Insurance in the Courts (Formerly Recent Court Decisions)

• Author: Randy Maniloff,Jeffrey W. Stempel,Marc Mayerson
• DOI: http://doi.org/10.1111/j.1540-6296.2009.01160.x
• Published date: 01 March 2009
• Date: 01 March 2009

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Risk Management and Insurance Review, 2009, Vol.12, No. 1, 141-182

INSURANCE IN THE COURTS

(FORMERLY RECENT COURT DECISIONS)

Randy Maniloff

Marc Mayerson

Jeffrey W. Stempel

NEW YORK EMBRACES CONSEQUENTIAL DAMAGES AS A REMEDY IN INSURANCE

BAD FAITH CLAIMS

Bi-Economy Market, Inc. v. Harleysville Insurance Co. of New York, 10 N.Y.3d 187, 886 N.E.2d

187, 856 N.Y.S.2d 505, 2008 N.Y. LEXIS 278 (N.Y., Feb. 19, 2008) and Panasia Estates, Inc.

v. Hudson Ins. Co., 10 N.Y.3d 200, 886 N.E.2d 135, 856 N.Y.S.2d 513, 2008 N.Y. LEXIS 275

(N.Y. Feb. 19, 2008)

New Yorkhas historically been a friendly jurisdiction for insurers facing bad faith claims.

It still is. But in a pair of late February 2008 decisions, the New York Court of Appeals,

the state’s highest court, added a significant weapon to the arsenal of policyholders

making bad faith claims. Taken together, these decisions permit policyholders, upon a

showing of bad faith in refusing or delaying payment, to seek consequential damages

flowing from the insurer’s failure to make timely, full payment under the policy.

Bi-Economy Market, Inc. v. Harleysville Insurance Co. of New York, 10 N.Y.3d 187, 886 N.E.2d

187, 856 N.Y.S.2d 505 (N.Y. 2008) and Panasia Estates, Inc. v. Hudson Ins. Co., 10 N.Y.3d

200, 886 N.E.2d 135, 856 N.Y.S.2d 513 (N.Y. 2008) are potentially pathbreaking decisions

in that the Court permitted two policyholders claiming unreasonable insurer delay or

resistance to payment to seek consequential damages. Prior to Bi-Economy and Panasia,

the Court had never expressly endorsed these remedies for insurer bad faith, nor had

there been much support for this form of policyholder remedy in the lower New York

courts.

Mr. Randy Maniloffand his firm represent insurers in coverage disputes. He is a frequent author

on insurance matters, including an annual survey of the “Top Ten” insurance cases for Mealey’s

Publications. Mr. Marc Mayerson and his firm representpolicyholders in coverage disputes. He

maintains an insurance weblog at insurancescrawl.com. Professor Jeffrey W. Stempel is the Doris

S. and Theodore B. Lee Professor of Law at the William S. Boyd School of Law at University

of Nevada, Las Vegas, and author of Stempel on Insurance Contracts (3d ed. 2006 & Supp. 2009).

Given the collaborative nature of this article, the views expressed are not necessarily those of

each author. Neither are opinions expressed in this article necessarily those of the University of

Nevada, Las Vegas; White & Williams; Spriggs & Hollingsworth; or their respective clients or

constituents.

141

142 RISK MANAGEMENT AND INSURANCE REVIEW

Although the full implications of the decisions will emerge only through subsequent

adjudication, the battlefield between policyholders and insurers in New York, one his-

torically tilted toward insurers, has moved significantly in the direction of policyholders.

Reading the reaction of the two judges dissenting from the Court’s two 5–2 majority opin-

ions, one might mistakenly get the impression that the insurance world was coming to

an abrupt end and that the Court had massively deviated from traditional contract prin-

ciples. On balance, however, the Court majority opinions appear completely consistent

with traditional noninsurance contract law and hardly spell doom for insurers.

What makes both Bi-Economy and Panasia noteworthy is that they are a significant expan-

sion of New York insurance law that has arguably been too protective of insurers. Even

after these decisions, New York law remains distinctly less favorable to policyholder

than the bad faith law of most states, which treats bad faith breach of an insurance pol-

icy as tort that gives rise to the full array of tort damages, including potential punitive

damages. By contrast, even after Bi-Economy and Panasia, New York appears to subject

insurers to the risk of punitive damages only if they commit independent torts other

than bad faith (e.g., fraud, conversion, defamation) against a policyholder. The emerging

new regime in New York makes it look more like states that treat first-party insurance

bad faith claims as a type of contract claim rather than a tort claim. See, e.g., Beck v.

Farmers Ins. Exch., 701 P.2d 795 (Utah 1985) (however, Utah, like most states, treats bad

faith by a third-party insurer as a tort).

If adhered to and applied logically in the future, the two decisions arguably presage a

regime in which the economic playing field formerly tilted in favor of insurers in cover-

age litigation, will be closer to level for a wide range of insurance products but remains

more protective of insurers than the law of most states. Insurers will undoubtedly at-

tempt to turn back these decisions and their implicit tide. In response, policyholders will

undoubtedly argue that the decisions are correct and that for too long, insurers in New

York,who are supposed to have fiduciary-like duties beyond those of ordinary contract-

ing parties, have largely been immunized in most bad faith cases from paying anything

beyond the policy limits even where they have acted unreasonably in breaching the

insurance contract.

To the extent these decisions usher in a new era in New York, there is a silver lining for

insurers: a sufficiently compensatory regime of consequential damages, prejudgment

interest, and attorney fee awards may as a practical matter supplant the efforts of

aggrieved policyholders to style matters as punitive damages claims, reducing some

of the pressure insurers undoubtedly feel from these types of claims notwithstanding

the punitive-damage dampening effects of State Farm Mut. Auto. Ins. Co. v. Campbell, 538

U.S. 408 (2003), which set a presumptive cap of nine times compensatory damages in

cases with substantial harm to policyholders.

Bi-Economy v. Harleysville. In Bi-Economy, a Rochester,New York meat market suffered a

severe fire,“resulting in the complete loss of food inventory and heavy structural damage

to the building and business-related equipment. Bi-Economy had commercial property

insurance with Harleysville, including business interruption coverage and replacement

cost coverage on the building and its contents in what was styled as a “Deluxe Business

Owner’s” policy. Under the terms of the coverage, the insurer was obligated to pay

the “actual loss” of business income resulting from the “necessary suspension of the

policyholder’s operations as during a “period of restoration” necessitated by a covered

INSURANCE IN THE COURTS 143

property loss. In addition, the policy covered “continuing normal operating expenses

incurred, including payroll.” As is typical in such policies, the period of restoration was

defined as beginning with the date of the physical property loss necessary to trigger

coverage and ending on the dates when the property “should be repaired, rebuilt, or

replaced with reasonable speed and similar quality.”

Bi-Economy submitted a claim. Harleysville disputed it and was willing to advance a

little over $163,000 to the policyholder in the early aftermath of the fire and cessation

of business operations. More than a year later, after resolution pursuant to the policy’s

ADR clause, Bi-Economy was awarded more than $407,000. During the pendency of the

dispute resolution, Harleysville “offered to pay only seven months of ...lost business

income, despite the fact that the policy provided for a full twelve months” of such

coverage The “family-owned” meat market went out of business and “never resumed

operations.” It sued its insurer, alleging that as a result of Harleysville’s breach of

the policy and bad faith performance the business collapsed. In addition to seeking

the full award of business interuption benefits available under the policy, Bi-Economy

also sought consequential damages resulting from the business’s demise that allegedly

resulted from the foot-dragging and resistance of Harleysville.

In response, Harleysville argued that it was not responsible for consequential damages

because of the policy’s “consequential loss” exclusion and because of the general rule

that the measure of damages for breach of an insurance policy is payment of the amount

of coverage owed under the policy. The argument was a winner with the trial court

(counterintuitively known as the Supreme Court in New York)and the intermediate ap-

pellate court (the “Appellate Division”). But Harleysville’s winning streak ended before

the Court of Appeals, which held that the lower court “erred in dismissing its breach of

contract claim seeking consequential damages for the collapse of its business resulting

from [the insurer’s] failure to fulfill its obligations under the contract of insurance” and

remanded the case for further proceedings.

The Court reiterated the traditional rule that in breach of contract cases, the nonbreach-

ing party normally can recover general damages that are the “natural and probable

consequence of the breach” (citing Kenford Co. v. County of Erie, 73 N.Y.2d 312, 319, 537

N.E.2d 176, 540 N.Y.S.2d 1 (1989)). In addition, the nonbreaching party can also seek

consequential damages that do not directly flow from the breach if such damages are

within the contemplation of the parties at the time of contracting. In other words, if the

nonbreaching party is damaged as a result of the breach for “risks foreseen or which

should have been foreseen at the time the contract was made,” these amounts should

be recoverable in a contract action if the consequential loss was foreseeable or probable

(citing Ashland Mgt. v. Janien, 82 N.Y.2d 395, 403, 624 N.E.2d 1007, 604 N.Y.S.2d 912

(1993), Restatement (Second) of Contracts §351, and Farnsworth on Contracts § 12.14). See

886 N.E.2d at 192. This basic rule of contract damages is most famously associated with

the 19th Century British case Hadley v. Baxendale, 9 Ex. 341 [1854], which was embraced

almost from its inception by American courts.

Following these traditional rules of contract damages, the Court of Appeals noted that

the questions of foreseeability and probability were to be determined according to “na-

ture, purpose, and particular circumstances of the contract known by the parties ...

as well as ‘what liability the defendant fairly may be supposed to have assumed con-

sciously,or to have warranted the plaintiff reasonably to suppose that it assumed, when