South Dakota Supreme Court Rejects Third-Party Bad Faith Lawsuits

September 24, 2001

The insurance industry applauded the South Dakota Supreme Court for its recent review and rejection of a third-party bad faith lawsuit against an insurance company.

“This is a major victory for insurers and their customers in South Dakota. Third-party lawsuits have significantly changed the incentives that guide the actions of claimants and lawyers. The opportunity for claimants to receive potentially larger awards, including punitive damages, has increased the frequency of insurance fraud and the cost of insurance premiums,” said Laura Kotelman, legal counsel for the National Association of Independent Insurers (NAII).

“The South Dakota Supreme court for the first time addressed the negative effect of third-party lawsuits on the civil justice system. The court examined whether a third-party claimant could maintain a direct cause of action against an insurance company and if a third-party claimant can seek punitive damages by pursuing a bad faith breach of contract claim against the insurer,” Kotelman said.

Kotelman reported that the Supreme Court ruling was in response to a lower courts decision in Trouten v. Heritage Mutual that allowed Robert Trouten to file a direct action suit against Heritage Mutual Insurance Company as a third party beneficiary to the insurance contract. The trial court also allowed Trouten to sue Heritage Mutual for bad faith breach of an obligation to pay under a contract.

Robert Trouten slipped and fell on the sidewalk abutting the insured’s building. He made a claim in excess of the $5,000 policy limit for medical expenses and the claim was rejected entirely by Heritage Mutual.

“The South Dakota Supreme Court held that the trial court erred in both decisions and upheld the legislative mandate that there is no direct cause of action against an insurance company by a third party claimant until such time as the third-party claimant has successfully brought suit against the insured,” Kotelman said.

The court reasoned that allowing Trouten’s suit to proceed would provide for a multiplicity of lawsuits; for example, a direct claim made against the insurance company along with a tort claim against the business-owner. That sort of “double dipping” was rejected by the court as bad public policy.

“The significance of the Supreme Court’s decision is that it affirms existing state legislation and establishes a precedent for future cases involving third-party claims,” Kotelman said.

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