Coverage for Punitive Damages: The Debate Rages
The debate over liability insurance coverage for punitive damages has ebbed and flowed for many years, but over the last 4 weeks in Texas it has reached an unprecedented pitch. In early June, the Fifth Circuit Court of Appeals issued its opinion in American International Specialty Lines Ins. Co. v. Res-Care, Inc.,--- F.3d ----, 2008 WL 2232089 (5th Cir. 2008), and the decision has subsequently received significant attention from the plaintiffs' bar for its potential impact on the availability of liability insurance coverage for punitive damages in Texas. The debate was fueled by Res-Care because several weeks earlier the Texas Supreme Court ruled in a workers compensation coverage case that in the context of workers comp claims, punitive damages were covered under an EL/WC policy. The policyholder and carrier "camps" have since engaged in a highly publicized war of words over the last month as to the true state of the law in Texas on this critical issue. The debate wont be resolved anytime soon.
In Res-Care, the Fifth Circuit found that the liability policy at issue did not cover punitive damages under the facts before it as a matter of public policy. The dispute in that case involved the insurer's right to reimbursement after it settled both covered and uncovered claims against the insured under a non-waiver agreement. The trial court refused to allow coverage for punitive damages under the primary policy (which was silent as to such coverage for punitive damages). The excess policy, on the other hand, expressly excluded coverage for punitive damages.
In its well-reasoned treatment of the issues, the Fifth Circuit looked to the Texas Supreme Court’s recent decision in Fairfield Ins. Co. v. Stephens Martin Paving, LP, 246 S.W.3d 653 (Tex.2008) for guidance, noting that the Texas Supreme Court had expressly considered whether public policy precludes insurance coverage of punitive damages in the workers' compensation scheme and also provided guidance for consideration of the issue in other contexts. Following Fairfield, the Fifth Circuit engaged in a two-step analysis looking at: (1) the plain language of the policy, and (2) legislative policy considerations. In Res-Care, the Fifth Circuit found that the primary insurance policy, through its silence, arguably provided coverage for punitive damages. As to the second point, however, the Fifth Circuit concluded the Texas Legislature precluded liability coverage for punitive damages for some health care providers. The court noted that the type of health care provider in this case -- an intermediate care facility for the mentally retarded -- did not fall within the statute. So, the Fifth Circuit then had to turn to general public policy considerations, weighing the right to freedom of contract against the punishment and deterrent purposes of punitive damages.
In finding that the purposes of punitive damages (to punish egregious tortfeasors and deter future conduct) outweighed the right to freedom of contract, the Fifth Circuit returned to the Texas Supreme Court's concern in Fairfield for “’[e]xtreme circumstances’ where ‘extreme and avoidable conduct that causes injury” may warrant different considerations… ‘Were the existence of insurance coverage to completely eviscerate the punitive purpose behind awarding exemplary damages, it could defeat not only an explicit legislative policy but also the court's traditional role in deterring conscious indifference.’” The Fifth Circuit then found that “extreme circumstances” were present in this case given the insured’s documented systemic problems of care and the circumstances of the patient’s death at issue.
Although the Fifth Circuit went to great lengths to properly apply Fairfield (which they did), the ultimate coverage conclusions appear inconsistent to one unfamiliar with the unique insurance issues at issue in Fairfield. In Fairfield, the high court of Texas went to great lengths to point out that its opinion was limited to the precise coverage before it and it had been guided by the Legislative intent behind Texas' workers compensation scheme which expressly permits injured workers and their families to sue for and recover punitive damages only in situations involving gross negligence and intentional torts by the employer. Knowing the larger coverage question regarding the insurability of punitive damages under general liability and professional liability policies remained unresolved, the high court of Texas went to great lengths to outline for future courts how the issues should be addressed. The Fifth Circuit followed this road map to perfection in Res-Care. There should not be a continuing debate over this issue, but there will be as the policyholder counsel bar continues to argue for an over-expansive reading of Fairfield to permit the coverage of all punitive damage findings under all liability policies. Those debates will unfortunately cost carriers millions over the next several years because there is not another punitive damage case pending before the Texas Supreme Court at this time. The interesting political question is whether inevitable changes to the currently all-Republican Texas Supreme Court will result in a very different court the next time this issue gets to the high court in Austin.
