Insurance companies won one and lost one in two recent appeals of multi-million-dollar punitive damages awards. While both cases hinged on the insurers' duty of good faith and fair dealing, the two appellate courts reached opposite outcomes on whether the duty applied.
In one, the Nevada Supreme Court reversed a $4.3 million punitive award upon ruling that the issuer of a surety bond, as a matter of law, cannot be sued in tort for breach of the duty of good faith and fair dealing.
In the other, the California Court of Appeal affirmed a $2 million punitive award after it found that an insurer breached its duty of good faith and fair dealing by denying coverage under a commercial lines policy and refusing to defend a lawsuit against the insured.
The Nevada case, Insurance Co. of the West v. Gibson Tile, 122 Nev. Adv. Op. No. 40 (May 11, 2006), arose out of a surety contract between Insurance Company of the West (ICW) and Gibson Tile to provide performance bonds on a construction project. ICW and Gibson entered into a standard form general indemnity agreement, which specified that ICW could seek indemnification from Gibson for any payments or expenses caused by Gibson's failure to perform on the construction project.
When two suppliers later sued Gibson for nonpayment, Gibson defended the claims on behalf of ICW and eventually settled both. ICW sued Gibson for indemnity, arguing that it had incurred costs in enforcing the terms of the surety contract. Gibson counterclaimed, asserting various causes of action relating to an alleged oral contract for additional bonds.
At trial, the judge instructed the jury, over ICW's objection, that a surety owes its principal a fiduciary duty. The jury found for Gibson on its counterclaims, awarding compensatory damages of $1.6 million and punitive damages of $4.3 million.
On appeal, the Nevada Supreme Court concluded that, as a matter of law, an insurance bad-faith claim does not lie against a surety because there is no special relationship between a surety and its principal. Therefore, the award of punitive damages was improper, the court held.
"Because there is no special relationship between a surety and its principal," the court said in its opinion, "the district court erred when it instructed the jury on fiduciary duties stemming from a special relationship, thus allowing the jury to find ICW liable for a tortious breach of the covenant of good faith and dealing."
The court explained that an action in tort for breach of the covenant arises only when there is a special relationship between the victim and the tortfeasor, generally characterized by the need to protect "the weak" from those with "vastly superior bargaining power."
In this case, however, "the parties occupied similar bargaining positions," the court found. As a matter of law, therefore, no special relationship arose between them.
"[B]ecause a suretyship relationship is not a special relationship giving rise to the tortious breach of good faith and fair dealing, there was no basis for the jury’s award of punitive damages."
In the California case, Century Surety Co. v. Polisso, No. C045334, Calif. App., 3rd Dist. (May 22 2006), Century appealed after a jury awarded Charles and Terese Polisso and their company, Kinzel Glass Company, $2 million in punitive damages on their cross-complaint for breach of the implied covenant of good faith and fair dealing and malicious prosecution.
The appeal grew out of events that started in 1996, when the S.W. Allen Construction company contracted with Polisso to install glass panels in an underground viewing chamber being built by the U.S. Forest Service at Taylor Creek near Lake Tahoe.
In connection with the contract, Polisso purchased a commercial lines policy from Century providing coverage for property damage liability and obligating Century to defend any lawsuits against him for property damages.
Before the construction project was over, a heavy rainstorm caused Taylor Creek to overflow and flood the viewing chamber, triggering a series of events that resulted in damage to the glass.
Allen sued Polisso and his company for damage to the glass and the chamber. Century denied coverage for the damage and declined to defend Polisso in the lawsuit.
As the Allen litigation moved forward, the Polissos continued their efforts to have Century cover the claims and provide a defense. Eventually, Century filed suit against them, seeking declaratory relief on the coverage questions. The Polissos counterclaimed for Century's failure to defend them in the Allen lawsuit or to pay them for damage to the glass.
The trial court dismissed Century's coverage claims prior to trial and sent the case to trial on the Polissos' counterclaims. The jury found that Century breached its implied covenant of good faith and fair dealing and awarded $2 million in punitive damages.
On Appeal, Century sought reversal of the award on several grounds, chief among them was that there were genuine disputes as to its legal liability under the insurance policy.
But the Court of Appeal found that, even if there had been a genuine dispute over coverage, there was no dispute over Century's duty to defend the Polissos.
"There was no legitimate dispute between Century and the Polissos over Century’s duty to defend them," the court said. The facts of the dispute with Allen clearly demonstrated at least the potential for coverage under Century's policy, it found.
The court also dismissed Century's claims that there was a genuine dispute as to coverage. "The question here is not a coverage question but whether Century acted in bad faith when it failed to pay under the policy."
Century's challenges to the punitive damages award on constitutional and evidentiary grounds fared no better.
"We have found Century engaged in misconduct over an extended period of time that was moderately high on the reprehensibility scale. … We therefore find the award reasonably achieves the state’s interests in retribution and deterrence without being grossly excessive."