Punitive damages: when, where and how they are covered.

AuthorPope, Michael A.
PositionBy insurance

NEWS stories about punitive damages seem to be an almost daily occurrence, from the $2.7 million award against McDonald's in the "hot coffee case,"(1) reduced by the trial judge to $680,000, to the U.S. Supreme Court's decision that arbitration panels may assess punitive damages in securities cases.(2) Although there are legislative efforts afoot at both the federal and state levels to curb them, punitive damages likely will not disappear and will continue to be a source of concern to insurance companies and defense counsel.(3)

Courts vary widely on the issue of the insurability of punitive damages. More than half the jurisdictions in the United States allow insurance coverage for punitive damages under certain circumstances. This article provides an overview of the current state of the law. (See the appendix, beginning on page 545, for a jurisdiction-by-jurisdiction listing of cases.)

Coverages for Punitive Damages

  1. Intentional Acts

    It should be noted initially that most insurance policies exclude coverage for any damages, compensatory or punitive, awarded on account of the intentional actions of the insured. Coverage for intentional acts is generally precluded by one of two different methods. Some policies define a covered "occurrence" to exclude injury or damage that is expected or intended from the standpoint of the insured,(4) while others simply exclude coverage for intentional acts.(5)

    Thus, when it is clear that the underlying action arose from an intentional action of the insured, all coverage, including coverage for punitive damages, will be denied.

  2. Direct Wrongful but Unintentional


    A more difficult question arises when punitive damages are assessed against an insured for its wrongful, yet unintentional, conduct, such as actions that are found to be willful, wanton or reckless. Courts are divided on the question of whether coverage is permissible in these situations. The policy language involved in most of these cases generally provides that the insurer agrees "to pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury or property damage."

    Most courts have determined that the payment of punitive damages falls within this very broad provision.(6) Rather, the reason for prohibiting coverage of punitive damages is generally grounded in public policy. The public policy at issue is that which states that "punitive damages are imposed against a defendant as punishment to the defendant and as a deterrent to the defendant and others."(7) Many courts have stated their belief that this public policy would be "frustrated if one were allowed to shift the risk of liability for such damages to an insurance company, thereby avoiding the punishment imposed."(8)

    In some jurisdictions, the public policy against the insurability of punitive damages has been established by statute rather than case law.(9)

    Although most states that uphold the insurability of punitive damages do so by court decisions, some have done so by statute.(10) Courts upholding insurability have rejected the public policy arguments. For example, in LeDoux v. Continental Insurance Co.,(11) the Alaska federal district court rejected the carrier's argument that public policy prohibits the coverage of punitive damages. The court acknowledged that the purposes of punitive damages are "punishment and deterrence," but it rejected the argument that coverage would vitiate this punitive and deterrent effect.

    According to the LeDoux court, the punitive and deterrent effect would exist despite insurance coverage because a punitive damages award "carries with it a degree of opprobrium, affects the ability of the insured to obtain automobile liability insurance, and is apt to increase the rates tortfeasors are charged for insurance in the future." The court also noted that, in the "absence of a provision excluding punitive damages, the insurance company is receiving premiums to cover these claims." The court concluded that "the public interests served by imposing punitive damages in these cases is not sufficiently strong to justify voiding the contract rights of the insured and thereby giving a windfall to the insurer."

    The Supreme Court of Arizona provided a similar analysis to support its decision that punitive damages assessed in a personal injury suit arising from a drag race were covered under an automobile policy. In Price v. Hartford Accident and Indemnity Co.,(12) it rejected the insurer's argument that coverage would detract from the deterrent and punishment purposes of punitive damages.

    In the court's words:

    First, even though a driver is insured for punitive damages he cannot engage in wanton conduct with impunity. In the instant case, drag racing would subject him to criminal penalties. His insurance rates would soar....

    Second, Hartford has voluntarily covered its insured's liability for punitive damages, and since its premiums were based on its exposure, it may be presumed that holding it liable for what it has promised to pay would not result in additional burdens on the driving public.

    Third, the criminal penalties include possible loss of the driver's license and compulsory attendance at traffic school.

    Fourth, punitive damages are not only designed to punish the offender but are also designed to serve as a deterrent to others. Since it is common knowledge that the vast majority of drivers do not carry million dollar liability policies, the possibility that punitive damages will exceed their policy limits will exercise a deterrent effect on them.

    Fifth, there is no evidence that those states which deny coverage have accomplished any appreciable effect on the slaughter on their highways.

    Sixth, the state of Arizona has more than one public policy. . . . One such public policy is that an insurance company which admittedly took a premium for covering all liability for damages, should honor its obligation.(13)

    With some exceptions, it is this debate over public policy that governs the insurability of punitive damages. Slightly more than half of U.S. jurisdictions allow coverage for punitive damages imposed for the insured's direct conduct, although a few of these allow coverage only when the policy language specifically provides for it.(14)

  3. Vicarious Liability Theory

    Many states, including some that prohibit coverage for punitive damages assessed for an insured's direct acts, permit insurance coverage for punitive damages imposed under a vicarious liability theory. For example, in United States Fidelity & Guaranty Co. v. Open Sesame Child Care Center,(15) a federal case applying Illinois law, an insured day care center sought coverage for a lawsuit arising from allegations that one of the insured's employees had molested a minor child. The insurer contended that it was not liable for punitive damages imposed against its insured for the acts of its employee.

    The court noted that, while Illinois public policy prohibits coverage for punitive damages imposed for an insured's own misconduct, it does not prohibit coverage for punitive damages imposed solely because of the insured's vicarious liability. Since the punitive damages were sought only in the counts based on vicarious liability and not in the count alleging direct liability, the insured was entitled to a defense and indemnity for any punitive damages levied against it.(16)

    In Kansas, coverage for punitive damages arising only on a vicarious liability theory are permitted by statute.(17)

    Illinois and Kansas are two of approximately 10 jurisdictions that do not allow coverage for punitive damages as a general rule but recognize vicarious liability cases as exceptions to that rule. The logic behind the exception seems to rest on the view that a party held vicariously liable is a relatively "innocent" obligor. Shifting liability from an "innocent" insured to a liability insurer is not viewed as an offense to public policy, and contracts are generally enforced absent some contravention of public policy. Provided an insurance policy covers punitive damages, the policy is enforced.(18)

    It is important to remember, however, that just because punitive damages are awarded against a corporation does not mean that they arose from vicarious liability. If the persons responsible for the corporation's misconduct are officers or directors of the corporation, the misconduct is generally attributed directly to the corporation.(19) Also, a corporation can be directly liable for the acts of its employees through theories such as negligent hiring and negligent supervision, in which case the exception for vicarious liability will not apply.(20)

    When it is unclear whether the punitive damages were a result of direct or vicarious liability, the burden is on the insurer to show that the corporation was directly at fault for the damages.(21)

    Other Coverages

    As a general rule, jurisdictions that bar coverage for punitive damages also refuse to permit coverage for sanctions such as attorneys's fees, statutory multiple damages and civil penalties imposed pursuant to statutes.

  4. Attorney's Fees

    Some states allow successful plaintiffs to recover their attorney's fees under certain circumstances. For example, a California statute allows an award of attorney's fees in civil cases arising from a felony of which the defendant has been convicted.(22) In Baker v. Mid-Century Insurance Co.(23) the victim of a drunk driving accident sued the drunk driver's insurer for the payment of attorney's fees he incurred in his suit against the driver. The plaintiff had settled his case with the driver for policy limits but had reserved the right to seek attorney's fees pursuant to the California statute.

    The defendant's insurer refused to pay the fees on the ground that California public policy does not permit coverage for punitive damages. Both the trial and appellate courts agreed with the insurer. The California Court of Appeal relied on...

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