Can Two Wrongs Make a “Right” to Seek Indemnification of Punitive Damages From a Liability Insurance Carrier?
In various factual scenarios insured parties act in a wanton, reckless, or consciously indifferent manner. A common example of this situation arises in automobile accident cases where the defendant driver was intoxicated at the time of the crash. A difficult issue is presented for the insurer when its insured is alleged to have acted in a wanton, reckless, or consciously indifferent manner. In such a situation, an insurer will almost always face the risk of exposing its insured to a punitive damages verdict if the insurer fails to accept a reasonable settlement offer or otherwise adequately defend the claim. An insurance carrier in a statutory or common law action for bad faith can clearly be subject to punitive damages based on its own conduct in handling the insured’s claim if the carrier’s conduct meets the appropriate statutory or common law standards. This article explores whether an insurance carrier may also be responsible for a punitive damage award against its insured, based on the insured’s conduct, as part of a compensatory damage claim in a subsequent action for bad faith against the carrier and, if so, the issues a carrier may encounter while discharging its obligation to its insured to act in good faith in the defense of an underlying claim involving punitive damages.
Most jurisdictions, including Florida, uniformly adhere to the public policy restricting liability insurance coverage for punitive damages because the justification for punitive damages—punishment and deterrence for those guilty of aggravated misconduct—would be frustrated if such damages were covered by liability insurance.2 H owever, this principle may not insulate an insurance carrier in Florida from later having to pay an underlying verdict for punitive damages if the liability carrier commits a separate act of bad faith while defending its insured. Thus, two analytically distinct wrongs might possibly create a right for the defendant insured, or a plaintiff taking an assignment from the defendant insured, to seek indemnification of punitive damages from the defendant’s liability insurance carrier.
When defending a third party claim in Florida, insurers are placed in a fiduciary relationship with their insureds.3 Consequently, when an insured surrenders all control to his or her liability insurance carrier over the handling of a claim or lawsuit filed by a third party, “the insurer must assume a duty to exercise such control to make such decisions in good faith and with due regard for the interest of the insured.”4 Generally, this good faith duty requires the insurer to advise the insured of settlement opportunities, advise as to the probable outcome of the litigation, warn of the possibility of an excess judgment, and advise the insured of steps to take to avoid an excess judgment.5 Additionally, the liability carrier must investigate the facts, give fair consideration to a settlement offer that is not unreasonable under the facts, and settle, if possible, where a reasonably prudent person, faced with the prospect of paying the total recovery, would do so.6 In short, courts recognize that insurers, as fiduciaries, owe a duty to their insureds to refrain from acting solely on the basis of the carrier’s own self-interests during settlement negotiations.7
The insurer’s duties do not disappear if the insured was intoxicated or guilty of other wanton, reckless, or consciously indifferent conduct at the time of the incident, despite the fact that the carrier, at least at the outset, will not be required to indemnify the insured for any punitive damage award. A request for compensatory damages in the complaint will trigger the insurer’s contractual duty to defend the entire case.8 Undoubtedly, the insurer is required to discharge its duty in good faith. Assuming the liability carrier breaches its duty of good faith in handling the case, the question remains whether, as a matter of law, the carrier might face any legal consequences for its breach if the uncovered portion of the damage award consists of punitive damages.
To date, only a handful of jurisdictions that favor a public policy restricting indemnification of punitive damages have published opinions addressing whether punitive damages may be recovered in a subsequent bad faith action.9 No Florida state appellate court has considered this issue. The jurisdictions that have considered whether to permit such a recovery recognize the tension between the insurer’s duty to act in good faith toward its insured in defending against a third party claim involving punitive damages and the public policy that punitive damages should be absorbed by the wrongdoer without the benefit of insurance protection. These courts have struggled over which competing interest should prevail.
A majority of the justices sitting on the highest state courts in New York, Colorado, and California favored the public policy against such a recovery over any obligation of good faith on the part of the carrier.10 The U.S. Court of Appeals for the 10th Circuit similarly held in a case interpreting Oklahoma law.11 These courts denied recovery on grounds that the bad faith conduct was not the proximate cause of the insured’s losses, that the insurer has no duty to act with regard to a claim for punitive damages, or that allowing recovery would be unsound public policy.12 As such, these jurisdictions, as a matter of law, do not permit a claim in a bad faith action that seeks recovery of punitive damages that were awarded for the insurer’s misconduct in the underlying lawsuit.
Still, no clear consensus has developed in the case law. Three out of seven justices in the Colorado and California decisions joined in strong dissenting opinions that emphasized the insurer’s good faith duties over any blanket prohibition against indemnification of punitive damages.13 Moreover, the U.S. Court of Appeals for the Eighth Circuit, interpreting Arkansas law, held that an insured could potentially recover punitive damages as part of the consequential damages flowing from an insurer’s bad faith.14 Even the 10th Circuit’s decision to bar such a recovery was a 2-1 decision with a strong dissent.15 Proponents of recovery maintain that there is no legal impediment that precludes an insured from recouping from its insurer any punitive damages related to the insured’s aggravated misconduct, assuming the insured can prove that the carrier, in fact, acted in bad faith while handling the initial tort claim thereby exposing the insured to punitive damages.
For practitioners trying to determine what a Florida state court might do if confronted with this issue, the 1970 federal decision in Ging v. American Liberty Ins. Co., 423 F.2d 115 (5th Cir. 1970), interpreting Florida law, may be persuasive. In Ging, the U.S. Court of Appeals for the Fifth Circuit considered whether a liability insurance carrier, when defending a claim for punitive damages, was “free to act in bad faith towards its insured” since the carrier owed no duty under Florida law to its insured relative to punitive damages. Ging arose out of an automobile accident where the defendant caused the death of a priest through “gross negligence.” Prior to trial, the plaintiff’s estate extended a settlement offer for the policy limits of $10,000 to settle the entire claim which was rejected by the defendant’s liability insurance carrier. At trial, the jury awarded $25,000 in punitive damages, in addition to $11,195 in compensatory damages.
After taking an assignment, the plaintiff’s estate filed a bad faith action in the Northern District of Florida against the defendant’s liability insurance carrier seeking recovery of the punitive damages awarded at the earlier trial.16 On the carrier’s motion for summary judgment, the trial court dismissed the bad faith action finding the carrier’s refusal to accept plaintiff’s original offer to settle “caused no legally compensable damage to its insured” and the insurer had no duty to act in good faith with respect to the punitive damages claim as it was beyond the scope of insurance coverage.
The Fifth Circuit reversed and sent the case back for trial. The court emphasized that the insurance carrier undertook the defense of the entire claim even though it did not have any duty with respect to the punitive damages portion. Therefore, once the insurance company proceeded to defend the uncovered claim, it was “under an obligation to act in good faith toward its insured to the entire extent of its undertaking.” The court’s opinion, however, provided no discussion as to why the insurer’s good faith duty should be extended, nor did it critically examine any public policy considerations that might be implicated by its holding.
Whether the issue of recovering punitive damages is couched in terms of proximate cause, duty, or simply a straightforward balancing of public policy, courts have generally focused on the same policy considerations.
1) Justification for punitive damages. Every law student is taught that punitive damages are not meant to reimburse an injured plaintiff, but rather to punish a defendant for wrongful acts that reach a certain level of malevolent or reckless behavior, in addition to deterring such future conduct. Even though reimbursement for the punitive damages is sought in a separate bad faith action, as opposed to direct indemnification in the underlying action, some courts view the end result as the same: the economic burden of punitive damages is shifted to the insurance carrier. The courts that have circumscribed such a recovery maintain that it is difficult to reconcile these twin goals with a result that would allow the insured wrongdoer to divert the economic punishment to an insurer.17
However, others have argued that it is inconceivable that an insured would somehow be enticed to engage in aggravated misconduct which might lead to punitive damages on the oft chance that perhaps the insurer would commit bad faith in discharging its duty to its insured.18 Additionally, commentators have observed that there is no public policy that precludes an insurance carrier from settling both a compensatory and punitive damage claim on behalf of its insured.19 They maintain that the goals of punishment and deterrence are no more undermined by allowing recovery of punitive damages in a bad faith action as they are by allowing the insurer to settle a punitive damage claim as an incidence to settling compensatory damages.
2) Tort vs. Contract. Notwithstanding the public policy of most states, almost all liability insurance contracts expressly exclude coverage for punitive or exemplary damages. Carriers have argued that they cannot be held liable for breach of a duty which they did not have in the first place.20 Their contracts prohibit indemnification of this type of damage and to allow recovery in a bad faith action circumvents this contractual limitation.
Judges writing in opposition to such reasoning draw a distinction between an action based upon contract, which is defined by the contract’s terms, and an action for bad faith which is based upon a cause of action in tort.21 Because damages for bad faith breach of an insurance contract are governed by principles of tort law, they claim that the insured, as plaintiff, should be allowed to recover all damages that are the natural and probable result of the tortious act.22 If the insured is barred from recovering punitive damages in a subsequent bad faith action, then the insured cannot be made whole for the losses sustained as a result of the insurer’s act of bad faith.23
3) Shifting the burden onto the public. Although the insurance carrier will initially reimburse the insured or pay the injured third party, some courts are concerned that, by allowing recovery of punitive damages, the carrier will ultimately pass those costs on to the consumer through higher insurance premiums.24 On the other hand, proponents have argued that an insurer may become equally liable for an award of compensatory damages in excess of the policy limits which, by definition, is also not within the terms of the insurance contract.25 The costs of a bad faith action involving only compensatory damages in the underlying verdict may also be passed on to the general public, but the cause of action for bad faith remains viable.
4) Incentive to settle. The insurer controls the defense of an action and has a duty to give fair consideration to all settlement offers regardless of the presence of a claim for punitive damages. Proponents of allowing recovery of punitive damages worry that barring such a claim, as a matter of law, would invite the insurer, when presented with a settlement offer, to disregard its obligation to take into account the insured’s interests in avoiding a punitive damage verdict.26 The insurer would, in effect, be immune from its own misconduct and there would be little incentive on the part of the insurer to settle a claim where a jury will likely award punitive damages, particularly when the compensatory damages are relatively small. Thus, prohibiting the insured from recouping punitive damages would undermine the public policy in favor of settling the underlying claim.27
Still, most courts would agree that an insurer has no absolute duty to settle a punitive damages claim before trial in order to protect its insured. Opponents contend that allowing recovery of punitive damages as part of a claim for compensatory damages in a bad faith action may have the practical effect of placing such an absolute duty on insurers by forcing them to settle all cases involving punitive damages in order to avoid subsequent liability in a bad faith claim.28
5) Qualitative comparison of insured’s and insurer’s conduct. To justify their position, some courts have compared the relative conduct of the carrier in committing an act of bad faith versus the original conduct of the insured which gave rise to punitive damages. They argue that the insured’s conduct is simply more immoral or blameworthy than the carrier’s act of bad faith. The New York Court of Appeals succinctly articulated this point:
Where an insurer has acted in bad faith in relation to an available pretrial settlement opportunity, it is guilty only of placing its insured at risk that a jury will deem him or her so morally culpable as to warrant imposition of punitive damages. . . Regardless of how egregious the insurer’s conduct has been, the fact remains that any award of punitive damages that might ensue is still directly attributable to the insured’s immoral and blameworthy behavior.29
However, others do not share the belief that the insured’s conduct is more egregious than the insurer’s act of bad faith. They place equal weight on the insurer’s good faith duty to act in the insured’s best interests while controlling the litigation. Rather than a bright-line prohibition against recovery, proponents of allowing recovery contend that the possibility of an insurer having to pay damages equivalent to an underlying verdict for punitive damages strikes the appropriate balance between the conduct of the insured and the insurer’s duties by requiring the insurer to consider fairly the insured’s interests and potential personal liability, in addition to its own interests when negotiating settlements.30 After all, a jury in a bad faith action may find that the insurer acted reasonably in handling the underlying claim, but to completely bar recovery will automatically absolve an insurer who has acted in bad faith toward its insured.
Insurer Obligations in Light of Current Florida Law
If recovery of punitive damages in a bad faith action is not precluded as a matter of law, then the insurance carrier will necessarily have to contend with unique issues that are not otherwise present when evaluating settlement offers and controlling the defense of the underlying claim. On the surface, the liability insurer’s good faith obligations to its insured in defending the claim seem incompatible with the fact that, at least initially, the carrier will not be responsible to indemnify any award of punitive damages. This apparent friction may force insurers to navigate potential conflicts of interest, questions about the adequacy of the carrier’s defense of the underlying claim, and allegations that the carrier failed to give appropriate consideration to the insured’s interests.
Any time that punitive damages are a possibility, an attorney advising an insurance carrier on how to handle the claim would do well to remember the insurer duties outlined by the court of appeals in Ging:
If such a duty was owed or undertaken, it included apprising the client of settlement opportunities within a reasonable time after they were presented; it entailed the duty to warn the client of difficulties which the litigation posed for him wherever such difficulties were not included within the contract of indemnity; it included the duty to advise the client of the outcome of the litigation and of any particular procedures which might lessen its financial impact upon him; and it included the conduct of settlement negotiations in good faith to the interests of the insured wherever those interests might be divergent from the interests of the insurance company.31
Perhaps the most difficult of these to satisfy is the obligation to conduct settlement negotiations in good faith by taking into account the interests of the insured. No court has given any specific guidance on how to discharge this duty and it would be highly unlikely that any court would ever suggest that tendering the policy limits is the only way to negotiate in good faith on behalf of an insured facing a likely verdict of punitive damages. Thus, the insurer must carefully evaluate and document its assessment of the potential award for compensatory damages and justify extending any offer less than the available policy limits. The insurer should communicate to its insured every settlement offer and clearly articulate its reasons for rejecting any offer. Such careful steps may not avoid a subsequent bad faith action, but they will help build an appropriate record to defend such an action if the insured becomes liable for a punitive damage award.
Even if Florida courts ultimately decide to prohibit recovery of punitive damages as an element of compensatory damages in a subsequent bad faith action, an insurance carrier must remain ever mindful of its obligations to its insured when punitive damages are part of the original tort claim. The New York decision in Ansonia Assoc. Limited Partnership v. Public Service Mutual Ins. Co., 257 A.D.2d 84, 692 N.Y.S.2d 5 (N.Y. App. Div. 1999), is instructive. In Ansonia, the defendant insured, facing a potential verdict for punitive damages, settled on its own with the plaintiff after the defendant’s carrier ignored repeated settlement offers. The defendant, in turn, sued its primary and excess insurance carriers for bad faith refusal to settle the underlying action. The carriers argued that the insured’s claim should be dismissed pursuant to the 1994 New York Court of Appeals decision in Soto v. State Farm Ins. Co.,83 N.Y.2d 718, 635 N.E.2d 1222, 613 N.Y.S.2d 352 (N.Y. 1994), which barred recovery of a punitive damages verdict in a subsequent bad faith action because of the public policy against recoupment of punitive damages from an insurer.
The Ansonia court disagreed with the insurance carrier’s position. Instead, the court drew a distinction between a claim where a jury has rendered a verdict awarding punitive damages and a claim where an insured has settled its case because of the threat of a punitive damages verdict. In the absence of an actual award of punitive damages, the public policy against indemnifying punitive damages was not implicated, notwithstanding that the reason the insured settled was to avoid paying punitive damages. The Ansonia court determined that the record would support a jury determination that the insurer’s rejection of all offers to settle was part of a deliberate strategy to avoid payment of the claim and to place its own financial interests above the interests of its insured. In sum, the insurer’s actions placed its insured under economic duress by forcing the insured to choose between exposure to potentially ruinous punitive damages by proceeding to trial or the loss of coverage for compensatory damages by entering into a compromise without the insurer’s consent.
At present, any tort claim where punitive damages may be awarded because the insured has acted in a wanton, reckless, or consciously indifferent manner presents a liability insurance carrier with a difficult task. If the insured becomes liable for punitive damages, a Florida court may very well allow the defendant insured, or a plaintiff taking an assignment, to recoup the punitive damage award from the liability insurer if the carrier fails to act in good faith.
1 While intentional conduct can also result in punitive damages, most liability insurance policies exclude coverage for compensatory damages resulting from intentional acts. In such a case, there can be complex issues for both the plaintiff and the defense concerning bad faith and the duty to defend versus the duty to indemnify, but such issues are beyond the scope of this article.
2 U.S. Concrete Pipe Co. v. Bould, 437 So. 2d 1061, 1064 (Fla. 1983) (“Florida public policy prohibits liability insurance coverage for punitive damages assessed against a person because of his own wrongful conduct.”).
3 State Farm Mutual Automobile Ins. Co. v. LaForet, 658 So. 2d 55, 58 (Fla. 1995).
4 Boston Old Colony, Ins. Co. v. Gutierrez, 386 So. 2d 783, 785 (Fla. 1980).
7 LaForet, 658 So. 2d at 58.
8 When a complaint alleges facts that are partially within and partially outside the coverage of a policy, the insurer is obligated to defend the entire suit. Sunshine Birds & Supplies, Inc. v. U.S.F. & G Co., 696 So. 2d 907, 910 (Fla. 3d D.C.A. 1997). This principle extends to cases where a complaint contains allegations of compensatory and punitive damages. American Hardware Mutual Ins. Co. v. Miami Leasing & Rentals, Inc., 362 So. 2d 28, 29 (Fla. 3d D.C.A. 1978).
9 At the time of writing this article, the following published cases addressed this topic: Soto v. State Farm Ins. Co.,83 N.Y.2d 718, 635 N.E.2d 1222, 613 N.Y.S.2d 352 (N.Y. 1994); Lira v. Shelter Ins. Co., 913 P. 2d 514 (Co. 1996); PPG Industries, Inc. v. Transamerica Ins. Co., 20 Cal. 4th 310, 975 P.2d 652, 84 Cal. Rptr. 2d 455 (Cal. 1999); Magnum Foods, Inc. v. Continental Casualty Co., 36 F.3d 1491 (10th Cir. 1994); Carpenter v. Automobile Club Interinsurance Exchange, 58 F.3d 1296 (8th Cir. 1995); and Ging v. American Liberty Ins. Co., 423 F.2d 115 (5th Cir. 1970). There are jurisdictions that have no public policy against insuring punitive damages or against insuring punitive damages based upon gross, reckless, or wanton conduct. See Hensley v. Erie Ins. Co., 168 W. Va. 172, 283 S.E.2d 227 (W. Va. 1981). Florida has a public policy flatly prohibiting such a recovery.
10 Soto, 83 N.Y.2d 718; Lira, 913 P. 2d 514; PPG Industries.
11 Magnum Foods, 36 F.3d 1491.
12 PPG Industries (denying recovery because carrier’s actions not the proximate cause of jury’s award of punitive damages against insured); Lira, 913 P. 2d 514 (denying recovery because insurer has no duty in tort); Soto (denying recovery because to do otherwise would be “unsound public policy”).
13 Lira, 913 P.2d at 518; PPG Industries, 20 Cal. 4th at 319, 975 P.2d at 658, 84 Cal. Rptr. 2d at 461.
14 Carpenter, 58 F.3d 1296.
15 Magnum Foods, 36 F.3d at 1510.
16 Ging, 293 F.Supp. 756.
17 Soto, 83 N.Y.2d at 724, 635 N.E.2d at 1225, 613 N.Y.S.2d at 355.
18 PPG Industries, 20 Cal.4that 324, 975 P.2d at 661-62, 84 Cal.Rptr.2d at 464-65.
19 Lira, 913 P.2d at 521-22.
20 Id. at 517.
21 Id. at 520-21.
22 Id. at 520.
23 Id. at 520. See also Carpenter, 58 F.3d at 1302-03.
24 PPG Industries, 20 Cal.4th at 319, 975 P.2d at 658, 84 Cal.Rptr.2d at 461.
25 Lira, 913 P.2d at n.3.
26 PPG Industries, 20 Cal.4th at 325, 975 P.2d at 662, 84 Cal.Rptr.2d at 465; Lira v. Shelter Ins. Co., 913 P.2d at 522.
27 PPG Industries, 20 Cal.4th at 325, 975 P.2d at 662, 84 Cal.Rptr.2d at 465.
28 Lira, 913 P.2d at 518.
29 Soto, 83 N.Y.2d at 724, 635 N.E.2d at 1225, 613 N.Y.S.2d at 355.
30 Lira, 913 P.2d at 523.
31 Ging, 423 F.2d at 120-21.
James H. Daniel is a shareholder in the law firm of Coker, Myers, Schickel, Sorenson & Green, P.A., Jacksonville. His practice includes personal injury and insurance litigation, as well as handling the firm’s appellate work. Mr. Daniel is a 1992 graduate of the University of Florida College of Law.
This column is submitted on behalf of the Trial Lawyers Section, Thomas D. Masterson, chair, and Judge Thomas P. Barber, editor.