Nearly one year ago, we wrote in general terms about how good faith is implied in New York contracts. This article, however, will focus on the underlying factors that New York’s courts will consider when applying this doctrine to non-solicitation agreements.

Fortunately, a hot-off-the-presses decision from New York State’s highest court offers some guidance – and some instructive language:

“Under New York common law, a seller has an “implied covenant” or “duty to refrain from soliciting former customers, which arises upon the sale of the ‘good will’ of an established business” (Mohawk Maintenance Co. v Kessler, 52 NY2d 276, 283 [1981]) … A seller’s “implied covenant” not to solicit his former customers is ‘a permanent one that is not subject to divestiture upon the passage of a reasonable period of time … This is so because “[t]he essence of [these types of] transaction[s] is, in effect, an attempt to transfer the loyalties of the business’ customers from the seller, who cultivated and created them, to the new proprietor” (id.) …

“Notwithstanding this “implied covenant,” a buyer assumes certain risks when he purchases an existing business and attempts to transfer the loyalties or “good will” of that business as his own. For example, the customers of the acquired business, “as a consequence of the change in ownership,” may choose to take their patronage elsewhere (id.). Indeed, “the occurrence of a certain amount of attrition is one of the risks that the purchaser must assume when he acquires an established business” (id.). Moreover, the seller of a business is free to subsequently compete with the purchaser and even “accept the trade of his former customers, provided that he does not actively solicit such trade …  [such as by] sending targeted mailings or making individualized telephone calls to his former customers informing them of his new business ventures … On the other hand … so long advertisements [are] general in nature — and not specifically aimed at the seller’s former customers — [they are] permissible under New York law.

“While the “implied covenant” places certain barriers on a seller’s conduct, it in no way prohibits a former customer or client from gathering information about that seller. In the free market, consumers of goods and services have the right to make informed choices …Thus, a seller of “good will” may answer the factual inquiries of a former client, so long as such responses do not go beyond the scope of the specific information sought …[but may not] explain, for example, why he believes his products or services are superior …

For additional information on this topic, please see “New York Court Clarifies Standard For “Improper Solicitation of Old Clients.”

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Having been down a similar road with respect to my own house several years ago, I found myself cheering when I read this decision, which was handed down on December 10.

In Carden v. Allstate, the plaintiffs were forced to rent another place to live when their home sustained serious fire damage. When they put in a claim under their homeowner’s policy, however, Allstate engaged in a modified version of the standard 3 “D”‘s – deny, delay and defend. (For an interesting expose on this topic, see Anderson Cooper’s report on insurance companies’ tactics, click on the link under the 3 “D”‘s.)

As the Court noted in its opinion, after first offering a low-ball offer that clearly did not cover the plaintiff’s losses that were required to be covered under the homeowner’s policy, they increased their offer – but it was still woefully inadequate, and forced plaintiffs to seek an independent evaluation, and for the appointment of an umpire to properly determine the appropriate payment they were entitled to under the policy. This umpire found that Allstate’s last offer was nearly $300,000 too low (and roughly $200,000 less than Allstate’s own independent adjuster’s estimate). And, despite an express provision in the policy entitling the plaintiffs to Additional Living Expense (“ALE”) for a maximum of 12 months during the reconstruction, Allstate refused to do so.

Left with no choice, the plaintiffs sued for breach of their insurance agreement. And won.

In finding Allstate guilty of bad faith, the Court stated as follows:

“As in all contracts, implicit in contracts of insurance is a covenant of good faith and fair dealing, such that a reasonable insured would understand that the insurer promises to investigate in good faith and pay covered claims (Bi-County Market, Inc. v. Harleysville Ins. Co. of New York, 10 NY3d 187, 193 [2008]). While New York does not recognize an independent tort cause of action for an insurer’s failure to perform its contractual obligations under an insurance policy (New York Univ. v. Continental Ins. Co., 87 NY2d 308 [1995]; Roconova v. Equitable Life Assur. Socy., 83 NY2d 603 [1994]), where an insurer breaches its duty to investigate, bargain and settle claims in good faith, consequential damages for breach of contract may be recovered not limited by the amount specified in the insurance policy (Acquista v. New York Life Ins. Co., 285 AD2d 73, 77 [1st Dept 2001]; see Bi-County Market, Inc. v. Harlysville Ins. Co. of New York, 10 NY3d 187, 192-93 [2008]) …

“[D]ue to the delay in the settlement process and consequent delay in reconstruction, Plaintiffs were forced to remain out of the dwelling for 18 months. Under the Policy, Plaintiffs were entitled to Additional Living Expense (“ALE”) for a maximum of 12 months which Defendant refused to extend .. Here, the Plaintiffs have submitted evidence in admissible form that Defendant offered Plaintiffs $265,000 and then $575,000 on a claim ultimately determined to be, and paid, in the amount of $832,982, and that Plaintiffs suffered damage due to the delay in reconstruction of their Dwelling due to Defendant’s bad faith delay in settling the claim. This makes out a prima facie claim for breach of the covenant of good faith.”

Make no mistake; an award of bad faith against an insurer in New York is extremely rare. In fact, New York’s appellate courts usually dismiss bad faith claims against insurers. That’s why an appeal of this decision is a near-certainty.

That said, I hope these plaintiff’s enjoy the moment.

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In a recent decision, New York’s Appellate Division, Second Department showed once again just how powerful New York’s insurance lobby is, and how, under the current structure of the law in New York, an insurer has almost no incentive to protect its clients – the insureds – by negotiating claims in good faith. Quite the contrary, in New York, insurers have every incentive to ignore their insureds’ interests, and to put their own economic self-interest first. (For more on this topic, please see “Bad Faith Claims in New York“.)

In CBL Path, Inc. v. Lexington Insurance Co., the plaintiff was confronted with an obvious negligence situation – their laboratory mixed up test results, causing a woman to undergo what was otherwise an unnecessary double mastectomy. Although their malpractice policy carried limits of $1 million, the defendant, a subsidiary of AIG, apparently never contacted the claimant to conduct any pre-litigation settlement negotiations, and as a result, the claimant ultimately filed suit, which brought a great deal of negative publicity to CBL.

CBL then sued its insurer for damage to its business reputation, lost profits, as well as the lost business opportunities that were directly caused by the negative publicity that it suffered due to the filing of the underlying negligence action.

Ultimately, and predictably, the Court was constrained to dismiss the action, following New York’s legal precedent, which the Court summarized as follows:

“Since an award of damages exceeding the policy limits is punitive in nature, it “is not applied routinely for breach of contract; and bad faith requires an extraordinary showing of a disingenuous or dishonest failure to carry out a contract …

“Since courts are understandably reluctant to expose insurers to liability exceeding the policy limits, the bad faith must be for conduct that is clearly more than ordinary negligence, i.e., more than merely poor judgment.”

The Court then articulated the rare circumstance under which an insurer can be held liable in bad faith in New York:

“Naturally, proof that a demand for settlement was made is a prerequisite to a bad-faith action for failure to settle. [Additionally,] the plaintiff in a bad-faith action must show that the insured lost an actual opportunity to settle the . . . claim at a time when all serious doubts about the insured’s liability were removed.

“Bad faith is established only where the liability is clear and the potential recovery far exceeds the insurance coverage” (id. at 454 [internal quotations marks and citations omitted]; see also Smith v General Acc. Ins. Co., 91 NY2d 648, 653; Soto v State Farm Ins. Co., 83 NY2d 718, 723; Vecchione v Amica Mut. Ins. Co., 274 AD2d 576, 578; cf. United States Fid. & Guar. Co. v Copfer, 48 NY2d 871, 873).”

Needless to say, I find this rule disturbing, because it tacitly allows insurers to ignore their fiduciary duties to their insureds – without any fear of adverse consequence. To borrow an old phrase, “There ought to be a law …”

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