New York jurisprudence is clear that liability insurers owe their insureds the duty of good faith and fair dealing to act in their insureds best interests in defending and settling claims. This duty arises as implied covenants of the contract between the insurer and insured and includes the duty of thorough investigation of all claims and defenses that may be asserted for or against the insured. New York law does not generally recognize a tort action based on insurer bad faith. However, where the insurer fails to settle an action within the policy limits resulting in a judgement against the insured for a sum in excess of the policy limits, the insured may bring a direct action against the insurer for bad faith to recover the excess judgement above the policy limits. This is premised on the fact that the insurer has complete control over all claims handling and defenses asserted on behalf of the insured during the litigation proceedings. This right of action may be assigned by the insured defendant to the injured plaintiff allowing a direct action against the insurer for bad faith refusal to settle and if proven the injured party may recover the excess judgement above the policy limits from the insurer.

The Court of Appeals, in the seminal case of Pavia v. State Farm Mut. Auto. Ins. Co., 82 N.Y.2d 445 (1993), set forth the following requisites in order for plaintiff to make out a prima facie case of bad faith for refusal to settle: