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$2 Million in Punitive Damages Assessed Against Insurer for Mishandling Subcontractor’s Claim
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April 28, 2008
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By Brienne Wesolek
Thelen Reid Brown Raysman & Steiner LLP
A general contractor entered into a contract with the United States Forest Service to construct an underground stream profile viewing chamber at Taylor Creek near South Lake Tahoe. The general contractor subcontracted with a glass company to supply and install glass panels in the viewing chamber.
After the subcontractor installed the panels, a heavy rainstorm hit the Tahoe area, causing the Taylor Creek to overflow and flood the viewing chamber. Clean-up efforts by the general contractor’s workers scratched the glass. The general contractor sued the subcontractor for breach of contract and negligence, alleging delay, defective work and materials, and failure to replace damaged and defective work.
The subcontractor carried a package Commercial Lines insurance policy. It included commercial general liability coverage for property damage claims by third parties arising after completion of the subcontract. The package also provided “all risk” first party coverage of damage to glass up to $15,000 until the glass was installed and became a permanent part of the building. It did not cover flooding, faulty workmanship or defective materials.
The insurer’s claims adjuster concluded that no damage was caused by faulty workmanship. Even so, the insurer declined to cover the loss on grounds of defective workmanship. The carrier initially declined to defend the subcontractor in litigation with the general contractor and filed suit against the subcontractor for declaratory relief to resolve insurance coverage issues. The subcontractor cross-complained against the insurer for breach of contract and breach of the implied covenant of good faith and fair dealing, alleging failure to provide a defense, failure to provide independent counsel and failure to pay for damage to the glass. It sought punitive damages.
Before trial, the insurer dismissed its claims against the subcontractor. At trial, the subcontractor amended its cross-complaint to allege malicious prosecution.
The trial court held the insurer owed the subcontractor a defense and independent counsel and that the all risk policy covered damage to the glass. The trial court awarded the subcontractor $637,911 in compensatory damages for economic and non-economic losses and $2,015,000 in punitive damages. (The insurer’s net worth was stipulated to be $56.9 million.)
The insurer appealed, contending that the compensatory and punitive damage award should be reversed because there was a genuine dispute as to insurer’s liability under the policy and that the punitive damages award should be reversed because of instructional, evidentiary and due process violations.
The California Court of Appeal rejected the insurer’s arguments and affirmed the trial court’s judgment in favor of the subcontractor. Century Surety Co. v. Polisso, 139 Cal.App. 4th 922, 43 Cal.Rptr.3d 468 (2006).
The Court of Appeal held that even if there were genuine coverage issues at the time the claim was tendered, there was no genuine dispute as to the insurer’s duty to defend based on the allegations in the general contractor’s lawsuit and information known to the carrier as a result of its investigation. The court reiterated the principle that “the duty to defend is broader than the duty to indemnify; an insurer may owe a duty to defend its insured in an action in which no damages ultimately are awarded.”
The insurer also argued that the punitive damage award was constitutionally excessive because its conduct was only minimally reprehensible. The Court of Appeal rejected the argument and found that the insurer’s conduct was reprehensible enough to justify an award of punitive damages. The court found that the insurer knew it had a duty to defend the subcontractor but “took every opportunity to stall, stonewall and engage in scare tactics” so that it could deny the subcontractor coverage.
The appeals court noted that the insurer’s coverage lawyer had concluded that a potential for coverage existed such that there was a duty to defend. Yet, the insurer’s coverage lawyer also advised serving a lawsuit on the subcontractor to dispute coverage and to seek recovery of defense costs as a “negotiating tool” in mediating with the general contractor. The insurer’s coverage counsel refused to waive reimbursement of defense costs, telling the subcontractor’s lawyer that the suit was a “scare tactic.” The insurer scheduled a motion in the coverage case two days before a mediation in the dispute with the general contractor even though opposing the motion would compromise the subcontractor’s defense against the general contractor.
While asserting a full reservation of rights, the insurer refused to provide the subcontractor with independent counsel. Counsel provided by the carrier advised the subcontractor to take 20 cents on the dollar in its litigation with the general contractor after previously telling the subcontractor that he had a good case. Although the insurer eventually agreed to provide independent defense counsel for the subcontractor, it failed to pay the lawyer’s bills for months. The carrier then refused to make further payments. The subcontractor’s lawyer had to sue the insurer for his fees in a separate action.
As the disputes with the general contractor and carrier wore on, the subcontractor fell behind on its taxes and faced a tax lien, lost the lease for its business premises and had to borrow money from relatives to remain in operation. The subcontractor filed for bankruptcy. He and his wife both suffered health problems as a result of the stress.
The Court of Appeal concluded that the insurer acted with “reckless indifference” to the health and peace of mind of the subcontractor and his wife and that it “exploited” their distressed financial condition. The carrier engaged in a five-year course of conduct “designed to avoid paying the insurance benefits covered by the policy.”
The Court of Appeal also held:
|  | The subcontractor’s wife was a due a defense in the suit by the general contractor because the policy expressly covered her and because the wife’s community property would have been subject to a judgment against the business, which was a sole proprietorship.
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| | Contrary to the insurer’s arguments, it was proper for the jury to consider the net worth of the insurer as provided by Civil Code §3295. Such consideration is necessary so that punitive damages will be large enough to deter similar behavior in the future.
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| | The ratio between punitive damages and actual damages was 3.2 to 1, which was within guideposts set out by the U.S. Supreme Court in BMW of North America, Inc. v. Gore, 517 U.S. 559 (1996) to assess whether a punitive award is grossly excessive in relation to the state’s legitimate interest in punishing and deterring unlawful conduct.
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| | The difference between the punitive damage award and the civil penalties authorized in comparable cases, a guidepost set out in the BMW case, is a question of law to be considered by the courts and not the jury.
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For more information about the issues covered in this report, please contact Brienne Wesolek in our San Francisco office at 415-369-7769 or at bwesolek@thelen.com or contact your Thelen attorney. For more information about Thelen’s Construction and Government Contracts Department, click here.
©2008 Thelen Reid Brown Raysman & Steiner LLP
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