacturer of the Hy-Rail System. These events and facts arose some three

years after Acuity denied the UM claim. Without submitting facts showing that the

claim was fairly debatable in 2000, Acuity also argues that DM&E's actions during

this time suggest that a UM claim did not exist. These facts are insufficient to

show that the claim was fairly debatable at the time Acuity made its decision to

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deny the claim. A similar scarcity of such facts exists up through September 2001

when DM&E filed the UM claim.

[¶28.] Acuity cites National Savings Life Insurance Co. v. Dutton, in support

of its claim that summary judgment is appropriate. 419 So2d 1357 (Ala 1982). The

Dutton court stated:

In the normal case in order for a plaintiff to make out a
prima facie case of bad faith refusal to pay an insurance
claim, the proof offered must show that the plaintiff is
entitled to a directed verdict on the contract claim and,
thus, entitled to recover on the contract claim as a matter
of law. Ordinarily, if the evidence produced by either side
creates a fact issue with regard to the validity of the claim
and, thus, the legitimacy of the denial thereof, the tort
claim must fail and should not be submitted to the jury.

Id. at 1362. The Alabama Supreme Court has since limited this rule. In Safeco Ins.

Co. of America v. Sims, the court held that the directed verdict rule "is not to be

read as requiring, in every case and under all circumstances, that the tort claim be

barred unless the trial court has literally granted plaintiff's motion for a directed

verdict on the contract." 435 So2d 1219, 1224 (Ala 1983). In Thomas v. Principal

Financial Group, the court held that the directed verdict rule should not apply

where an insurer "intentionally or recklessly failed to properly investigate the claim

or to subject the result of the investigation to a cognitive evaluation and review."

566 So2d 735, 744 (Ala 1990). 5

5. Other courts have been critical of the directed verdict rule and held that a
jury should generally determine whether a claim is fairly debatable. Skaling,
799 A2d at 1010; Zilisch, 995 P2d at 280; Farmland Mut. Ins. Co., 36 SW3d
at 376.

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[¶29.] The directed verdict rule is not consistent with our established case

law. The directed verdict rule focuses on the question of whether a defense of law or

fact exists at the time of the trial on the underlying claim. This is not the standard

for bad faith in South Dakota. The question for bad faith is whether the insurer's

investigation or decision to deny a claim was unreasonable and was made in

knowing or reckless disregard of the facts at the time the insurer made its decision

to litigate rather than to settle.

[¶30.] Acuity also cites Bellville v. Farm Bureau Mutual Ins. Co., in support

of its argument that the claim is fairly debatable as a matter of law. 702 NW2d 468

(Iowa 2005). In Bellville, the Iowa Supreme Court stated that the question of

whether a "claim is fairly debatable can generally be decided as a matter of law." 6

Id. at 473. The court in Belville reasoned that "[w]here an objectively reasonable

basis for denial of a claim actually exists, the insurer cannot be held liable for bad

faith as a matter of law." Id. (citation omitted). 7

[¶31.] Bellville involved appellate review of a bad faith claim following a fully

developed trial record. Further, the facts raised no question as to the adequacy of

the investigation or the evaluation of the claim by the insurer. On such a record,

the court in Bellville determined as a matter of law that the claim was fairly

6. The Belville court noted exceptions to the general rule, including situations
where there are disputes concerning the underlying facts of a case. Id. at
474.

7. Iowa has also rejected the directed verdict rule. Reuter v. State Farm Mut.
Auto. Ins. Co., Inc., 469 NW2d 250, 254 (Iowa 1991). The court in Belville
noted that there may be times, although inapplicable in that case, where the
fairly debatable question is a question of fact, such as where the underlying
facts are disputed. 702 NW2d at 474.
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debatable because it was "undisputed that evidence existed creating a genuine

dispute as to the negligence of an uninsured or underinsured motorist" at the time

the decision was made to deny benefits. Id. at 474. Such a record does not exist in

this case.

[¶32.] Jury questions remain concerning whether Acuity's investigation and

denial of the UM claim was unreasonable, and whether it knew or recklessly

disregarded the lack of a reasonable basis for denial under the policy. Fact

questions also exist as to whether the claim was fairly debatable. Because Acuity

has failed to show the absence of genuine issues of material fact, the circuit court's

entry of summary judgment on the bad faith and vexatious failure to pay claims is

reversed and the matter is remanded for further proceedings.

ii. Acuity's Litigation Conduct

[¶33] DM&E contends that Acuity acted in bad faith when it continually

refused to reassess its position after the UM claim was filed. DM&E describes the

evidence presented during the UM case as "overwhelming" and demonstrative of

Acuity's intransigence. DM&E also argues that Acuity's tactics and decisions

during the UM claim litigation were further evidence of bad faith. Specifically,

DM&E references the following: (1) Acuity's decision not to hire an expert in the

UM case; (2) Acuity's repetitive attempts "to appeal interlocutory rulings against it

when those rulings could be later appealed without prejudice;" (3) Acuity's claim of

privilege to avoid DM&E's requests for discovery; (4) Acuity's failure to settle

despite the quick jury verdict; and (5) Acuity's failure to pay the judgment or offer to

fairly settle even on appeal. Although we reverse the circuit court’s entry of

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summary judgment, we address these arguments because the issue is likely to arise

on remand.

[¶34.] In Walz, this Court stated that an insurer may have an obligation to

timely reassess its initial decision denying coverage based upon information

received subsequent to the initial decision. 1996 SD 135, ¶ 12, 556 NW2d at 71.

This Court has also recognized that an insurer may be held liable for its conduct, in

addition to its decision to deny benefits. Hein, 2007 SD 40, ¶ 13, 731 NW2d at 236;

Julson, 1997 SD 43, ¶ 6, 562 NW2d at 119; see also Sawyer v. Farm Bureau Mut.

Ins., 2000 SD 144, ¶ 19, 619 NW2d 644, 650. A review of these cases demonstrates

that each involved decisions or conduct by the insurer prior to the institution of

litigation on the underlying claim. We have not addressed the admissibility of

conduct or decisions by the insurer during the litigation to prove bad faith.

[¶35.] Some courts have adopted what has been labeled the "doctrine of

continuing bad faith," which was first recognized in White v. Western Title

Insurance Co., 710 P2d 309, 320 (Cal 1985); see also Douglas R. Richmond, Bad

Insurance Bad Faith Law, 39 Tort Trial & Ins. Prac. LJ 1, 39 (2003). In White, the

California Supreme Court held that evidence of low settlement offers and other

insurer litigation conduct was admissible to prove bad faith because an insurer's

contractual duty of good faith does not terminate even after the parties have become

litigation adversaries. 710 P2d at 317-18.

[¶36.] Since White, California appellate courts have narrowed its holding.

See Cal. Physicians' Serv. v. Superior Court, 12 CalRptr2d 95, 100 (CalCtApp 1992)

(concluding that "White stands for the proposition that [only] ridiculously low

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statutory offers of settlement may be introduced in a bifurcated trial, after liability

has been established, as bearing on the issue of bad faith of the insurance

company"); Palmer v. Ted Stevens Honda, Inc., 238 CalRptr 363, 368 (Cal CtApp

1987) (rejecting "the suggestion White be extended beyond the insurance setting,"

and stating "once litigation has commenced, the actions taken in its defense are not,

in our view, probative of whether defendant in bad faith denied the contractual

obligation prior to the lawsuit").

[¶37.] Most courts have strictly limited the type of post-filing conduct that

may be used as evidence of the insurer's bad faith. Scott Turner, Alex Mahler &

Rosanne Stafiej, The Decline of the So-Called Doctrine of Continuing Bad Faith, 43

Tort Trial & Ins. Prac. LJ 199, 208-09 (2008). Some jurisdictions impose a blanket

prohibition on all post-filing conduct as evidence of an insurer's bad faith. See

Parker v. S. Farm Bureau Cas. Ins., 935 SW2d 556, 562 (Ark 1996); Morris v. J.C.

Penney Life Ins. Co., 895 SW2d 73, 78 (MoCtApp 1995); Roussalis v. Wyo. Med.

Ctr., Inc., 4 P3d 209, 257 (Wyo 2000).

[¶38.] In jurisdictions that allow evidence of an insurer's settlement behavior

and other post-filing conduct, appellate courts have markedly restricted the

admissibility of such evidence. 8 Courts have found that public policy favors

8. See Palmer by Diacon v. Farmers Ins. Exch., 861 P2d 895, 914 (Mont 1993)
("Indeed, courts rarely should allow [evidence of post-filing conduct] and we
have adopted a balancing test for those rare circumstances"); Gooch v. State
Farm Mut. Auto. Ins. Co., 712 NE2d 38, 42-43 (IndCtApp 1999) (applying the
balancing test enunciated in Palmer, supra); Timberlake Const. Co. v. U.S.
Fid. & Guar. Co., 71 F3d 335, 340-41 (10thCir 1995) (applying Oklahoma
law) (holding that post-filing conduct should rarely be admissible to prove
bad faith); Sims v. Travelers Ins. Co., 16 P3d 468, 471 (OklaCtApp 2000)
(adopting the approach of the 10th Circuit Court of Appeals in Timberlake
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exclusion of much of an insurer's post-filing conduct for two reasons. As the

Montana Supreme Court wrote:

Public policy favors the exclusion of evidence of an
insurer's post-filing litigation conduct in at least two
respects. First, permitting such evidence is unnecessary
because during the initial action, [circuit] courts can
assure that defendants do not act improperly. Next, and
more importantly, the introduction of such evidence
hinders the right to defend and impairs access to the
courts.

Palmer, 861 P2d at 914. The Palmer court noted that the Rules of Civil Procedure,

in most cases, provide adequate remedies for improper conduct during litigation.

Id.

[¶39.] Admission of otherwise proper litigation tactics as proof of bad faith

can also penalize an insurer for pursuing legitimate avenues of defense. Moreover,

impairing a party's litigation rights obstructs an attorney from zealously advocating

on behalf of his or her client's interests.

Allowing litigation conduct to serve as evidence of bad
faith would undermine an insurer's right to contest
questionable claims and to defend itself against such
claims. [P]ermitting allegations of litigation misconduct

Const. Co., supra, stating "litigation conduct should rarely, if ever, be allowed
to serve as proof of bad faith"); Parsons v. Allstate Ins. Co., 165 P3d 809, 818-
19 (ColoCtApp 2006) (adopting the balancing test enunciated in Palmer,
supra and holding that an insurer's refusal to submit to a deposition and
filing an answer denying coverage was not admissible evidence of bad faith);
Barefield v. DPIC Cos, Inc., 600 SE2d 256, 271 (WVa 2004) (holding that an
insurer's attorney's alleged misconduct is not admissible as evidence of an
insurer's bad faith unless the insurer knowingly encourages, directs,
participates, relies upon or ratifies that behavior); but see Home Ins. Co. v.
Owens, 573 So2d 343, 344 (FlaDistCtApp 1990) (upholding admission of
evidence of an insurer's pleadings as well as the insurer's failure to answer a
request for admissions); Norman v. Am. Nat'l Fire Ins. Co., 555 NE2d 1087,
1110 (IllAppCt 1990) (with little discussion, court held that evidence of
insurer's conduct subsequent to denial of the claim is admissible).
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would have a chilling effect on insurers, which could
unfairly penalize them by inhibiting their attorneys from
zealously and effectively representing their clients within
the bounds permitted by law. Insurers’ counsel would be
placed in an untenable position if legitimate litigation
conduct could be used as evidence of bad faith.

Knotts v. Zurich Ins. Co., 197 SW3d 512, 522 (Ky 2006) (quoting Timberlake Const.

Co., 71 F3d at 340-41).

[¶40.] The admission of post-filing conduct as evidence of bad faith could also

impair an insurer's right of access to the courts.

'Free access to the courts is an important and valuable
aspect of an effective system of jurisprudence, and a party
possessing a colorable claim must be allowed to assert it
without fear of suffering a penalty more severe than that
typically imposed on defeated parties.'

White, 710 P2d at 324 (Lucas, J., concurring and dissenting) (quoting Young v.

Redman, 128 CalRptr 86, 93 (CalCtApp 1976)); see also Knotts, 197 SW3d at 520

(citing White, 710 P2d at 324 (Lucas, J., concurring and dissenting)).

[¶41.] As an evidentiary matter, many courts have questioned the probative

value of an insurer's post-filing conduct as evidence of bad faith.

After the onset of litigation, an insurer begins to
concentrate on supporting the decisions that led it to deny
the claim. The insurer relies heavily on its attorneys
using common litigation strategies and tactics to defend
against a debatable claim. Consequently, actions taken
after an insured files suit are at best marginally probative
of the insurer's decision to deny coverage.

Knotts, 197 SW3d at 521 (citing Randy Papetti, Note, Insurer's Duty of Good Faith

in the Context of Litigation, 60 Geo. Wash. L. Rev. 1931, 1972 (1992)); see, e.g.,

Palmer, 861 P2d at 915; Parsons, 165 P3d at 817-18. "These litigation strategies

and tactics will be offered up to juries who, with the benefit of hindsight, and

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without the benefit of extensive exposure to litigation practices and techniques, will

second guess the defendant's rationales for taking a particular course." White, 710

P2d at 324 (Lucas, J., concurring and dissenting). Realizing the possibility of having

their litigation strategy used against them in a future bad faith suit, an insurer may

be discouraged from exercising its legitimate litigation rights.

[¶42.] Consistent with the above authorities, we believe it would be a rare

case where the insurer’s decisions and conduct in the underlying litigation would be

admissible in a first party bad faith claim. The appropriate inquiry for the circuit

court in determining the relevance of such evidence is whether the insurer’s post-

filing conduct sheds light on the reasonableness of the insurer’s decision or conduct

in denying insurance benefits. The tort of first party bad faith, as alleged in the

instant case, “typically occurs when an insurance company engages in wrongdoing

during its processing or paying of policy benefits to its insured.” Hein, 2007 SD 40,

¶ 10, 731 NW2d 231, 235. As noted above, the relevant inquiry for such a claim is

the insurer’s decision and actions “at the time it made the decision to deny

coverage.” Walz, 1996 SD 135, ¶ 8, 556 NW2d at 70. “[I]f ‘the focus of a bad faith

claim is the insurer’s knowledge and belief during the time the claim is being

reviewed’ then the relevance of the litigation conduct is severely diminished.”

Timberlake Const. Co., 71 F3d at 340.

[¶43.] In addition to the limited relevance of the type of litigation conduct

proffered by DM&E, the circuit court must also carefully weigh the evidence under

SDCL 19-12-3 (Rule 403). The above cases demonstrate the critical importance of a

circuit court weighing the probative value of any potentially relevant litigation

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#24892, 24904

evidence against the danger of unfair prejudice. In most instances, questions

concerning the propriety of tactical litigation decisions by the insurer or insurer’s

counsel can be adequately addressed through application of the Rules of Civil

Procedure, or through rules governing attorney conduct, rather than presenting the

evidence to a jury as part of the tort claim.

[¶44.] Because significant discovery remains outstanding, these evidentiary

questions are remanded for the circuit court’s consideration after the completion of

discovery. The circuit court should apply these rules in considering the

admissibility of the evidence DM&E seeks to offer.

ISSUE TWO

[¶45.] Whether the circuit court abused its discretion by granting
DM&E's motion to compel discovery and denying Acuity's motion to quash
subpoenas.

[¶46.] Acuity cross appeals the circuit court's discovery order requiring

Attorneys Thimsen and Moore to give a deposition and produce documents in

response to a subpoena duces tecum. Acuity argues that the requested discovery is

protected by the attorney-client and work product privileges. DM&E argues that

Acuity has waived any privilege because of its reliance upon counsel to investigate

and determine the UM claim. Acuity asserts that no waiver has occurred because it

has not raised an advice of counsel defense.

[¶47.] This Court normally reviews a circuit court's discovery orders under an

abuse of discretion standard. Maynard v. Heeren, 1997 SD 60, ¶ 5, 563 NW2d 830,

833 (citing Weisbeck v. Hess, 524 NW2d 363, 364 (SD 1994)). "When we are asked

to determine whether the [circuit] court's order violated [a statutory privilege],

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however, it raises a question of statutory interpretation requiring de novo review."

Id.; see also Delzer v. Penn, 534 NW2d 58, 61 (SD 1995).

i. Attorney-Client Privilege

[¶48.] Initially we note that our review of this issue is hampered by the lack

of a record showing the specific documents and communications which Acuity

claims are privileged. The record shows there was a general privilege objection

asserted to the requested depositions of Thimsen and Moore and the production of

any documents in their possession. The objections were overruled and an order

compelling the discovery was entered. The failure of a party to provide a court with

sufficient information to determine the question of privilege raises substantial

questions concerning the efficacy of the objection:

As a starting point, it is clear that ultimately a party
asserting privilege must make a showing to justify
withholding materials if that is challenged. The question
whether the materials are privileged is for the court, not
the party, to decide, and the court has a right to insist on
being presented with sufficient information to make that
decision. It is not sufficient for the party merely to offer
up the documents for in camera scrutiny by the court.
Ultimately, then, a general objection cannot suffice for a
decision by a court although it may suffice for a time as
the parties deal with issues of privilege in discovery.

8 Charles A. Wright & Arthur R. Miller, Federal Practice and Procedure § 2016.1

(2009).

[¶49.] Acuity failed to submit a privilege log, or offer in camera review to

consider the privilege issue. The Court has previously stated that the preferred

procedure for handling privilege issues is to allow for an in camera review of the

documents, and court review or supervision of a deposition in camera. State v.

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#24892, 24904

Cates, 2001 SD 99, ¶ 17, 632 NW2d 28, 35-36; Weisbeck, 524 NW2d at 373 (Miller,

C.J., concurring in part and concurring in result in part); see also Maynard, 1997

SD 60, ¶ 28, 563 NW2d at 839-40 (Konenkamp, J., concurring in part and

dissenting in part). We will review the issue here based upon the record before this

Court, but future litigants asserting a privilege objection should be aware of the

obligation to create a record sufficient for meaningful review of a claim of privilege.

[¶50.] The attorney-client privilege is set forth in SDCL 19-13-3. 9 As

discussed above, it is unclear whether the attorney-client privilege is applicable to

the entire discovery at issue. However, the parties' arguments primarily focus on

whether any applicable privileges have been waived. As to Attorney Moore, there

appears to be no dispute between the parties that the requested discovery is

privileged, so we address the waiver issue as to him.

9. "A client has a privilege to refuse to disclose and to prevent any
other person from disclosing confidential communications made for
the purpose of facilitating the rendition of professional legal services
to the client:

(1) Between himself or his representative and his lawyer or
his lawyer's representative;

(2) Between his lawyer and the lawyer's representative;

(3) By him or his representative or his lawyer or a
representative of the lawyer to a lawyer or a representative of
a lawyer representing another party in a pending action and
concerning a matter of common interest therein;

(4) Between representatives of the client or between the client
and a representative of the client; or

(5) Among lawyers and their representatives representing the
same client."

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#24892, 24904

[¶51.] The attorney-client privilege is personal to the client and may only be

waived by the client, or through his attorney. State v. Catch the Bear, 352 NW2d

640, 645 (SD 1984). The party asserting a claim of waiver has the burden of

establishing a waiver of a privilege. Id. at 647 (citing Hogue v. Massa, 80 SD 319,

123 NW2d 131 (1963)). To invoke a waiver the record must "demonstrate that [the

client] impliedly or explicitly consented to his attorney waiving the attorney-client

privilege on his behalf." State v. Rickabaugh, 361 NW2d 623, 625 (SD 1985).

[¶52.] DM&E asserts that Moore should be required to produce discovery and

give a deposition concerning his representation of the manufacturer of the Hy-Rail

system. Although Moore and Thimsen are partners, they represented different

clients. There is no showing that the Hy-Rail manufacturer has taken any action to

expressly or impliedly waive its privilege as to Moore. Further, there is no showing

that Moore had any personal involvement in representing Acuity or has information

for which a waiver of the privilege, if any, by Acuity would apply.

[¶53.] Based upon this undisputed record, there is no showing of any waiver

of the privilege as to Moore's client. Accordingly, the circuit court's discovery order

relating to Moore would violate his responsibility to hold his client's

communications in confidence. Moore cannot be required to produce this discovery

and the circuit court erred by compelling the deposition and discovery requests as to

Moore.

[¶54.] As to the discovery requested of Thimsen, both parties cite Kaarup v.

St. Paul Fire & Marine Insurance Co., 436 NW2d 17 (SD 1989). DM&E argues that

Acuity has waived any applicable privilege under Kaarup because it relies upon

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#24892, 24904

advice of counsel. Acuity argues that Kaarup is inapplicable because it has not

asserted an advice of counsel defense. Kaarup held that the attorney-client

privilege is impliedly waived to the extent that a party asserts advice of counsel as

an essential element of its defense. Id. at 21. Kaarup limited the extent of the

waiver stating:

We do not believe, as some courts have held, that the
defense of advice of counsel waives the attorney/client
privilege with respect to all communication between client
and counsel concerning the transaction for which
counsel's advice was sought. We find that the
attorney/client privilege is waived only to the extent
necessary to reveal the advice given by an attorney that is
placed in issue by the defense of advice of counsel.

Id. (internal citation omitted).

[¶55.] Several courts hold that the attorney-client privilege does not apply

where the attorney acted as a claims adjustor on the initial claim determination

because the attorney is not acting as a lawyer in such instance. First Aviation

Servs., Inc. v. Gulf Ins. Co., 205 FRD 65, 68-69 (DConn 2001); Allendale Mut. Ins.

Co. v. Bull Data Sys., Inc., 152 FRD 132, 137 (NDIll 1993); Mission Nat’l Ins. Co. v.

Lilly, 112 FRD 160, 163 (DMinn 1986); Evans v. United Servs. Auto. Ass’n., 541

SE2d 782, 791 (NCCtApp 2001). In Lilly, the insurer immediately hired a law firm

upon receipt of a notice of a fire "to fulfill its ordinary business function of claims

investigation." Id. at 163. The Lilly court held under such facts that:

It would not be fair to allow the insurer's decision in this
regard to create a blanket obstruction to discovery of its
claims investigation. To the extent that Cozen &
O'Connor acted as claims adjusters, then, their work-
product, communications to client, and impressions about
the facts will be treated herein as the ordinary business of
plaintiff, outside the scope of the asserted privileges.

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#24892, 24904

Id.

[¶56.] In this case, Behrend testified that outside counsel exclusively

conducted the investigation and solely made the initial determination to deny the

UM claim. The evidence suggests that Acuity completely delegated its claims

function to outside counsel (Thimsen). Under such facts, we believe the above rule

is applicable. Accordingly, we hold that where an insurer unequivocally delegates

its initial claims function and relies exclusively upon outside counsel to conduct the

investigation and determination of coverage, the attorney-client privilege does not

protect such communications. 10

[¶57.] We have found no contrary authority under facts as they exist in this

case. Further, this holding is consistent with our legislature's codification of the

attorney-client privilege, which is "in accord with modern authorities which hold

that privileges created by statute are to be strictly construed to avoid suppressing

otherwise competent evidence." Catch the Bear, 352 NW2d at 646-47 (citations

omitted). A contrary holding would permit an insurer to insulate its claims

handling process from any disclosure or review by simply delegating the claims

10. Some courts have required bifurcation of the bad faith claim and reserved
discovery until the plaintiff has first established coverage on the underlying
claim. See Bartlett v. John Hancock Mut. Life Ins. Co., 538 A2d 997, 1000-01
(RI 1988), abrogated on other grounds in Skaling, 799 A2d 997; Allstate Ins.
Co. v. Swanson, 506 So2d 497, 498 (FlaDistCtApp 1987); In re Bergeson, 112
FRD 692, 697 (DMont 1986). Since the parties agreed to bifurcation in this
case it is unnecessary to address this issue.
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#24892, 24904

process to its attorneys and asserting privilege.

ii. Work Product Privilege

[¶58.] The above holding is equally applicable to the work product privilege.

This holding does not address the question of whether such material may still be

ordinary work product; and, on this record, we are unable to determine to what

extent the requested discovery was prepared in anticipation of litigation.

Accordingly, we remand the case to the circuit court to determine the extent of any

work product claims as to the requested discovery of Thimsen.

[¶59.] Our holding does not address the attorney-client privilege applicable to

Thimsen's role as defense counsel for Acuity, or the communications subject to this

privilege. On remand, the circuit court will need to determine the question of

attorney-client privilege and work product privilege based upon Thimsen's dual

capacities of claims adjustor and defense counsel for Acuity. The court should then

consider the questions of waiver of any applicable privilege.

CONCLUSION

[¶60.] The court's order entering summary judgment is reversed and the

claims are remanded to the circuit court. On Acuity's cross appeal, we reverse the

circuit court's discovery order as to Moore. We affirm the circuit court's discovery

order as to Thimsen to the extent it is consistent with this Court's holding. We

remand this latter issue for the circuit court to make the determinations set forth in

this opinion.

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[¶61.] GILBERTSON, Chief Justice, MEIERHENRY, Justice, SABERS,

Retired Justice, and TRANDAHL, Circuit Judge, concur.

[¶62.] JENSEN, Circuit Judge, for KONENKAMP, Justice, disqualified.

[¶63.] TRANDAHL, Circuit Judge, for ZINTER, Justice, disqualified.

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