June 2008

Texas Lets Insurers Cover Punitive Damages

By Ruth E. Piller, Litigation News Associate Editor

In a unanimous but somewhat confined decision, the Texas Supreme Court has held that its state’s public policy does not prohibit insurance coverage of punitive damage awards for gross negligence in the workers’ compensation context. Fairfield Ins. Co. v. Stephens Martin Paving, LP.

In Stephens Martin, the state’s high court answered a certified question that had been referred to it by the U.S. Court of Appeals for the Fifth Circuit: Does Texas public policy prohibit a liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence?

The Texas Supreme Court answered in the negative, holding that public policy favors the freedom of contract. The court, however, limited its opinion to the workers’ compensation context.

Stephens Martin was brought by the survivors of an employee who was killed on the job. The defendant insurer issued the employer’s workers’ compensation policy, which included customary employer’s liability provisions. After winning workers’ compensation benefits, the employee’s survivors sued the employer for gross negligence, but sought only punitive damages.

The insurer brought a declaratory judgment action in federal court, asserting that it had no duty to defend or indemnify the employer because Texas public policy precludes insurance coverage for punitive damage awards.

After the district court denied the insurer’s summary judgment motion, the insurer appealed to the U.S. Court of Appeals for the Fifth Circuit, which certified the question to the Texas Supreme Court. That court, in turn, unanimously held that the state’s public policy does not preclude insurance coverage of punitive damages in the workers’ compensation context.

Coverage attorneys say Stephens Martin does not necessarily signal a major change in the way insurance policies will be underwritten or interpreted. Rather, they maintain that the decision is only the latest contribution to a decades-old body of law that has split over whether insuring punitive damage awards should be against public policy.

“The insurance coverage issue of whether or not a policy holder can be covered as a matter of public policy for punitive damages has been kicking around for a number of years,” says John E. James, Wilmington, DE, cochair of the Section of Litigation’s Insurance Coverage Litigation Committee. Most states have actually resolved the issue, he says, in favor of coverage in limited circumstances, although the states are not unanimous in their approach.

Indeed, in an extensive survey of the law, the Texas Supreme Court summarized the public policy of practically every jurisdiction that has addressed the insurability of punitive damages, finding that 45 states’ highest courts or legislatures have spoken to the issue. Of those jurisdictions:

• 25 states have generally indicated their public policy does not prohibit coverage for punitive damages;
• Eight states prohibit coverage for exemplary damages;
• Seven states permit coverage for such damages, but only when the insured’s liability is vicarious;
• Three states allow insurance coverage of punitive damages in the uninsured motorist context but have not addressed the issue under other circumstances; and
• Two states prohibit insurance coverage of punitive damages in the context of uninsured motorists but have not addressed the issue with respect to other forms of coverage.

Of the five remaining jurisdictions, four of them (which until Stephens Martin included Texas) have yet to address the insurability of punitive damages, and one state (Nebraska) prohibits the imposition of punitive damages.

In Stephens Martin, the supreme court observed that in light of the foregoing statistics, “the majority of states that have considered whether public policy prohibits insurance coverage of exemplary damages for gross negligence, either by legislation or under the common law, have decided that it does not.”

Christopher W. Martin, Houston, a member of the Section’s Insurance Coverage Litigation Committee, cautions that Stephens Martin should not be interpreted as a signal as to how the court would rule on the insurability of punitive damage awards outside the workers’ compensation context. The court’s “opinion does not signal a national trend in insurance coverage. If anything, it is the exact opposite.”

Those who say punitive damage awards should not be covered by insurance point to the policy considerations of punishing the wrongdoer, which is obviously diluted when the wrongdoer’s insurer is required to pay the damage award instead of the wrongdoer itself. However, as the Texas Supreme Court observed in Stephens Martin, there are competing policy considerations, such as the freedom to enter into a contract.

“I think to some extent the philosophy of the court is affected by the fact that our society has become more litigious and that punitives are often excessively awarded in situations even of gross negligence,” James says. “At least the majority of states think it is appropriate to protect a company by permitting it to buy insurance [to cover punitive damages] for a case in which there is a runaway jury.”

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