Recent Court Decisions
Stempel, Jeffrey W., Journal of Risk and Insurance
SUPREME COURT FORBIDS INSURER FROM SEEKING REIMBURSEMENT THROUGH
FEDERAL COURT AcTION PURSUANT To ERISA
Great-West Life & Annuity Insurance Co. v. Knudson, 122 S. Ct. 708 (U.S. Supreme Court--
January 8, 2002)
In a perhaps surprising outcome, the more conservative wing of the U.S. Supreme Court held in a 5-4 opinion that an Employee Retirement Income Security Act (ERISA) plan insurer does not have the right to go to federal court to attempt to recoup payments made to an insured who subsequently obtains a tort recovery for the same loss. The Court's more liberal members dissented and would have permitted the insurer to seek the relief requested in federal court.
Specifically, the issue that divided the Court was whether ERISA provides insurers of an ERISA plan with a right to file a federal court action to seek recovery of payments when a plan insured receives benefits and then also receives a tort settlement in connection with the claim. Great-West Life & Annuity Insurance Co., which provided stop-loss medical expense insurance to Earth Systems, Inc., asserted that the insured was enjoying a double recovery and that Great-West was entitled to reimbursement pursuant to the terms of the Earth Systems ERISA benefit plan, which had assigned its rights to reimbursement to Great-West. Section 502(3) of ERISA permits a civil action in U.S. District Court
by a participant, beneficiary, or fiduciary (A) to enjoin any act or practice which violates... the terms of the [ERISA employee welfare] plan [such as a group medical plan], or (B) to obtain other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of . the terms of the plan.
See 29 U.S.C. sec1132(a) (3) (emphasis added).
Earth Systems was the plan fiduciary, and it assigned its right to reimbursement to Great-West, which has paid the bulk of the medical bills of Janette Knudson, wife of Earth Systems employee Eric Knudson at the time of her injury.
Janette Knudson was injured in a June 1992 auto accident and rendered quadriplegic. The Earth Systems medical plan covered more than $411,000 of her medical expenses, with Earth Systems paying $75,000 (the attachment point for its stop-loss policy with Great-West) and Great-West paying the remainder. The Knudsons sued Hyundai, the maker of the car in which she was riding, as well as other defendants in connection with the accident. The parties agreed to a $650,000 settlement. When Great-West was notified, it filed a federal court action seeking to enjoin the state court proceeding and any state court allocation of the settlement proceeds and to force an allocation of the proceeds with repayment to Great-West.
The federal trial court found that Great-West could not bring the proceeding. The settlement was effected, confirming Great-West's worst fears, as the California state court found that only $13,828.70 of the $650,000 settlement was for past medical expenses and subject to reimbursement. Feeling about $300,000 short because of this series of events, Great-West appealed but lost again. It then sought and was granted Supreme Court review.
The Court focused its legal inquiry on whether the relief Great-West sought was "equitable." Law has long recognized a technical distinction between "equitable" claims and those made "at law." Equitable claims essentially involve court orders that require something to be done or that a party refrain from doing something. The most common form of equitable relief is the injunction. A court might issue an injunction ordering a former employee to stay away from his or her former office or to stop disclosing confidential information of the former employer. Courts also issue more affirmative injunctions that require a party to do something. For example, an injunction may require that a defendant tear down a wall that was built without permission of a neighborhood association. The sometimes controversial school desegregation and prison administration orders issued by courts are injunctions and constitute equitable relief. By contrast, an action at law is generally one that seeks money damages. Personal injury or breach-of-contract claims seeking damage are classic examples of pure actions at law. But if the contract action seeks to require the defendant to perform a specific promised obligation, it has an injunctive or equitable component as well.
As applied to the Great-West case, the Court was concerned with whether the attempt to obtain payment from the Knudsons was an equitable action (in which case Section 502 of ERISA applied) or an action at law (in which case it did not). Justice Scalia, writing for the majority that included Justices O'Connor, Kennedy, Thomas, and Chief Justice Rehnquist, found that the reimbursement action was more properly classified as legal. The majority reasoned that Great-West was in essence asking for a monetary award, which was legal relief.
In dissent, Justice Ginsburg (joined by Justices Stevens, Souter, and Breyer) acknowledged that money was the object of Great-West's efforts but that this was because Great-West had already paid money for the medical bills and was trying to get it back in a restitution action. Historically, restitution has usually been considered an equitable action on the rationale that a court ordering restitution is essentially issuing an injunction requiring the return of something. The dissenters also argued that treating the Great-West action as equitable was more consistent with the purpose of ERISA, which in part seeks to make treatment of ERISA plans consistent across the country and not subject to state idiosyncrasies. Having all such reimbursement claims heard in federal court is thought to assist that purpose. Justice Stevens dissented separately, emphasizing this point.
According to the majority, the dissent position might be correct if all the restitution seeks is return of property or a particular item. However, when the restitution to be had is through payment of funds, this is legal rather than equitable restitution. The majority's analysis was primarily historical and textual and did not address the matter of statutory purpose in great detail. However, the majority might have noted that the federal common law of contract applicable to ERISA matters would nonetheless provide the applicable substantive law in any of these reimbursement disputes even if the case were heard in state court.
Both the majority and dissent have reasonable arguments regarding the jurisprudential technicality at issue in the case (equitable relief versus legal relief), and the majority probably has the better argument on the facts of the case. Obviously, to the extent the Knudsons repaid Great-West it would not be with the same dollars originally expended by the insurer. Money is fungible. Great-West's action can be seen as more like a breach-of-contract lawsuit (the ERISA plan was a contract obligating the Knudsons to repay) rather than an effort to obtain an injunction forcing the Knudsons to turn something over to Great-West.
As a practical matter, however, the Knudson decision means that health plan insurers operating pursuant to an employer's plan may not go to federal court to force reimbursements of this nature. The insurers still may, of course, go to state court and even seek to intervene in the tort actions commenced by injured health plan members. However, the conventional wisdom is that state courts are more sympathetic toward compensating the injured employee and less concerned about the insurer being paid back. As a result, Knudson is generally considered a decision adverse to health insurers, although it is also of course too early to determine the ultimate effect of the decision.
Initial interpretations of Knudson have varied according to whether insurer or patient counsel is commenting. Compare Dave Lenckus, High Court Narrows Right of Recovery, BUSINESS INSURANCE (February 11, 2002) at 3 (quoting insurers and counsel highly critical of the decision) with Alison B. Bianchi, ERISA Ruling Opens Door for Defenses By Plaintiffs, LAWYERS WEEKLY USA (February 4, 2002) at 1 (plaintiff attorneys generally positive about Knudson). Intense criticisms of the decision seem a bit shrill. See, e.g., Lenckus, supra at 4 (Knudson "ruling restricts health plans' recovery rights against plan participants who obtain third-party damages to cover medical costs and could drive up plan costs and lead to long benefit delays and coverage reductions" and quoting self-insurance association spokesman to effect that Knudson decision is a "lose-loselose situation for everybody"). Would justices Scalia, Rehnquist, O'Connor, Kennedy, and Thomas really do that to employers and insurers? Probably not. And they did not.
Under Knudson, employer plans or health insurers as assignees of reimbursement rights still may pursue their contractual rights-they just must do so in the state court proceeding that has jurisdiction over the injured insured's claim against third parties. Although the state forum may not be as favorable, this is not the equivalent of stripping the insurer or employer plan of rights to recovery. Lawyers representing plan members who obtain tort recovery argue, with some force, that state courts operating under Knudson will not be hostile to plan reimbursement rights but will be more evenhanded than many federal courts in considering the costs to the insured of having prosecuted the claim that results in recovery. See Bianchi, supra, at 32 (quoting plaintiffs' attorney that after Knudson, it will be easier to "argue that [the plan] ought to bear [its] fair share of attorney fees and litigation costs that it took to recover the money and that the plaintiff needs to be made whole before [the plan] can be reimbursed. The plan shouldn't get a free ride and recover 100 percent on the dollar."). The ultimate impact of Knudson will probably take several years of litigation to fully emerge. Although the decision is not the dramatic gutting of plan/insurer rights asserted by some, Knudson clearly shifts the practical balance of power away from employer plans and insurers and toward insured persons pursuing recovery against third parties. In addition, Knudson suggests some narrowing of the reach of the ERISA statute, a Supreme Court attitude that may be important for future ERISA cases. Currently, the Court has pending at least one case regarding ERISA preemption and the applicability of an Illinois law requiring independent medical review of claims. Many other states have similar laws. Oral argument on the Illinois case was heard in January 2002, shortly after the Knudson decision was announced.
FEDERAL APPEALS COURT FINDS LIABILITY INSURER NEED NOT COVER GUN-RELATED LAWSUIT AGAINST RETAILER; LAwsUIT SOUGHT ONLY EQUITABLE RELIEF RATHER THAN "DAmAGES" COVERED By THE POLICY
Ellett Brothers, Inc. v. United States Fidelity and Guaranty Corp., 25 F.3d 384 (U.S. Court of Appeals for the Fourth Circuit-December 28, 2001).
Another recent case of note turned in large part on the distinction between equitable and legal relief under the law. Ellett Brothers is a large sporting goods retailer that, among other things, sells guns. Ellett was sued by several California municipalities and the NAACP, with plaintiffs arguing that Ellett's gun sales are dangerous and cause damage to society because they contribute to the excess availability of inexpensive firearms. The California city suits alleged that this violated the state's Business and Professions Code and sought the following relief:
restitution to the public of funds obtained in violation of the Code, disgorgement of profits acquired by violating the Code, civil penalties for violating the Code, and costs of suit [as well as] attorneys fees and "further relief as the Court deems equitable and just." The California municipalities did not seek compensatory or punitive damages.
In the fourth lawsuit, the NAACP alleged that Ellett created and maintained an illegal secondary market for guns. It sought an injunction requiring Ellett to change its marketing practices and an injunction requiring Ellett to contribute to a fund to supervise gun dealers, attorneys fees, and "further relief as this Court deems just and proper." The NAACP similarly did not seek compensatory or punitive damages.
275 EM at 386 (citations to record omitted).
The Ellett insurers denied coverage on the ground that the commercial liability policies purchased by Ellett only provide coverage for claims seeking money damages and do not cover efforts to obtain injunctive or equitable relief against the policyholder. Coverage litigation ensued. The federal trial court in South Carolina ruled for the insurers as a matter of law and granted summary judgment, ruling that the insurers had no duty to defend Ellett in the actions.1 The trial court also permitted Ellett to voluntarily dismiss its claims for indemnity by the insurers on the ground that an ultimate decision on indemnity could only be determined after adjudication of the underlying facts. The Fourth Circuit, the federal appeals court for Virginia, West Virginia, Maryland, and the Carolinas, affirmed the trial court rulings. In doing so, the Appeals Court set forth a strong, bright-line rule regarding the meaning of the term "damages" in a liability insurance policy. Judge Michael concurred in the result but took issue with the majority's bright-line pronouncement regarding the universality of the meaning of "damages" under a liability policy as well as the majority's highly pronounced ground rule regarding the distinctions between legal and equitable relief. Had Ellett Brothers been decided after Great-West v. Knudson (the U.S. Supreme Court decision discussed above), Judge Michael would have had additional ammunition.
The Ellett Brothers result seems indisputably correct in light of the facts of the coverage question (and although I have the potential prejudices of a former expert witness, I have seen the pleadings as well as the reported opinion). However, the Fourth Circuit's sweeping pronouncements about insurance policy language unmoored from context seem incorrect and in conflict with applicable law concerning the meaning of "damages" in connection with environmental cleanup claims. According to the majority:
We have previously held that the term "damages" in an insurance contract unambiguously means legal damages, and that "as a general rule comprehensive general liability policies do not extend coverage to claims for equitable relief" [citing Cincinnati Ins. Co. v. Milliken and Co., 857 F.2d 979, 981 (4th Circuit, 1988) and Braswell v. Faircloth, 300 S.C. 338, 387 S.E.2d 707, 710-711 (S.C. Ct. App., 1989)]. We may well have been without authority, in the context of the single contractual dispute at issue in Milliken, to so define the term "damages" for all contracts in futuro, as each contract is to be interpreted according to the intent of the parties. However, our authority therein to create a default rule of contract interpretation whereby in the absence of any contrary intent by the parties, the term "damages" in insurance contracts will be interpreted so as not to reference equitable relief, would seem unassailable. And, here, that default rule of contract interpretation is sufficient to sustain the district court's summary judgment, because there is nothing in the contract between Ellett and its insurers that evidences an intention to include equitable, in addition to legal, claims for relief, among those as against which Ellett's insurers must defend.
275 F.3d at 387.
The majority also noted that the Court of Appeals has in the past "described restitution [one of the remedies sought against Ellett Brothers] as an 'equitable remedy."' 275 F.3d at 388. Fair enough, but after Great- West v. Knudson, it appears there are now in the view I I was retained by one of the insurers as a potential expert witness but did not submit testimony in light of the trial court's grant of summary judgment. of the Supreme Court two types of restitution: legal and equitable. To the extent that those suing Ellett want to have Ellett pay money, a case can be made that the action is one of legal restitution, much like the insurer's claim against Knudson for reimbursement of medical bills. At the least, Knudson suggests that the Fourth Circuit's week-earlier decision may be more problematic than the Ellett Brothers majority acknowledged.
In his concurrence, Judge Michael implicitly makes this point, even though he did not have the benefit of the Knudson opinion, which had yet to be rendered when Ellett Brothers was decided. In addition, the concurrence makes some telling points about problems with the majority opinion. For example, the concurrence establishes rather forcefully that South Carolina precedent on the issue is more complicated than appreciated by the majority. In fact, the Braswell v. Faircloth opinion cited by the majority arguably helps Ellett Brothers more than the insurers. Braswell held that a policyholder might recover government-imposed environmental cleanup costs even though the insurers in that case were making an argument similar to that of the Ellett Brothers insurers: The claim against the policyholder was one sounding in equity and did not seek "legal" relief, which is what is meant by a liability insurance policy's promise to defend claims for "damages." See 275 F.3d at 389 (Michael, J., concurring). Continued the concurrence:
Because this case may be resolved on an alternate and well-established ground, I would not apply our rule in Milliken, which appears to be in conflict with the result in Braswell.
The legal/equitable distinction aside, the lawsuits underlying this case still do not seek "damages," as that term is commonly understood. South Carolina law provides that a term in an insurance contract, as in contracts generally, should not be expanded beyond "its plain, ordinary, and popular meaning." The term "damages" is ordinarily meant to include "the estimated reparation in money for detriment or injury sustained."
Here, the underlying lawsuits seek an injunction to abate a nuisance, restitution, disgorgement of profits, civil penalties, attorneys' fees, costs, and contribution to a fund to monitor gun dealers. None of these remedies would repair or compensate for injuries sustained in the past by victims of gun violence. An injunction to abate a nuisance, specifically, one requiring changes in methods of distributing and marketing firearms, is forwardlooking relief to prevent future harm, not relief to redress past harm. Likewise, monies for a fund to monitor gun dealers are not costs of past injuries, nor are attorneys' fees and court costs. Civil penalties are fines payable to the government to punish and deter bad conduct, not payments of the costs of an injury or harm. In some cases, equitable relief in the form of restitution or disgorgement is used to restore damaged property or goods, as in the case of environmental cleanup, and thus the relief may fall within the ordinary meaning of "damages."
275 EM at 390-91.
In my view, Judge Michael's concurrence assesses the coverage dispute in a more accurate manner, one not nearly as likely to create problems in future cases, as does the majority's approach.
In addition, the concurrence might have invoked concepts such as the reasonable expectation of the policyholder in favor of a determination for the insurers in the case. Most businesses purchase liability insurance to protect them if they are sued on a monetary claim. They probably do not expect their liability insurance to cover the sorts of "social change" litigation at issue in Ellett Brothers, in which the plaintiffs are trying to directly alter the business operations of the policyholder (as opposed to indirectly altering business practices through the threat of monetary civil liability).
The majority opinion is subject to another criticism. It adopts a "default rule" that "damages," as used in a liability policy, means legal damages and not equitable relief, unless the policy language is to the contrary But this would seem to suggest that where policy language is ambiguous, it is construed in favor of the insurer on this question. This, of course, would be a substantial departure from the ordinary rule of insurance contracts that ambiguous language is construed in favor of the policyholder and against the insurer, which is usually the drafter of the policy. See JEFFREY W. STEMPEL, LAW oF INSURANCE CONTRACT DISPUTES sec4.02 (2d ed. 1999 & Supp. 2002). Perhaps the majority did not intend its default rule proposition to have this effect. If so, this provides further indictment of the breadth of the majority's pronouncement. If not, and the majority really intended to alter the prior "default rule" of construing ambiguities against the contract drafter in the case of liability insurance, this probably suggests even greater problems with the majority opinion, which was authored by Judge Michael Luttig and joined by Chief Judge J. Harvie Wilkinson, both of whom are frequently said to be on a "short list" of potential Bush Administration Supreme Court appointees. Although the Ellett Brothers insurance coverage dispute may not be the stuff of high constitutional law, the majority opinion's sweeping, linguistic, and technical textualism might prompt concern in some quarters as to the jurisprudential approaches of these judges.
ARIZONA SUPREME COURT FINDS INSURER-APPOINTED DEFENSE COUNSEL OWES DUTIES To INSURER BUT THAT PRIMARY CLIENT IS POLICYHOLDER-DEFENDANT
Paradigm Insurance Co. v. Langerman Law Offices, 24 P.3d 593 (Supreme Court of Arizona, June 13, 2001).
A continually vexing issue in the defense of claims has been the relative roles of policyholder, insurer, and legal counsel retained by the insurer to defend the policyholder. The Arizona Supreme Court has now weighed in on the issue with an opinion that appears to strike a fair balance for all concerned.
Dr. Benjamin Vanderwerf was sued for malpractice. He tendered the claim to his insurer, Paradigm. Paradigm assigned the Langerman law firm ("Langerman") to defend the case. Subsequently, Paradigm became dissatisfied with Langerman's legal work. Specifically, Paradigm asserted that Langerman had failed to investigate possible coverage of Vanderwerf under the hospital's liability policy and possible tender of the defense to the hospital's carrier. Paradigm retained new counsel, which did put the hospital insurer on notice, but the hospital insurer denied coverage on the ground of late notice and tender. Paradigm eventually settled the malpractice suit against Vanderwerf but contended it had been damaged by Langerman in that Paradigm had been forced to defend the lawsuit and use its own funds to resolve the matter when defense and at least part of settlement should have been provided by the hospital's insurer had notice and tender been given in a timely fashion.
When Langerman's bill arrived, Paradigm balked, claiming that Langerman's services had been substandard. Langerman sued to collect, and Paradigm counterclaimed for damages allegedly arising from Langerman's negligence. The trial court ruled via summary judgment that there was no attorney-client relationship between Paradigm and Langerman since Langerman's "client" in the malpractice dispute was Paradigm's policyholder, Vanderwerf. The Arizona Court of Appeals reversed in part, essentially holding that insurer-retained counsel owes duties to both the policyholder and the insurer. The Arizona Supreme Court concurred with much of the Court of Appeals view but disagreed as to the full scope of the asserted "dual client" relation found by the Court of Appeals.
We believe the court of appeals' characterization ... was too absolute. A host of potential problems are created by holding that, as a matter of law, a lawyer hired by the insurer to represent an insured always accepts the responsibilities of dual representation until a conflict actually arises-thus always automatically forming an attorney-client relationship with both the insurer and the insured.
24 P.3d at 598.
The Arizona Supreme Court vacated in part and remanded for application of the High Court's opinion.
In Paradigm, the Arizona Supreme Court held that an express agreement was not required for counsel to be obligated as a lawyer to both insurer and policyholder. Rather, the existence of an attorney-client relationship is determined according to the standards set forth in Restatement of the Law Governing Lawyers, which provides:
A relationship of client and lawyer arises when: (1) a person manifests to a lawyer the person's intent that the lawyer provide legal services for the person; and ... (a) the lawyer manifests to the person consent to do so.
24 P.3d at 596, quoting AMERICAN LAW INSTITUTE, RESTATEMENT OF THE LAW GOVERNING LAWYERS 14 (2000).
However, the duties owed by retained counsel to the insurer should not be viewed as diminishing the duties of counsel toward the policyholder. According to the Paradigm Court, an "attorney who represents an insured owes him undeviated and single allegiance whether the attorney is compensated by the insurer or the insured." See 24 P.3d at 595, quoting Parsons v. Continental Am. Group, 550 P.2d 94,98 (Arizona, 1976) and Barmat v. John & Jane Does Partners, 747 P.2d 1216 (Arizona Court of Appeals, 1986) (internal quotations and citations omitted). However, as between insurer and policyholder, the policyholder has greater claim to the rights of a traditional client of the insurer.
[W]hen a conflict actually arises, and not simply when it potentially exists, the lawyer's duty is exclusively owed to the insured and not the insurer. Because a lawyer is expressly assigned to represent the insured, the lawyer's primary obligation is to the insured, and the lawyer must exercise independent professional judgment on behalf of the insured. Thus, a lawyer cannot allow an insurer to interfere with the lawyer's independent professional judgment, even though, in general, the lawyer's representation of the insured is directed by the insurer.
24 P.3d at 597 (citations omitted).
[T]he potential for conflict between insurer and insured exists in every case; but we note that the interests of insurer and insured frequently coincide. For instance, both insurer and insured often share a common interest in developing and presenting a strong defense to a claim that they believe to be unfounded as to liability, damages, or both. Usually insured and insurer have a joint interest in finding additional coverage from another carrier. Thus, by serving the insured's interest the lawyer can also serve the insurer's, and if no question arises regarding the existence and adequacy of coverage, the potential for conflict may never become substantial. In such cases, we see no reason why the lawyer cannot represent both insurer and insured; but in the unique situation in which the lawyer actually represents two clients, he must give primary allegiance to one (the insured) to whom the other (the insurer) owes a duty of providing not only protection, but of doing so fairly and in good faith.
24 P.3d at 598, citing Zilisch v. State Farm Mutual Auto Ins. Co., 995 P.2d 276, 279-80 (Arizona, 1999) (in Zilisch the Arizona Supreme Court summarized at some length its common law of bad faith applicable to insurers).
Under Paradigm and other case law, the policyholder and insurer-appointed counsel automatically have a traditional lawyer-client relationship that imposes full fiduciary duties on counsel. Whether the insurer is also a client of the lawyer depends on the facts and circumstances of the case. Other states have suggested that the insurer is never a full-fledged client of counsel but is more in the nature of a third-party payer of counsel. Many states (Paradigm Insurance suggested that it was the majority of states, an issue the Court did not decide; see 24 P3d at 598, n. 2.) hold that both insurer and policyholder are clients of the attorney.
Paradigm, again relying on the ALI restatement, appears to take the view that the lawyer and the insurer are essentially in a lawyer-client relationship so long as there is not an actual or clearly looming potential conflict of interest between insurer and policyholder. Minor potential for conflict does not vitiate counsel's ability to represent both insurer and policyholder, but the Paradigm court expressly stated that it did not "endorse the view that the lawyer automatically represents both insurer and insured until the conflict actually arises." 24 P.3d at 599. Regardless of the precise relations of the three affected entities (insurer-policyholder-counsel), "[C]ommunications between the nonclient insurer and the lawyer would generally be entitled to the same degree of confidentiality-as long as the general requirements for privilege are met-as those between the insured client and the lawyer." 24 P.3d at 599, n. 3.
As to the potential liability of attorney Langerman, the Paradigm court also stated (and overruled the Court of Appeals in this regard) that an action for professional negligence could be maintained against counsel even if the insurer was not a "client" in the full sense of the term. The Paradigm court noted that a well-developed body of law exists that makes lawyers liable to third parties under certain circumstances. Generally, this takes place when the lawyer is aware of third-party reliance and has not disputed it, and where the lawyer's duties to the third party do not interfere with counsel's duties toward a full-fledged client. See 24 P.3d at 599-600, 601; Restatement 51(3). Consequently, there is no legal bar to an insurer suing appointed counsel for counsel's negligent failure to meet the apt standard of care. Whether the insurer recovers, of course, will depend on whether counsel in fact erred. But the bottom line in Arizona under Paradigm (and probably in most jurisdictions) is that insurers may bring actions against retained counsel for counsel's subpar performance. In some states, the action will be restricted to breach of contract rather than being called legal malpractice because of the view that counsel does not have a client relationship with the insurer. In all states, where counsel does not act to the insurer's satisfaction because counsel owed conflicting duties to the policyholder, an action by the insurer would not be apt absent unusual circumstances (e.g., fraud or other misconduct that goes beyond what was proper representation of the policyholder's interest).
GEORGIA HIGH COURT DETERMINES THAT AUTO INSURER MUST PAY FOR "DIMINISHED VALUE" OF CAR THAT HAS BEEN IN COLLISION EVEN AFTER FULL REPAIR OF VEHICLE
State Farm Mutual Automobile Ins. Co. v. Mabry, 2001 Ga. LEXIS 910 (Supreme Court of Georgia, November 28, 2001).
An emerging area of insurance coverage litigation has been the apt measure of damages after a vehicle has been in a collision and incurred repairs. To oversimplify, most automobile insurers read the standard auto policy as requiring only that the vehicle be adequately repaired. If the policyholder wishes to take a cash payment rather than have the vehicle repaired by the insurer, the amount of payment should (in the insurer's view) be the cost of the repairs reasonably necessary to put the vehicle back in its former condition. This may include, of course, auto body work as well as mechanical repair of the vehicle and replacement of various parts of the car.
On the opposite side of the issue, some policyholders argue that once a car has been in an accident, it loses some of its market value merely from having been in an accident, even if the vehicle is well repaired. These policyholders, in a variety of suits across the country, have asserted that they are entitled to an additional cash payment for the "inherent diminished value" that inheres after a collision.
Recently, the Georgia Supreme Court issued an opinion siding with the policyholders on this question. The opinion may be important in the continuing state-by-state battle over this issue because it is the first state supreme court to decide the issue in what might be termed the "modern era" of such litigation. There are analogous precedents about this issue that tend to divide 50-50 between insurers and policyholders, but most are older. Since then, policy language, society, and the legal and insurance systems have changed, and policyholders have made renewed efforts in favor of diminishedvalue coverage. In addition, the Georgia opinion was unanimous, a perhaps surprising result in light of the seeming national division over the controversy but perhaps not surprising in view of Georgia precedent in this area. In my view, the Georgia opinion in State Farm Mutual Automobile Ins. Co. v. Mabry is incorrect, a point elaborated on in JEFFREY W. STEMPEL, LAW OF INSURANCE CONTRACT DISPUTES sec22.11 (2d ed. 1999 & Supp. 2002) and touched upon below.2 Nonetheless, it is indisputably the insurance law of Georgia and will likely have significant impact.
Mabry began as two policyholders sued State Farm. They had made first-party physical damages claims, but the insurer refused to pay for claims of "diminution in value of their vehicles caused by the fact of the physical damage." The trial court sided with the policyholders, ordering State Farm to assess claims for such damage and to pay such damage costs if it was determined that a vehicle lost market value after an accident beyond the cost of physical repair.
The auto insurance policy in question, which is similar to most such policies, states that the insurer would
pay for loss to your car, minus any deductible. The policy contains a provision limiting State Farm's liability to the lower of the actual cash value of the vehicle or the cost of repair and replacement, and a provision giving State Farm the right to settle a loss by paying up to the actual cash value of the car or paying "to repair or replace the property or part with like kind and quality." That provision also requires that the policyholder pay for any "betterment" resulting from repair and replacement.
2001 Ga. LEXIS at *13.
The trial court ruled that there was potential for diminished market value in every case in which the vehicle was involved in an accident. The Supreme Court affirmed this as a finding of fact by the trial court that was not clearly erroneous (the standard by which trial court determinations of fact are reviewed).
As to the issue of what the insurer must provide, the Supreme Court viewed this as a matter of law to be decided by the Court. Citing Georgia precedent, the Court found that
the question of an insurer's obligation to pay for diminution in value under the physical damage coverage of automobile polices is not one of first impression. The basic holding establishing the measure of damages and the effect of a limitation of liability provision appeared 75 years ago in U.S. Fidelity & Guaranty Co. v. Corbett, 35 Ga. App. 606,134 S.E. 336 (1926),
2 I have also been an expert witness for an automobile insurer on this issue in litigation outside of Georgia.
where the Court of Appeals held that the undertaking of the company to insure the owner against "actual loss or damage" must be taken as the primary obligation under which the measure of the liability would be the difference between the value of the property immediately before the injury and its value immediately afterwards... and the stipulation that the liability should not exceed the cost of repair or replacement must be construed as a subordinate provision, limiting or abating the primary liability, to be pleaded defensively if the insurer would diminish or limit the amount of recovery by reason thereof.
2001 Ga. LEXIS 910 at *16-*17.
The Georgia Supreme Court also viewed more recent precedent as reiterating the view of the Corbett court, which in essence seems to adopt a market value approach to determining the loss caused by a collision and to make any limitation on recovery an affirmative defense of the policyholder. In Mabry, the Court certainly took this view. See id. at *19-*22. State Farm argued that subsequent changes in policy language make diminished-value payment appropriate only if resulting from "repairs which do not return the vehicle to its pre-loss condition." he Mabry Court in essence rejected this argument and found insufficient differences in the policy language to avoid the application of what the Mabry Court saw as Georgia precedent. Concluded the Court:
We recognize that there is a split of authority regarding an insurer's liability for any loss of value resulting from a covered loss event. Others have determined that diminution in value is not an element of loss under policies such as those involved in this case. Georgia, however, has been consistent in interpreting the physical damage coverage of automobile insurance policies to require that the insured be made whole, basing the measure of damages on the value of the vehicle.
Having reviewed both Georgia law and that of other jurisdictions, we adhere to the long-standing contract interpretation set forth in [Georgia precedent]. The rationale of those cases remains solid. The insurance policy, drafted by the insurer, promises to pay for the insured's loss; what is lost when physical damage occurs is both utility and value; therefore, the insurer's obligation to pay for the loss includes paying for any lost value. That interpretation has stood for 75 years in Georgia and has become, therefore, part of the agreement between the parties when they enter into a contract of insurance that includes the promise to pay for the insured's loss. Thus, our holding in this case that State Farm is obligated to pay for diminution in value when it occurs is based in reason, precedent, and the intent of the parties. Recognition of diminution in value as an element of loss to be recovered on the same basis as other elements of loss merely reflects economic reality.
Id. at *25-*27.
As noted above and with all due respect to the Georgia Supreme Court, I disagree. Insurance policies may or may not be designed to provide coverage for full-scale "economic" losses. For example, a commercial general liability policy arguably meets this test because it is supposed to pay for any judgments against the policyholder as well as the costs of defense. But even this type of policy does not really give the policyholder full economic recompense. Consider the average lawsuit. It consumes valuable employee time and costs the company productivity that may never be recouped. Absent highly specific language obligating the insurer, there is never an insurance policy payment for this line item. Economic reality indeed.
When discussing first-party consumer insurance, it is quite clear that policies are in no way designed to compensate the policyholder for all costs associated with a loss. Certainly, no insurer has ever been required to pay the policyholder for his or her time in attending to repair, documenting a claim, selecting replacement materials, and the like. To the extent that the Mabry decision suggests that full and complete compensation for all aspects of a loss is the insurance norm, the Court is clearly incorrect.
On the more specific issue of diminished value, the Mabry Court is also incorrect. Firstparty property insurance is essentially out-of-pocket, or replacement cost insurance. It is not designed to address the more ethereal issues of personal taste (e.g., "I'll never find another Delorean quite like the one I had" or "They just don't make that shade of color anymore"), nor is it designed to address the full economic ripple effect of a property loss (e.g., "Now that there is one less Delorean in the world, it will cost me more to add to my collection of Deloreans."). Although the market's discount of a car after it has been in a crash is less far-fetched, it is the same type of intangible loss that even if economically calculable is not the kind of loss usually covered by property insurance.
Consider a house in which there occurs mass murder followed by arson in an attempt to cover up the crime. The home may be rebuilt from the ground up into a palace every bit as nice as its predecessor-but one would hate to be the realtor with this listing. The market value will be reduced because of the terrible tragedy that occasioned the rebuilding, which will make the house less attractive to potential purchasers (except those with a taste for the macabre). Should the policyholder (or its estate, perhaps, under this hypothetical) be paid an additional cash sum for the reduced sales value of the home? Under Mabry, the answer would appear to be "yes." The gruesome facts of the property loss create this economic loss to the owner of the property. But the homeowner's policy was not designed to provide this kind of compensation. In my view, neither is the collision and comprehensive first-party coverage of the standard auto policy.
Undoubtedly, many in the legal (and perhaps the insurance) community disagree with me on these matters. For those who do, Mabry is a useful precedent that continues the ongoing debate over diminished-value claims, a debate likely to continue for some time.
Jeffrey W. Stempel
University of Nevada-Las Vegas…
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Recent Court Decisions. Contributors: Stempel, Jeffrey W. - Author. Journal title: Journal of Risk and Insurance. Volume: 69. Issue: 2 Publication date: June 2002. Page number: 245+. © 2009 American Risk and Insurance Association, Inc. Provided by ProQuest LLC. All Rights Reserved.
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