In an issue of first impression, the Third Circuit Court of Appeals held that punitive damages awarded against an insured in a prior personal injury suit are not recoverable as compensable damages in a later breach of contract or bad faith suit against an insurer, in light of Pennsylvania’s public policy that insurers cannot insure against punitive damages. Wolfe v. Allstate Property & Cas. Ins. Co., 790 F.3d 487 (3d Cir. 2015). However, the Court also held that the plaintiff did not need compensatory damages to succeed on a claim that the insurer violated its contractual duty of good faith by failing to settle, nor did the plaintiff need compensatory damages to succeed on a statutory bad faith claim.

The underlying personal injury action in Wolfe arose out of an automobile collision in which the at-fault driver was intoxicated and had three prior DUIs. The injured party refused the insurance company’s nominal settlement offer and sued the insured. When the injured party learned of the driver’s intoxicated state, the complaint was amended to include a count for punitive damages. The insurer advised its insured that if a verdict was rendered on the punitive damages claim, then the insurer would not pay that portion of the verdict and the insured would be responsible. The insurer refused to increase its settlement offer and the case went to jury with an award of $15,000 in compensatory damages and $50,000 in punitive damages. The insurer paid the compensatory damage award but not the award for punitive damages. The insured assigned his rights against the insurer to the injured party who filed suit against the insurer alleging breach of contract, bad faith under Pennsylvania’s bad faith statute and violation of Pennsylvania’s Unfair Trade Practices and Consumer Protection Law. Under the breach of contract claim, the plaintiff sought to recover the $50,000 punitive damage award, interest and attorney’s fees and costs. Under the bad faith statute, the plaintiff sought an award of statutory interest, punitive damages and an assessment of court costs.

The District Court denied the insurer’s pre-trial motion for summary judgment and motion in limine to exclude evidence related to the punitive damages award in the underlying trial. The insurer moved for summary judgment arguing that, “since it had no duty to indemnify for punitive damages, it could not be required to consider the potential for punitive damages when deciding whether to settle the compensatory claim.” Wolfe, at 491. The insurer also argued that it was entitled to summary judgment because the jury’s compensatory damages award was within the policy limits and it paid that portion of the verdict. Id. In support of the motion in limine, the insurer argued that the plaintiff “was barred as a matter of public policy from claiming the $50,000 punitive damages award as an item of damages, because indemnification for punitive damages was impermissible under Pennsylvania law”, and that the evidence was irrelevant.  Id.

The Court first addressed the appeal of the motion in limine, and concluded that the punitive damages award was not relevant in the later suit and should not have been admitted.  The Court held that “[b]ecause Pennsylvania law prohibits insurers from providing coverage for punitive damages in order to ensure that tortfeasors are directly punished, … [the insurer] cannot be responsible for punitive damages incurred in the underlying lawsuit. To hold otherwise would shift the burden of the punitive damages to the insurer in clear contradiction of Pennsylvania public policy.” Id. at 493. The Court concluded that punitive damages awarded in an underlying case are not properly considered as compensable damages in a breach of contract claim against the insurer. Following from that reasoning, the Court explained that “an insurer has no duty to consider the potential for the jury to return a verdict for punitive damages when it is negotiating a settlement of the case. To impose a duty would be tantamount to making the insurer responsible for those damages, which, as we have discussed, is against public policy.”  Id.

With regard to its motion for summary judgment, the insurer argued that once the punitive damage award is removed from the equation, the District Court should have granted summary judgment in its favor because “an insurer does not breach its duty or act in bad faith, as a matter of law, if it does not settle and the jury awards a compensatory judgment within the policy limits because there is no harm to the insured.” Id. at 497. However, the Circuit Court disagreed and concluded that removing the punitive damages award would not require an entry of judgment in favor of the insurer. In examining the breach of contract claim, the Court held that under Pennsylvania law, even without compensatory damages, an insurer can be liable for nominal damages for violating its contractual duty of good faith by failing to settle. Id. at 498.  Also, a plaintiff is not required to show compensatory damages to succeed on a statutory bad faith claim because the statute only permits recovery of punitive damages, interest and costs. Id. at 499.

The takeaway from this case is that a bad faith claim cannot be based on an insurer’s failure to consider the potential for its insured getting hit with a punitive damage award when it is considering settling a personal injury action where punitive damages are not insurable. However, this does not completely insulate an insurer from a bad faith claim if the insurer still acted in bad faith in failing to settle the claim. That issue in Wolfe would be re-tried without the evidence of punitive damages being introduced.

Issues like this vary from state to state, but should always be considered as part of Tip #6 in our Ten Steps for Avoiding Bad Faith Failure to Settle Claims, which is part of Dentons’ Stopping The Setup training program.