Bad Faith Breach of Contract in the Insurance Context and in the Oil and Gas Context: A Comparison

By Graves, Sheila R. | Faulkner Law Review, Spring 2010 | Go to article overview
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Bad Faith Breach of Contract in the Insurance Context and in the Oil and Gas Context: A Comparison


Graves, Sheila R., Faulkner Law Review


PART I. THE INTRODUCTION

In 2007, the Alabama Supreme Court issued Exxon Mobile Corporation v. Alabama Department of Conservation and Natural Resources; a fifty-one page opinion that begins like a chemical engineering textbook with vocabulary including slop oil, diamondoids, cogenerated electricity, flare offs, and sweetened sour gasses. The complex thirty-four volume transcript (1) and a jury award that was the largest punitive damages award in Alabama's history (2) made one justice wishfully consider handing-off the decision to the Rotary Club (3) whose simple Code of Ethics would ask only whether Exxon was an honest, fair, and friendly corporation and did it seek the benefit of all concerned? (4)

Exxon rightly answered to the highest court of the State which applied the legal elements of fraud and breach of contract. Alabama's citizens should applaud the wisdom and courage of those elected to Alabama's Supreme Court for their ability to justly apply the law of the State, to simplify complex and evolving science, to root out the correct legal issues, and to resist the temptation of wrongfully accepting enormous punitive damages. The task of the Court was at once simple and complex. In one sense, the case required only a relatively straightforward determination of whether the disputed issue arose under contract or fraud principles. (5) Did Exxon have an intentional scheme to cheat Alabama out of royalties due under the lease deserving of punitive damages, or is this case simply a question of contract interpretation that, even if breached in bad faith, would not allow punitive damages? The fact that $3.5 billion rested upon this answer complicated the question. (6) The Court applied the law of the state and determined that a fraud claim could not stand. Though correct in its application of the current law, the Alabama Supreme Court has twice alluded to a remedy that would have far-reaching effects on future oil and gas litigation. (7) Justice Lyons called this remedy "tortious bad faith breach of contract," (8) also known as the no reliance fraud standard in breach of contract. (9)

Part I section A of this note includes a necessarily simplified recitation of the facts where the issue in Exxon emerged as a question of whether a fraud was perpetrated on the State, deserving of punitive damages, or whether Exxon and the State were in a contract dispute where only compensatory damages were available. The note investigates the overlap where a tort is the basis of the breach so that traditional compensatory contract damages may give way to tort's punitive damages in Part I section B. Part I section C explores the elements of the tort in question in Exxon; namely fraud. Section C gives special attention to the element of justifiable reliance. The section reveals the element of reliance as the bottleneck for cases like Exxon, where the State cannot provide proof that it adopted a different course of action after it perceived the alleged fraud. Part II is a careful examination of the current law in bad faith breach of contract where punitive damages are awarded. Here, the note refers to the three exceptions to the general rule that allow punitive damages in contract disputes. (10) Two exceptions have no application in Exxon, but the third exception, the no reliance fraud standard in the insurance context, is explored in depth. Part II includes the exception's history and its application in Alabama and other jurisdictions. The note examines policies behind insurance contract protections. The part exposes several motives that form the basis of the willingness for courts and legislatures to routinely allow punitive damages in insurance contracts even when the element of reliance cannot be proved. These motives are: to protect the non-breaching party from severe financial damage, to provide deterrence to the breaching party, to punish the culpable party who demonstrates malice, fraud, or a conscious disregard for the rights of others, and to guard against violations of public policy.

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Bad Faith Breach of Contract in the Insurance Context and in the Oil and Gas Context: A Comparison
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