The Birth of Bad Faith

Fifty years ago, personal injury attorney William Shernoff stood before a California jury as it awarded a record-breaking $5.1 million in punitive damages against Mutual of Omaha for mishandling his client’s disability claim. It was a huge verdict for 1974, and for Shernoff personally, who was 35 years old and just starting to try cases.

But there was no one in the courtroom gallery to hear it.

“It was empty,” he says. “I remember feeling like, ‘Gee, I just did this nice big verdict and nobody was even here.’ It was just another case.’”

So he moved on to the next one—with no immediate awareness that he’d just helped create a new area of law: insurance bad faith. “There was no bad faith law before the Egan case,” he says. “You couldn’t really fight with insurance companies. You didn’t have any tools, so to speak.”

If some of the details from the Egan case are hazy, Shernoff doesn’t have to look far to refresh his memory, considering it’s been cited 8,000 times in appellate arguments and detailed in four books he authored. “This one came along and fell in my lap,” he says. “All I remember thinking is, ‘Boy, this is a good case. I should really take this one to trial.’”

“I fell in love with the idea of going up against the big insurance corporations for the little guy. That appealed to me, and I knew it would appeal to a jury if you had a good story to tell.”

A few years prior, Shernoff’s first trial had been on behalf of a farmer whose insurance claimed he wasn’t disabled because he could walk to his mailbox. After that win, people began approaching him with similar claim denials, saying they’d been paying lawyers by the hour to write letters to the insurance company and they couldn’t afford to do it anymore. 

“There must be a way to help these people,” he remembers thinking.

Shernoff grew up in the rural Wisconsin town of Crivitz, population 500. His father, the only lawyer for 100 miles, often accepted chickens, vegetables or whatever payment clients could offer. “He was a real simple country lawyer helping people with divorces or whatever problem they had,” he says.

Shernoff may have been new to trial work when Michael Egan approached him about his claim denial, but he had no reservations about suing the largest accident and health insurance company in the world.

“I fell in love with the idea of going up against the big insurance corporations for the little guy,” he says. “That appealed to me, and I knew it would appeal to a jury if you had a good story to tell.”

Michael Egan’s story—recounted in the first chapter of Shernoff’s book, Payment Refused—was simple and sympathetic. The stout Irish immigrant supported his disabled wife and young daughter as a roofer, working on top of homes in Pomona, until one morning, as he stepped down the ladder, a rung broke and he fell 12 feet to the ground, seriously injuring his back.

Egan carried a Mutual of Omaha disability insurance policy that promised to pay $200 a month for life if he became totally disabled by an accident, but after a few months of benefits the company cut him off—about the same time his total disability was declared by his doctor after a failed back surgery.

Mutual of Omaha had classified Egan’s injury as a sickness rather than an accident. And sickness payments only lasted three months.

Shernoff began the trial by having Egan, his wife and daughter all take the stand to recount how the claims manager came to their home and laughed at Egan and called him a fraud and made them all cry. They described a second visit in which a different employee told Egan he was no longer eligible for disability benefits and offered to make a small payment if he surrendered his policy.

“The jury was already convinced Mutual of Omaha was a bunch of crooks,” Shernoff says of the family’s testimony. “They told the story of how these adjusters were so rude and inconsiderate and nasty and then it got worse when I put the two adjusters on the stand. They came across like idiots. They didn’t do any investigation, didn’t talk to the doctor, just reclassified him to save $40,000.”

That became the defense strategy: to blame the reclassification and denial on those two employees and show the home office was unaware and could not be held responsible.

On direct examination, a manager testified that the Egan file had been misplaced and must have fallen through a “corporate crack.” But when he referred to a file jacket, Shernoff’s ears perked up. He’d been given the contents of Egan’s file during discovery, but no file jacket—which would show who took out the file, and when.

“I asked the judge to make them produce the file jacket immediately,” Shernoff says. “It showed during this time period of reclassification they had reviewed the file like 20 times, so I made a big deal out of this ‘corporate crack’ thing. That established it was not only these two bad apples; the home office was just as complicit.”

In closing, after the questioning of the company’s controller established its $27 million in net profits for the year, Shernoff asked the jury to award Egan not only his disability benefits and a fair amount for his mental and emotional distress, but also punitive damages. He felt a month or two of corporate earnings would be appropriate.

“Nobody is trying to break any company,” he remembers telling the jury. “But we do have a lot of people around that believe very strongly in decent and honest practices in the business, and they are all rooting for you. There are a lot of people that will be sick and disabled in this country in the future and shouldn’t be cheated out of their money.”

After two days of deliberation, the jury awarded Egan $45,600 for past and future benefits, $78,000 for mental and emotional distress and a $5.1 million in punitive damages—just about the two months of corporate earnings Shernoff had asked for.

“At the time, it was a record in punitive damages in the state,” Shernoff says.

Despite the empty gallery that day, the verdict made headlines; but Shernoff still had no real concept of its impact until Mutual of Omaha appealed to the California Supreme Court. There, the court affirmed that punitive damages should be available against insurance companies “to restore balance in the contractual relationship” and that those companies are liable for the actions of their employees.

“That was the spark that lit the fire,” Shernoff says. “They basically said insurance companies hold themselves out as fiduciaries and have a duty to investigate claims fairly. The Egan decision says insurance companies have to look for ways not only to deny a claim but look for ways to support a claim; and if they don’t do that, it’s bad faith. So that opened a whole new world of insurance bad faith cases with emotional distress and punitive damages, and sometimes they go very high. Before Egan? No way.”

His book, first published in 1986, recounts nearly a dozen of his own multimillion-dollar insurance bad faith cases, including $5 billion for Holocaust victims whose life insurance was never paid and an $86.7 million verdict on behalf of the American-Samoan government over hurricane damage—all made possible by the Egan decision.

As with any new tort, it took a while to catch on. While trying cases both in and out of California, Shernoff led seminars, wrote articles, went on book tours and promoted bad faith litigation through his position as president of Consumer Attorneys of California.

“Once this case came down, nobody knew how to practice law in this area,” he says. “I had a corner on the market for a good 10 years before it started to develop through appellate court decisions, which all cited Egan. … Now for homeowners and health insurance you have bad faith law. It’s evolved and gone to other states. Hawaii was one of the first that cited Egan and established bad faith—which they need nowadays. Every time there’s a catastrophe, there are a lot of bad faith insurance cases. Now they have a remedy. “To me,” he adds, “the most satisfying thing is being part of developing a new body of law. Not a lot of lawyers can say that.”