All members of FORC are familiar with their own state's definition of "insurance" which has been set forth statutorily by the various state legislatures since the beginning of risk sharing. A more "squishy" area of the law has been service warranties or, in this case, a vehicle service contract. In January of this year, the Oklahoma Supreme Court had an opportunity to review a vehicle service contract and determined it to be "insurance" under Oklahoma's statute and consequently subject to "bad faith."
The facts of the case were that the petitioner, Mr. McMullan, bought a used car and with it, a vehicle service contract. After six months, his used car had experienced a mechanical breakdown, for which he submitted a claim to the vehicle service warranty company. The claim was denied and Mr. McMullan filed a lawsuit alleging that the provider of the vehicle service contract, Enterprise Financial Group, (1) breached the service contract; (2) committed unfair and deceptive practices under the Oklahoma Service Warranty Insurance Act, Okla. Stat. tit. 36, § 6633 (2001); and (3) acted in bad faith. The provider, Respondent, filed a Motion for Partial Summary Judgment and immediately certified an interlocutory order for immediate appeal to the Oklahoma Supreme Court. The Supreme Court granted certiorari to address the question of whether a vehicle service contract is an "insurance" contract and consequently subject to bad faith claims, a question of first impression. Not wanting to spoil the anticipation of the Court's decision amongst all the insurance regulatory lawyers of the U.S., I must inform you that, at least under Oklahoma law, our insurance regulatory practice has been enlarged to include vehicle service contracts.
The Law of Fair Dealing
The Oklahoma Supreme Court announced initially in the 1977 case of Christian v. Am. Home Assurance Co., 1977 OK 141, 577 P.2d 899, that insurance contracts were subject to bad faith awards. In the more recent case of Bankers Trust Co. v. Brown, 2005 OK CIV App 1, 917, 107 P.3d 609, the Oklahoma Supreme Court cited the "special relationship between an insurer and an insured" in further enunciating the tort liability for breach of the covenant of good faith and fair dealing in insurance contracts. The result was that not only may an insured seek damages for the benefits under their policy, but they may also recover as a result of the "harm flowing from insurer's bad faith breach." Taylor v. State Farm Fire & Cas. Co., 1999 OK 44, 919, 981 P.2d 1258. Bad faith damages can include "mental pain and suffering, financial losses, embarrassment, and loss of reputation" according to the 10th Circuit Court of Appeals. See Vining v. Enter. Fin. Group, Inc., 148 F.3d 1206 (10th Cir. 1998). The case of Buzzard v. Farmers Insurance Co., 1991 OK 127, ¶24, 824 P.2d 1105, added that punitive damages were also recoverable in insurance bad faith breach cases. As one can tell from the cited cases, the Supreme Court continued to enlarge the tort liability of insurers, but the Court had not expanded this tort theory of recovery to non-traditional insurance claims, until now.
McMullan v. Enterprise Financial Group, Inc., 2011 OK 7, 247P.3d 1173
On January 31, 2011, the Oklahoma Supreme Court issued its opinion in McMullan v. Enterprise Financial Group, Inc., (cited hereinabove) and not only determined that vehicle service contracts are "insurance" under Oklahoma statutes, but consequently, they are subject to the tort of "bad faith" as all other insurance contracts.
Oklahoma, in its statutory scheme, and within the Insurance Code (Title 36, Oklahoma Statutes) has enacted the Oklahoma Service Warranty Insurance Act (Okla. Stat. tit. 36, §§ 6601-6639 (2001)). Petitioner argued that regardless of what these vehicle service contracts were labeled, they were, in reality, "insurance contracts" and consequently subject to bad faith breach. Petitioner relied on not only the public policy considerations of the Oklahoma Service Warranty Insurance Act, but also argued that other jurisdictions have determined service contracts of this type to be "contracts of insurance." Respondent argued that insurers are regulated under one scheme of regulation and service warranties are regulated under a different set of rules and that service contracts were "warranties" and not "insurance contracts." The Court, in its opinion, however, held that it was not the "extent of regulation" that determines whether a service provider is an "insurance company" nor was the extent of regulation what makes a service agreement an "insurance contract."
"Insurance" in Oklahoma is defined as "a contract whereby one undertakes to indemnify another or to pay a specified amount upon determinable contingencies" (Okla. Stat. tit. 36, § 102 (2001)). The Court went on to opine that while "indemnity" is not specifically defined within the confines of the Oklahoma Insurance Code, the Service Warranty Insurance Act, which is contained within the Oklahoma Insurance Code, defines indemnity as "undertaking repair or replacement of a consumer product." Id. §6602.7. The Court determined that "maintenance service contracts under the terms of which there are no provisions for such indemnification and home warranties are expressly excluded from this definition of 'service warranty'." Id. §6602.14(a).
The Court quoted the seminal case of Group Life & Health Insurance Co. v. Royal Drug Co., 440 U.S. 205, 211 (1979) in its discussion of what constituted "insurance":
[t]he primary elements of an insurance contract are the spreading and underwriting of a policyholder's risk. "It is characteristic of insurance that a number of risks are accepted, some of which involve losses, and that such losses are spread over all the risks so as to enable the insurer to accept each risk at a slight fraction of the possible liability upon it."
The Court went on to quote Jordan v. Group Health Ass'n, 71 App. D.C. 38, 107 F.2d 239, 245 (1939):
Whether the contract is one of insurance or of indemnity there must be a risk of loss to which one party may be subjected by contingent or future events and an assumption of it by legally binding arrangement by another. Even the most loosely stated conceptions of insurance... require these elements. Hazard is essential and equally so a shifting of its incidence.
The Supreme Court concluded:
Vehicle service contracts are written like insurance policies.... The vehicle service provider agrees to indemnify the consumer for mechanical repair costs. In other words, the consumer has purchased insurance -- regardless of whether the vehicle service company is labeled as an insurance company and regardless of whether it labels its agreements insurance.
McMullan, 2001 OK 7, 13, 247 P.3d at 1178.
The Court went through a very good analysis of other jurisdictions and their Court's determinations of whether vehicle service contracts constituted insurance. According to their analysis, the states are split on this issue, but our Court adopted the rationale of an Arizona case, Jim Click Ford, Inc. v. City of Tucson, 154 Ariz. 48, 739 P.2d 1365 (Ct. App. 1987) where the Court recognized five indicia of an insurance contract:
1. An insurable interest;
2. A risk of loss;
3. An assumption of the risk by the insurer;
4. A general scheme to distribute the loss among the larger group of persons bearing similar risks; and
5. The payment of a premium for the assumption of risk.
Additionally, our Court found the Utah case of Pugh v. North American Warranty Services, Inc., 2000 UT App 121, 1 P.3d 570 to be persuasive in their reasoning where Utah held a vehicle service contract was insurance because if the car broke down during the warranty period, the provider of the vehicle service contract "absorbed the cost of the repair." The Court went on to hold that while the agreement was named a "vehicle service contract" rather than "automobile repair insurance" it served the same purpose and consequently was an insurance contract.
Oklahoma's Supreme Court held as its reasoning:
The consumer pays for indemnity and pays to shift the risk of paying for high repair costs to the vehicle service provider in exchange for a pre-paid premium. Because these contracts function like insurance, their providers should be subject to the same covenants of good faith that insurers must meet.
McMullan, 2011 OK 7, 19, 247 P.3d at 1180.
As stated hereinabove, this holding means that vehicle service contracts are now considered insurance contracts and consequently are subject to bad faith tort claims and the trial bar has a new cause of action of bad faith tort liability which appears to have grown out of the "special relationship" of an adhesion contract coupled with an agreement to bear risk.
Embry v. Innovative Aftermarket Systems, L.P., 2010 OK 82, 247 P.3d 1158
The Oklahoma Supreme Court also issued a further enunciation of bad faith tort liability outside the traditional realm of insurance contracts in Embry v. Innovative Aftermarket Systems, L.P., 2010 OK 82, 247 P.3d 1158. Plaintiff sought damages from Defendant for its failure to pay the difference which remained on an automobile loan after the total loss insurance settlement by plaintiff's insurer was applied to the outstanding loan. This type of product is generally referred to as "Gap Protection" and is oftentimes sold at the time of the car purchase so the debtor will not owe additional money on its loan after the car is totaled for its then value. The lower court had eliminated bad faith and negligence theories of recovery for Plaintiff and the case was appealed to the Oklahoma Supreme Court. At issue on the "bad faith" cause of action was a determination of whether this "Gap Protection" was an "insurance" product.
The trial court ruled that the tort recovery for bad faith and the failure to deal fairly and in good faith was limited to insurance contracts and that tortious bad faith could only occur if the parties recognized and believed their contract was insurance. The Supreme Court recognized that Courts, including the Supreme Court, had been reluctant to extend tort recovery for bad faith beyond the traditional "insurance contract" but said such liability was dependent upon the "special relationship" the contract created. This "special relationship" that is a predicate to tort liability for bad faith is based upon: "(1) a disparity in bargaining power where the weaker party has no choice of terms, also called an adhesion contract and (2) the elimination of risk." Rodgers v. Tecumseh Bank, 1988 OK 36, ¶¶ 14-16, 756 P.2d 1223, 1226. Embry, 2010 OK 82, ¶7, 247 P.3d at 1160. The Court went on to say:
"Tort liability is allowed in these types of contracts, because bad faith, or, more properly, breach of the implied duty to deal fairly and in good faith, precipitates the precise economic hardship the contract was intended to avoid." Christian v. American Home Assurance Co., 1977 OK 141, 577 P.2d 899.
Id.
The Court stated that the Defendant wrote the contract, set forth the definitions, described how it would work and even set forth a how to compute the "deficiency." The Court concluded: "Clearly, the contract to pay the deficiency involves the 'special relationship' necessary to support tort recovery for bad faith." The Court affirmed the lower court in its elimination of negligence as a cause of action, but reversed the lower court and held that the Defendant breached the implied covenant "deal fairly and in good faith" consequently expanding the tort theory of bad faith to so-called "Gap Products".
Conclusion
With the decisions in McMullan and Embry, Oklahoma's Supreme Court has broadened bad faith tort liability beyond the traditional insurance contract and created two new recoveries of tort liability for bad faith breach of contract: vehicle service contracts and those contracts which involve a "special relationship" between the parties. Now, at least in Oklahoma, vehicle service contracts and so-called Gap products are subject to the same covenant of good faith and fair dealing to which traditional insurance companies must adhere. The basis of this expansion into bad faith is the "special relationship" at least ostensibly, which exists whenever an adhesion contract is joined with a contract to eliminate risk; these two ingredients have been combined to create liability in tort for bad faith breach, just like traditional insurers in Oklahoma have been subject to for over three decades.