Are Your Damages Covered?

Insurance often drives settlements in litigation. Both defense and plaintiff's counsel need to be savvy about how claims are characterized in order to maximize available insurance coverage. Typically, the focus is on liability: Was the conduct intentional or negligent? Does the claim arise out of a contractual liability? Even if the causes of action alleged do not appear covered on their face, are facts alleged that could give rise to a covered claim?

One often overlooked area is how damages are described. This is an issue that may not be relevant to the defense of the case, where the prime concern may simply be: How much? Defense counsel may therefore overlook how damages are characterized legally. But insurance coverage can often depend on how the substantive law of the case defines recoverable damages.

For example, statutory remedies often provide for the payment of a specific amount for each violation. Some policies, including directors and officers liability policies or employment practices policies, usually exclude coverage for "fines and penalties." In these cases, insurers will argue that the statutory remedy is a "fine or penalty," contending that the specific per-violation sum is penal in nature. But an examination of cases decided under the statute (e.g., addressing the specific evidentiary showing needed to support an award) often reveals that the remedy is compensatory in nature. The specific per-violation remedy may simply be a liquidated measure of a presumed personal injury that would otherwise be too small to have to prove. This is the case with many consumer protection statutes.

Statutes that provide for damages multipliers will also draw insurer objections that any multiplied portion is penal and not covered. But case law may not support this argument. Cases under the Sherman Act and Federal False Claims Act have construed those laws' treble damages provisions as primarily compensatory, not punitive, in nature.

Punitive damage claims raise another issue that counsel need to be aware of. California law prohibits indemnifying punitive damage awards as a matter of public policy. But the policy is grounded in the legal showing of "fraud, oppression or malice" required under California law for a punitive award. Some states allow an award of punitive damages on a showing of intent that does not offend California public policy (e.g., recklessness or gross disregard). Indeed, many policies expressly agree to cover punitive damages unless the law applicable to the claim makes them uninsurable. Therefore, in any case in which California may not provide the choice of law for the plaintiff's punitive damage claim, counsel should look to the state's legal standard for an award of punitive damages before assuming they are not insurable.

Another issue that has arisen under the False Claims Act, and arises in many other circumstances, is whether the damages plaintiff is seeking are "restitutionary" in nature. The issue arises because, in California, indemnity for "restitution" is precluded as a matter of public policy. See Bank of the West v. Superior Court, 2 Cal.4th 1254 (1992). This is why, for example, claims brought under Business and Professions Code §17200, California's Unfair Business Practices Act, are not insurable — the only remedy is restitution.

In one recent False Claims Act case handled by this firm, in which coverage was provided under a directors and officers liability policy, plaintiffs characterized their damages as a "disgorgement" of ill-gotten profits (for reasons that they thought would appeal to a jury). Our clients' insurers cited repeatedly to plaintiffs' description in claiming no coverage. But the trial court (backed by cases construing the act) ruled that only compensatory, and not restitutionary, damages were recoverable under that statute. The case is a reminder that how plaintiffs may characterize their case is not the measure of whether the claims are covered by an insurance policy. This is true with respect to liability. For example, claims couched only as intentional torts may nonetheless give rise to potentially covered damages and a duty to defend, if the facts would support liability on a negligence basis. The same is true with respect to how damages are characterized. What matters are the facts, and the kinds of damages that are legally recoverable in the case.

A still more common issue arises under general liability policies in claims alleging "property damage." The issue often arises in products liability cases where the plaintiff claims damages measured by lost profits, lost good will, added costs and/or lost revenue. For example, the manufacturer of a defective electronic component, which has caused a device to short-circuit and burn out, may allege lost profits and lost good will, in addition to costs of repair.

Insurers often argue in these cases that the way plaintiff is measuring damages means they are seeking the recovery of "economic losses" and not "property damage." The coverage dispute in this area does not arise so much from plaintiff's characterization of its damages or the legal scope of remedies available in the case. Instead, the "economic loss" argument depends primarily on how insurers and insureds read the basic insuring language in the policy. There, insurers typically agree to pay "damages because of ... property damage." The insurers' "economic loss" defense usually depends on assuming that the only damages recoverable are the costs to repair or replace the property that's been damaged. But California courts have generally rejected this argument, noting that lost profits and diminished good will are simply another way of measuring damages "because of" the property damage at issue.

Another issue that arises frequently is whether an award of attorneys fees to plaintiffs is covered. Under directors and officers liability policies, the issue is usually framed in terms of whether the definition of "loss" includes (or does not expressly exclude) a fee award to plaintiffs. In cases arising under general liability policies, the issue can be: Is a fee award "damages" subject to the policy's limits of liability, or is it an award of "costs," such that it falls within the policy's unlimited obligation for "supplementary payments"? Here again, where the plaintiff's fee award is grounded in a statute, the answer may depend on how the statute describes the right to fees. Some statutes provide that the fees are awarded "as costs of suit." A few cases have held that in such instances the plaintiffs' fee award falls within the policy's supplementary payments provision, making them payable in addition to the limits of liability.

As with most insurance issues that arise in the course of defending a civil lawsuit, it is important to identify early in the case the issues on which coverage will turn. Expectations on all sides about what insurance money may be available have to be clear well before any mediation or settlement conference. Policyholders looking to insurance money to settle cases need to understand that defense counsel may not be sensitive to the insurance implications of how damages are characterized. They typically are focused on keeping any potential damage claim as low as possible. Plaintiffs' counsel, too, may want to be careful about how they characterize damages, if the defendant's insurance is the primary source of any recovery. Insurance coverage counsel look at damages issues through a different lens than defense or plaintiff's counsel, and can help set the stage for productive settlement talks.

Dennis M. Cusack is a partner at Farella Braun & Martel in San Francisco, where he represents policyholders in coverage disputes arising out of individual and class actions for product defects, securities, patent infringement, antitrust and unfair competition, personal injuries, investment and employee benefits fraud, environmental cleanups, construction defects, wrongful termination and discrimination, and a variety of commercial torts. He can be reached at [email protected].

Reprinted with permission from the November 11, 2011 issue of The Recorder. © 2011 ALM Media Properties, LLC.  Further duplication without permission is prohibited. All rights reserved.