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January 4, 2002 - Paying Excess Verdict Won't End Bad Faith Claim Against Insurer

An insurer's payment of excess damages does not extinguish an insured's cause of action for bad faith refusal of coverage, a divided state Supreme Court has decided. Under the rule announced by the high court last week, insurance companies cannot avoid liability for bad faith by agreeing to pay damage awards in excess of coverage limits.

A five-justice majority of the high court, in affirming a Superior Court decision in the case, The Birth Center v. St. Paul Cos., was led by Justice Sandra Schultz Newman. The Superior Court had reversed a Delaware County trial court's order setting aside a jury verdict in favor of the insured on the ground that the insurer had paid the excess award. In The Birth Center, the majority rejected the position that an insurance carrier's payment of excess damages on behalf of its insured obviated any possible claim of bad faith. "The fact that the insurer's intransigent failure to engage in settlement negotiations forced it to pay damages far in excess of the policy limits ... does not insulate the insurer from liability for its insured's compensatory damages where the insured can prove that the insurer's bad faith conduct caused the damages," Newman wrote.

The Birth Center was accused of negligence in a complaint filed in 1986 by parents who alleged that their daughter suffered physical injuries and brain damage during childbirth. The St. Paul Cos. insured The Birth Center under a professional liability policy with a $1 million limit. The insurance carrier refused to settle the case or make an offer of settlement before trial.

In March 1993, a jury returned a verdict setting The Birth Center's liability at $4.3 million and fixing the plaintiff's damages at $7.1 million. In September of that year, St. Paul agreed to indemnify The Birth Center for its excess liability and settled the case for $5 million. Even after the settlement, The Birth Center refused to sign a release that would have freed St. Paul from bad faith liability and then proceeded to file a lawsuit alleging that it breached its implied covenant of good faith.

A Delaware County jury in 1996 found by clear and convincing evidence that St. Paul acted in bad faith and that its actions were a substantial factor in exposing The Birth Center to liability in excess of its insurance coverage. The jury heard evidence that St. Paul refused to settle even after three judges had encouraged the insurer to tender a settlement. There was also evidence at trial that a St. Paul claims representative said the company tries "all of these bad baby cases, and we're going to trial."

Common Pleas Judge George Koudelis, however, entered judgment notwithstanding the verdict, concluding that the insurer's agreement to pay the excess verdict nullified the insured's bad faith claim. But the Supreme Court majority agreed with the Superior Court that payment of an excess verdict does not preclude an award of compensatory damages connected to the insurer's bad faith.

That is partly because the insurer, in paying the excess damage award, was doing so only to avoid a future finding of punitive damages, Newman said. "St. Paul did not pay the excess verdict out of the goodness of its heart," Newman wrote. "It had reason to believe that The Birth Center was going to sue for bad faith and it knew that if it were found to have acted in bad faith, it would be liable for punitive damages as well as the amount of the excess verdict." The bad faith pre-dating the payment of excess damages, Newman said, was a substantial factor in causing The Birth Center to sustain the excess damage award.

The majority added that the insured party may demonstrate that it has suffered liability stemming directly from the insurer's bad faith. The payment of the excess verdict, therefore, does not obviate all damages on the part of the insured. "When an insurer breaches its insurance contract by a bad faith refusal to settle a case, it is appropriate to require it to pay other damages that it knew or should have known the insured would incur because of the bad faith conduct," Newman wrote. The decision of the high court reinstates the $700,000 jury award handed down by the Delaware County trial jury. The jury verdict did not specify whether the award was for compensatory damages. Lawyers on opposite sides of the case differed as to the practical effect of the Supreme Court's pronouncement.

"It was always our position that if the court went this way, it would discourage insurers from paying excess damages, and would encourage insureds to [try to] prove bad faith," said Carl D. Buchholz III of Rawle & Henderson, who represented St. Paul before the high court. "The majority rejected that theory and stated that it would encourage insurers to pay excess judgments. That's the great unknown of this decision." Michael R. Bradley of Brooks Bradley & Kenney in Delaware County, who was co-counsel of record to The Birth Center, said that the effect of the high court ruling would be to promote settlements, not deter them.

Bradley pointed out Newman's observation that the excess damages were paid by St. Paul to avoid exposure to punitive damages, but left open the possibility of liability for breach of contract under common law. The late John Brooks of Brooks Bradley & Kenney argued the case for The Birth Center before the Supreme Court in October 2000.

Newman also said that Section 8371, the bad faith statute, doe not prohibit the award of compensatory damages that had been available under common law. St. Paul had argued that the enactment of Section 8371 pre-empted common law remedies for bad faith refusal to provide coverage. The statute, Newman reasoned, "merely provides an additional remedy and authorizes the award of additional damages.

"Section 8371 provides for 'special damages,'" Bradley said. He added that special damages are provided in addition to common law rights. "The statute was not meant to decrease existing remedies but to add to them," he said. Buchholz said that the bad faith statute pre-empted previous regulation of bad faith liability. Since Section 8371 permits punitive damages but not compensatory damages, "it is hard to say that common law contract claims still survive." The dissenters agreed that contract damages are unavailable for bad faith refusal to provide coverage.

Justice Stephen A. Zappala wrote that under the statute, the cause of action is akin to a tort claim. Therefore, the only damages available to The Birth Center would have been the excess verdict itself, interest, punitive damages, court costs and attorney fees.

Justice Ronald D. Castille joined Zappala's dissent. But Justice Russell M. Nigro, in a concurring opinion, said that compensatory damages are available, since a bad faith claim is akin to a breach of contract cause of action. A bad faith cause of action alleging that an insurer breached an implied contractual duty to consider the insured's claims in good faith is a contract claim, Nigro said. A statutory bad faith claim may sound in tort, but contract damages may still be recovered where the insured alleges a breach of a contractual duty.

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