Punitive Damages in a Bad-faith, Failure-to-settle Case: are They Recoverable?


REPRINTED WITH PERMISSION FROM WESTLAW JOURNAL

26 No. 6 Westlaw Journal Insurance Coverage 1

Westlaw Journal Insurance Coverage

*1

November 12, 2015

Commentary

PUNITIVE DAMAGES IN A BAD-FAITH, FAILURE-TO-SETTLE CASE: ARE THEY RECOVERABLE?

By Steven Plitt, Esq., Kunz Plitt Hyland & Demlong aa1

Copyright © 2015 Thomson Reuters .

Steven Plitt of Kunz Plitt Hyland & Demlong discusses state and federal opinions addressing whether punitive damages in a failure to settle bad faith case are recoverable by the insured as damages.

Can punitive damages awarded against an insured in a prior personal injury lawsuit be recoverable as an item of compensatory damages in a later filed breach of contract and bad-faith suit against the insurer? The answer to that question may depend upon whether the state has a prohibition on the indemnification of punitive damages. California, 1 Colorado 2 and New York 3 have such indemnification prohibitions.

Colorado’s public policy prohibits an insurer from providing coverage for punitive damages. Because of this, the Colorado Supreme Court in Lira v. Shelter Insurance Co. 4 found that if the insured were permitted to collect against the insurer the punitive damages awarded against the insured as part of the insured’s bad faith damages in a failure to settle case, the compensatory damages which derived from the insured’s own wrongful conduct would undercut the public policy of Colorado against the insurability of punitive damages. 5 Moreover, the Lira court also found that insurance companies that have not contracted to insure punitive damages had no duty to settle the compensatory part of an action in order to minimize the insured’s exposure to the non-covered punitive damages. 6

The California Supreme Court in PPG Industries Inc. v. Transamerica Insurance Co. found that the insurer’s breach of the covenant of good faith and fair dealing in failing to accept a settlement offer within policy limits was not the proximate cause of the punitive damages award in the underlying action. 7 Permitting an insured to seek recovery for the punitive damage award as “compensatory” damages in the bad-faith case for the insurer’s breach of the covenant of good faith and fair dealing would impose an obligation on the insurance company to indemnify the insured in violation of California’s public policy against indemnification for punitive damages. 8

For similar reasons, the New York Court of Appeals in Soto v. State Farm Insurance Co. found that the insured’s cause of action against the insurer was based on bad-faith liability due to an excess judgment attributable to punitive damages, the recovery of which would violate New York’s public policy, which precluded indemnification for punitive damages generally. 9 Permitting such a recovery would improperly focus on the insurer’s alleged wrongful act in refusing to settle while minimizing the insured’s own blameworthy conduct. As noted by the Soto court, “[r]egardless of how egregious the insurer’s conduct has been, … any award of punitive damages that might ensue is still directly attributable to the insured’s moral and blameworthy behavior.” 10 The Soto court precluded the recovery of the punitive damages that had been awarded in the underlying case in order to preserve the “condemnatory and retributive character punitive damage awards” in New York. 11

*2 Some courts in other jurisdictions have reached a contrary result where the state law did not preclude indemnification where the state’s public policy or statutory law did not preclude the indemnification for punitive damages. As an example, the 8th U.S. Circuit Court of Appeals in Carpenter v. Automobile Club Interinsurance Exchange permitted the insured to seek the punitive damages that were awarded against the insured in a subsequent bad-faith failure to settle lawsuit. 12 The court focused on Arkansas law “[w]here an insurer, either through negligence or bad faith, fails to settle a claim against its insured within the policy limit, when it is possible to do so, such insurer is liable to the insured for any judgment recovered against him (or her) in excess of such policy limits.” 13 The insured could not be made whole without recovery of the entire amount of the excess judgment obtained in the underlying court action which included punitive damages as part of the overall award. The 8th Circuit did not consider Arkansas public policy, however.

Most recently, the 3rd Circuit, interpreting Pennsylvania law, concluded that the insured could not seek reimbursement of a punitive damage award entered in the underlying action in the subsequent bad-faith failure-to-settle case that was brought. The court in Wolfe v. Allstate Property & Casualty Insurance. Co. 14 recognized at the outset that Pennsylvania had a public policy against the insurability of punitive damages. 15 The court found because Pennsylvania law prohibited insurers from providing coverage for punitive damages the insurer could not be responsible for punitive damages incurred in the underlying lawsuit. 16 To hold otherwise would shift the burden of the punitive damages to the insurer, contradicting Pennsylvania’s public policy on the issue. As such, the punitive damages award component was not a compensable item of damages as a matter of law.

Additionally, the Wolfe court found that because punitive damages were not a compensable item of damages in a failure-to-settle bad faith case, as a matter of law, in accordance with Pennsylvania’s public policy, it followed that insurance companies had no duty to consider the potential for the jury to return a verdict for punitive damages when it was negotiating a settlement of the case. To impose such a duty would be tantamount to making the insurer responsible for those damages, which were against public policy. 17

In those jurisdictions where the state public policy prohibits indemnification for punitive damages, recovery of the punitive damages awarded in the underlying case are not “compensable” damages in a follow up bad-faith failure-to-settle case against the insurer. To permit such a recovery would improperly focus upon the insurer’s alleged wrongful act in refusing to settle while minimizing the insured’s own blameworthy conduct. If the insured were permitted to shift responsibility for its own wrongdoing to the insurance company, the insurance company would pass the economic burden of paying punitive damages on to the public at large as part of its higher cost of doing business. 18

Footnotes

1

PPG Indus. v. Transamerica Ins. Co., 20 Cal.4th 310, 84 Cal.Rptr.2d 455, 975 P.2d 652 (1999).

2

Lira v. Shelter Ins. Co., 913 P.2d 514 (Colo. 1996).

3

Soto v. State Farm Ins. Co., 83 N.Y.2d 718, 613 N.Y.S.2d 352, 635 N.E.2d 1222 (1994).

4

913 P.2d 514, 516 (Colo. 1996) (“[I]n an action by an insured against his insurer for bad faith failure to settle, the insured may not collect as compensatory damages the punitive damages awarded against him in the underlying lawsuit.”).

5

Id. at 217 (“The damages which are claimed to be ‘compensatory’ in the instant case are none other than the punitive damages from the underlying case. The contract between the parties expressly precluded recovery for punitive damages incurred by the insured. The insured may not later utilize the tort of bad faith to effectively shift the cost of punitive damages to his insurer when such damages are expressly precluded by the underlying insurance contract.”).

6

Id. at 516.

7

20 Cal.4th 310, 84 Cal.Rptr.2d 455, 975 P.2d 652 (1999).

8

Id., 84 Cal.Rptr.2d 455, 975 P.2d at 658. The California court also noted that the goal in awarding punitive damages — punishing the intentional wrongdoer for its own outrageous conduct and deterring it and others from engaging in such conduct in the future — would be circumvented by permitting that type of recovery. Id., 84 Cal.Rptr.2d 455, 975 P.2d at 657.

9

83 N.Y.2d 718, 613 N.Y.S.2d 352, 635 N.E.2d 1222 (1994).

10

Id., 613 N.Y.S.2d 352, 635 N.E.2d at 1225.

11

Id.

12

58 F.3d 1296, 1302 (8th Cir. 1995) (interpreting Arkansas law).

13

McChristian v. State Farm Mut. Auto. Ins. Co., 304 F. Supp. 748, 750 (W.D. Ark. 1969).

14

790 F.3d 487 (3rd Cir. 2015).

15

Id. at 492-93 (citing Butterfield v. Giuntoli, 448 Pa. Super. 1, 670 A.2d 646, 654 (1995) and Esmond v. Liscio, 209 Pa. Super. 200, 224 A.2d 793, 799 (1966)).

16

Id. at 493.

17

Id. at 496 (citing by example, Zieman Mfg. Co. v. St. Paul Fire & Marine Ins. Co., 724 F.2d 1343, 1346 (9th Cir. 1983) (“The proposition that an insurer must settle, at any figure demanded within the policy limits, an action in which punitive damages are sought is nothing short of absurd. The practical effect of such a rule would be to pass on to the insurer the burden of punitive damages in clear violation of California statutes and public policy”); accord Wardrip v. Hart, 28 F. Supp. 2d 1213, 1215-16 (D. Kan. 1998)).

18

PPG Indus. v. Transamerica Ins. Co., 20 Cal.4th 310, 84 Cal.Rptr.2d 455, 975 P.2d at 657; 652 (1999).

aa1

Steven Plitt is the current successor author of “Couch on Insurance, 3d.” He is a founding partner of the coverage boutique law firm Kunz Plitt Hyland & Demlong in Phoenix, where he serves as chairman of the insurance practice group and maintains a national practice. He frequently testifies as an expert witness in insurance-related cases on subjects including bad faith, coverage issues, insurance agent errors and omissions, and legal malpractice. He can be reached at [email protected].

26 No. 6 WJINSC 1

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