Bad Faith, Sureties, Insurance Coverage, and Punitive Damages: Who Gets the Check When the Misconduct Ends?
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Here’s a neat little story out of the Massachusetts Lawyers Weekly today on a Massachusetts Appeals Court decision holding that the surety on a construction contract does not cover, under the construction bond it issued, punitive damages awarded for the bad faith conduct of a principal of the construction company covered under the bond. Although turning on the specific language of the bond and what losses it extended to, the ruling parallels the common issue arising under insurance policies of all types as to whether a policy’s coverage extends to punitive damage awards and, in fact, whether public policy even allows parties to insure punitive damages awards, an issue I discussed awhile back in some detail in this post here. The primary issue in those cases is twofold: first, whether the policy language extends coverage to punitive damage awards and then, second, whether allowing a party to insure against such an award provides the wrong marketplace incentives with regard to corporate conduct and should not be allowed as a result. Those same two issues were in play in this surety bond case, with the Appeals Court first concluding that the language of the bond does not extend to the punitive damages award itself, and second, that expanding the language to cover such awards would risk undermining the entire surety bond system in the state. The court’s conclusion on this issue is summed up in this paragraph from the opinion:
By its terms, then, the bond did not cover punitive damages, payment of which is payment for punishment, not for "labor, materials and equipment" [which is what the bond stated it covered]. See Gasior v. Massachusetts Gen. Hosp., 446 Mass. 645, 653 (2006) ("purpose of punitive damages has been described as punishment and deterrence rather than compensation of an injured party"); Kapp v. Arbella Mut. Ins. Co., 426 Mass. 683, 686 (1998). To conclude that the bond encompassed punitive damages would be to rewrite the agreement Travelers made with Peabody and to risk diluting through punitive awards to a few subcontractors and materialmen the "security to [all] subcontractors and materialmen on public works," LaBonte v. White Constr. Co., 363 Mass. 41, 45 (1973), that the bond is designed to afford. See New Hampshire Ins. Co. v. Gruhn, 99 Nev. 771, 773 (1983).
I can’t say I disagree with the court on either aspect of its reasoning. Standard rules of contract interpretation, properly applied, cannot support a finding that the relevant language of the bond extended coverage to punitive damage awards, and the policy reasons for not extending coverage in general to such awards is frequently compelling in insurance coverage cases, just as it was in this case.
The case itself is C & I Steel v. Travelers Casualty and Surety, and you can find the opinion itself here.
Insurance Bad Faith Litigation in Massachusetts and the Other 49 States
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Want to learn more about insurance bad faith litigation? Well, you could retain me, but if you want something more off the rack, here is a nice looking seminar, with a well credentialed faculty, on the subject. Of course, for local readers, it is important to note that the seminar looks to provide a general overview, as most seminars do, concerning overall principles related to insurance bad faith litigation. Here in Massachusetts, the issues would be a little different and have their own peculiar twists and turns, because we are one of the few jurisdictions with a unique bad faith statute actually granting a bad faith cause of action to policyholders and injured parties; litigating a bad faith case here requires a deep understanding of years of court rulings applying that statute.
Attorney's Fee Awards, and the Duty to Indemnify
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I have written before about the American Rule - which requires parties to a lawsuit, in the absence of a fee shifting statute or contractual agreement, to pay their own legal fees - and the exception under Massachusetts law that runs in favor of insureds who prevail in coverage cases against their insurers. The Supreme Judicial Court has now established that this exception runs only to disputes over an insurer’s duty to defend, and not to disputes over the duty to indemnify. Thus, while an insured who proves that its insurer breached a duty to defend can recover from the insurer its legal fees in proving this point, the same is not true for an insured who proves that its insurer breached the duty to indemnify. Here’s the story, with a link to the case. This resolves an unsettled point of Massachusetts law, as to whether the right to recover attorneys fees runs along with a claim over the duty to indemnify, or instead only along with a claim for breach of the duty to defend. It turns out to be the latter only.
In the long run, it’s a better decision than the opposite holding would have been. A decision to deny indemnity without a reasonable basis for doing so is already punishable in Massachusetts under the state’s consumer protection act. When, in contrast, a denial of indemnity is reasonable, an insurer should be able to try to prove that its coverage determination was correct without having to factor in the risk of having to pay the insured’s legal fees if a court finds that the insurer’s interpretation of its coverage obligations, while reasonable, was wrong.
Bad Faith Litigation: Do the Numbers Add Up?
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I am a little bit of a skeptic - I don't think it has devolved yet to cynicism - when it comes to insurance bad faith litigation. Done right, a state law system of bad faith rules and rights can establish appropriate boundaries for all three sides of the insurance triangle - the insurer, the insured and the claimant. Done wrong, however, it tends to be little more than a system for imposing additional obligations and expenses on insurers beyond any that were bargained for or paid for by insureds.
Beyond that, the whole subject of bad faith litigation, including whether it is appropriate and the rules that should govern it, tends to become one of public relations and political posturing, rather than of rational legal and economic thought. This article demonstrates that exact dynamic in the context of a dispute in West Virginia over the elimination of third party bad faith claims against insurers, after years in which such claims were actionable. What jumps out at me is the assertion that a particular amount - 77 million dollars in premium reductions - of savings to the public can be attributed to the elimination of the bad faith cause of action.
Now it is beyond my skills as an amateur economist, but it seems to be that there must be enough data pre and post the ban on such claims to actually measure, at least roughly, the economic effect of banning, as opposed to allowing, such bad faith claims against insurers. It would make an interesting test case as to the economic impact, pro or con, of insurance bad faith litigation, and might be a good starting point for more empirically based and rational discussions as to whether other states should allow, or instead ban, such causes of action. This would be a nice substitute for the current state of the debate in most states over whether bad faith litigation should be allowed, which tends to consist of little more than entirely predictable and unverifiable public posturing of the type reflected in the article on the effect in West Virginia of banning such causes of action.