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Overturning a punitive damages award of $650,000 in an insurance bad-faith case, the 3rd U.S. Circuit Court of Appeals has ruled that punitive damages cannot be awarded in a case where neither the insurer’s liability nor the amount due was clear. The decision in W.V. Realty Inc. v. Northern Insurance Co. is significant because it apparently draws a bright line between bad-faith suits in which the plaintiff is entitled to nothing more than compensatory damages for the bad-faith conduct and those in which the insurer’s conduct “also imports insult or outrage, and is committed with a view to oppress or is done in contempt of plaintiffs’ rights.” The unanimous three-judge panel also found that the insurer was entitled to a new trial because the jury heard testimony about “hundreds” of other bad-faith lawsuits pending against the company. In an 18-page opinion, U.S. Circuit Judge Maryanne Trump Barry found that “the jury may well have concluded … that the fact that hundreds of other bad-faith lawsuits had been filed against Northern made it more likely that it committed bad faith in this lawsuit.” At trial, plaintiffs’ attorney Michael R. Mey of Wormuth Mey & Sulla in Scranton, Pa., raised the issue of the other bad-faith lawsuits during his questioning of Northern’s in-house counsel, Lloyd Johnson. Months before trial was scheduled to begin, Judge A. Richard Caputo of the Middle District of Pennsylvania sanctioned Northern for failing to disclose the existence of the other bad-faith suits. Caputo found that the conduct of the outside lawyer representing Northern was “inadvertent and excusable” but that sanctions were nonetheless warranted because Northern’s conduct in considering the discovery request was “not substantially justified.” In the trial, Caputo ruled that Mey was allowed to tell the jury about the discovery violation. Mey questioned Johnson about an affidavit signed by a Northern claim litigation specialist that said “after careful review” she was unaware of any lawsuits involving “claims for bad faith.” After Northern responded in discovery that there were no such lawsuits, the plaintiffs said their own research found 15 lawsuits. Mey suggested in his questioning that the litigation specialist had not conducted a “careful review” but instead had relied on Johnson’s representation that there were no such lawsuits. He then asked Johnson whether it was true that “as a matter of fact, it turned out that there were hundreds of lawsuits.” After Johnson conceded that there were, Mey handed him a document that Mey described as “a compilation of those lawsuits” and asked Johnson to identify it. Defense counsel objected, and Caputo told Mey that he could only ask Johnson to identify the document but could not suggest what that document was. Now the 3rd Circuit has ruled that the evidence of the other lawsuits was unfairly prejudicial. Barry found that Caputo hadn’t cured the problem by merely instructing Mey not to suggest what the document was. “The horse was already out of the barn, for the jury had been told that the 20-page spreadsheet which Johnson identified listed the ‘hundreds’ of bad-faith lawsuits against Northern and the other two companies,” Barry wrote in an opinion joined by Senior 3rd Circuit Judge Max Rosenn and visiting Senior U.S. District Judge Louis H. Pollak of the Eastern District of Pennsylvania. Although Mey never moved the “compilation” into evidence, Barry found that “the damage had been done, for the jury saw that compilation and certainly knew what it was.” Barry found that evidence of the discovery violation was inadmissible because it was not, in itself, an act of bad faith in which the insurer was “using litigation to evade an obligation under the policy.” But even if the discovery violation was committed on the part of Northern to avoid its obligations under the policy, Barry concluded, it would still be inadmissible under Rule 403 of the Federal Rules of Evidence “because its probative value was substantially outweighed by its unfair prejudicial effect.” Barry found that Mey “questioned Lloyd Johnson about the other bad-faith lawsuits not so much to demonstrate that Northern committed an intentional discovery violation as to establish a pattern of bad faith.” No unfair prejudice would have occurred, Barry said, if the trial judge had “permitted evidence of an insurance bad-faith discovery violation to be admitted into evidence without permitting plaintiffs to disclose to the jury that the information sought by them and withheld by Northern happened to be other bad-faith cases.” Instead, Barry said, “the jury not only was permitted to learn that the discovery violation related to other bad-faith lawsuits, information that was irrelevant, but it was permitted to learn that there were “‘hundreds’ of them.” Caputo didn’t cure the unfair prejudice, Barry found, because he never explained to the jury that when deciding whether Northern acted in bad faith, “it could consider the fact that Northern committed a discovery violation but not the fact that there were other bad-faith lawsuits against Northern.” The plaintiffs in the suit, W.V. Realty Inc. and New Montage Manor Inc., were the owners and operators of a 46-room motel, restaurant and catering business with a banquet facility, in Moosic, Pa. Northern issued an insurance policy that provided coverage for building and property damage up to $1.36 million and coverage for business interruption losses up to $650,000. In January 1996, after the roof over the banquet hall portion of the building collapsed, the plaintiffs submitted claims for damage to the building and for business interruption losses. Northern determined that the restoration period was six months, but the plaintiffs contested that determination, arguing that their business was interrupted for two years because they had been forced to cancel all of the events that had been scheduled for 1996 and 1997 in the wake of the roof collapse. Even if the banquet hall were rebuilt by the beginning of 1997, the plaintiffs insisted, they would not be able to recover their lost sales because weddings and other events are booked an average of 14 months in advance. Between February and June 1996, Northern advanced more than $25,000 to the plaintiffs to reimburse them for the returned deposits and other expenses. But the plaintiffs were soon complaining that their bank would not make a decision about whether to rebuild until it knew the amount of money the plaintiffs would receive for their business interruption losses. Northern at first calculated that the plaintiffs were entitled to about $49,000 for the business interruption claim but later raised that figure to more than $65,000. Experts for the plaintiffs submitted a report to Northern that assessed their losses for 1996 and 1997 at $695,000. The dispute went to court, and, pursuant to the policy terms, after each side chose an appraiser, the court appointed a neutral umpire. In December 1999, the umpire awarded the plaintiffs more than $1.2 million, including the policy limit of $650,000 for the business interruption claim. The award was later affirmed by both the common pleas court and the Pennsylvania Superior Court. In February 2000, the plaintiffs sued Northern for bad faith. Caputo granted Northern’s motion for summary judgment on the plaintiffs’ bad faith claim with regard to the payout on the building damage claim. As a result, the sole issue left for trial was whether Northern acted in bad faith with regard to the business interruption claim. Shortly before trial, Northern paid the plaintiffs the remainder of what was owed them under the umpire’s award. The jury awarded the plaintiffs $650,000 in punitive damages, and Caputo later awarded attorney fees of more than $248,000 to the plaintiffs. Now the 3rd Circuit has ruled that Northern is entitled to a new trial because of the unfairly prejudicial effect of allowing the jury to hear about the “hundreds” of other bad-faith lawsuits. And in the retrial, the appellate court found that the plaintiffs are not entitled to seek punitive damages. But Northern didn’t win everything it asked for in the appeal because the court also found that “there was sufficient evidence submitted to the jury on the issue of bad faith even when the improperly admitted evidence is stripped away.” Barry found that the evidence showed that between January and August 1996, when the plaintiffs were forced to surrender the property to the bank, they did not earn any money from their catering business because they had no place to hold events, but continued to incur bills for its mortgage, utilities, insurance, employees and taxes. “Northern was aware of all of this and aware that plaintiffs’ utilities were about to be terminated and that the bank was threatening foreclosure. During this time, Northern paid nothing for the ongoing business interruption losses,” Barry wrote. But while there was a basis for a finding of bad faith, Barry found that “there was no basis for an award of punitive damages even had there been no trial error.” Pennsylvania, Barry noted, has adopted Section 908 of the Restatement (Second) of Torts, which provides that punitive damages may be “awarded to punish a defendant for outrageous conduct, which is defined as an act which, in addition to creating actual damages, also imports insult or outrage, and is committed with a view to oppress or is done in contempt of plaintiffs’ rights.’” Barry found that the case against Northern was distinguishable from cases in which the 3rd Circuit has upheld awards of punitive damages “because the insurer made no offer to pay despite the plaintiff’s serious injury and the insurer’s clear liability.” In the case against Northern, Barry found, “neither liability nor the amount due was clear.” Barry found that Northern “may not have had a completely open mind with regard to what plaintiffs believed to be the proper restoration period.” But while the dispute over the appropriate restoration period caused much of the delay, Barry also found that “plaintiffs’ interpretation was a somewhat unorthodox one based on the unique nature of their business.” As a result, Barry concluded, “while Northern’s decision not to advance plaintiffs the undisputed portion of their business interruption losses in May of 1996 is surely some evidence of bad faith, it, without more, does not support an award of punitive damages.”

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