By Rory Eric Jurman and Steven S. Cula
As appeared in Law360 Expert Analysis on February 15, 2017
Willful, Wanton and Reckless Conduct
Effect on Reinsurers of Punitive Damages Assessed Against Insurers
A frequently encountered type of conduct on the part of defendant tortfeasors that raises the question of the applicability of punitive damages is the operation of a motor vehicle in a willful, wanton and reckless manner, as is often found in the case of the operator found guilty of driving under the influence.
The landmark punitive damages case relating to automobile liability insurance policies is Northwestern National Casualty Co. v. McNulty, 307 F.2d 432 (5th Cir. 1962). In that case, the insured, while drunk and operating his vehicle at 80 miles-per-hour or more,crashed into the rear of the plaintiff’s vehicle. The plaintiff suffered severe and permanent brain injuries. There was no employer defendant or party named as a defendant by reason of any vicarious liability; only the active tortfeasor was named in the lawsuit. Construing Florida law, the court found that, as a matter of public policy,liability insurance does not require an insurer to pay punitive damages assessed against the insured because of his or her own wrongful conduct. The court stated that "punitive damages are awarded for punishment and deterrence would seem to require that the damages ultimately rest on the party actually responsible for the wrong. If the person were permitted to shift the burden to an insurance company, punitive damages would serve no useful purpose." Id.
In Nicholson v. American Fire & Casualty Insurance Co., 177 So.2d 52, 53 (Fla. 2d DCA1965), the court held that a contract obligating an insurer to pay “all sums which the insured shall legally become obligated to pay as damages” did not include an obligation to pay amounts assessed as punitive damages. The Nicholson court agreed with McNulty that “as a matter of public policy punitive damages in this state are based on a theory inconsistent with their coverage by liability insurance.” Nicholson, 177 So.2d at53. It should be noted, however, that in Nicholson the compensatory and punitive damages were awarded against the active tortfeasor only; no respondeat superior was involved.
The Florida Supreme Court has interpreted Section 768.72(1) as “creat[ing] a substantive legal right not to be subject to a punitive damages claim and ensuing financial worth discovery until the trial court makes a determination that there is a reasonable evidentiary basis for recovery of punitive damages.” Globe Newspaper Co.v. King, 658 So. 2d 518, 519 (Fla. 1995). The Fifth District more recently observed:“Because the amount of an award may be a pittance to a rich man and ruination to a poor one, the goal of punishment must of necessity take into account the financial worth of the wrongdoer. Accordingly, although section 768.72(1) is procedural in nature, it also provides a substantive right to parties not to be subjected to a punitive damage claim and attendant discovery of financial worth until the requisite showing under the statute has been made to the trial court.” Estate of Despain v. Avante Group Inc., 900 So. 2d637, 641 (Fla. 5th DCA 2005).
Under Florida statutes, punitive damages may be awarded against an insurer where"the acts giving rise to the violation occur with such frequency as to indicate a general business practice and these acts are: (a) willful, wanton and malicious; (b) in reckless disregard for the rights of any insured; or (c) in reckless disregard for the rights of a beneficiary under a life insurance contract." Fla. Stat. Ann. §624.155; See Scott v.Progressive Express Insurance Co., 932 So.2d 475 (Fla. 4th DCA 2006).
The reinsurance industry defines extracontractual obligations (ECO) as monetary awards required by law against an insurer for its negligence to its insured. ECO claims are brought by the underlying insured against its insurance carrier, seeking damages arising out of the insurer's alleged faulty handling or defense of a claim. An example of an ECO claim is a punitive damages award assessed against an insurance company based on the insurer's bad faith failure to pay its insured in a timely fashion.Reinsurance 762-63 (Robert W. Strain ed., rev. ed. 1997).
A standard reinsurance contract provides that the reinsurer will reimburse the cedent fora certain portion or amount of the settlements and judgments actually paid by the cedent on claims arising under its insurance policies. Moreover, the typical ECO clause provides that the reinsurer will reimburse the cedent for payments made by the cedent on a claim that goes beyond the four corners of the coverage provisions of the underlying insurance contract. Punitive damages awarded on bad faith claims are precisely the type of claim that falls outside the underlying insurance contract, but which the reinsurer likely has to pay under an ECO clause.
Generally, a reinsurer's liability to its cedent is determined by the parameters of the reinsurance contract. Thus, it is often the case that unless the reinsurance contract provides for ECO coverage, a reinsurer will not be required to reimburse a cedent for such claims. However, in the absence of a specific clause, a court may still find the reinsurer liable for ECO claims. The more specific and accurate parties can be in drafting language for the ECO clause, the greater guidance they will have when an ECO situation arises.
Other issues may factor into whether there is reinsurance coverage for ECO liabilities.One, is whether and to what extent an ECO clause provides coverage if there is also a separate errors & omissions policy available providing coverage for the same loss. If an E&O policy is also applicable, reinsurers may argue that the E&O policy should provide coverage first. A reinsurer could address this issue by including specific language in the reinsurance contract. For example, the E&O policy may contain another insurance clause requiring "other policies" to pay out before the E&O policy, but also specifically stating that these "other policies" do not include reinsurance ECO coverage. Ultimately,close review of the reinsurance contract as well as the E&O policy should be undertaken if this situation arises.
Of course, whether a claim for punitive damages will be covered under a reinsurance contract will depend on which state's law governs the interpretation of the contract and whether that state allows for the insurability of punitive damages. Thus, in certain jurisdictions, a reinsurer may correctly assert that to provide reimbursement for punitive damages violates state law and, therefore, the ECO provision in the parties' reinsurance contract is void for that limited purpose in that state.
Punitive damages are, incredibly, often overlooked in insurance negotiations and agreements. Possibly because the acts that may warrant punitive damages are often so egregious, that neither the insured nor the insurer even contemplates such a situation ever arising. However, the amount of money damages that may be awarded through punitive damages, should alone make this issue a legitimate concern. There is no substitute for a well-drafted, ironclad insurance policy. Thus, it is imperative that insurers either expressly exclude punitive damages in the actual policy, or, if the agreement is to include coverage for punitive damages, to include unambiguous,limiting language.
Jurisdictions vary in their treatment regarding coverage of punitive damages, mostly based on whether the punitive damages were assessed as a result of direct liability or vicarious liability. These decisions are often guided by the policy concerns that may arise as a result of allowing insurability of punitive damages. To that end, when litigating coverage for punitive damages, an effective strategy will take into consideration the underlying facts for which the punitive damages were assessed, in conjunction with the law of the relevant jurisdiction.