IX. Compensatory Damages, Bad Faith or Both -- The Brass Ring and Meat and Potatoes

IX. Compensatory Damages, Bad Faith or Both -- The Brass Ring and Meat and Potatoes

A. Compensatory Damages - What They Are?

Compensatory damages are very frequently overlooked by counsel in the quest for punitive damages. Consider this: Virtually, no large punitive damage awards withstand appeals. Virtually, no compensatory damages are upset on appeal.

Focus on compensatory damages. This is an accounting matter first and a causation matter second. Under established law, the policyholder is entitled to recover all damages incurred by the policyholder as a consequence of a breach of an insurance policy under the rule announced in Hadley v. Baxendale. Hadley held that the damages recoverable for breach of contract are those that arise naturally from the breach, or those that were in the contemplation of the parties at the time the contract was made. Consequential damages for an insurance company's breach can include lost profits and damages for the loss of the business without regard to policy limits. The policyholder can recover consequential damages as a measure of contract damages entirely apart from policy limits and any punitive damages for the insurance company's bad faith.

There are established methods to calculate and prove compensatory damages in insurance coverage disputes. They are not unlike the ways lawyers prove damages for bodily injury. They are virtually identical to the ways a business calculates a business interruption claim on a first party property insurance policy. Consider this: a farmer reports to Stonewall Insurance Company that the John Deere tractor has been stolen. The Stonewall adjuster has "heard" that pot has been grown in the area. Of course, Stonewall Insurance does not want to aid in such an immoral, illicit and politically incorrect activity. Investigation of the claim proceeds, with the adjuster busy doing the work of the state police and the Federal Drug Enforcement Agency. The bank holding the mortgage on the farm hears about the inquiry and decides not to renew the mortgage. Like the proverbial Job, the farmer's life is downhill thereafter. Stonewall eventually pays $30,000 for the stolen tractor which it later retrieves and offers to return to the now "former" farmer. Stonewall then demands the $30,000 back and sues the "former" farmer. The "former" farmer defaults. One stolen tractor and the "former" farmer's farm is lost and the former farmer's credit is irresponsibly damaged.

A perfect bad faith case? Maybe, but the bad faith case would not be worth much even at 10 times the policy limits of $30,000.

What about compensatory damages? There is a huge body of lore and law on "business interruption" insurance. That lore and that law can be applied to the farm business and it can be applied to recover much more than the value of the tractor.

Take next the case of a small business, Jones Leather Goods Co., which for generations has manufactured leather goods and sent the scraps to the local municipal landfill. The state and federal environmental authorities sue Jones to recover clean-up costs. Stonewall Insurance Company denies liability insurance coverage because it does not like "polluters." Jones Leather defends itself, paying lawyers $275,000 and settling with the authorities for $300,000.

A good bad faith case, maybe. What about compensatory damages? Booker Jones IV is asked what, if any, impact the failure of Stonewall to defend had on the leather business. Among the many items he catalogues is the fact that the company lost 5% of its sales because he and other members of management had to spend time on the governments' claims. Five percent of sales over the 6 or 7 years translates into $23,000,000 in lost profits. In theory at least, $23,575,000 could support a very large bad faith award, even under BMW.

B. Compensatory Damages --What the Cases Say

To depart from the cardinal rule -- to learn insurance lore -- not insurance law -- there are many cases permitting compensatory damages. As demonstrated by the following fifty-two representative cases, courts throughout the country have granted policyholders consequential damages for their insurance company's breach of its insurance policy as breach of contract damages, distinct from any bad faith recovery, and without regard to policy limits. The cases are:

1. Gray v. Grain Mut. Ins. Co., 871 F.2d 1128, 1130-32 (D.C. Cir. 1989) (applying North Carolina law) (affirming the trial court's award of consequential damages resulting from the insurance company's breach of its duty to settle).

2. Carpenter v. Automobile Club Interinsurance Exch., 58 F.3d 1296, 1303 (8th Cir. 1995) (applying Arkansas law) (holding that an insurance company could be required to pay, as consequential damages for failure to settle, sums that would not otherwise be covered under the terms of the insurance policy).

3. Bettius & Sanderson, P.C. v. National Union Fire Ins. Co., 839 F.2d 1009, 1014-15 (4th Cir. 1988) (applying Virginia law) (awarding consequential damages for loss of profits of law firm forced to dissolve by insurance company's breach of its insurance policy).

4. A&E Supply Co. v. Nationwide Mut. Fire Ins. Co., 798 F.2d 669, 677-78 (4th Cir. 1986), cert. denied, 479 U.S. 1091 (1987) (applying Virginia law) (recognizing, as a matter of contract law, that violation of the duty of good faith by an insurance company entitles policyholder to full consequential losses: "foreseeable losses, not susceptible to mitigation").

5. Murphy v. Cincinnati Ins. Co., 772 F.2d 273, 276-77 (6th Cir. 1985) (applying Michigan law) (recognizing that damages recoverable for breach of an insurance policy include "those that arise naturally from the breach or those that were in the contemplation of the parties at the time the contract was made," and, in this case, included attorneys' fees incurred in bringing the insurance coverage action).

6. Salamey v. Aetna Cas. & Sur. Co., 741 F.2d 874, 877 (6th Cir. 1984) (applying Michigan law) (allowing, as consequential damages for the breach of an insurance policy, lost profits from the policyholder's inability to reopen his store without an insurance recovery: "'The policy limits restrict the amount the insurer may have to pay in the performance of the contract, not the damages that are recoverable for its breach.'") (quotation omitted).

7. Don Burton, Inc. v. Aetna Life & Cas. Co., 575 F.2d 702, 708 (9th Cir. 1978) (in dicta, noting that, for breach of an insurance policy, the policyholder could recover consequential damages for the loss of his business, if sufficient evidence of a causal relationship between the breach and the anticipated net profits were demonstrated).

8. Alliance Ins. Co. v. Alper-Salvage Co., 19 F.2d 828 (6th Cir. 1927) (applying Tennessee law) (holding policyholder was entitled to damages for loss of use of its property caused by insurance company's breach of its insurance policy).

9. Heller Int'l Corp. v. Sharp, 839 F. Supp. 1297, 1302-03 (N.D. Ill. 1993) (applying Illinois law) (noting that the "general principles of contract law apply equally well in the insurance contract context," and that "[i]n many instances, the measure of damages is governed by the contractual policy amount. That rule is not an absolute. As noted above, Illinois law does allow recovery of consequential damages 'where they were reasonably foreseeable, were within the contemplation of the parties at the time the contract was entered, or arose out of special circumstances known to the parties.'").

10. Haardt v. Farmer's Mut. Fire Ins. Co., 796 F. Supp. 804, 811 (D.N.J. 1992) (applying New Jersey law) (holding policyholder could recover consequential damages for insurance company's breach of its insurance policy in failure to pay for repair of house, including devaluation of property and loss of rents).

11. Pacific Employers Ins. Co. v. P.B. Hoidale Co., 789 F. Supp. 1117, 1124 (D. Kan. 1992) ("Employers concedes that lost profits are recoverable for breach of an insurance policy. Such damages are limited to those which may fairly be considered to arise '"in the usual course of things, from the breach itself, or as may reasonably be assumed to have been within the contemplation of both parties as the probable result of the breach"'") (citations omitted).

12. Red Ceders, Inc. v. Westchester Fire Ins. Co., 686 F. Supp. 614, 616 (E.D. Mich. 1988) (applying Michigan law) ("An insured may recover consequential damages for the insurer's breach of contract. . . . The policy's limits on losses do not restrict consequential damages claimed as a breach of the policy.").

13. Diaz Irizarry v. Ennia, N.V., 678 F. Supp. 957, 962 (D.P.R. 1988) (applying Puerto Rico law) (holding that consequential damages are recoverable for breach of an insurance policy if "foreseeable").

14. Earth Scientists (Petro Servs.) Ltd. v. United States Fidelity & Guar. Co., 619 F. Supp. 1465, 1474-75 (D. Kan. 1985) (applying Kansas law) (permitting policyholder to seek as consequential damages lost profits, including those for closing down its operations, as a result of insurance company's failure to pay for damage to policyholder's oil rig).

15. Ingersoll Milling Mach. Co. v. M/V Bodena, 619 F. Supp. 493, 507 (S.D.N.Y. 1985) (holding policyholder was entitled to recover expenses of bringing action against other companies to cover the cost of a loss after insurance company breached its insurance policy by failing to cover the loss).

16. Strader v. Union Hall, Inc., 486 F. Supp. 159, 164 (N.D. Ill. 1980) (applying Illinois law) (permitting policyholder to seek consequential damages for breach of an insurance policy).

17. Mann v. Glens Falls Ins. Co., 418 F. Supp. 237, 249 (D. Nev. 1974), rev'd on other grounds, 541 F.2d 819 (9th Cir. 1976) (applying Nevada law) (adopting Reichert in toto and holding policyholder could recover consequential damages for insurance company's breach of its insurance policy).

18. McDowell v. Union Mut. Life Ins. Co., 404 F. Supp. 136, 140-41 (C.D. Cal. 1975) (applying California law) (holding that insurance company's breach of an insurance policy exposed it to liability for consequential damages, including expenses associated with the policyholder's bankruptcy, including filing fees, legal expenses, and loss of credit reputation).

19. Asher v. Reliance Ins. Co., 308 F. Supp. 847, 852 (N.D. Cal. 1970) (applying Alaska and California law) (holding policyholder could recover as consequential damages from insurance company's breach of its insurance policy, loss of rents because of insurance company's failure to pay for burned property under fire insurance policy if "such damage were 'proximately caused' by or 'flowed naturally and expectedly' from the defendant's breach").

20. Scrima v. Insurance Co. of N. Am., 116 B.R. 951, 960-62 (Bankr. W.D. Mich. 1990) (allowing consequential damages -- loss of profits -- for insurance company's breach of insurance policy).

21. Independent Fire Ins. Co. v. Lunsford, 621 So. 2d 977, 979 (Ala. 1993) (affirming a verdict for the policyholder "of compensatory damages for breach of contract, including damages for mental anguish)).

22. State Farm Mut. Auto. Ins. Co. v. Allstate Ins. Co., 88 Cal. Rptr. 246, 259 (App. Ct. 1970) ("damages for breach of the duty to defend are not inexorably imprisoned within the policy limit but are measured by the consequences proximately caused by the breach").

23. Travelers Ins. Co. v. Wells, 633 So. 2d 457, 461-63 (Fla. Dist. Ct. App. 1993), clarified, 1994 Fla. App. LEXIS 2445 (Fla. Dist. Ct. App. 1994) (allowing consequential damages -- projected net profits -- for breach of insurance contracts for loss of business caused by failure of insurance company to renew insurance policy causing policyholder's business to cease: "[c]onsequential or resulting collateral damage may also be recovered if it can be sufficiently proved").

24. Life Investors Ins. Co. v. Johnson, 422 So. 2d 32, 34 (Fla. Dist. Ct. App. 1982) (applying Hadley and finding that a breach of an insurance policy "may give rise to damages which were in contemplation of the parties at the inception of the contract").

25. Leader Nat'l Ins. Co. v. Smith, 339 S.E.2d 321, 331 (Ga. App. 1985) (finding that, as with other contracts, "'[r]emote or consequential damages are not recoverable unless they can be traced solely to the breach of the contract or unless they are capable of exact computation, such as the profits which are the immediate fruit of the contract, and are independent of any collateral enterprise entered into in contemplation of the contract,'" noting "[l]oss of profits has often been regarded as consequential damages and is recoverable in contract actions," and noting "'[d]amages growing out of a breach of contract . . . must have arisen according to the usual course of things, and be such as the parties contemplated as a probable result of the breach'") (citations omitted).

26. Clark v. Standard Life & Accident Ins. Co., 386 N.E.2d 890, 898 (Ill. Ct. App. 1979) (holding that, for breach of an insurance policy, "consequential damages may be recovered when they 'were reasonably foreseeable and were within the contemplation of the parties at the time the contract was executed' arising out of special circumstances communicated and known to both parties") (citation omitted).

27. Indiana Ins. Co. v. Plummer Power Mower & Tool Rental, Inc., 590 N.E.2d 1085, 1092 (Ind. App. Ct. 1992) (finding proper an award of consequential damages caused by insurance company's breach of its insurance policy: "When a business owner contracts for insurance on his primary source of income, he has the expectation of prompt payment so that he can rebuild and continue his business after the occurrence of a catastrophe such as the fire involved in this case. Delayed payment, whether as a result of good or bad faith, will undoubtedly result in the failure of the owner's business. The damages incurred from such inability to pay bills flow directly, and are proximately caused by, the insurer's failure to pay. The likelihood of such damages is only unforeseeable to unreasonably narrow-minded insurers.").

28. Salvator v. Admiral Merchants Motor Freight, 509 N.E.2d 1349, 1359-61 (Ill. Ct. App.), appeal denied, 515 N.E.2d 126 (Ill. 1987) (affirming award of consequential damages -- loss of earnings -- for insurance company's breach of its insurance policy).

29. Mohr v. Dix Mut. County Fire Ins. Co., 493 N.E.2d 638, 643-44 (Ill. Ct. App. 1986) (noting "[c]onsequential damages . . . may be recovered where they were reasonably foreseeable, were within the contemplation of the parties at the time the contract was entered, or arose out of special circumstances known to the parties," and that "[l]ost profits may be recovered where the loss is shown with reasonable certainty, the defendant's wrongful action caused the loss, and the lost profits were within the contemplation of the parties when they entered the contract").

30. Hochman v. American Family Ins. Co., 673 P.2d 1200, 1203 (Kan. App. Ct. 1984) (affirming award of interest paid by a policyholder on loan to repair tractor as consequential damages for insurance company's failure to pay for tractor repair, noting "[d]amages recoverable for breach of contract are limited to those which may fairly be considered as arising, in the usual course of things, from the breach itself, or as may reasonably be assumed to have been within the contemplation of both parties as the probable result of the breach").

31. Hinson v. Zurich Ins. Co., 196 So. 2d 827, 829-31 (La. App. Ct. 1967) (finding that a policyholder can recover consequential damages for loss of wages and humiliation incurred by loss of employment on account of insurance company's breach of its insurance policy, but finding that lost wages were not sufficiently proved in this case).

32. Pennsylvania Threshermen & Farmers' Mut. Cas. Ins. Co. v. Messenger, 29 A.2d 653 (Md. 1943) (willful failure to comply with obligations under liability insurance policy requires insurance company to respond in damages for any loss suffered as a consequence: "[t]he damages allowed for breach of a contract should compensate the injured person for the loss he has sustained as a result of the breach. The court should endeavor to place the injured person as far as possible by monetary award, in the position in which he would have been, if the contract had been properly performed").

33. Lawrence v. Will Darrah & Assocs., Inc., 516 N.W.2d 43, 48 (Mich. 1994) (finding policyholder could recover as consequential damages for insurance company's breach of its insurance policy those damages "the promisor knows or has reason to know" about, including lost profits from trucking business by reason of insurance company's failure to pay for repair of truck).

34. Miholevich v. Mid-West Mut. Auto Ins. Co., 246 N.W. 202, 203 (Mich. 1933) (damages sustained by policyholder in body execution following failure of insurance company to pay judgment were such as were contemplated by the parties and hence recoverable).

35. Wendt v. Auto-Owners Ins. Co., 401 N.W.2d 375, 377-80 (Mich. Ct. App. 1986) (finding policyholder could bring action for damages consequential to insurance company's breach of its obligation to pay for the repair of a truck, including loss of use of the owed money, default on a note upon which the truck was security, loss of use of the truck, decline in policyholder's business, and storage costs of damaged truck).

36. Parmet Homes, Inc. v. Republic Ins. Co., 314 N.W.2d 453, 457 (Mich. 1981) (although disallowing consequential damages for unrelated venture which policyholder could not participate in because of failure of insurance company's to pay on policies, on the ground that damages from such unrelated venture were not foreseeable, noting "the damages recoverable for breach of contract are those that arise naturally from the breach and were within the contemplation of the parties at the time the contract was executed. Loss of profits which result from the breach may be considered in assessing damages").

37. Olson v. Rugloski, 277 N.W.2d 385, 387-88 (Minn. 1979) (holding that policyholder, whose insurance company breached its insurance policy by failing to reimburse him for the loss of his trucks, was responsible for consequential damages from that breach, including lost profits: "When the insurer refuses to pay or unreasonably delays payment of an undisputed amount, it breaches the contact and is liable for the loss that naturally and proximately flows from the breach. . . . Lost profits may recovered if they are a natural and proximate result of the breach and are proved with reasonable, although not absolute, certainty.") (citation omitted).

38. Aetna Cas. & Sur. Co. v. Day, 487 So. 2d 830, 835 (Miss. 1986) ("Although the insurance policy expressly limits coverage to a specific amount, this is not to say that damages for breach of contract are limited to those of mere repair. In a contract action, generally a plaintiff may recover consequential damages reasonably foreseeable at the time the contract was made and established at trial, where properly pled and supported by substantial evidence.").

39. Landie v. Century Indem. Co., 390 S.W.2d 558, 562 (Mo. Ct. App. 1965) ("'Thus, all the cases agree that where it is the insurer's duty to defend, and the insurer wrongfully refuses to do so on the ground that the claim upon which the action against the insured is based is not within the coverage of the policy, the insurer is guilty of a breach of contract which renders it liable to the insured for all damages resulting to him as a result of such breach.'") (citation omitted).

40. A.B.C. Builders, Inc. v. American Mut. Ins. Co., 661 A.2d 1187, 1192 (N.H. 1995) (awarding costs of financing settlement and other consequential damages proper in breach of insurance policy action "because an insurance policy is a contract" and "its breach may result in an award of consequential damages if they were foreseeable and can be proved").

41. Drop Anchor Realty Trust v. Hartford Fire Ins. Co., 496 A.2d 339, 342-43 (N.H. 1985) (finding compensable consequential damages from insurance company's breach of duties under an insurance policy to pay for repair of policyholder's hotel, including loss of good will and business reputation and lost profits for vacation season).

42. Jarvis v. Prudential Ins. Co., 448 A.2d 407, 410 (N.H. 1982) (finding "[t]he insured may recover specific consequential damages if he can prove that such damages were reasonably foreseeable by the insurance company and that he could not have reasonably avoided or mitigated such damages").

43. Lawton v. Great Southwest Fire Ins. Co., 392 A.2d 576, 578 (N.H. 1978) (holding consequential damages may be recovered for breach of an insurance policy, thereby holding that (i) consequential damages are not limited by doctrine that insurance policies are mere contracts to pay money; (ii) the policy limits are merely limits for payments owed on account of an insurable event and not limits for damages from breach of contract and (iii) financial injuries from an insurance company's breach of its duty).

44. Pickett v. Lloyd's (a Syndicate of Underwriting Members), 600 A.2d 148, 155 (N.J. App. Div. 1991), aff'd, 621 A.2d 445 (N.J. 1993) (finding policyholder could recover consequential damages -- including loss of use -- for breach of insurance policy to pay for replacement of tractor-trailer: "we consider the damages awarded here to have been reasonably foreseeable at the time the policy was issued, and thus recoverable in an action for breach of contract. Here, the insurer knew it was insuring a commercial tractor used by [the policyholder]. Although the insurance application is not part of the record, the policy form issued on January 5, 1987 described the vehicle and its use as commercial. Thus, it was reasonably foreseeable to both parties at the time the contract was entered into that if the vehicle was totally destroyed the insured's livelihood and income would be affected.").

45. Exum v. Ferguson, 637 P.2d 553, 555 (N.M. 1981) (holding that policyholder was entitled to consequential damages from insurance company's breach -- failure to pay for damage to his truck -- including loss of profits and loss of equity in the truck that was repossessed).

46. Mitchell v. Intermountain Casualty Co., 364 P.2d 856, 857 (N.M. 1961) (although noting "contractual damages recoverable for breach of the contract are those damages contemplated by the parties at the time of the making of the contract," finding that the damages were not foreseeable).

47. Bibleault v. Hanover Ins. Co., 417 A.2d 313, 318-19 (R.I. 1980) (noting that "[t]raditionally, recovery in contract for breach of a unilateral or independent obligation to pay a certain sum of money is confined to the actual amount owed under the contract plus legal interest," but holding "[t]he duty of an insurer to deal fairly and in good faith with an insured is implied by law. Since violation of this duty sounds in contract as well as in tort, the insured may obtain consequential damages for economic loss and emotional distress and, when appropriate, punitive damages").

48. Brown v. South Carolina Ins. Co., 324 S.E.2d 641, 645-47 (S.C. 1984), appeal dismissed, 348 S.E.2d 530 (S.C. 1985) (finding bad faith to be an action based on contract, but noting that "the insurer is liable for whatever consequential damages follow as a natural consequence and proximate result of the breach," and holding that damages consequential to insurance company's breach in failing to pay for damage to car, including lost income, were recoverable).

49. Holmes v. Nationwide Life Ins. Co., 258 S.E.2d 924, 926-27 (S.C. 1979) (holding that "'[i]n breach of contract actions, only such damages as may reasonably be supposed to have been in the contemplation of both parties at the time the contract was made may be collected,'" and allowing, as consequential damages for insurance company's breach, interest on loan policyholder was forced to procure to pay medical expenses) (citation omitted).

50. Beck v. Farmers Ins. Exch., 701 P.2d 795, 801-02 (Utah 1985) (allowing consequential damages -- "those reasonably within the contemplation of, or reasonably foreseeable by, the parties at the time the contract was made" -- for breach of an insurance policy, noting "a broad range of recoverable damages is conceivable, particularly given the unique nature and purpose of an insurance contract. An insured frequently faces catastrophic consequences if funds are not available within a reasonable period of time to cover an insured loss; damages for losses well in excess of policy limits, such as for a home or business, may therefore be foreseeable and provable").

51. Hayseed's, Inc. v. State Farm Fire & Casualty, 352 S.E.2d 73, 79-80 (W. Va. 1986) (noting that "[i]t is now the majority rule in American courts that when an insurer wrongfully withholds or unreasonably delays payment of an insured's claim, the insurer is liable for all foreseeable, consequential damages naturally flowing from the delay," and, thus, "the policyholder is entitled to damages for net economic loss caused by the delay in settlement, as well as an award for aggravation and inconvenience").

52. Newhouse v. Citizens Security Mut. Ins. Co., 501 N.W.2d 1, 6 (Wis. 1993) (finding, upon breach of its insurance policy, "[t]he insurance company must pay damages necessary to put the insured in the same position he would have been in had the insurance company fulfilled the insurance contract. Policy limits do not restrict the damages recoverable by an insured for a breach of the contract by the insurer").

One insurance company responded to a policyholder's claim for consequential damages by complaining that the cases cited by the policyholder involved first party rather than third party claims. Yet the insurance company failed to note why this distinction made a difference and then noted that where consequential damages were awarded to a third party, it was "almost inevitably because of the insurers wrongful, bad faith, refusal or delay in settlement of a claim against the insured." In fact, the insurance company's opening argument was that the policyholder had misinterpreted the "ancient" case of Hadley v. Baxendale. The power of the argument for compensatory damages is obvious when these are the best arguments a group of insurance companies can make in opposition.

Thus, under general principles of law, a policyholder can recover as consequential damages for a breach of an insurance policy any losses that either (i) arose from the breach itself, or (ii) were in the contemplation of the parties. In support of the first wing of this rule, a policyholder might prove that, had the insurance company properly complied with its obligations to investigate and defend claims against the policyholder, the policyholder's business would have been better and the financial burdens would have been ameliorated. Moreover, the policyholder would have had some guarantee of the policyholder's future health.

Alternatively, in support of the second wing of the Hadley rule, the policyholder could demonstrate that the policyholder purchased millions of dollars in liability insurance coverage and a separate defense obligation. The purchase of such massive protection rendered it foreseeable that an insurance company's delay in complying, or failure to comply, with investigation, defense and indemnity obligations in the face of catastrophe would cause the policyholder to suffer consequential damages. Under either wing of Hadley, it is clear that policyholders can and should seek consequential damages.

Do not miss the meat and potatoes.

BAD FAITH IN INSURANCE COVERAGE DISPUTES AND THE PUBLIC NATURE OF INSURANCE -- UNDERSTANDING THE RECOVERY TOOLS AVAILABLE TO POLICYHOLDERS

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