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When State Farm Insurance refused a proposed settlement for the amount of its policy limit for a law suit arising out of an automobile accident, the matter went to trial and a jury returned a verdict against State Farm’s insured in the amount of three times the policy limit. State Farm paid the entire judgment but the Insured (Mr. and Ms. Campbell) then sued the insurance company for bad faith, fraud, and intentional infliction of emotional distress. A jury in that trial awarded the Campbells compensatory damages of $2.6 million and punitive damages of $145 million.

The compensatory damages were eventually reduced by the state courts to $1 million but the $145 million punitive damages survived the appeals through the state courts. On appeal to the Supreme Court, State Farm argued that the punitive damage award was excessive and violated the Due Process Clause of the Fourteenth Amendment. The Supreme Court agreed and reversed the judgment, holding that under the circumstances of this case, it was more likely that the punitive damages that could be justified would be “at or near the compensatory damages amount.”

The explanation by the Court is instructive. The court relied principally upon guide posts for reviewing punitive damages that it had established in the recent case of BMW of North America, Inc. v. Gore, 517 U.S. 559. “It should be presumed that a plaintiff has been made whole by compensatory damages, so punitive damages should be awarded only if the defendant’s culpability is so reprehensible to warrant the imposition of further sanctions to achieve punishment or deterrence.” The Supreme Court stated, “In this case, State Farm’s handling of the claims against the Campbell’s merits no praise, but a more modest punishment could have satisfied the State’s legitimate objectives.” Instead the trial was used improperly as a platform to expose, and punish, the perceived deficiencies of State Farm’s operations throughout the country. This resulted in the Utah courts awarding punitive damages to punish and deter conduct that bore no relation to the Campbell’s harm.

The second guidepost considered by the court was the disparity between the actual harm suffered by the plaintiff and the punitive damages award. The Court stated that few awards exceeding a single-digit ratio between punitive and compensatory damages will satisfy due process. “Single-digit multipliers are more likely to comport with due process,” said the Court. In this case, the Court found a presumption against an award with a 145 to 1 ratio. Applying The Gore case guideposts, the Court concluded that in light of the substantial compensatory damages award, it was likely that only punitive damages in about the same amount as the compensatory damages could be justified. State Farm Mutual Automobile Insurance Co. v. Campbell, (No. 01-1289, April 7, 2003).

Comment by Kent Holland:

The question of who gets to decide whether to settle a case has been a matter of concern for design professionals under their professional liability policies, and it has been a matter of concern for contractors under their various liability policies. Language from a typical professional liability policy states: “If YOU refuse to consent to any settlement or compromise recommended by US involving any part of OUR limits of liability and acceptable ot the claimant, and YOU elect to contest the CLAIM, suit or proceeding, then OUR liability shall not exceed the amount which WE would have paid for DAMAGES and CLAIM EXPENSES at the time the CLAIM or suit or proceeding could have been settled or compromised.”

What is interesting is that professional liability carriers sometimes find themselves in the situation where they believe it is appropriate to settle a case but their insured design professional feels strongly that they did nothing wrong, and they don’t want to settle for fear that this will be a black mark against them. This policy language is sometimes called a “hammer clause” and it says in essence to the insured design professional, “OK, you can exercise a right under the policy to refuse to settle the matter, but if the amount that is awarded at trial is greater than what we could have settled the case for, you (the design professional) will be responsible for the excess amount, and we (the insurance company) will pay only that part of the judgment that is within the amount for which the case could have been settled with the plaintiff.

The flip side of the settlement decision is what happened in the State Farm case. In the event that the carrier refuses to settle for an amount proposed by a plaintiff within the policy limit, as was apparently the situation in the underlying automobile claim that gave rise to the State Farm case, the carrier may be on the hook for the full judgment, including that part which exceeds the policy limit. But there is still the question of additional hardship, time, costs, and emotional distress incurred by the Insured as a result of the insurance company’s refusal to settle the case when it could have been settled. In an effort to encourage the carrier to settle (and for the purpose of laying a foundation for an en eventual bad faith claim against the carrier), the insured’s attorney will often write to the carrier at the time that the carrier is refusing to settle the underlying case. That letter will typically state that the Insured desires to settle the matter for the amount proposed by the plaintiff and that the insurance company’s failure to do so is deemed by the insured to be bad faith and is subjecting the insured to damages such as those claimed by the plaintiff in the State Farm case. This may be considered by the court in determining whether the insurance company acted in bad faith, with intentional disregard of the best interests of its Insured under the policy.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 5, No. 7 (Aug 2003).

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