Mesmer v. Maryland Automobile Insurance Fund

ELDRIDGE, Judge. This is an action against a liability insurer based upon the insurer’s allegedly erroneous denial of coverage. The issues are whether the action sounds in contract, in tort, or both, and what is the appropriate measure of damages. I. In January 1989 the Maryland Automobile Insurance Fund (“MAIF”), a state agency, issued an automobile liability policy on a 1981 Buick Skylark to Gladys Mesmer with personal injury liability coverage limits of $20,000.00 per person and $40,000.00 per accident.

Krist Leo Salmi of Wheaton, Maryland, was the insurance agent or broker who produced the policy. The application and declaration page of the policy listed Gladys as the owner and operator of the vehicle. Gladys’s daughter, Denise Mesmer, was also listed as an operator of the Buick. The application stated that both Gladys and Denise held valid Maryland driver’s licenses, resided in Silver Spring, Maryland, and that Gladys had been ²⁴⁷ refused automobile liability coverage by two private insurance companies. 1 On or about July 19, 1989, Gladys contacted Salmi and informed him that “[w]e’ve changed vehicles.” Both Gladys and Salmi stated that the matter primarily discussed was that Denise would be the primary driver of the newly acquired vehicle and that neither of them raised the issue of who was the owner of the newly acquired vehicle.

Salmi secured from MAIF a new insurance policy that removed the Buick and added a 1989 Chevrolet Spectrum, without any change in coverage limits. The declaration page listed Gladys as the named insured and listed both Gladys and Denise as operators of the Chevrolet. The declaration page also included Item 8, stating that “[u]nless otherwise stated herein: (a) [t]he automobile^) described in item 3 is (are) solely owned by the named insured.... ” The Chevrolet, however, was not titled in either Denise’s or Gladys’s name. The titled owner was Robert Arthur Hyman, Gladys’s future husband, with whom she and Denise lived.

According to the complaint in the instant case, the Chevrolet had been purchased in the name of Mr. Hyman “[i]n order to secure financing.” On February 22, 1990, Denise, while in the District of Columbia, negligently operated the Chevrolet and caused an accident. Peggy Lyons was seriously injured in the accident. The accident was reported to MAIF, which investigated the matter for approximately two months. On April 20, 1990, MAIF notified Gladys that it was denying coverage on the ground that she did not have an insurable interest in the Chevrolet at the time the policy was issued and that, therefore, the policy was being voided as of January 31, 1990, and ²⁴⁸ premium payments would be refunded.

Three days later MAIF informed Hyman that the Chevrolet did not qualify as an insured vehicle under the terms of the policy and that the policy was being voided ab initio. In September 1990 and again in July 1991, the attorneys representing McKeeba Lyons, mother of Peggy Lyons, contacted MAIF by letter. The first letter requested that MAIF “post its policy” to enable the injured party to “proceed against other available insurance.” The second letter offered to “settle this matter as against Denise Mesmer for MAIF’s policy limit of $20,000.” MAIF responded to both letters but declined to enter into any negotiations concerning Peggy’s claim, stating that the Chevrolet did not qualify as an insured vehicle and that there was no coverage. Neither the Mesmers, nor Lyons, nor Hyman brought a declaratory judgment action to challenge MAIF’s position that there was no coverage.

Peggy filed suit in the Superior Court for the District of Columbia against Denise. MAIF was not named as a party to and did not receive notice of the action filed in the District of Columbia. On April 14, 1992, following a jury trial, a judgment for Peggy against Denise, in the amount of $19,563,-203.00, was entered. On April 30, 1993, the instant action was filed in the Circuit Court for Montgomery County by Denise and Gladys against MAIF.

Denise subsequently assigned her rights against MAIF to Peggy. The original complaint was amended to add Peggy as a plaintiff and add Salmi, the producer of the policy, as a defendant. 2 The plaintiffs sought to recover the amount of the District of Columbia judgment, attorney fees, and other ²⁴⁹ damages from MAIF and Salmi based on alleged breach of contract and negligence. ²⁴⁸ "D.C. has paid approximately one-half million dollars for Plaintiff Lyons’ health care to date. Absent recovery by Plaintiff Lyons, D.C. will be required to pay for health care for Plaintiff Lyons for the rest of her life. Under District of Columbia law, D.C. is subrogated to the extent it has paid for Plaintiff Lyons’ health care to date.” ²⁴⁹ The parties filed cross motions for summary judgment.

The issues presented in the motions were as follows: (1) whether the plaintiffs’ claims were actions in tort or in contract; (2) whether Peggy could sue MAIF as a third-party beneficiary of Denise’s policy; (3) if the claims were in tort, whether the doctrine of sovereign immunity barred a claim against MAIF for bad faith failure to settle a claim; (4) whether or not MAIF was guilty, as a matter of law, of a bad faith failure to settle a claim; (5) whether the plaintiffs’ claims were barred by the statute of limitations; and (6) whether MAIF would be liable under the doctrine of respondeat superior for any negligence by Salmi. After oral argument, the circuit court held as follows: (1) the plaintiffs’ claims were in both contract and tort; (2) Peggy had standing to maintain the instant case as a third party beneficiary; (3) MAIF is a state agency and is thus cloaked with sovereign immunity in tort actions; (4) because MAIF has immunity, the issue of whether MAIF was guilty of bad faith refusal to settle the claim need not be reached, but that if it were reached, it would be a matter for the trier of fact at trial; (5) the action was not barred by the statute of limitations; and (6) since MAIF is not liable in tort because of sovereign immunity, MAIF cannot be held liable in tort under the doctrine of respondeat superior. The circuit court also held, as a matter of law, that MAIF had a contractual duty to defend Denise in the underlying tort action and that MAIF breached this duty. The Court awarded the plaintiffs the $20,000.00 policy limit and $9,673.95 in attorney fees as damages for breach of contract.

Final judgment, pursuant to Maryland Rule 2-602, was entered by the circuit court with regard to all claims against MAIF. The judgment incorporated the above-summarized rulings. The circuit court stayed all claims against Salmi pending the outcome of a timely filed appeal. A timely notice of ²⁵⁰ appeal was subsequently filed by the plaintiffs.

MAIF did not cross-appeal. 3 The plaintiffs filed a petition for a writ of certiorari in this Court which we granted prior to consideration of the case by the Court of Special Appeals. Mesmer v. Maryland Automobile Insurance Fund, 342 Md. 633 , 679 A.2d 539 (1996).

II

The issues before this Court arise out of MAIF’s voiding or rescinding ab initio the insurance policy issued to Gladys for the Chevrolet. The rescission resulted in MAIF’s denial of coverage and refusal to defend the Mesmers against Peggy’s claim. The plaintiffs argue “that Appellants’ claim for the excess judgment sounds in contract rather than tort,” that the claim is based on the insurer’s breach of the “ ‘duty to defend [which] is a contractual obligation,’ ” and that “because a claim for damages resulting from a wrongful failure to defend sounds in contract, such a claim is not even arguably barred by sovereign immunity. Sovereign immunity for contract actions has been statutorily abrogated in Maryland.” (Appellants’ brief at 4-5).

The plaintiffs further argue that, although a tort claim based upon an insurer’s wrongful failure to settle requires a “show[ing] that the carrier acted in bad faith,” a contract claim based on the insurer’s failure to defend simply requires a showing that the contract was breached. (Id. at 5-6). The plaintiffs go on to argue that the damages for breach of the contractual duty to defend are not confined to the policy limits and attorney fees but may properly include “the amount of an excess judgment.” (Id. at 6-12). The plaintiffs alternatively contend that, “[i]f this Court decides that bad faith is a necessary element of the claim for recovery of the excess judgment,” and “if the Court further ²⁵¹ decides that the existence of that element renders this a tort claim for purposes of sovereign immunity, then” MAIF does not enjoy sovereign immunity. {Id. at 14).

They argue that, under the legislation creating MAIF as an insurer, “MAIF was intended to function ... in a manner similar to a private insurance company” and “it is not endowed with sovereign attributes consistent with sovereign immunity.” (Id. at 14, 21). The plaintiffs distinguish Harrison v. Motor Vehicle Admin., 302 Md. 634, 648 , 490 A.2d 694, 701 (1985), where this court stated that MAIF is a “State agenc[y] which [has] inherited the sovereign attributes of the State and [is] performing a governmental function.” They point out that Harrison involved MAIF’s function as successor to the Unsatisfied Claim and Judgment Fund and not MAIF’s function as a carrier issuing motor vehicle insurance policies. MAIF argues that its “failure to defend Ms. Mesmer as a result of its rescission of its insurance policy gives rise to, at most, contractual damages that are confined to the limits set forth in the [insurance] policy and the costs of defending the District of Columbia litigation.” (Appellee’s brief at 5). MAIF asserts that, as “Ms. Mesmer obtained counsel to represent her in the District of Columbia litigation, MAIF’s failure to defend her ... could not be the proximate cause of the judgment entered against her in that litigation” (id. at 4).

MAIF further argues that any claim for the excess judgment must be brought on a basis of the insurer’s bad faith failure to settle, that such a claim against an insurer can only be made in a tort action, that MAIF is a state agency entitled to sovereign immunity in tort cases except to the extent that such immunity has been waived by the Maryland Tort Claims Act, Maryland Code (1984, 1995 Repl.Vol., 1998 Supp.), § 12-101 el seq. of the State Government Article, and that the plaintiffs, in making their claims, failed to comply with the requirements of the Tort Claims Act.

III

We agree with the plaintiffs insofar as they argue that their claims against MAIF sound exclusively in contract ²⁵² rather than tort. A liability insurer’s mistaken refusal to provide any defense whatsoever, on the grounds that there is no valid insurance contract or that there is no coverage under an insurance contract, gives rise to a breach of contract action against the insurer. It does not give rise to the tort action for an alleged bad faith failure to settle a third party claim against the insured. Consequently, we need not and shall not reach the issues of whether MAIF enjoys sovereign immunity from tort claims asserted against MAIF itself and whether the Maryland Tort Claims Act furnishes the only tort remedy against MAIF.

On the other hand, we disagree with the plaintiffs’ contention that the amount of the excess judgment in the underlying tort case is recoverable in this contract action. Instead, the circuit court correctly held that the damages for breach of contract are limited to the policy limits and the costs of defending the underlying tort action. Therefore, we shall affirm the judgment of the circuit court. A. In Maryland, insurance policies are treated like other contracts.

Except as modified by statutes or regulations, the legal principles applicable to contracts generally are also applicable to insurance policies. See, e.g., Kendall v. Nationwide, 348 Md. 157, 165-166 , 702 A.2d 767, 770-771 (1997); Litz v. State Farm, 346 Md. 217, 224-225 , 695 A.2d 566, 569 (1997); JMP v. St. Paul Fire, 345 Md. 630, 634-636 , 693 A.2d 832, 834 (1997); Bailer v. Erie Insurance, 344 Md. 515, 521-522 , 687 A.2d 1375, 1378 (1997), and cases there cited. It is a settled and “familiar proposition that not every duty assumed by contract will sustain an action sounding in tort.” Council of Co-Owners v. Whiting-Turner, 308 Md. 18, 32 , 517 A.2d 336, 343 (1986). See also, e.g., U.S. Gypsum v. Baltimore, 336 Md. 145, 156 , 647 A.2d 405, 410 (1994); Decoster v. Westinghouse, 333 Md. 245, 250-251 , 634 A.2d 1330, 1332-1333 (1994); Erie Ins.

Co. v. Chops, 322 Md. 79, 84 , 585 A.2d 232, 234 (1991); Jacques v. First Nat’l Bank, 307 Md. 527, 534 , 515 ²⁵³ A.2d 756, 759 (1986); Matyas v. Suburban Trust Co., 257 Md. 339, 342-344 , 263 A.2d 16, 18-19 (1970); Heckrotte v. Riddle, 224 Md. 591, 595-596 , 168 A.2d 879, 881-882 (1961); Otis Elevator Co. v. Embert, 198 Md. 585, 597-598 , 84 A.2d 876 , 881-882 (1951). A contractual obligation, by itself, does not create a tort duty. Instead, the duty giving rise to a tort action must have some independent basis. As explained by Chief Judge Murphy for the Court in Wilmington Trust Co. v. Clark, 289 Md. 313, 328-329 , 424 A.2d 744, 754 (1981), “[w]hile a tort action in favor of a contracting party can be founded upon a duty arising out of the contractual relationship, ... the duty giving rise to the tort cause of action must be independent of the contractual obligation____ Mere failure to perform a contractual duty, without more, is not an actionable tort.” In a leading case on this point, Heckrotte v. Riddle, supra, 224 Md. at 595-596 , 168 A.2d at 881-882 , Judge Horney for the Court stated: “That the buyers did not ... assert an action in tort independent of contract is obvious.

And, while there was an allegation of ‘carelessness and negligence’ on the part of the seller-builder ... it is apparent that the allegations were not so stated as to claim that the asserted negligent breach of contract was also a breach of duty imposed by law. Thus, it is clear that the second count did not state an action ex delicto. The mere negligent breach of a contract, absent a duty or obligation imposed by law independent of that arising out of the contract itself, is not enough to sustain an action sounding in tort.... For it is only when a breach of contract is also a violation of a duty imposed by law that the injured party has a choice of remedies.” See also Casper v. Chas.

F. Smith & Son, 316 Md. 573, 578 , 560 A.2d 1130, 1133 (1989); Jacques v. First Nat'l Bank, supra, 307 Md. at 534 , 515 A.2d at 759 ; Matyas v. Suburban Trust Co., supra, 257 Md. at 342-344 , 263 A.2d at 18-19 ; Otis Elevator Co. v. Embert, supra, 198 Md. at 597-598 , 84 A.2d at ²⁵⁴ 881-882; Slacum v. Trust Co., 163 Md. 350, 352-353 , 163 A. 119, 120 (1932); Samuel v. Novak, 99 Md. 558, 567-568 , 58 A. 19, 20 (1904); Simon v. Union Hosp. of Cecil County, Inc., 15 F.Supp.2d 787, 800 (D.Md.1998); Board v. Plymouth Rubber, 82 Md.App. 9, 31 , 569 A.2d 1288, 1298 , cert. denied, 320 Md. 505 , 578 A.2d 778 (1990) (“Under Maryland law, negligent breach of a contract, absent a duty or obligation imposed by a source independent of that arising out of the contract itself, is not enough to sustain an action sounding in tort”). There is no single principle or simple test for determining when a defendant’s breach of a contract will also breach an independent duty and give rise to a tort action. Nevertheless, when the dispute is over the existence of any valid contractual obligation covering a particular matter, or where the defendant has failed to recognize or undertake any contractual obligation whatsoever, the plaintiff is ordinarily limited to a breach of contract remedy. It is when the defendant has proceeded on the basis that a contractual obligation exists, has undertaken that obligation, and has undertaken it in violation of the appropriate standard of care, that the plaintiff may, in some circumstances, maintain a tort action.

Some earlier cases set forth this distinction in terms of “nonfeasance” and “misfeasance.” Professor Prosser has explained (William L. Prosser, Handbook of the Law of Torts, § 92, at 614-615 (4th ed.1971), footnotes omitted): “The relation between the remedies in contract and tort presents a very confusing, field, still in process of development, in which few courts have made any attempt to chart a path. * * * “The line of division which developed quite early was that between ‘nonfeasance,’ which meant not doing the thing at all, and ‘misfeasance,’ which meant doing it improperly. Much scorn has been poured on the distinction, but it does draw a valid line between the complete non-performance of ²⁵⁵ a promise, which in the ordinary case is a breach of contract only, and a defective performance, which may also be a matter of tort. In general the courts have adhered to the line thus drawn; and a failure even to begin or attempt performance of an agreement to lend money, to employ the plaintiff, to furnish transportation, to deliver goods ordered, to furnish light for a room, to obtain the dissolution of an injunction and permit the plaintiff to proceed with the construction of a road, or to attend as a physician, all are held to amount to mere breaches of contract, for which no tort action will lie.” Later, Prosser continued (id. at 616-618, emphasis added, footnotes omitted): “Where the defendant has done something more than remain inactive, and is to be charged with ‘misfeasance,’ the possibility of recovery in tort is considerably increased---[A] carrier remains liable in tort, as well as on the contract, for negligent injury to a passenger or for carrying him past his station, for negligent loss or damage to goods shipped, or for delay in their delivery. Here again the duty is an incident of the relation rather than the contract, and the carrier would be liable if the passenger were carried free. “Beyond this the American courts have extended the tort liability for misfeasance to virtually every type of contract where defective performance may injure the promisee.

An attorney or an abstractor examining a title, a physician treating a patient, a surveyor, an agent collecting a note or lending money or settling a claim, or a liability insurer defending a suit, all have been held liable in tort for their negligence.... The principle which seems to have emerged from the decisions in the United States is that there will be liability in tort for misperformanee of a contract whenever there would be liability for gratuitous performance without the contract—which is to say, whenever such misperformanee involves a foreseeable, unreasonable risk of harm to the interests of the plaintiff.” See also 3 Harper, James and Gray, The Law of Torts, § 18.6, at 725-730 (2d ed.1986); W. Page Keeton, Prosser and Keeton ²⁵⁶ on the Law of Torts, § 92 (5th ed.1984); Speiser, Krause and Gans, The American Law of Torts, §§ 1:20, 1:21 (1983); Restatement of the Law, Second, Torts, § 323. Although later Maryland cases have disapproved of the “nonfeasance” and “misfeasance” terminology, we have generally recognized the distinction set forth above. Thus, in Matyas v. Suburban Trust Co., supra, 257 Md. at 342 , 263 A.2d at 18 , where the defendant arguably had a contractual obligation to remove snow from a public sidewalk but failed entirely to undertake the obligation, Judge J. Dudley Digges for this Court stated that “we will not impose tort liability on the basis of a contractual obligation that was never undertaken.” The Court went on to draw a distinction between “a gratuitous or contractual undertaking which was actually begun but negligently performed” and “as is the case here, a complete failure to initiate performance of a purely contractual duty.” Ibid.

Other cases are to the same effect. See, e.g., Otis Elevator Co. v. Embert, supra, 198 Md. at 597-598 , 84 A.2d at 881-882 (differentiating the situation where one totally fails to perform his contract with the situation where, in the performance of the contract, one does so in a dangerous manner or creates a dangerous condition, and pointing out that the distinction is “between conduct, in breach of a contract, which constitutes only a breach of contract and conduct which also constitutes a breach of duty, arising out of the nature of the work undertaken”); E. Coast Fr. Lines v. Cons. Gas Co., 187 Md. 385, 402 , 50 A.2d 246, 254 (1946) (“The Gas Company is not charged with using its electric current in any dangerous manner or, by its use, creating any dangerous condition.

What it is charged with is a non-performance of its contract with the City. For such non-performance the greater weight of authority is that it is liable only to the City and that it owes no duty to the general public for which it may be made responsible by an action in tort for negligence”); Consolidated Gas Co. v. Connor, 114 Md. 140, 156-157 , 78 A. 725, 729 (1910) (“it is well settled that nonfeasance is the non-performance of a duty, for which the agent is liable only to his principal, while misfea ²⁵⁷ sanee is the improper performance of a duty, for which the agent is liable to third persons injured by such negligence. If, for example, the Gas Company in this case had failed to supply gas to the City lamps in accordance with its contract, this would have been a nonfeasance, for which the company would have been responsible only to the City. But when, in carrying out the contract, it distributes the gas through defective pipes and thus permits it to escape into the streets and houses of the City, there is manifestly involved an affirmative element of negligence amounting to misfeasance, and for this the company is liable to anyone who may suffer in consequence”); Miller v. Schaefer, 80 Md.App. 60, 74 , 559 A.2d 813, 819-820 (1989), aff'd, 322 Md. 297 , 587 A.2d 491 (1991) (where Judge Karwacki pointed out for the court that it is “[t]he defective performance of a contractual undertaking [which] may give rise to an action both in tort or in contract”).

B. The above-discussed distinction, between a pure contract duty and a tort duty growing out of the manner in which a contractual obligation is undertaken, is reflected in our opinions dealing with (1) a liability insurer’s breach of the insurance contract by erroneously disclaiming coverage, and (2) a liability insurer’s undertaking to defend against a claim and its bad faith failure to settle the claim within policy limits. The former gives rise only to a breach of contract action; the latter gives rise only to a tort action. (1) Under the typical liability insurance policy, the insurer has a duty to indemnify the insured, up to the limits of the policy, for the payment of a judgment based on a liability claim which is covered. The insurer also has a duty to defend the insured against a liability claim which is covered or which is potentially covered.

The source of both duties is solely the insurance contract. As stated in Brohawn