Hurley v. State Farm Mutual Automobile Insurance Company et al

Filing 57

ORDER that the parties will depose Judith Penzler, Steve Ladig, Teresa Herrera, and Jody Anderson for the limited purpose of determining the basis for the increased payments to Hurley. Defendants will pay plaintiff's out-of-pocket expenses for these depositions. Signed by Chief Judge Karen E. Schreier on 7/11/2012. (KC)

UNITED STATES DISTRICT COURT
DISTRICT OF SOUTH DAKOTA
SOUTHERN DIVISION
WILLARD HURLEY,
Plaintiff,
vs.
STATE FARM MUTUAL
AUTOMOBILE INSURANCE
COMPANY and
STATE FARM FIRE AND CASUALTY
COMPANY,
Defendants.

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CIV. 10-4165-KES

ORDER

Plaintiff, Willard Hurley, alleges a bad faith claim against defendants,
State Farm Mutual Automobile Insurance Co. and State Farm Fire and
Casualty Co. (collectively State Farm). Hurley moved to compel discovery,
which the court granted in part and denied in part. Docket 49. Because State
Farm claimed that the attorney-client privilege protected some documents, the
court conducted an in camera review of the allegedly privileged documents.
After reviewing the documents, the court determined that further argument
was necessary and held a hearing on July 9, 2012.
BACKGROUND
The pertinent facts to this order are as follows:
Hurley maintained auto coverage and umbrella coverage policies with
State Farm. On October 21, 2007, Hurley was injured in an automobile

accident as a result of another driver’s actions. The other driver’s personal
liability insurance limits were insufficient to compensate Hurley. After State
Farm declined to substitute its own draft of the other driver’s settlement,
Hurley accepted the limits of the other driver’s policy and entered into a
release with the driver.
Hurley then filed a claim with State Farm, which denied his claim.
Hurley brought suit against State Farm for breach of contract to recover under
the underinsured motorist (UIM) provisions of his policy. After about one year
of litigation, State Farm made an unconditional payment of $340,000 to
Hurley and later paid an additional $200,000 to resolve the case. Hurley then
commenced this action alleging first-party bad faith refusal to pay an
insurance claim.
DISCUSSION
In interrogatory numbers 6-10 and requests for production numbers 1,
14, and 15, Hurley seeks information concerning State Farm’s conduct that
occurred after Hurley filed his UIM claim with State Farm. Hurley seeks the
information to understand why State Farm increased his claim’s valuation
from zero dollars to $540,000. State Farm originally refused to provide the
requested information but, after Hurley moved to compel, State Farm provided
all the documents with the portions subject to the attorney-client privilege
redacted.

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State Farm contends that the information sought is not relevant because
it occurred after the breach of contract litigation commenced, and it does not
relate to State Farm’s initial denial of Hurley’s claim. According to State Farm,
only information regarding its initial denial of Hurley’s claim is relevant.
The South Dakota Supreme Court has addressed State Farm’s
argument. In Dakota, Minnesota & Eastern Railroad Corp. v. Acuity, 771
N.W.2d 623 (S.D. 2009), the court reasoned 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. In the first-party context, there exists a contractual
relationship, whereby the insurer has accepted a premium from
its insured to provide coverage. . . . 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., [562 N.W.2d 117, 119 (S.D.
1997)]. Bad faith conduct may include the failure to conduct a
reasonable investigation concerning the claim.
Id. at 629 (emphasis in original) (other quotations omitted). “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.” Id. at
632. Additionally, an insurer has a duty to reassess the insured’s claim based
upon information received subsequent to its initial decision. Id. at 633 (citing
Walz v. Fireman’s Fund Ins. Co., 556 N.W.2d 68, 71 (S.D. 1996)).

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The court then addressed the admissibility of an insurer’s conduct after
the institution of litigation on the underlying claim:
[W]e 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
. . . 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 . . . typically occurs when an
insurance company engages in wrongdoing during its processing
or paying of policy benefits to its insured.
Id. at 635 (quotations omitted). The court concluded that because significant
discovery remained outstanding, it could not determine the admissibility of the
post-litigation conduct and remanded the matter back to the trial court for
consideration after the completion of discovery. Id. at 636.
Hurley seeks information regarding why State Farm changed its
valuation of his UIM claim. State Farm made a substantial change in position
after litigation began—from zero dollars to more than half-a-million dollars.
The information sought by Hurley would shed light on whether State Farm’s
initial denial of his claim was reasonable. Because a first-party bad faith claim
focuses on whether an insurance company consciously engaged in wrongdoing
during the processing or paying of policy benefits to its insured, evidence
relating to State Farm’s decision to dramatically increase the valuation of
Hurley’s claim is relevant.

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Furthermore, the relevancy standard for discovery is broader than the
standard for admissibility. See, e.g., Fed. R. Civ. P. 26(b)(1) (allowing discovery
that “appears reasonably calculated to lead to the discovery of admissible
evidence.”); Hofer v. Mack Trucks, Inc., 981 F.2d 377, 380 (8th Cir. 1992)
(reasoning that while Rule 26(b) forbids “fishing expeditions in discovery,” the
relevancy standard for “discovery is broader than in the context of
admissibility.” (citing Oppenheimer Fund, Inc. v. Sanders, 437 U.S. 340, 352
(1978))). Thus, State Farm’s actions up to and including the time that it paid
Hurley’s claim are relevant and discoverable.
The parties dispute whether State Farm waived its right to assert the
attorney-client privilege. State law supplies the rules of decision for
attorney-client privilege in diversity cases. Fed. R. Evid. 501. Because this is a
diversity case and South Dakota law is the governing substantive law, South
Dakota law supplies the law on privilege.
The party claiming a privilege has the burden to establish that the
privilege exists. DM&E, 771 N.W.2d at 637 (citing State v. Catch the Bear, 352
N.W.2d 640, 645 (S.D. 1984)). The attorney-client privilege protects from
disclosure “confidential communications made for the purpose of facilitating
the rendition of professional legal services to the client[.]” SDCL 19-13-3. There
are four “[m]inimum elements” of the attorney-client privilege: “(1) a client; (2)
a confidential communication; (3) the communication was made for the

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purpose of facilitating the rendition of professional legal services to the client;
and (4) the communication was made in one of the five relationships
enumerated in SDCL 19-13-3.” Catch the Bear, 352 N.W.2d at 645.
After reviewing the documents provided to the court by State Farm in
camera, the court finds that the documents are confidential communications
from an attorney to a client, one of the five enumerated relationships in SDCL
19-13-13. The communications also appear to have been made for the purpose
of rendering professional legal services to the client. Thus, the documents are
protected by the attorney-client privilege.
A client can waive the attorney-client privilege if, among other reasons,
the client’s actions fall under the advice-of-counsel exception to the attorneyclient privilege. Bertelsen v. Allstate Ins. Co., 796 N.W.2d 685, 701 (S.D. 2011).
In Bertelsen, the South Dakota Supreme Court reaffirmed its reliance on the
test from Hearn v. Rhay, 68 F.R.D. 574 (E.D. Wash. 1975) for determining
whether a client has waived the attorney-client privilege. Id. at 702. Hearn
articulates a three-part analysis: (1) whether the assertion of the attorneyclient privilege was the result of an affirmative act; (2) whether the asserting
party, through the affirmative act, made the protected information relevant to
the case; and (3) whether “ ‘application of the privilege would have denied the
opposing party access to information vital to his defense.’ ” Id. (quoting Hearn,
68 F.R.D. at 581).

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In Bertelsen, the South Dakota Supreme Court added additional
considerations to the Hearn analysis. “First, the analysis . . . should begin
with a presumption in favor of preserving the privilege.” Id. at 702. “Second, a
client only waives the privilege by expressly or impliedly injecting his
attorney’s advice into the case.” Id. (reasoning that “[a] denial of bad faith or
an assertion of good faith alone is not an implied waiver of the privilege.”
(citations omitted)). Under this analysis, “[t]he key factor is reliance of the
client upon the advice of his attorney.” Id. (citation omitted). “Finally, a client
only waives the privilege to the extent necessary to reveal the advice of counsel
he placed at issue.” Id. (citing DM&E, 771 N.W.2d at 638).
Hurley claims that State Farm impliedly asserted the advice-of-counsel
exception during two of its employees’ depositions. Judith Prenzler, a State
Farm employee, prepared an assessment of Hurley’s UIM claim’s value. Docket
31-6 at 2. During her deposition, attorney Fuller instructed Prenzler not to
answer certain questions posed by Hurley’s counsel:
Q: Ultimately what was the value that you placed on Dr. Hurley’s
underinsurance claim prior to settlement?
MR. FULLER: And I’m going to object for the reason that without
further review of her—Judy’s further review of documents, that
that [sic] information may be based upon attorney-client
communications or recommendations. I’m instructing her not to
answer.
Docket 31-6 at 2. Hurley’s counsel questioned Prenzler about State Farm’s
change in position to initially offer zero dollars in July of 2009 to eventually
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paying Hurley $540,000: “Q: Tell me what factors caused State Farm’s change
of position so drastically. MR. FULLER: Again, I’m instructing her not to
answer.” Docket 31-6 at 2.
Steve Lading, a State Farm employee, completed the initial evaluation of
Hurley’s claim for mediation. Docket 31-7 at 2 (“I’m the one that had done the
evaluation, the initial evaluation, for the mediation.”). At one time, State Farm,
through Ladig, sent Hurley a check for $340,000. Hurley’s counsel questioned
Ladig about this check:
Q: At the time the check was sent, did his claim in your opinion
have a value in excess of $340,000?
MR. FULLER: Well, I’m going to object to this, because I’m not
sure what role if any he had in those decisions, and a lot of that is
attorney-client communication, recommendations, and I certainly
know I didn’t talk to Steve Ladig about it.
Docket 31-7 at 2. Hurley’s counsel also questioned Ladig about determining
Hurley’s loss of earning capacity: “Q: Did you change your mind at all on loss
of earning capacity? MR. FULLER: I’m instructing him not to answer that
question. His information and his evaluation, if he did an evaluation, was
based, you know, on attorney-client communication.” Docket 31-7 at 2.
The court questioned State Farm about the deposition testimony during
the hearing. State Farm responded that it has the right to assert the advice-ofcounsel defense, but it chose not to assert the defense, and, thus, it did not
waive the attorney-client privilege. Instead, State Farm argued that it changed

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its position regarding the valuation of Hurley’s claim after Hurley’s treating
physician stated that his condition was worsening and his employer was
seeking a physician who could do the procedures that Hurley was unable to
perform. To support this position, State Farm referenced an email dated
September 2, 2010, from Teresa Herrera to Jody Anderson (their positions at
State Farm are unclear) explaining the treating doctor’s analysis.
State Farm’s amended answers to interrogatories state that the factors
that caused it to pay Hurley $540,000 in insurance benefits includes
information documented in the activity log, “excluding information protected
by the attorney-client privilege.” Docket 36-2 at 4. But during oral argument,
in response to the court’s inquiry, State Farm stated that the decision to
change the valuation in Hurley’s claim was “intertwined” with the advice of
counsel. The court then asked State Farm whether it was true that its decision
to change the valuation in Hurley’s claim was based on both the advice of
counsel and information that State Farm independently collected. State Farm
responded that the court was correct, and again stated that its decision to
change the claim’s valuation was “intertwined” with the advice of counsel.
Because the amended answers to interrogatories seem to conflict with the
responses to inquiries during oral argument, the court is unclear as to the
basis for State Farm’s increase in its payment and whether the justification
includes information obtained from advice of counsel.

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Hurley is entitled to know why State Farm increased its payment
because the question of whether State Farm had a reasonable basis to deny
his claim is a necessary element in a first-party bad faith case. See, e.g.,
Brooks v. Milbank Ins. Co., 605 N.W.2d 173, 177 (S.D. 2000) (reasoning that
under South Dakota law the elements of a first-party bad faith claim include
“the absence of a reasonable basis for denial of the claim; and that the insurer
knew there was not a reasonable basis to deny the claim or that the insurer
acted in reckless disregard of the existence of a reasonable basis to deny the
claim.”).
Under Bertelsen, the court must examine whether State Farm, through
its affirmative act, made the privileged information relevant to the case. Ladig’s
and Prenzler’s depositions and attorney Fuller’s argument that the advice of
counsel was “intertwined” with State Farm’s decision to change the valuation
of Hurley’s claim could show that State Farm was relying at least in part upon
the advice of counsel in determining the value of Hurley’s claim. State Farm,
however, has produced some evidence, namely the email dated September 2,
2010, which could show that it did not rely on the advice of counsel in
changing its valuation of Hurley’s claim.
Given the presumption in favor of preserving the attorney-client
privilege and the uncertainty of whether State Farm has impliedly asserted the

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advice-of-counsel defense in this bad faith action, the court is unable to rule
on Hurley’s motion to compel at this time.
During the hearing, Hurley requested as alternative relief an opportunity
to depose Prenzler and Ladig again and to depose Herrera and Anderson.
Conducting the four depositions will allow Hurley an opportunity to discover
the information to which he is entitled while allowing State Farm to clarify
whether it relied on the advice of counsel in determining whether to pay
Hurley’s claim. Thus, Hurley’s request for the depositions is granted. In the
event Prenzler, Ladig, Herrera, and Anderson claim that their decision to
increase their payment to Hurley was based in part on attorney-client
privileged information, they should state that for the record. They should then
record in a written affidavit the substance of the attorney-client privileged
information upon which the witness relied and file the affidavit under seal with
the court for further in camera review.
State Farm’s conduct, especially its refusal to allow Prenzler and Ladig
to respond during the depositions to the non-privileged reasons for the
increase in payment to Hurley, necessitates the additional depositions. As a
result, State Farm will pay the out-of-pocket expenses for Hurley’s attorney to
conduct the four depositions. See, e.g., United States ex rel. O’Keefe v.
McDonnell Douglas Corp., 132 F.3d 1252, 1258 (8th Cir. 1998) (reasoning that
the district court has wide latitude in discovery); Spann v. Crawford, No. 06-

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4042, 2007 WL 2407020, at *2 (W.D. Mo. Aug. 17, 2007) (requiring a party to
pay for costs of a depositions when his conduct, namely failing to appear for
the first deposition, required another deposition); Monsanto Co. v. Ralph, No.
00-CV-135, 2001 WL 35817667, at *4 (E.D. Mo. Oct. 10, 2001) (reasoning that
the court “can force parties to retake depositions, perhaps pay for the
inconvenience to the other party[.]”). If, after conducting the additional
depositions, Hurley believes that the documents sought in the motion to
compel are still necessary, he can supplement his motion to compel.
Accordingly, it is
ORDERED that the parties will depose Judith Penzler, Steve Ladig,
Teresa Herrera, and Jody Anderson for the limited purpose of determining the
basis for the increased payments to Hurley. Defendants will pay plaintiff’s outof-pocket expenses for these depositions.
Dated July 11, 2012.
BY THE COURT:

/s/ Karen E. Schreier
KAREN E. SCHREIER
CHIEF JUDGE

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