This is one of a series of articles originally published in Mealey’s Litigation Report: Insurance Bad Faith, Vol. 21, #28 (June 17, 2008). © 2008
[Editor’s Note: Carol M. Rooney is a partner with the law firm of Butler Weihmuller Katz Craig LLP with offices in Charlotte, Miami, Mobile, Tallahassee, and Tampa. She is an experienced trial lawyer in the firm’s Coverage and Extra-contractual Departments [Subrogation]. This commentary, other than the quoted material, is the author’s opinion; not her law firm’s, and not Mealey’s Publications’. Copyright © 2008 by the author. Responses are welcome.]
The ability of an insured to recover consequential damages under an insurance contract allegedly caused by failure or delays in the insurer making payments has traditionally been controversial. Jurisdictions have been divided in their approach as noted in the following annotation cited by the district court in Indiana:
With regard to the right of an insured or other beneficiary under an insurance policy to recover consequential…damages for such failure or delay in making payment, in the absence of…statutory penalties, there is a decided difference of opinion among the jurisdictions. The right to such consequential damages, under the general rule that damages recoverable for a breach of contract are such as may reasonably be considered as arising naturally from the breach of contract itself, is supported by some modern authority. On the other hand, the rule that damages for breach of a contract to pay money are limited to the amount owing under the contract, with interest, frequently has been applied to deny the recovery of consequential damages resulting from failure or delay in making payment under an insurance contract.1
Recent opinions of the New York Court of Appeals have added to the controversy. The opinions are clearly contrary to previous rulings by New York courts and essentially allow the insured to recover “extra-contractual” damages in a pure breach of contract action. The dissenting opinions underscore this concern. This commentary will review the recent opinions in light of previous holdings of New York courts.
In Bi-Economy Market, Inc. v. Harleysville Ins. Co. of New York,2 the Court found error in the trial court’s dismissal of the plaintiff insured’s claim for consequential damages allegedly resulting from the defendant insurer’s breach of the insurance contract. The insured’s business, a wholesale/retail meat market, suffered a fire which resulted in the loss of inventory as well as business income. The insured filed a claim with the insurer for its losses including lost business income.3
The policy provided coverage for lost business income for up to one year from the date of the fire. Specifically, the policy provided that the insurer would “pay for the actual loss of Business Income. . . sustain[ed] due to. . . the necessary suspension of operations during the period of restoration.” Business income was defined as “(1) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred; and (2) Continuing normal operating expenses incurred, including payroll.” The period of restoration was defined as the period of time that “begins with the date of direct physical loss or damage” and “ends on the date when the property…should be repaired, rebuilt or replaced with reasonable speed or similar quality.”4
The insurer disputed the claim for actual damages and advanced the undisputed amount. After the dispute was submitted to alternative dispute resolution, the insured was awarded additional monies. During the pendency of the proceedings, the insurer offered to pay lost business income accrued for a period of seven months. The insured never resumed business operations.5
The insured’s suit against the insurer alleged causes of action for bad faith claims handling; tortious interference with business relations and breach of contract, seeking consequential damages for “the complete demise of its business operation in an amount to be proved at trial.”6 The insured alleged that the insurer improperly delayed payment for its building and contents damage and failed to timely pay the full amount of its lost business income claim. Further, the insured alleged that its business collapsed as a result of the insurer’s breach of contract and that liability for such consequential damages was reasonably foreseeable and contemplated by the parties at the time of contracting.7
The insurer moved to amend its answer to raise the defense that the contract excluded consequential damages and for partial summary judgment on the breach of contract action. In support of its motion, the insurer cited several contractual provisions excluding coverage for “consequential loss.”8
The Supreme Court9 granted the motion and the Appellate Division of the Supreme Court affirmed, holding that the contract expressly excluded coverage for consequential losses, and that it could not be said that the parties contemplated consequential damages at the time the contract was formed. The Appellate Division granted the plaintiff leave to appeal to the New York Court of Appeals.10
The insured’s appeal asserted that the courts below erred in dismissing its breach of contract claim seeking consequential damages for the collapse of its business allegedly resulting from the insurer’s failure to fulfill its obligations under the insurance contract. The Court of Appeals agreed and ordered that the cause of action be reinstated.11
The Court of Appeals noted the nature of damages available under a breach of contract action citing to a New York case that generally described the damages recoverable.12 The Court found it well-settled that the non-breaching party may recover general damages that are the natural and probable consequence of the breach.13 The Court noted that special or consequential damages, which do not so directly flow from the breach, are recoverable in limited circumstances. In order to recover consequential damages, these damages must have been contemplated by the parties as the probable result of a breach of contract at the time of or prior to the contract’s formation. To determine whether consequential damages were reasonably contemplated by the parties, courts must look to the nature, purpose and “particular circumstances” of the contract known by the parties.14
The Court did not discuss the “particular circumstances” of the insurance contract at issue. Rather, the Court found that the very purpose of business interruption coverage would have made the insurer aware that if it breached its obligations under the contract to “investigate in good faith and pay covered claims,” it would have to respond in damages to the insured for the loss of its business as a result of the breach.15 The Court also points to the implied covenant of good faith and fair dealing, implicit in “all contracts,” and cites to a New York case finding that “a reasonable insured would understand that the insurer promises to investigate in good faith and pay covered claims.”16 The Court cites to other jurisdictions that essentially hold that an insured bargains for more than just payment of monies under an insurance policy but “peace of mind.”17 The Court cited to the Kenford case and its progeny, noting that consequential damages cannot be speculative or conjectural. Rather, consequential damages must be “reasonably foreseeable” and proximately caused by the breach.18
The Court essentially found that, because the insurance contract included coverage for business interruption, the parties agreed and understood that the insurer would potentially be liable for consequential damages. As stated by the Court:
When an insured in such a situation suffers additional damages as a result of an insurer’s excessive delay or improper denial, the insurance company should stand liable for these damages. This is not to punish the insurer, but to give the insured its bargained-for benefit.19
The Court discussed the purpose of insurance contracts, particularly those including business interruption coverage, as including an additional performance-based component. It is not enough to simply evaluate the claim and make payments. The payments must be made on a timely basis. The Court found that because the insured’s claim was not evaluated and paid on a timely basis, the insured’s business collapsed. Thus, the insurer should be liable for these “additional damages,” i.e., the collapse of the insured’s business.20
The Court also did not consider the contractual exclusion for consequential losses as demonstrating that the parties contemplated and rejected the availability of consequential damages in the event of a breach. Rather, the Court found that consequential “losses” referred to those delays caused by third parties or by the suspension, lapse or cancellation of any license, lease or contract. This was contrasted with consequential damages which are “in addition” to those losses caused by a calamitous event and “include those additional damages caused by a carrier’s injurious conduct – in this case, the insurer’s failure to timely investigate, adjust and pay the claim.”21
The lengthy dissenting opinion notes that the majority abandoned previous rulings by the Court that rejected the argument that a “bad faith” failure to pay a claim by an insurer could, without more, justify a punitive damages award.22 In previous decisions, the Court held that punitive damages are not available for a breach of an insurance contract unless the plaintiff shows both “egregious tortious conduct” directed at the insured claimant and a pattern of similar conduct directed at the public generally.23 The dissent accuses the majority of discarding the previous rule without even discussing it by simply changing labels. Punitive damages are now called “consequential damages.” A bad faith failure to pay a claim is now called a breach of the covenant of good faith and fair dealing.24
The dissent noted that underlying the Court’s previous decisions was the recognition of the serious harm that awards of punitive damages can cause. Although punitive damages can sometimes serve to deter insurer wrongdoing, and thus protect insureds from injustice, the dissent notes they will do so at too great a cost. Insurers’ fear of unlimited and unpredictable punitive damages awards will lead insurers to increase their premiums, and “inflict a burden on every New Yorker who buys insurance.”25
The dissent found that the majority’s authorization of consequential damages, while remedial in form, were obviously punitive in fact. Such damages were not triggered by simply breaching the contract, as true consequential damages are, but rather, only by a breach committed in bad faith. According to the dissent, the only purpose of the “consequential damages” authorized by the majority is the punishment of wrongdoers and to deter future wrongdoing.26 The dissent characterizes the obligation breached as simply the one to pay money. Thus, consequential damages are “out of place” in a suit where an insurer is alleged to have breached the contract by failing to pay the claim.27
The dissent also clearly finds the majority’s analysis ludicrous that the parties must have contemplated the potential of consequential damages at the time of the insurance contract’s formation. As stated by the dissent:
Can anyone seriously believe that the parties in these cases would, if they had “considered the subject,” have contracted for the results reached here? Imagine the dialogue. Applicant for Insurance: “Suppose you refuse, in bad faith, to pay a claim. Will you agree to be liable for the consequences, including lost business, without regard to the policy limits?” Insurance company: “Oh, sure. Sorry, we forgot to put that in the policy.”28
The dissent notes that in insurance contracts, the parties have already told us what damages they contemplated; it is payment equal to the losses covered by the policy, up to the policy limits. Thus, there is no need to imagine what the parties would have concluded had they considered the subject, as required by the majority’s faulty premise for authorizing consequential damages.29
The Court continues in the same vein with the Panasia Estates, Inc. v. Hudson Ins. Co.30 decision, decided the same day, which, not surprisingly, cites to Bi-Economy with approval. In Panasia, the New York Court of Appeals found that the trial court had properly denied the defendant insurer’s motion for partial summary judgment that the plaintiff insured’s claim for consequential damages were not recoverable based upon the insurer’s alleged breach of contract.31
In, Panasia, the insured, the owner of commercial rental property, had a commercial property insurance policy with the insurer. The policy included builder’s risk coverage. During renovations to the insured’s property, the roof was opened to perform construction work. Rain entered through the opening in the roof causing damage. The insured filed a claim with its insurer for the damages. According to the insured, the insurer was promptly notified of the loss but failed to investigate or adjust the claim until several weeks had passed. The claim was subsequently denied by the insurer based upon a policy exclusion for repeated water infiltration over time and wear and tear.32
The insured filed suit against the insurer alleging that it breached the insurance contract by failing to properly investigate the loss and denying coverage under the policy. The insured sought both direct and consequential damages that it claimed stemmed from the insurer’s breach of the insurance contract.33 The insurer moved for partial summary judgment on the insured’s bad faith allegations and all prayers for consequential, extra-contractual, or incidental damages and attorney’s fees. The insurer relied, at least in part, on the contractual exclusion for consequential losses in support of its motion.34
The Supreme Court denied that part of the insurer’s motion directed at the insured’s claim for consequential damages.35 The Appellate Division affirmed, citing to Acquista v. New York Life Ins. Co., stating that an insured may recover foreseeable damages beyond the limit of its policy for the breach of a duty to investigate, bargain for and settle claims in good faith.36 In addition, the Appellate Division rejected the insurer’s argument that the contractual exclusion for consequential losses precluded the insured’s claim for consequential damages.37
The Court found that the lower courts properly rejected the insurer’s motion for judgment as a matter of law that consequential damages were not recoverable in a claim for breach of an insurance contract. The Court, citing to the Bi-Economy decision, stated that consequential damages resulting from a breach of the covenant of good faith and fair dealing may be asserted in an insurance contract context so long as the damages were within the contemplation of the parties as the probable result of a breach at the time of or prior to contracting. The Court noted that the lower courts failed to consider whether the specific damages sought by the insured were foreseeable damages as a result of the insurer’s breach. As the record was not fully developed on that issue, the claim must be considered by the Supreme Court.38
The dissent in Bi-Economy noted that the majority’s opinion essentially nullified the previous holdings of the Court in Rocanova v. Equitable Life Assur. Socy. of U.S. and New York Univ. v. Continental Ins. Co. by changing the label of the damages sought from “punitive” to “consequential.”39 An insured in New York can now pursue punitive damages against its insurer under the guise of “consequential damages” so long as such damage were contemplated by the parties as potentially recoverable at the time of the contract’s formation and said damages were proximately caused by the breach. This is not exactly a high bar to meet when the majority in Bi-Economy equates the existence of business interruption coverage to foreseeable knowledge on the part of the insurer of the imminent collapse of the insured’s business if coverage is denied in “bad faith”. The dissent notes the majority’s apparent fundamental misunderstanding of the purpose of business interruption coverage which is to compensate the insured for a business interruption that has already occurred, not to prevent one from occurring.40
Previous decisions of New York Courts considering whether consequential damages would be allowed under an insurance contract had set a much higher bar for the recovery of said damages. Most of the courts had required that the insurance policy contain specific language permitting the recovery of said damages. In Globecon Group, LLC v. Hartford Fire Ins. Co.,41 the district court noted that New York courts had all consistently held that consequential damages are unavailable in insurance cases, unless the plaintiff alleges that the specific injury was of the type contemplated by the parties at the time of contracting. Further, in order to demonstrate such an understanding on the part of the parties, the district court noted that it has followed other New York courts in requiring that a specific contractual provision permit the recovery of consequential damages.42 The district court noted that the few New York courts that have allowed recovery of consequential damages in the absence of a specific contractual provision were inconsistent with the weight of authority in New York.43
Following Bi-Economy and Panasia, the consequential damages now potentially recoverable in New York under an insurance contract include all those “additional damages” caused by an insurer’s “injurious conduct” regardless of whether a specific provision in the policy authorizes same. Discovery into the extent and nature of the insurer’s “injurious conduct” which allegedly resulted in such “additional damages” will be allowed and further obfuscate the fact-finder’s determination as to whether the insurer actually breached the insurance contract.
In a traditional breach of contract action, the defendant’s motive or state of mind is irrelevant. The inquiry is limited simply to “what was the agreement between the parties” and “was that agreement breached.” Adding the concept of “reasonably foreseeable damages” to the inquiry has unfortunately been used to go beyond the agreed-upon terms of the contract to find a result that the plain language of the contract clearly would not support.44 An insurer plainly does not contemplate the type of damages authorized by the Bi-Economy and Panasia opinions by virtue of entering into an insurance contract which includes coverage for business interruption. If courts are going to award “punitive” damages in the context of a breach of an insurance contract, at least call it what it is rather than presume fantastical negotiations that obviously have no place in reality.
It remains to be seen whether the Bi-Economy and Panasia decisions represent the new trend in New York and elsewhere. It appears more courts are moving in the direction of expanding the damages recoverable under the insurance contract well beyond those expressly authorized by the contract.45 This movement has disturbing implications for the insurance industry and those who purchase insurance as aptly stated by the Bi-Economy dissent:
The majority’s bad policy choice is more important than the flaws in its reasoning. This attempt to punish unscrupulous insurers will undoubtedly lead to the punishment of many honest ones. Under today’s opinions, juries will decide whether claims should have been paid more promptly, or in larger amounts; whether an insurer who failed to pay a claim did so to put pressure on the insured, or from legitimate motives, or from simple inefficiency; and whether, and to what extent, the insurer’s slowness and stinginess had consequences harmful to the insured. All these very difficult, often nearly unanswerable, questions will be put to jurors who will usually know little of the realities of either the insured’s or the insurer’s business. The jurors will no doubt do their best, but it is not hard to predict where their sympathies will lie.
The result of the uncertainty and error that the majority’s opinions will generate can only be an increase in insurance premiums. That is the real “consequential damage” flowing from today’s holdings.46
After more than 200 years of being the protector of contract and a bulwark against the expansion of extra-contractual claims, the Bi-Economy and Panasia opinions reflect New York’s foray into the increasingly muddy waters of quasi-contract law. New York’s strained interpretation of contract law, and states that choose to follow, will only serve to increase the economic burdens of consumers and businesses who contract with them.