Zalma on Insurance

Barry Zalma, CFE, is an insurance coverage attorney. 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.

Mr. Zalma is the author of Insurance Claims: A Comprehensive Guide, published by Specialty Technical Publishers, Vancouver, BC at http://www.stpub.com The Truth, The Whole Truth & Nothing But The Truth, Property Claims 2nd Edition and Liability Claims and all course books used by ClaimSchool, Inc. in its training programs. He is also the author of three books published by Thomas Investigative Publishing, and numerous articles for insurance trade publications and law journals.

Mr. Zalma writes the monthly Zalma's Insurance Fraud Letter which is available, FREE, from ClaimSchool, Inc. and over the internet at http://www.zalma.com

Specialty Technical Publishers has published "Mold: A Comprehensive Claims Guide" by Culver City lawyer Barry Zalma. The book is the only comprehensive guide to cover all issues relating to claims of damage by mold or fungal infestations. It is an essential tool for every person who owns real property, manages real property, for all risk managers, realtors, property inspection companies, insurance agents and brokers, insurance claims people, and lawyers who represent property owners or insurers. It is available at http://www.stpub.com or by calling 1800-251-0381

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US Supreme Court Restrains Punitive Damages

(Excerpted from Zalma’s Insurance Fraud Letter, May, 2003)

Putting a choke collar on punitive damages in the United States the US Supreme Court, by a 6-3 vote in State Farm Mutual Automobile Insurance Co. v. Campbell, No. 01-1289, overturned a $145 million verdict against an insurer -- saying a punitive damages award of $145 million, where full compensatory damages are $1 million, is excessive and violates the Due Process Clause of the Fourteenth Amendment. By reducing the exposure to excessive and debilitating punitive damages we can hope the Supreme Court's ruling gives insurers more courage to fight insurance fraud.

Justice Kennedy, writing for the majority limited the ability of state and federal courts to award huge punitive damages awards and concluded that it was improbable that a punitive damage award more than a single digit multiplier of the compensatory damages award would seldom, if ever, pass the due process test. Concluding that the Due Process Clause of the Fourteenth Amendment prohibits the imposition of grossly excessive or arbitrary punishments on a tortfeasors, the test to follow is that posited by the court in BMW of North America, Inc. v. Gore, 517 U. S. 559.

The Campbell case arose out of an automobile accident where one party was killed and another severely injured. The Campbells, insured by State Farm attempted to pass six vehicles on a two-lane highway, failed, and caused the driver of an oncoming car to drive off the road to escape collision with the Campbells' vehicle. The Campbells only had $25,000 coverage per person and $50,000 in the aggregate. The Campbells felt they were not at fault because there was no contact between the two vehicles. State Farm ignored the advice of its adjuster and counsel to accept policy limits demands and took the case to trial. The verdict at trial was over $180,000 and the State Farm appointed counsel told the Campbells to put their house on the market since they would need the money to pay the verdict. State Farm refused to pay the judgment and to fund an appeal. The Campbells retained personal counsel to pursue an appeal that was not successful, entered into a settlement with the plaintiffs where the plaintiffs agreed to not execute on their judgment in exchange for an assignment of 90% of all money received in a bad faith action by the Campbells against State Farm. Before suit was filed State Farm paid the full judgment.

At trial the plaintiffs brought in evidence of actions of State Farm in first party cases across the country, in third party cases not similar to the Campbells' auto accident and other evidence not related to the facts of their case.

The Supreme Court found that State Farm's "handling of the claims against the Campbells merits no praise," but concluded, "a more modest punishment could have satisfied the State's legitimate objectives. "Instead, this case was used as a platform to expose, and punish, the perceived deficiencies of State Farm's operations throughout the country. However, a State cannot punish a defendant for conduct that may have been lawful where it occurred."

The Punitive Damages Test

The test to determine if punitive damages are proper was established by Gore. It requires the trial court to consider:

(1) The degree of reprehensibility of the defendant's misconduct;

(2) The disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and

(3) The difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases.

Using Evidence Not Related to the Plaintiff

The Supreme Court was offended, and found wrongful the position taken by the plaintiffs starting with the opening statement and carrying through to the final instructions to the jury.

("You're going to hear evidence that even the insurance commission in Utah and around the country are unwilling or inept at protecting people against abuses"); id. at 242 ("[T]his is a very important case. . . . [I]t transcends the Campbell file. It involves a nationwide practice. And you, here, are going to be evaluating and assessing, and hopefully requiring State Farm to stand accountable for what it's doing across the country, which is the purpose of punitive damages"). This was a position maintained throughout the litigation.

Finding the argument and the rulings by the Utah courts incorrect in this regard Justice Kennedy, writing for the majority, concluded: "A State cannot punish a defendant for conduct that may have been lawful where it occurred."

Simply stated, the Supreme Court made absolutely clear that punitive damages could only be assessed for actions of the tortfeasor to the plaintiff in the state where the action was brought. It said:

[A]s a general rule, ... a State [does not] have a legitimate concern in imposing punitive damages to punish a defendant for unlawful acts committed outside of the State's jurisdiction. Any proper adjudication of conduct that occurred outside Utah to other persons would require their inclusion, and, to those parties, the Utah courts, in the usual case, would need to apply the laws of their relevant jurisdiction. Phillips Petroleum Co. v. Shutts, 472 U. S. 797, 821-822 (1985).

The reason for this limitation on a court's ability to award punitive damages was Due Process and fairness to the defendant.

For a more fundamental reason, however, the Utah courts erred in relying upon this and other evidence: The courts awarded punitive damages to punish and deter conduct that bore no relation to the Campbells' harm. A defendant's dissimilar acts, independent from the acts upon which liability was premised, may not serve as the basis for punitive damages. A defendant should be punished for the conduct that harmed the plaintiff, not for being an unsavory individual or business. Due process does not permit courts, in the calculation of punitive damages, to adjudicate the merits of other parties' hypothetical claims against a defendant under the guise of the reprehensibility analysis, but we have no doubt the Utah Supreme Court did that here.

The Bright Line

The Supreme Court refused, again, to impose a bright-line ration, which a punitive damages award cannot exceed. However, it concluded in language that is of utmost importance to every defendant -- especially insurers -- charged with actions of bad faith that warrant an award of punitive damages. Justice Kennedy, and the majority, concluded, "in practice, few awards exceeding a single-digit ratio between punitive and compensatory damages, to a significant degree, will satisfy due process." More importantly, "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." In the Campbell case, they were awarded $1,000,000 in compensatory damages for 18 months of emotional distress and no physical injury. Much of the distress they suffered was caused by the outrage and humiliation the Campbells suffered at the actions of their insurer; and it is a major role of punitive damages to condemn such conduct. The court also recognized that emotional distress damages, although compensatory in nature, also include punishment as an element of the tort.

An application of the Gore guideposts to the facts of this case, especially in light of the substantial compensatory damages award (a portion of which contained a punitive element), likely would justify a punitive damages award at or near the amount of compensatory damages. The punitive award of $145 million, therefore, was neither reasonable nor proportionate to the wrong committed, and it was an irrational and arbitrary deprivation of the property of the defendant.

How Punitive Damages Really Works

In March 1996 Steven Hayward, Vice President, research for the Pacific Research Institute for Public Policy and William S. Loughman published a paper at http://www.pacificresearch.org/pub/sab/entrep/punitive1/punitive2.html called "The Role of Punitive Damages in Civil Litigation: New Evidence from Lawsuit Filings" that established empirically that the problem with punitive damages is not the award of the judgment but the effect of claims for punitive damages on settlement. Finding that between 1.5 and 2% of all cases filed go to trial the punitive awards are a small, and possibly insignificant gauge of the effect of claims of punitive damages claims on litigation. Mr. Hayward and Lughman found that:

The large disparity between median punitive award amounts and average award amounts ($50,000 and $735,000 respectively in the DoJ estimates) highlights the unpredictability of punitive awards. ... [P]unitive damages are unpredictable and arbitrary. In California cases during [1990 and 1994] the range of punitive awards runs from 710 times compensatory damages to 0.0001 times compensatory. (In one case, a defendant who was not assessed any compensatory damages was nevertheless hit with $62,000 in punitive damages. It is precisely this uncertainty that provides the plaintiff with additional leverage in the settlement process.

In addition research by Mr. Laughman established:

Lawsuits that include punitive damage demands take about six months longer to resolve than lawsuits that do not include punitive damage demands.

The probability of a punitive damage award if a case proceeds to trial is 14 percent or high. For business defendants, the probability is more than 20 percent.

Research by Mr. Lughman and experience defending such actions make it clear that the unpredictability of a prospective punitive damage award contributes significantly to the uncertainty (and therefore the risk) of a court trial outcome. An uncertainty that still exists, but may have been reduced somewhat by the Supreme Court's ruling. In addition, the uncertainty posed by the prospect of unlimited punitive damages, combined with the relative probability of a punitive damage award if a case goes to jury trial, provide litigants who demand punitive damages "with potent leverage against risk-averse defendants," like insurance companies, and "tip the balance in settlement bargains in favor of litigants with weak or even frivolous cases.

Concentrating on trial verdicts, as the Supreme Court has done, overlooks where the real money is in civil litigation: out-of-court settlements. The small number of punitive damage trials affects decisions in the vast majority of lawsuits that do not proceed to trial. Verdicts are the signals taken by every litigant. Mr. Hayward explains that:

The main determining factor of whether a filed lawsuit will yield a settlement to the plaintiff is the "threat credibility" of the suit, i.e., what is the probability of a verdict favorable to the plaintiff if the case goes to trial, and what is the likely amount of damages that the plaintiff could win?

An increase in the prospective amount of a jury verdict increases the likelihood of a settlement offer by the defendant and tends to increase the amount of such settlements. Punitive damage demands will often tip the balance in bargaining to the plaintiff, even one with a weak or frivolous case. It does so in two ways: by increasing the size of a prospective jury award if the case is taken to trial and by increasing the legal costs that a defendant will have to incur to fight the suit at trial. The professional fraud investigator, the SIU investigator for insurance companies, the insurance defense lawyer, and most importantly the fraud perpetrator are aware of this dynamic of the suit settlement process. As long as punitive damage awards are uncertain suits against risk-averse insurers will continue to be settled for fear of the large award if the case is taken to trial.

State Farm v. Campbell, supra. may be a turning point in the settlement process. By providing a line in the sand -- albeit not a bright line -- limiting punitive awards to approximately 4 times compensatory or single digit multiplier the uncertainty is removed from the process. Actuaries can calculate and reserve against punitive awards. The risk averse insurer can, and should, refuse to settle all cases where they believe fraud is involved. By doing so they will take the profit incentive out of the picture and make it less profitable to file suit against insurers when there is a genuine dispute as to coverage. Certainty in the exposure faced by the insurer will make unnecessary the payment of nuisance settlements or settlements to people who perpetrate fraud.

Conclusion

After years of abusive punitive damages awards and thousands of settlements to avoid the lottery-like nature of punitive damages awards the US Supreme Court has finally set a line in the sand that will prevent trial courts from assessing excessive and unreasonable punitive damages awards. Punitive damages should, if Campbell is applied with good faith, never exceed three or four times the compensatory award and when the compensatory award is large, as was the $1 million awarded the Campbells for 18 months of emotional distress, should not exceed one time the compensatory award. Defense lawyers now have a guide to explain to juries that their punishment of a defendant is limited. Plaintiff's lawyers can take heart that if the punitive award is reasonable and a single digit modifier will be able to collect their judgment without unnecessary appeals.

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