Defense Digest

The Pennsylvania Superior Court Redefines Bad Faith Conduct Under 42 Pa. C.S.A. 8371 To Include Defense Conduct While Also Expanding The Ability Of Insureds To Obtain Punitive Damages In Pennsylvania Bad Faith Actions
By Chester F. Darlington Jr., Esq.*

In two separate court decisions, the Pennsylvania Superior Court has begun a trend in redefining Pennsylvania's "Bad Faith" statute, 42 Pa.C.S. 8371, by expanding it to include conduct by the insurer in defending itself during bad faith litigation and defending itself from threatened, but yet to be filed, bad faith litigation.  The Superior Court has also expanded the ability of insureds to obtain punitive damages in bad faith actions.  This current trend in Pennsylvania's intermediate appellate court represents a dramatic and arguably radical change in the law.

Historically, bad faith has been limited to conduct related to claims handling and claim decisions.  In O'Donnell v. Allstate Ins. Company , 734 A.2d 901 (Pa. Super. 1999), the Superior Court held that conduct during discovery in litigation could not be considered in determining bad faith since Pennsylvania's bad faith statute "was designed to provide 'a remedy for bad-faith conduct by an insurer in its capacity as an insurer and not as a legal adversary in a lawsuit filed against it by an insured'."  Two recent cases from the Pennsylvania Superior Court ignore this established case law and consider defense conduct unrelated to the claims adjustment process as bad faith.

Hollock v. Erie Ins. Exchange, 842 A.2d 409 (Pa. Super. 2004) is arguably the most important Pennsylvania bad faith case in years.  The Hollock case involved a dispute regarding the amount of damages in an underinsured motorist ("UIM") claim.  After notifying Erie of the UIM claim, Hollock's attorney enclosed an old declaration sheet which reflected $250,000 in coverage.  In reality, there was $500,000 in coverage.  According to the court, Erie failed to advise Hollock's attorney of this fact and misled the attorney as to the amount of coverage.  After Hollock provided medical records and other documents in support her claim, Erie requested a demand from Hollock's attorney.  Hollock's attorney demanded $450,000, and in response, Erie offered $30,000.  Erie cited a lack of causation to the injuries as support for its offer.  The case proceeded to UIM arbitration, and the panel awarded $856,000.  Erie then tendered the policy limits of $500,000 to Hollock.  Hollock then filed a bad faith claim against Erie in the Court of Common Pleas of Luzerne County.  In a non-jury proceeding, the trial court returned a verdict in the amount of $278,825.90 in compensatory damages (including attorney fees) and $2.8 million in punitive damages. 

On appeal an issue was whether the trial court acted properly in considering the conduct of the company and its employees during the trial in finding bad faith.  The trial court found that the deposition and trial conduct of Erie's representatives was evidence of bad faith.  The testimony was "a blatant attempt to undermine the truth-finding process of this court."  In finding bad faith, the trial court cited: (1) an Erie Vice-President who testified at trial that he did not review any documents in preparation for his trial testimony; (2) a claims examiner who reviewed his deposition transcript and log notes prior to his trial testimony, but did not review others' log notes because "he did not want to confuse his memory;" (3) claims examiners/managers who did not review Erie's claim practices and the Hollock claim file before their trial testimony; (4) the absence of any settlement offer by Erie in the litigation after a conference with the court where the court inquired whether Erie would make an offer; (5) Erie representatives evaded questions at their depositions and at trial and failed to review documents prior to their testimony to "feign ignorance;" and (6) an Erie claims examiner provided contradicting trial testimony from his deposition testimony and was able to answer questions during Erie's case-in-chief that he had little or no response in the plaintiff's case-in-chief.   

The Superior Court held that the trial court properly considered the trial conduct of the Erie employees in finding bad faith.  The court reasoned that since the Hollock case did not concern the conduct of an insurer following conclusion of the bad faith litigation, and involved a breach of the underlying insurance contract, it was appropriate for the trial court to consider Erie's "continued conduct in relation to its insured" at the trial, even though the policy limits had been tendered long before.

Another issue in the Superior Court's decision in Hollock was the burden of proof to award punitive damages in an action under 42 Pa.C.S.A 8371 and the constitutionality of the $2.8 million punitive damages award.  On appeal, Erie argued that, to award punitive damages under 42 Pa. C.S. 8371, the award may not be sustained unless the plaintiff proves bad faith and "aggravating circumstances beyond those that justify the award of compensatory damages."  Erie also argued that the $2.8 million award was "grossly excessive" pursuant to the United States Supreme Court's decision in State Farm Mut. Automobile Ins. Co. v. Campbell , 538 U.S. 408; 123 S. Ct. 1513, 155 L. Ed. 2d 585 (2003).

In Campbell, the United States Supreme Court recognized that punitive damage awards are subject to procedural and substantive constitutional limitations and  that the Due Process clause of the Fourteenth Amendment to the United States Constitution prohibits the imposition of "grossly excessive" or "arbitrary" punishments.  The Court restated its three “guideposts” for the review of punitive damage awards: (1) the degree of reprehensibility of the defendant’s misconduct; (2) the disparity between the actual and potential harm suffered by the plaintiff and the punitive damages award; and (3) the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases.  In regards to the second "guidepost," the Supreme Court declined to “impose a bright-line ratio which a punitive damages award cannot exceed,” however, stated that its “jurisprudence and the principles it has now established demonstrate, however, that in practice, few awards exceeding a single-digit ratio between punitive and compensatory damages, to a significant degree, will satisfy due process.”  Thus, under Campbell, the Court established a standard that few constitutional punitive damage awards will ever exceed a single-digit ratio.  The Hollock punitive damage award was approximately a 10-1 ratio and, thus, above the Campbell standard. 

The Superior Court rejected Erie's arguments, finding that the language of the bad faith statute provides no pre-condition for the finding of punitive damages other than the finding of bad faith.  In rejecting Erie's argument, the Superior Court recognized that a finding of bad faith under does not automatically compel the awarding of punitive damages and that the statute allows the award of punitive damages without additional proof, subject to the trial court's discretion.  The Superior Court also held that the amount of the punitive damage award was constitutionally proper.  The Superior Court found that the 10-1 ratio of punitive damages to compensatory damages was proper due to the Erie's reprehensible conduct, its significant wealth, and the "limited" compensatory award.  Importantly, the trial court in Hollock , in awarding punitive damages, based its award in part on the conduct of Erie's employees "throughout the trial."  Thus, while not discussed directly in the Superior Court's opinion, the Superior Court affirmed the trial court's consideration of Erie's trial conduct in determining and awarding punitive damages, a factor not previously recognized under Pennsylvania law. 

In Hayes v. Harleysville Ins. Co., 841 A.2d 121 (Pa. Super. 2003), a dispute existed regarding the amount of UIM coverage.  Harleysville had proceeded upon the belief that the insured had selected a reduced UIM coverage when he purchased his policy in 1985 and had affirmed that selection on a form in 1990.  Prior to the UIM arbitration, the insured's counsel notified Harleysville that he intended to file a bad faith cause of action after the UIM arbitration.  At the day of the UIM arbitration, counsel for Harleysville was provided with documents showing that the insured's insurance agent had, in fact, signed the 1985 selection form for lower UIM coverage.  Counsel for Harleysville then provided an opinion letter to the insurer advising them the selection form was defective and that the insurer should tender the policy limits irrespective of agreement to settle the threatened bad faith claim.  Harleysville disagreed with its counsel's opinion and instead offered the policy limits on the condition of a full release by the insured of the threatened bad faith cause of action.  The insured denied the offer and proceeded to UIM arbitration.  The panel found in favor of the insured, and Harleysville subsequently tendered the policy limits.  The insured then filed a bad faith action, and in a non-jury proceeding, the Philadelphia County Court of Common Pleas found, among other things, that Harleysville acted in bad faith by attempting to settle the UIM claim with the threatened bad faith claim. The Superior Court, with little discussion, affirmed the trial court on this issue and held that Harleysville's action in this regard was bad faith.  

Both Hollock and Hayes appear to signal a trend that litigation, trial and defense conduct by the insurer may be considered in determining if an insurer committed bad faith under Pennsylvania's bad faith statute and in determining punitive damages.  Further, the Superior Court ignored the limits placed on the amount of punitive damages by the United States Supreme Court.  As such, and for the time being, insurers must understand and consider that defense conduct that was historically considered immune from being considered as bad faith evidence and that is unrelated to the adjustment of a claim may now be used as evidence of bad faith against them.  Also, it is possible that the plaintiffs' bar may attempt to use the holdings of these cases, despite the fact they contradict other established case law, to expand the scope of potential bad faith conduct into new areas not recognized by the law.  However, while these cases appear to expand the bad faith statute into new areas, petitions for Allowance of Appeal to the Pennsylvania Supreme Court are currently pending in both cases.  Thus, the Pennsylvania Supreme Court may have the final say. 

*  Chet, an associate in our Philadelphia office, can be reached at (215) 575-2752 or cdarlington@mdwcg.com.