© Barry Zalma 2005
Some insurers, rather than acting in good faith and dealing fairly with their insureds, unjustly delay payment of claims until they are sued. Once sued the insurer pays the claim and eliminates, by so doing, the right of the insured to collect compensatory damages for breach of contract. By doing so the nefarious insurer hopes to limit its punitive damage exposure to he single digit limit on punitive damages set by the U.S. Supreme Court in State Farm Mutual Automobile Insurance Co. v. Campbell, 123 S.Ct. 1513, 538 U.S. 408, 155 L.Ed.2d 585 (U.S. 2003).
The Third Circuit Federal Court of Appeals, faced with such a situation refused to allow the insurer to avoid the result of its wrongful conduct by paying a claim after suit is filed. The Third Circuit upheld a punitive damages award that appeared to be 75 times larger than the compensatory award. The only contract benefits not paid before trial was $2,000 expended to prepare a proof of loss, a specific additional coverage. The trial court, however, had found that in addition to the $2,000 the insured was damaged and awarded attorneys fees and costs, added them all together and awarded punitive damages only one time the sum of compensatory damages and attorneys fees and costs. Refusing to limit itself to the obvious nine times the $2,000 in compensatory damages suggested by the defendant and its Amici, the Third Circuit looked at all of the facts of the case and upheld a $150,000 punitive damages award against the insurer.
In Willow Inn Inc. v. Public Service Mutual Insurance Co., No. 03-2837 (3d Cir. 02/14/2005) 2005.C03.0000110 a unanimous three-judge panel upheld U.S. District Judge Berle M. Schiller's decision after a non-jury trial to award $150,000 in punitive damages and $2,000 in compensatory damages.
Schiller found that after the Willow Inn was severely damaged by a tornado in June 1998, Public Service Mutual ("PSM") dragged its feet and used "stonewalling tactics" to avoid paying the full amount due on an insurance claim. Judge Schiller concluded:
Specifically, unreasonable delays in the processing of the Willow Inn's claims were extraordinarily unwarranted such that there can be no conclusion except that PSM knowingly or recklessly disregarded the absence of a reasonable basis for its conduct. The record is replete with examples of PSM's failure to respond in a timely fashion to Willow Inn's various reasonable requests, and even to the requests of those working on PSM's behalf. As one egregious example, PSM's unjustified delay in appointing an appraiser prevented the appraisal from commencing, despite the Willow Inn's and its adjusters' diligent efforts, until more than eight months after the Willow Inn's initial appraisal request. Similarly, PSM failed to pay the Willow Inn for its costs incurred in preparing proof of the Willow Inn's loss, or to even acknowledge the Willow Inn's request for more than three months, despite ample evidence that the Willow Inn was entitled to this compensation. While each of these examples standing alone evinces bad faith, this conclusion becomes even stronger when one considers the abundance of evidence presented at trial pointing out the dramatic contrast between the Willow Inn's conscientious efforts and PSM's reckless and obstructive actions. …
After considering Willow Inn's petition and the parties' briefs, on April 11, 2002, the District Court awarded Willow Inn $128,075 in attorney fees and $7,372 in costs.
It was to the attorneys fees, costs and $2,000 claims adjustment expense that was used as the compensatory damages basis for a punitive damage award.
The Court concluded that: "As Willow Inn's main insurance claim had been settled before this case was brought, and because the $2,000 award on the contract claim was only incidental to the bad faith thrust of this litigation, we conclude that the attorney fees and costs awarded as part of the 8371 claim is the proper term to compare to the punitive damages award for ratio purposes. These awards totaled $135,000, resulting in approximately a 1:1 ratio, which is indicative of constitutionality under Gore and Campbell."
The basis for the award of punitive damages, and facts that every insurer should avoid was the finding that:
- The plaintiff was "financially vulnerable."
- at the time of the storm, the Willow Inn was a relatively modest family-run business which also served as the residence of certain family members.
- the need for obtaining the insurance proceeds was particularly pressing.
- Repeated misconduct is more reprehensible than an individual instance of malfeasance.
- PSM's bad faith, was not the result of one specific event, but, rather, a series of instances in which PSM failed or refused to act on plaintiff's claim.
- The trial judge also found that the "unreasonable delay" in paying the claim was not the result of "mere accident."
- At trial PSM offered no credible basis for its substantial delay.
- The delay rendered PSM’s conduct "outrageous."
The insurer, and several amici, argued that since the compensatory award was just $2,000 the punitive award should have been no more than nine times that amount, or $18,000.
The 3rd Circuit rejected the argument, found that the $2,000 figure was a "red herring" and should not serve as the starting point for analyzing whether the punitive award was excessive since it only dealt with a single aspect of the claim handling.
The Third Circuit acknowledged that its conclusion was not without conceptual difficulty. It held that the purpose of Pennsylvania's bad faith statute and the language establishing the ratio analysis in Campbell are in tension. The Pennsylvania bad faith statute empowers a court which finds "that the insurer has acted in bad faith toward the insured" to award interest, shift the insured plaintiff's court costs and attorney fees to the insurer defendant, and impose punitive damages. The statute explains Pennsylvania's policy that whereas parties act at arm's-length when negotiating insurance contracts, insurers must deal fairly and not in their narrowly-defined economic self-interest when their insureds submit claims in good faith.
The attorney fees and costs were awarded in the insured's bad faith suit, not in a suit to settle the main underlying insurance claim, which PSM eventually paid. Finding, also, that "one function of punitive-damages awards is to relieve the pressures on an overloaded system of criminal justice by providing a civil alternative to criminal prosecution of minor crimes,"[Mathias v. Accor Economy Lodging, Inc., 347 F.3d 672, 676 (7th Cir. 2003)], and the structure of the Pennsylvania statute enlists counsel to perform a filtering function akin to prosecutorial discretion, because rational attorneys will refuse to work on a contingent fee arrangement when their investigation reveals the bad faith allegations of prospective clients to be meritless.
Once the attorney fees and costs were treated as compensatory damages for Campbell ratio purposes, the Third Circuit agreed that the ratio was one-to-one and therefore constitutional.
This decision emphasizes that Campbell does not provide insurers with a panacea to avoid payment of punitive damages for its bad faith claims handling conduct. To avoid such damages it is essential that all claims be handled professionally, efficiently and with all reasonable speed in compliance with local fair claims practices regulations. This means that every claim must include:
- Prompt response to a notice of claim;
- Personal contact with the insured to advise the insured of its obligations under the policy;
- Providing the insured with all forms required to satisfy the requirements in case loss occurs.
- A complete and thorough investigation of the claim.
- Immediate response to all inquiries from the insured or its representative.
- Compliance with all policy conditions – Unlike PSM, when appraisal is demanded by the insured the insurer should appoint its appraiser immediately but in no event more than 15 days after the demand.
- When appraisal is demanded appraisers should be instructed to resolve the disputes as rapidly as possible.
- Pay all claims immediately after satisfactory proof of claim is submitted.
Insurers must always deal with their insureds fairly and in good faith. This does not mean that every claim made must be paid just because an insured asks. Once the policy conditions have been complied with by the insured and if the insurer has no policy defense or exclusions, the claim must be paid.
Damages should be limited by, as did PSM, by payment immediately upon concluding that the loss was covered and compensable. It should not, however, attempt to hide in a strict interpretation of Campbell. In fact, the U.S. Supreme Court made clear that its single digit guidepost is not carved in stone.
Nonetheless, because there are no rigid benchmarks that a punitive damages award may not surpass, ratios greater than those we have previously upheld may comport with due process where "a particularly egregious act has resulted in only a small amount of economic damages." Ibid.; see also ibid. (positing that a higher ratio might be necessary where "the injury is hard to detect or the monetary value of non-economic harm might have been difficult to determine"). The converse is also true, however. When compensatory damages are substantial, then a lesser ratio, perhaps only equal to compensatory damages, can reach the outermost limit of the due process guarantee. The precise award in any case, of course, must be based upon the facts and circumstances of the defendant's conduct and the harm to the plaintiff.
In Willow Inn the court applied the above quoted exception to the limits imposed by Campbell and merely said that the act was "particularly egregious" but resulted in only a "small amount of economic damages."
Punitive damages have been reigned in by Campbell but it has not been eliminated Insurers would better protect themselves from punitive damages by handling claims professionally rather than rely on the single digit limits of compensatory damages established by the U.S. Supreme Court. If the dissenters on the U.S. Supreme Court move to the majority it is also possible that Campbell will be changed and Justice Scalia’s opinion will move into the majority where he said: "the Due Process Clause provides no substantive protections against "excessive" or " 'unreasonable' " awards of punitive damages. I am also of the view that the punitive damages jurisprudence which has sprung forth from BMW v. Gore is unsusceptible of principled application; accordingly, I do not feel justified in giving the case stare decisis effect."
In insurance and punitive damage law the only thing certain is that there will be change.
Barry Zalma is an insurance coverage attorney and Certified Fraud Examiner. He is the founder of Barry Zalma, Inc., a California law firm whose practice emphasizes the representation of insurers and those in the business of insurance. The firm's practice stresses first party property matters, third party liability coverage situations, and litigation support including consulting and expert testimony. He is also the principal of Zalma Insurance Consultants, a firm that provides insurance coverage and claims handling advice and counsel and the services of Mr. Zalma as an expert witness in state and federal courts across the United States.
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