Dispute with Excess Insurer Highlights the Multifaceted Nature of Bad Faith
By David A. Gauntlett*
Introduction
Evanston Insurance Company and FullStory Inc. recently initiated litigation against each other in separate lawsuits (brought by the insurer in California federal court, by the insured in Illinois federal court) filed just days apart. While any substantive determinations will take time, the allegations serve as a reminder that insurer bad faith comes in many forms. In particular, an insurer’s unreasonable delays can be just as harmful and improper as a wrongful denial.
Nature of the Coverage Dispute
The competing federal lawsuits focus on whether Evanston owes $5 million in excess cyber liability coverage for FullStory’s costs defending lawsuits alleging that its “Session Replay” software unlawfully captured users’ electronic communications. The underlying suits claim that FullStory and its customers violated users’ privacy rights by secretly recording website visitors’ keystrokes, mouse clicks and personal information. FullStory contends that its primary insurance coverage has been exhausted, triggering Evanston’s excess policy, which provides up to $5 million once a $5 million underlying limit is reached. Evanston, however, maintains that the underlying limit was never satisfied and that FullStory has not provided sufficient evidence to establish exhaustion.
The coverage dispute stems from litigation between FullStory and its primary insurers, North American Capacity Insurance Co. and Peleus Insurance Co. After initially denying coverage, the primary insurers were found in 2023 to have a duty to defend FullStory in four of 28 underlying actions. The parties settled their coverage dispute in 2024, after which FullStory sought payment from Evanston. Evanston rejected the claim, arguing that the settlement did not establish that the $5 million underlying limit had been reached and that the covered defense costs totaled only about $3 million. Evanston also alleges that FullStory failed to provide timely notice of certain claims, withheld information about its litigation with the primary insurers and delayed providing requested documentation.
FullStory, in its Illinois lawsuit, alleges that Evanston’s refusal to pay constitutes a bad-faith denial of coverage. FullStory maintains that payments by the primary insurers, together with amounts it paid itself, satisfied the underlying limit and that its defense and other losses have exceeded $10 million. It further contends that Evanston’s repeated demands for additional information and refusal to recognize exhaustion were “vexatious and unreasonable.” FullStory says the denial has deprived it of funds needed to operate and grow its business, which it describes as a growth-stage company with constrained capital.
Similar Bad Faith Standards
The “vexatious and unreasonable” language was incorporated into FullStory’s complaint because it is the standard for insurer bad faith under Illinois law.[1] If California law applies (as Evanston presumably desires based on its filing in federal court there), bad faith is determined based on a “reasonableness” standard for third-party insurance claims.[2]
Illinois frames insurer bad-faith relief through section 155, which applies when the insurer’s action or delay is “vexatious and unreasonable” in a dispute over policy liability, loss payable, or unreasonable delay in settling a claim. The Illinois Supreme Court has described section 155 as an extracontractual remedy for policyholders whose insurer vexatiously and unreasonably refuses to recognize liability or pay a policy claim.[3] The inquiry is fact-specific and turns on the totality of the circumstances, including the insurer’s attitude, whether the insured was forced to sue, whether the insured was deprived of property use, the adequacy of investigation and communications, and whether a bona fide coverage dispute existed.[4] In the third-party context, Illinois recognizes a separate duty-to-settle line of cases involving a liability insurer controlling the defense and settlement of a third-party claim, where a refusal to settle within limits may expose the insurer to liability beyond policy limits.[5]
California uses different terminology but a closely related limiting principle: insurer bad faith depends on whether the insurer acted unreasonably or without proper cause.[6] California’s implied covenant requires the insurer to give at least as much consideration to the insured’s interests as to its own, and an insurer that unreasonably and in bad faith withholds policy benefits may face tort liability.[7] In third-party liability cases, California applies that same reasonableness-centered duty to settlement decisions: when there is a substantial risk of an excess judgment and settlement within limits is the most reasonable way to dispose of the claim, an unwarranted refusal to settle breaches the implied covenant.[8]
The practical difference is one of formulation and remedy, not permission for arbitrary claims handling. Illinois asks whether the insurer’s conduct was “vexatious and unreasonable” under section 155, while California asks whether the denial, delay, or settlement decision lacked a reasonable basis under the implied covenant.
Bad Faith Delay Is as Actionable as Unreasonable Denial
Both jurisdictions recognize that an insurer may not use delay tactics—including repeated or unnecessary demands for information—to postpone fulfilling obligations owed to an insured facing third-party liability.
In California, the implied covenant of good faith and fair dealing requires a liability insurer to give at least as much consideration to the insured's interests as to its own when handling third-party claims, and an insurer that unreasonably delays recognizing its defense or indemnity obligations may face tort liability even if it eventually accepts coverage.[9] When benefits are due, delayed payment or delayed defense based on inadequate or tardy investigations breaches the implied covenant because it frustrates the insured's contractual right to prompt protection from third-party liability.[10] The principle that "no breach of the covenant of good faith and fair dealing can occur if no benefits are due under the policy" applies only when no potential for coverage exists, not when the insurer delays acknowledging a duty it ultimately owes.[11] Thus, even an insurer that pays the full limits of its policy or ultimately provides a defense may be liable for breach of the implied covenant if improper claims handling causes detriment to the insured.[12]
Illinois law addresses third-party bad faith with equal clarity. Section 155 of the Illinois Insurance Code expressly applies where policy liability or "an unreasonable delay in settling a claim" is at issue, and permits fees, costs, and a statutory penalty when the insurer's action or delay is vexatious and unreasonable.[13] Illinois courts have found section 155 violations in the defense-and-indemnity context when an insurer fails to respond to its insured's demands for coverage, fails to file a declaratory judgment action to determine coverage, and fails to defend the insured under a reservation of rights.[14] The statute specifically contemplates delay as an independent basis for relief, separate from outright denial, and requires courts to assess vexatious and unreasonable delay under the totality of the circumstances, including the insurer's attitude, whether the insured was forced to sue, the existence of any bona fide coverage dispute, the adequacy of the insurer's investigation, and the sufficiency of communications between the insurer and insured.
Conclusion
Regardless of whether the FullStory case proceeds under Illinois or California law, Evanston faces potential bad faith liability for two distinct issues. If its coverage determinations were unreasonable, that alone will trigger liability. But even if its ultimate conclusions were reasonable, improper delays in handling the claim can also sustain the bad faith liability asserted by FullStory.
*David A. Gauntlett is a principal of Gauntlett Law and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett Law at www.gauntlettlaw.com.
[1] 215 Ill. Comp. Stat. Ann. 5/155 (“In any action by or against a company wherein there is in issue the liability of a company on a policy or policies of insurance or the amount of the loss payable thereunder, or for an unreasonable delay in settling a claim, and it appears to the court that such action or delay is vexatious and unreasonable, the court may allow as part of the taxable costs in the action reasonable attorney fees, other costs, plus an amount not to exceed any one of the following amounts . . . .”)
[2] Hangarter v. Provident Life & Accident Ins. Co., 373 F.3d 998, 1009–10 (9th Cir. (Cal.) 2004) ("The key to a bad faith claim [under California law] is whether or not the insurer's denial of coverage was reasonable.”)
[3] Cramer v. Insurance Exch. Agency, 174 Ill. 2d 513, 520 (1996).
[4] Nine Grp. II, LLC v. Liberty Int'l Underwriters, Inc., 168 N.E.3d 956, 964 (Ill. Ct. App. 2020).
[5] Cramer v. Insurance Exch. Agency, 174 Ill. 2d 513, 525 (1996).
[6] Neal v. Farmers Ins. Exchange, 21 Cal. 3d 910, 921 (1978).
[7] Frommoethelydo v. Fire Ins. Exch., 42 Cal. 3d 208, 214 (1986).
[8] Commercial Union Assurance Cos. v. Safeway Stores, 26 Cal. 3d 912, 917 (1980).
[9] Maslo v. Ameriprise Auto & Home Ins., 227 Cal. App. 4th 626, 632 (2014).
[10] Lincoln Property Co., N.C., Inc. v. Travelers Indemnity Co., 137 Cal. App. 4th 905, 915 (2006).
[11] Schwartz v. State Farm Fire & Casualty Co., 88 Cal. App. 4th 1329, 1339 (2001).
[12] Brehm v. 21st Century Ins. Co., 166 Cal. App. 4th 1225, 1236 (2008).
[13] 215 ILCS 5/155.
[14] Am. Serv. Ins. Co. v. Franchini, 396 Ill. App. 3d 413, 417 (2009).