November 1, 2013
By Kyle E. Hart
Ignorance is bliss. Punitive damages are not. Unfortunately, many contractors blissfully assume that if they are held liable for punitive damages, then their liability insurance will cover them. That may or may not be the case. Determining whether a contractor has coverage for punitive damages is a two-step process. First, you must analyze the applicable policy. If there is coverage, then the next step is to determine whether coverage is prohibited as a matter of public policy.
Many insurance policies exclude punitive damages, or are ambiguous about whether they are covered. If the policy expressly excludes coverage for punitive damages, then the analysis is over; there is no coverage. If the policy is ambiguous or silent, then there may or may not be coverage, depending on the applicable law. In most states, the courts have held that a reference to “damages” is broad enough to include punitive damages, as well as compensatory damages. However, a few courts disagree. These courts focus on the phrase “damages because of ‘bodily injury’ or ‘property damage’” that are a part of all liability policies and reason that punitive damages, which are intended to punish and deter, rather than to compensate for injury or damage, do not fit with the scope of the policy.
Usually, punitive damages are awarded only if there has been proof of intentional bad acts, and most insurance policies also exclude coverage for damages caused by intentional acts of the insured. This is usually accomplished by a straight-forward exclusion or by defining an “occurrence” to exclude damages that are “expected or intended from the standpoint of the insured.” If the conduct that caused the damages was intentional, then any damages related to that conduct is excluded, including both compensatory and punitive damages.
Unfortunately, even if there is nothing within the four corners of the insurance policy excluding coverage for punitive damages, the analysis is not over. For public policy reasons, many states (including Minnesota and North Dakota) prohibit insurance coverage for directly assessed punitive damages, based on the notion that allowing coverage would defeat the purpose of punitive damages (i.e., punishment and deterrence). Other states allow for insurance coverage of punitive damages, so long as the applicable insurance policy does not exclude coverage. Because of the conflicting law, choice of law issues are important. To complicate matters, most insurance policies do not include a provision that requires a court to apply the law of any particular state. Therefore, when faced with a claim for punitive damages, you need to evaluate the best “potentially applicable law” and jurisdiction to commence a lawsuit to determine whether there is insurance coverage. Oftentimes, the jurisdiction of the underlying lawsuit in which the Plaintiff is seeking punitive damages is not the best jurisdiction to commence the coverage lawsuit.
For example, in a recent case, one of our contractor clients was faced with a frightening punitive damage claim in a Pennsylvania court arising out of an accident in Pennsylvania, where direct punitive damages are, as a matter of public policy, not covered by insurance. Instead of commencing the coverage dispute in Pennsylvania and applying Pennsylvania law, we commenced a lawsuit in Arizona, where our client’s offices were located, where the truck involved in the accident was licensed, where our client’s insurance contract was formed, and where punitive damages can be covered by insurance. Ultimately, our contractor client was able to convince its insurer to settle with the Plaintiff to avoid the risk of having to pay punitive damages.
In addition to finding a jurisdiction with favorable law, insurance coverage for punitive damages can depend on whether the damages are “direct” or “vicarious.” In this regard, even in states that prohibit insurance coverage of “direct” punitive damages (i.e., for conduct sanctioned by upper management), they may allow coverage for “vicarious” liability (i.e., liability for the acts of rank and file employees, subcontractors, etc.).
So, what is a contractor to do? First, talk with your insurance broker/agent and your attorney. They can audit your insurance policies to determine whether they expressly provide coverage for punitive damages. If not, then they can assist you in obtaining a punitive damage endorsement. Be sure to review all of your policies, including your pollution, professional and umbrella policies. Many insurers of these policies are willing to negotiate coverage for punitive damages – if you ask! If you reside and perform most of your work in a state that prohibits insurance coverage for punitive damages, you can increase your odds of obtaining coverage by obtaining an explicit endorsement providing for coverage and agreeing with your insurance company that coverage disputes will be decided in a favorable jurisdiction and/or be decided by applying a favorable state’s laws. This type of clause is referred to in the insurance industry as a “most favorable jurisdiction” clause. Care should be taken to pick a jurisdiction and state with favorable law, but also some connection to the contractor, insurance company or place of work, because a court might refuse to enforce the clause if the contractor, insurance company and claim have no connection with the chosen jurisdiction or law.
Finally, it is possible to purchase a punitive damages “wrap” policy from the off-shore market (i.e., Bermuda). These policies are costly, but they can provide a contractor with coverage for punitive damages that is not subject to the vagaries of the United States court system.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © 2013 FWH&T