Chapter Eleven

• Jurisdiction: New York

Chapter Eleven

INSURANCE COVERAGE FOR PUNITIVE DAMAGES

James M. Ringer, Esq. Martin L. Seidel, Esq.

i. Introduction

Following the 1996 Supreme Court decision¹²⁰⁰ overturning a punitive damage award on due process grounds, debate over punitive damage reform has moved to the forefront of government and business agendas. From the corporate boardroom to state governments and the U.S. Congress, there have been movements to modify the grounds for awarding punitive damages and the amounts that can be awarded. Not surprisingly, these efforts have faced fierce opposition from those who claim that the threat of punitive damages is a bulwark of corporate responsibility. The current focus on punitive damages makes for an ideal context in which to explore issues relating to their insurance coverage.

In this chapter, the following issues respecting insurance coverage of punitive damages will be considered:

1. How courts construe policies to determine if their terms encompass coverage for punitive damages;

2. The rationales for and against determinations that insurance coverage for punitive damages, even if expressly provided for in a policy, is void as violative of public policy;

3. The factual scenarios that alter the public policy analyses respecting coverage for punitive damages, including vicarious liability and whether the insured is a governmental entity;

4. The insurer’s duty to defend claims for punitive damages;

5. The insurability of statutory treble damages and the applicability thereto of the public policy rationale to void coverage for punitive damages; and

6. The insurer’s obligation to indemnify where actions, including claims for punitive damages, are settled.

In considering the insurability of punitive damages, it is helpful to understand the purpose of punitive damages, issues relating to those damages and case law on the constitutionality of punitive damages.

II. Purpose of Punitive Damages

Generally, the purpose of punitive damages is to “act as a deterrent” to wrongdoers and serve as a warning to prevent others from engaging in like conduct.¹²⁰¹ Most often, punitive damages are awarded as a result of malicious or intentional conduct.¹²⁰² Unintentional conduct “may also form the basis for punitive damages when the conduct constitutes conscious disregard of the rights or safety of others.”¹²⁰³ Further, there are some states in which, under certain circumstances, gross negligence will trigger awards of punitive damages.¹²⁰⁴ For example, the Court of Appeals has stated that New York law sanctions punitive damages based on negligence.¹²⁰⁵ The degree of negligence so required, however, is not readily amenable to exact quantification, apparently including criminally culpable negligence,¹²⁰⁶ as well as reckless disregard for the lives and safety of others.¹²⁰⁷

The rationale for awarding punitive damages is not to make whole the plaintiff who has suffered. This usually has already been accomplished by the award of compensatory damages. Instead, the punitive damage award “may be considered expressive of the community attitude towards one who willfully and wantonly causes hurt or injury to another.”¹²⁰⁸ For these reasons, it does not correlate to actual damages (although many jurisdictions do require a reasonable relation between the award and the damage done) as its purpose is, instead, to suppress the wrongful conduct.¹²⁰⁹ Otherwise stated, punitive damages are “private fines” imposed by civil courts to punish conduct constituting a conscious disregard for the rights of others or conduct so reckless as to constitute conscious disregard.¹²¹⁰

New York courts have followed this nearly uniform approach and awarded punitive damages in cases involving wrongful motive, willful or intentional wrongdoing, or reckless indifference equivalent to willful or intentional misdoing. In cases where punitive damages are awarded, there is a strong sense that the wrong complained of is “morally culpable or is actuated by evil and reprehensible motives.”¹²¹¹ Punitive damages also are “available for the purpose of vindicating a public right only where the actions of the alleged tort-feasor constitute gross recklessness or intentional, wanton or malicious conduct aimed at the public generally or are activated by evil or reprehensible motives.”¹²¹² Mere negligence is not enough. In Gravitt, for example, the Second Department held that the actions of a doctor who left a surgical instrument in the body of a patient did not rise beyond ordinary negligence and, therefore, punitive damages were not available.¹²¹³ Even when a plaintiff claims gross negligence, the Appellate Division has stated that punitive damages are awarded only in “singularly rare cases,” such as those involving an improper state of mind, malice or wrongdoing to the public.¹²¹⁴ Finally, in New York, punitive damages are not awarded for the unintended result of an intentional act.¹²¹⁵

The types of cases in which punitive damage awards commonly are rendered vary. Courts have awarded punitive damages in complex commercial litigation involving claims for tortious interference with contractual relations, as well as those for antitrust and civil theft.¹²¹⁶ Punitive awards are especially common in products liability cases involving exposure to asbestos or other toxic substances or defective products.¹²¹⁷ Simple tort cases, such as those involving assault, as well as automobile accidents involving gross negligence, have similarly emerged as candidates for punitive awards.¹²¹⁸

Although New York courts award punitive damages in all these situations, punitive damage awards in New York usually are not available for breach of contract claims involving only private wrongs.¹²¹⁹ A plaintiff, therefore, can request punitive damages only if the breach of contract allegations rest on fraud “ ‘aimed at the public generally,’ evincing a ‘high degree of moral turpitude,’ and demonstrating ‘such wanton dishonesty as to imply a criminal indifference to civil obligations.’ ”¹²²⁰

III. Current Issues

The insurability of punitive damages is significant only insofar as it is permissible to award such damages. Issues respecting insurability also are less important as the size and frequency of punitive awards decrease. In this context, proposed reforms and issues of constitutionality are relevant to the insurability of punitive damages.

A. Proposed Reforms

The preoccupation with tort reform has created a tidal wave of proposed reform concerning punitive damages at the state and federal levels. Although in 1996 President Clinton vetoed tort reform legislation passed by the U.S. Congress that would have limited punitive damages, various states have enacted punitive damage reforms. For example, at least two states have passed statutes requiring that punitive damages be assessed by the judge rather than the jury, even if other issues are tried by the jury.¹²²¹ Other states, such as Alabama, have enacted statutory caps on punitive damages.¹²²² Moreover, some states, such as California, have imposed, either statutorily or judicially, a clear and convincing evidentiary standard for punitive damages and/or have required a bifurcated trial as to the amount of punitive damages, if the defendant so requests.¹²²³ The underlying belief is that juries are inclined to award excessive amounts of punitive damages. If standards for such awards are specifically set, the frequency of these awards will decline. Proponents of reform contend that without the specter of punitive damages, U.S. companies will be more competitive and productive in the world market. While consumer groups claim that such reforms are aimed at protecting industry at the expense of consumers,¹²²⁴ others insist that punitive damages rarely are awarded. Reforms, therefore, would protect only the worst offenders.¹²²⁵

B. Skyrocketing Awards

Where there is agreement, however, is that the increasing attention to punitive damage reform has been marked by a substantial rise in jury awards. Although the practice of awarding double or triple compensation for injuries dates back at least to the 13th century,¹²²⁶ the amount of these awards has not been extremely high. Not too long ago, the largest affirmed award in a products liability case was $250,000.¹²²⁷ Since that time, however, juries have awarded 30 times that amount in punitive damages.¹²²⁸ A study by the Association for California Tort Reform found the average punitive damage award by state juries increased by 178% to $3 million from 1987 to 1989.¹²²⁹ Other studies, however, have found that the number of punitive awards has actually declined since 1986 if the large number of asbestos cases are not included in the tally.¹²³⁰

C. Constitutionality of Punitive Damages

For an insurer seeking to avoid covering a punitive damage award and an insured seeking to avoid that part of a punitive damage award in excess of its policy limit or within its retention amount, a potential threshold argument is that the award itself is impermissible because punitive damage awards violate the U.S. Constitution. Since the late 1990s, the U.S. Supreme Court has decided six cases in an attempt to answer the question of whether there are federal constitutional limits on punitive damage awards. Five of those cases considered whether punitive damage awards were excessive or otherwise unconstitutional under the Due Process Clause of the 14th Amendment. The other considered whether an award was excessive under the 8th Amendment. While earlier Supreme Court cases have indicated there might be situations in which punitive damages would be unconstitutional, it was not until the Court’s decision in BMW of North America, Inc. v. Gore¹²³¹ that it found a punitive damage award exceeded the constitutionally permissible limits of the 14th Amendment’s Due Process Clause.

1. Due Process Clause

a. “Grossly Excessive” Punitive Damage Awards

In BMW, a sharply divided court held that $2 million in punitive damages awarded...