Can two wrongs make a "right" to seek indemnification of punitive damages from a liability insurance carrier?

• Author: Daniel, James H.

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) However, 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.

Insurer Duties

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.

Case Law

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...