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by Bret Linley 

In Alabama, the standard for determining whether an insurer has acted in bad faith in a third-party liability coverage dispute has been an unsettled issue. Two recent decisions from federal courts in Alabama indicate that the issue is unlikely to be settled anytime soon.

In Alabama, the tort of bad faith is a creation of the courts rather than the legislature. The Alabama Supreme Court created the tort of bad faith in the third-party insurance context in Waters v. American Cas. Co. of Reading, Pa., 73 So.2d 524 (Ala. 1953) and in the first-party insurance context in Chavers v. Nat'l Sec. Fire & Cas. Co., 405 So. 2d 1, 6 (Ala. 1981). The standard for first-party bad faith claims is unquestionably whether the carrier had “any reasonably legitimate or arguable reason” to deny coverage (also framed as “the absence of a debatable reason). Nat'l Sec. Fire & Cas. Co. v. Bowen, 417 So. 2d 179, 183 (Ala. 1982). The same clarity does not exist in the third-party liability insurance context.

One Alabama Supreme Court opinion suggests that the standard is the same debatable reason test applied to first-party bad faith claims. Mut. Assur., Inc. v. Schulte, 970 So. 2d 292, 296 (Ala. 2007). Other Alabama Supreme Court precedent instead suggests a “totality of the circumstances” standard wherein the jury must consider “all the facts and circumstances” of the claim to determine whether the carrier acted in bad faith. Waters, 73 So. 2d at 532. One of the major differences between these two standards is how they are applied in the context of a summary judgment motion. Under the debatable reason standard, an insurer may be able to show the existence of a debatable reason as a matter of law, and thus prevail on a motion for summary judgment. In contrast, under the totality standard, disputes often involve issues of fact, making summary judgment more challenging to obtain and thus increasing the possibility that the bad faith claim will be resolved at trial.

Federal courts in recent years have tended to apply the totality approach. See Franklin v. Nat'l Gen. Assur. Co., No. 2:13-CV-103-WKW, 2015 WL 350633, at *10 (M.D. Ala. Jan. 23, 2015). However, in 2024 a Northern District of Alabama court explicitly applied the debatable reason test to a third-party bad faith claim regarding coverage for an award of attorney’s fees against an insured in the underlying claim. Evanston Ins. Co. v. Brady, No. 4:23-CV-106-CLM, 2024 WL 917371, at *6 (N.D. Ala. Mar. 4, 2024). Then, earlier this year a Southern District of Alabama court weighed in and applied the totality approach, disagreeing with Brady. Gaudet & Co., Inc. v. ACE Fire Underwriters Ins. Co., No. CV 21-00372-JB-MU, 2025 WL 357798, at *5 (S.D. Ala. Jan. 31, 2025). The takeaway from these recent decisions appears to be that the standard for third-party bad faith claims in Alabama will remain unsettled in the future, at least until the Alabama Supreme Court clarifies the issue.

In light of this lack of clarity, carriers adjusting claims in Alabama should be aware that for liability claims, unlike first-party claims in Alabama, the safe harbor of the debatable reason standard may not be available. Instead, the totality approach, which offers less certainty as to what constitutes bad faith and presents a more difficult standard for summary judgment, may apply.

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The opinions expressed are those of the authors and do not necessarily reflect the views of the firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.