MATTHEW EISELE

HOUSTON

J. STEVENSON WEIMER

HOUSTON

Chapter 22

COVERAGE OF LIABILITY

FOR PUNITIVE DAMAGES

I. THE INSURING AGREEMENT

The insuring agreement in the marine Protection and Indemnity Form SP-23 provides that the assured will be indemnified against "all such loss and/or damage and/or expense" which the assured shall "become liable to pay and shall pay on account of the liabilities, risks, events and/or happenings" covered. Absent an express exclusion, the only provision which arguably could affect the coverage of punitive damages is that certain "fines and penalties" will not be indemnified if they result from the failure of the insured to exercise due diligence to prevent such "violations." Though this language perhaps indicates an intention to exclude indemnification of punitive damages, it is not likely to be dispositive under existing law.

II. CHOICE OF LAW: THE INITIAL QUESTION

State law may be referred to when there is no rule recognized by the general maritime law on the issue, and the matter does not require national uniformity. Wilburn Boat Co. v. Fireman's Fund Ins. Co., 348 U.S. 310,316 (1955); Commodities Reserve Co. v. St. Paul Fire& Marine Ins. Co., 879 F.2d 640 (9th Cir. 1989). Admiralty law provides the choice of law principles governing the determination of which state's law will be applied. Ahmed v. American Mut. S.S. Owners Protection & Indem. Ass'n, 444 F. Supp. 569, 571 (N.D. Cal. 1978); Navegacion Goya SA. v. Mutual Boiler & Mach. Ins. Co., 1972 A.M.C. 650, 653 (S.D.N.Y. 1972). Admiralty courts apply the "greatest interest" rule in deciding which state's or nation's law might be applicable. Coats v. Penrod Drilling Corp., 5 F.3d 877 (5th Cir. 1993); Commodities Reserve Co. v. St. Paul Fire and Marine Ins. Co., 879 F.2d 640 (9th Cir. 1989); Eagle Leasing Corp. v. Hadfield Fire Ins. Co., 540 F.2d 1257, 1261 (5th Cir. 1976) (applying law of state where policy issued and delivered); Irwin v. Eagle Star Ins. Co., 455 F.2d 827, 830 (5th Cir.) (substantial contacts with Florida), cert. denied, 409 U.S. 852 (1972); Liman v. American S.S. Owners Mut. Protection & Indem. Ass'n, 299 F. Supp. 106,108 (S.D.N.Y.), aff'd 417 F.2d 627 (2d Cir. 1969), cert. denied, 397 U.S. 936 (1970). See also RESTATEMENT (SECOND) OF CONFLICT OF LAWS § 188 (1969). See generally D. GILMORE & C. BLACK, THE LAW OF ADMIRALTY 69 (2d ed. 1975).

A small body of case law has held that P&I coverage would not be afforded where punitive damages were awarded, based upon an absence of such specifically enumerated coverage in the policy. Dubois v. Arkansas Valley Dredging Co., 651 F. Supp. 299 (W.D. La. 1987); Smith v. FrontLawn Enterprises, Inc., 1987 AMC 1130 (E.D. La. 1986). In Smith the court also noted that the "fines and penalties" provision of the P&I policy "covers situations where there has been a violation of a law and is therefore inapplicable to . . . punitive damage claims based on unseaworthiness and failure to pay maintenance and cure." 1987 AMC at 1131.

The Dubois court went further, declaring that even if a policy provided for coverage in express terms, such a provision would be unenforceable as against public policy. Dubois, 651 F. Supp. at 302. But see Daughdrill v. Ocean Drilling & Exploration Co., 665 F. Supp. 477, 481 (E.D. La. 1987) (court stated in dicta that because the inherent nature of a P&I policy is to spread the risk of liability among those similarly situated, coverage for punitive damages may foster the underlying public policy goals of such damages). However, the determinative impact of choice of law limits the significance of Dubois and Smith. See Taylor v. Lloyd's Underwriters of London, 972 F.2d 666, 669 (5th Cir. 1992) (interpreting the issue of whether punitive damages are covered by a CGL policy the Court held that Dubois and Smith have not established a specific and controlling federal rule disallowing the recovery of punitive damages from an insurance company) and Randall v. Chevron U.S-4., Inc., 13 F.3d 888, 910 (5th Cir.) as modified, 22 F.3d 568 (5th Cir. 1994), overruled on other grounds, 164 F.3d 901 (5th Cir. 1999), (applying Louisiana law in the absence of a controlling federal rule, punitive damages and the cost of defending a punitive damage claim are covered under a P&I policy). Because of Wilburn Boat and choice of law principles, public policy and the interpretation of policy language remain the dispositive factors in deciding whether coverage exists.

III. INTERPRETATION OF POLICY LANGUAGE

At the outset, a determination must be made whether the policy language is broad enough to encompass punitive damages. Courts have divided on this issue with regard to standard liability provisions. Generally, courts have seized upon language insuring "all sums" or "any losses" when coverage has been granted. See, Ridgway v. Guy"Life ]ns. Co., 578 F.2d 1O26, 1029 (5th Cir. 1978) (applying Texas law); General Cas. Co. v. Woodby, 238 F.2d 452, 457-58 (6th Cir. 1956) (applying Tennessee law); Ohio Cas. Ins. Co. v. Weyare Fin. Co., 75 F.2d 58, 59 (8th Cir. 1934) (applying Missouri law), cert. denied, 295 U.S. 734 (1934); Greenwood Cemetery, Inc. v. Travelers Indem. Co., 232 S.E.2d 910 (Ga. 1977); Abbie Uriguen Oldsmobile Buick, Inc. v. United States Fidelity Ins. Co., 511 P.2d 783, 789 (Idaho 1973); Norfolk & W. Ry. Co. v. Hartford Accident & Indem. Co., 420F. Supp. 92, 95 (N.D. Ind. 1976) (applying Indiana law); Skyline Harvestore Systems, Inc. v. Centennial Ins. Co., 331 N.W.2d 106,107 (Iowa 1983); Continental Ins. Co. v. Hancock, 507 S.W.2d 146,152 (Ky. 1974); Harrel. Travelers Indem. Co., 567 P.2d 1013,1014-15 (Or. 1977); State v. Glen Falls Ins. Co., 404 A.2d 10 1, 105 (Vt. 1979); Cieslewicz v. Mutual Serv. Cas. Ins. Co., 267 N.W.2d 595, 597-98 (Wis. 1978).

However, a minority of courts have looked to the scope of the covered risk to decide whether punitive damages are recoverable by the insured. Thus, language following the terms "caused by" or "arising out of" has been used to limit policy coverage to purely compensatory damages. Punitive damages are deemed by these courts to be a result of the insured's conduct, not the damages sustained by the injured person. Gleason v. Fryer, 491 P.2d 85 (Colo. Ct. App. 1971); Brown v. Western Cas. & Sur. Co., 484 P-2d 1252 (Colo. Ct. App. 197 1); Casperson v. Webber, 213 N.W.2d 327, 331 (Minn. 1973). The rationale for this position is grounded on the notion that punitive awards are not granted to compensate the plaintiff; rather, such awards are intended to punish the defendant. Consequently, punitive damages are held to fall outside of the category of damages for bodily injury or property damage.

Other courts have looked to the intentions or reasonable expectations of the insured in order to extend or deny coverage. Lazenby v. Universal Underwriters Ins. Co., 383 S.W.2d 1, 5 (Tenn. 1964). Such cases often involve an ambiguity as to the scope of coverage. Harrel v. Travelers Indem. Co., 567 P.2d 1013,1015 (Or. 1977); Cieslewiczv. MutualServ. Cas. Ins. Co., 267N.W.2d 595, 598 (Wis. 1978). In any event, it is clear that reasonable expectations would not include coverage for damages resulting from intentional misconduct. 7 J. APPLEMAN, INSURANCE LAW AND PRACTICE § 4312 at 132-33 (1962). Cf Hensley v. Erie Ins. Co., 283 S.E.2d 227 (W. Va. 1981) (coverage implied for gross, wanton or reckless conduct).

When litigation involves an ambiguous policy, courts have applied a rule of interpretation that such ambiguities are construed in favor of the insured. W. VANCE HANDBOOK OF THE LAW OF INSURANCE § 136 (3rd ed. 195 1) (discussing doctrine of contra proferentum). See Abbie Uriguen Oldsmobile Buick, Inc. v. United States Fire Ins. Co., 511 P.2d 783, 7 8 9 (Idaho 1973); Mazza V. Medical Mut. Ins. Co., 319 S.E.2d 217 (N.C. 1984); Carroway v. Johnson, 139 S.E.2d 908 (S.C. 1965). For example, an ambiguity may arise from the rule that unless actual damages are sustained, punitive damages may not be awarded. Therefore, punitive damages "arise out of" or are "caused by" bodily injury or property damage. This interpretation of course gives "bodily injury" and property damage" a double meaning within the policy. Cieslewicz v. Mutual Serv. Cas. Ins. Co., 267 N.W.2d 595 (Wis. 1978). Traditionally, admiralty cases have applied state insurance law principles of contra proferentum in construing maritime policies. See Thomas R. Beer, Comment, Established Federal Admiralty Rules In Marine Insurance Contracts and the Wilburn Boat Case, 1 U.S.F. MAR. L. J. 149 (19 89). See also Morrow Crane Co. v. Affiliated FM Ins. Co., 6 8 6 F. Supp. 265, 267-68 (D. Or. 1987), aff d, 885 F.2d 612 (9th Cir. 1989); Ingersoll Mill, Mach. Co. v. M/V BODENA, 619F. Supp.493,505 (S.D.N.Y. 1985) (applying New York law) modified, 829F.2d 293 (2d Cir. 1986).

Nevertheless, not al1jurisdictions will automatically apply the doctrine of contra proferentum when policy provisions are susceptible to different constructions. See Baltimore Bank & Trust Co. v. United States Fidelity & Guar. Co., 43 6 F.2d 743, 746 (8th Cir. 1971) (applying Missouri law). When commercial insurance contracts are involved, courts will consider a construction that "is most reasonable from a business point of view. " 9 ARNOULD, MARINE INSURANCE § 105 at 88 (1961 ed.). See also Avondale Indus., Inc. v. Travelers Indem. Co., 8 87 F.2d 1200, 1207 (2d Cir. 1989), cert. denied, 496 U.S. 906 (1990).

IV. PUBLIC POLICY

Once coverage has been established, a second inquiry is necessary to determine whether such an application is void under state law. Some courts have denied insurance coverage of punitive damages on the grounds that such coverage contravenes the public policy of the jurisdiction. Dubois v. Arkansas Valley Dredging, Inc., 651 F. Supp. 299 (W.D. La. 1987). See GHIARDI & KiSCHER, PUNITIVE DAMAGES LAW & PRACTICE, § 6.11 (1984). Cf SHAUMAIER & MCKINSEY, THE INSURABILITY OF PUNITIVE DAMAGES, 72 A.B.A.J. 68 (1986). To allow coverage is thought to frustrate the public's interest in punishing or deterring extreme misconduct. Hartford Accident & Indem. Co. v. Hempstead, 397 N.E.2d 737, 743 (N.Y. 1979); Padavan v. Clemente, 350 N.Y.S.2d 694, 696 (N.Y. App. Div. 1973). However, this view is not universally accepted. Courts have generally divided along the following categories:

(1) Coverage denied as a matter of public policy;

(2) Coverage denied, except for the vicarious liability of the insured;

(3) Coverage not barred by public policy; and

(4) Coverage allowed, except for intentional misconduct.

1. Coverage Denied as a Matter of Public Poligy.

Some jurisdictions flatly hold that public policy forbids the coverage of punitive damages. Variety Farms, Inc. v. New Jersey Mfrs. Ins. Co., 410 A.2d 696 (N.J. 1980). In these jurisdictions it is unnecessary to apply contractual interpretation principles to reach a conclusion as to coverage. Such coverage is void as a matter of law. Moreover, the prohibition of insuring against punitive damages is applicable whether the insured's liability results from his own acts or those of his servant. Hartford Accident & Indent. Co. v. Hempstead, 397 N.E.2d 737 (N.Y. 1979). Several other decisions have followed this approach. See e.g.,; City Prod. Corp. v. Globe Indent. Co., 151 Cal. Rptr. 494 (Cal. 1979); Newark v. Hartford Accident & Indent. Co., 342 A.2d 513 (N.J. 1975); American Ins. Co. v. Saulnier, 242 F. Supp. 257, 261 (D. Conn. 1965).

Courts taking this view contend that allowing tortfeasors to shift the burden of punitive damages to the insurer would defeat the purpose of such awards: deterrence. If entities are permitted to insure against punitive damages, these courts reason, then the deterrence effect of such damages would be nullified. Dubois v. Arkansas Valley Dredging Co., Inc., 651 F. Supp. 299, 302-03 (N.D. La. 1987) (seaman could not recover punitive damages from dredge operator's insurer).

This view has met with some resistance from legislatures, however. Several courts have adopted the view that insurance coverage of punitive damages is contrary to public policy, only to have their holdings superseded by state legislatures. See, eg., Northwestern Nat. Cas. Co. v. McNulty, 307 F.2d 432, 434-35 (5th Cir. 1962), superseded by statute Va. Code Ann. §3 8.1-42.1 (Michie 1999); Guarantee Abstract & Title Co. v. Interstate Fire & Cas. Co., 618 P.2d 119 5 (Kan. 1980), overruled on other grounds, 652 P.2d 665 (Kan. 1982), superseded by statute, Kan. Stat. Ann. §40-2,115 (1999). American Sur. Co. v. Gold, 375 F.2d 523, 526 (1Oth Cir. 1966), superseded by statute, Kan. Stat. Ann. §40-2, 115 (1999).

2. Coverage Denied, Except for the Vicarious Liability of the Insured.

The line of analysis that coverage should be denied for public policy reasons has, in many jurisdictions, given way to an exception for the vicarious liability of the insured. Grant v. North RiverIns. Co., 453 F. Supp. 1361, 1370 (N.D. Ind. 1978) (applying Indiana law);. Dorsey v. Honda Motor Co., 655 F.2d 650 (5th Cir. 1981) (applying Florida law after McNulty), modified on other grounds, 670 F.2d 21 (5th Cir.), cert. denied, 103 S. Ct. 177 (1982). The rationale for this exception is the same one asserted to deny coverage--only the wrongdoer should be held accountable. Courts recognizing this exception allow coverage when the insured is not the "active wrongdoer." Travelers Ins. Co. v. Wilson, 261 So. 2d 545, 548 (Fla. App. 1972). In these situations, the courts acknowledge that the insured is not personally at fault; rather, the insured is held vicariously liable for another's wrongfid conduct. U.S. Concrete Pipe Co. v. Bould, 437 So. 2d 1061 (Fla. 1983); Country Manors v. MasterAntenna Systems, 534 So. 2d 1187, 1192 (Fla. App. 1989). Thus, when an insured is held liable for punitive damages arising out of an employee's act, it will be granted coverage unless it is guilty of gross negligence in failing to discharge the employee. Dayton Hudson Corp. v. American Mut Ins. Co., 621 P.2d 1155 (Okla. 1980) (applying the doctrine of respondeat superior). The relevant inquiry is whether there are any direct acts of the insured leading to the plaintiffs injuries.

If the insurer denies coverage, it has the burden of proving that the jury's award was not predicated on the vicarious liability of the insured. Morrison v. Hugger, 369 So. 2d 614 (Fla. App. 1979).

Several other decisions have followed this exception. Norfolk & W. Ry. Co. v. Hartford Accident & Indem. Co., 420 F. Supp. 92, 95 (N.D. Ind. 1976) (applying Indiana law); Commercial Union Ins. Co. v. Reichard, 404 F.2d 868 (5th Cir. 1968) (applying Florida law); Ohio Cas. Ins. Co. v. Weyare Fin. Co., 75 F.2d 58 (8th Cir. 1934) (applying Missouri law). See generally Southern American Ins. v. Gabbert Jones, Inc., 769 P.2d 1194 (Kan. App. 1989).

V. COVERAGE ALLOWED

A growing majority of courts have rejected the policy argument set forth in McNulty, and allow coverage for punitive damage liability. See Burrel & Young, Insurability of Punitive Damages, 62 MARQ. L. REV. 1, 18 (1978). The leading case advancing this view is Lazenby v. Universal Underwriters Ins. Co., 383 S.W.2d I (Tenn. 1964). The Lazenby court noted the importance ofpunishing and deterring grievous misconduct, but concluded that punitive awards were not successful at meeting these objectives. Thus, there was little reason to preclude the insuring of punitive damages. Under this approach, it would be hard to justify an award of punitive damages regardless of the availability of insurance. It is apparent that this result was reached through a balancing of public policy and contract principles. See also Universal Ins. Co. v. Tenery, 3 9 P.2d 776, 779 (Colo. 1934) (balancing contract interests with public policy).

Other cases have stated that a contract should be upheld unless it had a tendency to promote wrongful acts. Harrell v. Travelers Indem. Co., 567 P.2d 1013, 1016-17 (Or. 1977). This view proceeds from a belief that deterrence is not furthered by denying coverage. Therefore, as long as insuring punitive damages is not shown to promote extreme misconduct, there is no compelling reason to hold such agreements invalid. Moreover, Harrel recognized that such contracts do not shift the burden of punitive damages to the insurer because an extra premium for such coverage should be charged. Id. at 10 19-20. Lastly, it was noted that the exposure to punitive damages may arise in a wide variety of activities, and often includes normal business risks. The court concluded that a sweeping rule of noninsurability would be unreasonable and burdensome.

One court has adopted a position that ifthe policy language is approved by the state insurance commission, then it is not violative of any public policy. Dairyland County Mut. Ins. Co. v. Wallgren, 477 S.W.2d 341 (Tex. Civ. App.--Fort Worth 1972).

Those cases that have found no public policy prohibiting insurance that covers punitive damages include the following: Colson v. Lloyd's ofLondon, 435 S.W.2d 42 (Mo. Ct. App. 1968); Valley Forge Ins. Co. v. Jefferson, 628 F. Supp. 502 (D. Del. 1986); Fagot v. Ciravola, 445 F. Supp. 342 (E.D. La. 1978); Price v. HarffordAccident & Indent. Co., 108 Ariz. 485, 502 P.2d 522 (1972); State v. Sanchez, 119 Ariz. 64, 579 P.2d 568 (1978, App.); Whalen v. On-Deck, Inc., 514 A.2d 1072 (Del. 1986); Greenwood Cemetery, Inc. v. Travelers Indent. Co., 238 Ga. 313, 232 S.E.2d 910 (1977);Abbie Uriguen Oldsmobile Buick Inc. v. UnitedStates Fire Ins. Co., 95 Idaho 501, 511 P.2d 783 (1973); Cedar Rapids v. Northwestern Nat Ins. Co., 304 N.W.2d 228 (Iowa 198 1) overruled on other grounds, 440 N.W.2d 377 (Iowa 1989); First Natl Bank v. Fidelity & Deposit Co., 283 Md. 228, 389 A.2d 359 (1978); Anthony v. Frith, 394 So. 2d 867 (Miss. 1981); First Bank (NA.) v. Transamerica Ins. Co., 679 P.2d 1217 (Mont. 1984); Mazza v. Medical Mut. Ins. Co., 311 N.C. 621, 319 S.E.2d 217 (1984); Brown v. Maxey, 369 N.W.2d 677 (Wis. 1985); Sinclair Oil Co. v. Columbia Cas. Co., 682 P.2d 975 (Wyo. 1984).

VI. COVERAGE ALLOWED EXCEPT FOR INTENTIONAL TORTS

Within those jurisdictions which hold that there is no public policy bar to coverage of punitive damages, some jurisdictions except cases of intentional misconduct. Such jurisdictions reason that punitive damages awarded from incidents occurring due to gross negligence can be covered because such incidents can be classified as accidents, and may be part of the cost of doing business. However, such courts reason, intentional torts are by definition not accidents, and should not be viewed as a cost of business. Therefore, public policy prevents coverage of punitive damages arising from intentional torts. See Southern Farm Bureau Casualty Ins. Co. v. Daniels, 246 Ark. 849, 440 S.W.2d 582 (1969); Continental Ins. Cos. v. Hancock, 507 S.W.2d 146 (Ky. 1973); Harrell v. Travelers Indem. Co., 279 Or. 199, 567 P.2d 1013 (1977); Lazenby v. Universal Underwriters Ins. Co., 214 Tenn. 639,383 S.W.2d I (1964); Hensley v. Erie Ins. Co., 283 S.E.2d 227 (W. Va. 1981).

In at least one case, however, this view has been specifically rejected. In St. Paul Mercury Ins. Co. v. Duke University, 670 F. Supp. 630 (M.D.N.C. 1987) (applying North Carolina law), the district court held that North Carolina public policy prevented insurance coverage of punitive damages awarded for intentional torts. The Fourth Circuit disagreed, holding that there was no such public policy prevention, and holding that Duke University was covered by its insurance policy for punitive damages arising out of intentional torts. St. Paul Mercury Ins. Co. v. Duke University, 849 F.2d 133 (4th Cir. 1988).

VII. CONCLUSION

In general, the question of whether a standard form P&I policy (without a specific exclusion) covers punitive damages will be determined under applicable state law, including the particular public policy (if any) of the former state and the state whose law is applicable to the contract of insurance. If insurers do not wish their policies to be construed to cover punitive damages, a specific exclusion should be written into the policy or added by a clearly worded endorsement within the policy. See The Insurability of Punitive Damages: A New Solution to an Old Defense, 16 WAKE FORREST L. REV. 345 (1980). See also APPLEMAN, INSURANCE LAW PRACTICE 4312; COUCH, INSURANCE, Vol. 15A § 56. 1.