Flying high in April, shot down in May

A case out of California's Fifth District Court of Appeals - Neil v. Jones [2002 DJDAR 5283] - demonstrates the 'easy come, easy go' of litigation. In 1996, the Jones hit Cal-Eagle Insurance Company for $2 million compensatory damages and $11 million punitive damages for Cal-Eagle's bad faith miscalculation of monies owed by Jones for additional insurance premiums. The Plaintiff[Neil] essentially brought a collection action for the $21,000 allegedly owed as additional premiums after an audit purported to show that more premiums were owed than was paid in the estimated initial premium. Jones cross-complained against Cal-Eagle for damages arising from a breach of the Covenant of Good Faith and Fair Dealing by alleging that the audit was fraudulent. Jones eventually prevailed at trial to the tune of $11 million in punitive damages.

That's right a $21,000 collection case turns around and results in a $11 million pop the other way. That's like going to your doctor to get a splinter removed and coming out in a coma.

An issue in the case was whether the Insurance Company's premium practices, which concededly constitute a breach of contract, will support the punitive damage claim. Under California law, like most states, you can't get punitive damages for a breach of contract. The law doesn't want to discourage people from breaching contracts. People shouldn't generally be forced to comply with non-economic bargains; they should be able to pay the contract's value and be on their way to bigger and better breaches of contract.

However, California developed a doctrine which allowed the recovery of 'non-economic' damages - such as punitives - for tortious breaches of the Covenant of Good Faith and Fair Dealing. The high water mark of this doctrine was in the mid-1980's, but by the early-1990's the doctrine was substantially pruned back. The Death of Contract was prematurely predicted.

The one place where the tortious breach doctrine remained vital was with insurance contracts. Like the guy in your fourth grade class who ate paste, insurance is viewed as being "special." Insurance is heavily regulated, and the last thing you want is for insurance companies to start negotiating coverage after the accident happens. In the Neil case, the trial court was persuaded to apply the tortious breach doctrine to the premium side of insurance, rather than limit the doctrine to the claims side.

The Fifth DCA basically said 'no.' The factors that allow the imposition of tort damages in insurance cases do not apply to an abuse of an insurer's rights to audit premiums. Interestingly, the Neil court was quite clear that it was part of a process of rolling back the tort of bad faith, which according to Professor Gilmore, would "tortify" contract law. This is interesting in large part because it shows how the zeitgeist plays an important role in practical litigation. When this case was winding its way through pretrial motions in the early-90s, it was unclear how far the bad faith breach of contract doctrine had been rolled back. However, from the safe distance of a decade, its very clear that the bad faith breach of contract doctrine has the same intellectual force as mood rings, and you end up with two different decisions, and Plaintiff is out $11 million, and counsel is out something like $4 million.

Side note: although I was not involved in this case, my old firm represented the insurance company before the appeal. I always believed that the bad faith breach doctrine could not be applied to the premium side of the insurance contract. But, then I'm a business litigation attorney, and not an insurance attorney. When someone says 'your client breached in bad faith', we say ' and your point is....'