Bad Faith, Sureties, Insurance Coverage, and Punitive Damages: Who Gets the Check When the Misconduct Ends?

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.