Daily Development for Thursday, July 3, 2008=20
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC=20 School of Law
Of Counsel: Husch Blackwell=20 Sanders
Kansas City, Missouri=20

This DD is based upon a report by Liskow and Lewis: =20 www.liskow.com: Harold J. Flanagan;   William W. Pugh; and Kevin J.=20 Connolly.  It=E2=80=99s not exactly real estate law, but insurance against punitive=20 damages, is, in the modern era, a question near and dear to the hearts of all=20 real estate investors.   As is his wont, the editor has savagely=20 edited and rewritten the original report, including the comments, but has tried=20 to retain substance.

INSURANCE; PUNITIVE DAMAGES: Texas court wrestles with=20 question of whether public policy permits arrangements by which commercial=20 parties insure themselves against punitive damages for gross=20 negligence.

Fairfield Insurance Company v. Stephens Martin Paving, LP,=20 246 S.W.3d 653 (Tex. 2008)

The Texas Supreme Court (upon referral from the federal=20 Court of Appeals for the Fifth Circuit) considered whether Texas' public policy=20 prohibits a "liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence." The court=20 answered this question in the negative by narrowly holding that exemplary=20 damages are insurable under workers' compensation and employers' liability=20 policies. Rather than clearing the air, the court's long awaited opinion actually raises more questions about the insurability of punitive=20 damages.

An employee died as a result of injuries sustained when road=20 construction equipment he was operating rolled over. His employer, carried a=20 workers' compensation and employers' liability insurance policy. The employee's=20 survivors brought suit against the employer alleging gross negligence, seeking=20 relief outside the workers' compensation policy. The employer=E2=80=99s insurer took the=20 position that it did not owe sued a duty to defend or indemnify the employer for=20 exemplary damages based upon gross negligence, and sued to assert its position=20 in federal court.  The federal district court concluded that the language=20 in the policy covered exemplary damages and that the public policy of Texas did=20 not prohibit insurance coverage for those damages, and ordered defense, and if=20 applicable, indemnification.. The insurer appealed, and the U.S. Fifth Circuit=20 certified the broad question of the insurability of punitive damages for gross=20 negligence to the Texas Supreme Court.

For purposes of its analysis, the Texas Supreme Court=20 assumed that the policy provided coverage for the exemplary damages sought in=20 the underlying suit. It  limited its discussion to the second prong of the=20 analysis and presumed that the policy language covered the exemplary damages=20 sought.

The court first analyzed the context in which the relevant=20 legislative background, concluding that the Texas legislature had spoken on the=20 issue with respect to the workers' compensation statutes and the Texas=20 Department of Insurance's execution of those statute.  The court determined=20 that the Legislature clearly intended to provide for and to allow additional=20 insurance coverage for an employer's gross negligence. This, in fact, ended the=20 inquiry, since the legislature=E2=80=99s determination of public policy was=20 dispositive. 

But the court  recognized that the Fifth Circuit framed=20 its certified question as a broad inquiry into Texas public policy concerning=20 coverage for exemplary damages. Although hesitant to opine on policy language=20 and fact situations not before the court, it did continue to discuss other=20 circumstances where the insuring of punitive damages might violate Texas public=20 policy. First, the court cited a variety of examples where the Legislature had=20 taken action and explicitly prohibited an insurer from payment of punitive=20 damages. Second, the court expressed concern that the insurability of punitive=20 damages in some other contexts might violate public policy, even if not=20 expressly prohibited by the Legislature. For instance, the court noted that=20 coverage for exemplary and punitive damages in the uninsured and underinsured=20 motorist context might be against public policy given that the uninsured motorist would not be punished for his recklessness and that such payment would,=20 in practice, be

 made by all of the policyholders in the state. Thus,=20 the court recognized the deterrent effect of punishing a party by punitive=20 awards, and expressed concern that transferring these costs to an insurer could=20 defeat their purpose. Ultimately, the high Court left open many questions about=20 the limits of insuring against such damages.

Reporters=E2=80=99 Comment 1:  Whether other states will adopt=20 the narrow holding of this case - applicable to worker=E2=80=99s compensation=20 situations, depends, of course on the language of the statutes in those=20 states. 

Reporters=E2=80=99 Comment 2: But what about the broader policy=20 issue?  As the Texas Supreme Court stated, freedom to contract is a major=20 consideration in resolving disputes over the insurability of punitive damages.=20 How far this freedom runs, however, is still unclear. In some insurance=20 agreements, insurers and their policyholders explicitly bargain for and agree to=20 include coverage for punitive damages. But, in many instances there are no=20 explicit contractual terms demonstrating the specific intent to insure such=20 damages. Regardless, even if the policy clearly provides coverage for punitive=20 awards, state law or public policy may explicitly or implicitly prohibit coverage for certain types or categories of such awards.

For example, even if punitive damages based on vicarious=20 liability are insurable under this decision, awards based on direct liability=20 may not be. The Texas court clearly noted that the purpose of exemplary damages=20 is to punish the wrongdoer and to deter similar behavior. This purpose could be=20 frustrated by allowing the penalty to be shifted to a third party through=20 insurance. An offender who can "pass the buck" for his wrongdoing to an insurer=20 arguably does not directly suffer the loss and therefore might not be=20 sufficiently deterred from repeating his behavior. For this reason, although=20 sometimes making an exception for vicarious liability, California, Florida,=20 Massachusetts, and New York, to name a few, have strictly prohibited the insuring against punitive damages that are directly assessed against a=20 policyholder.

Reporters=E2=80=99 Comment 3:  Likewise, even if punitive=20 damages based on gross negligence are insurable, it is still unclear what this=20 means for awards based on other standards such as fraud, malice, or reckless,=20 willful or intentional conduct. The standard in the instant case was based on=20 gross negligence. The court did not address whether it would violate public=20 policy to insure an award of punitive damages based on some other standard of=20 conduct. Further, the meaning of these standards is often undefined and may=20 differ based on a state's common law and statutory provisions.

For instance, would it be permissible to insure conduct so=20 reckless as to demonstrate a substantial lack of concern for whether an injury=20 would result? If so, is it also permissible to insure a course of action that=20 shows an actual or deliberate intention to cause harm? Generally, such conduct=20 is expressly excluded. But whether or not excluded, it is not an insurable event=20 because it is not fortuitous. At least where actual intent is at issue, there=20 clearly are open questions as to whether claims for punitive damages would be=20 insurable, even under facts very similar to this case and even in Texas.

Items reported here and in the ABA publications=20
are for general information purposes only and=20
should not be relied upon in the course of=20
representation or in the forming of decisions=20 in
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