California Supreme Court Adds Clarity to U.S. Supreme Court’s Guideposts for Evaluating Constitutionally of Punitive Damages Awards in Insurance Bad Faith Case

June 21, 2016

Insurance LawThe United States Supreme Court’s landmark rulings in State Farm Mut. Automobile Ins. Co. v. Campbell, 538 U.S. 408, 123 S.Ct. 1513, 155 L.Ed.2d 585 (2003) (Campbell), and BMW of North America, Inc. v. Gore, 517 U.S. 559, 575, 116 S.Ct. 1589, 134 L.Ed.2d 809 (1996) (Gore), established three guideposts  for determining whether a punitive damages award violates the Due Process clause of the United States Constitution: (1) the degree of reprehensibility of the defendant’s misconduct; (2) the disparity between the actual or potential harm suffered by the plaintiff and the punitive damages award; and (3) the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases. As a practical matter, the second guidepost has proved to be the most important because it allows courts to draw a line that punitive damages awards may not cross, although the line may move depending on the facts of the case and the reprehensibility of defendant’s conduct. Ratios as high as 10 to 1 have passed constitutional muster, but any ratio greater than 1 to 1 is likely to face a constitutional challenge.

Despite several decades of jurisprudence under Campbell and Gore, uncertainty exists over what damages may be included in the ratio’s compensatory damages denominator. Defendants maintain that only jury awards of compensatory damages for tortious conduct should be included in calculating the ratio of punitive to compensatory damages. Plaintiffs urge courts to consider post-verdict damages added by the trial court as well. Of course, doing so lowers the ratio of punitive damages to compensatory damages and increases the size of a constitutional permissible punitive damages award.

The California Supreme Court recently addressed the proper elements of the compensatory damages denominator in Nickerson v. Stonebridge Life Insurance Co., __ Cal.4th __, __ Cal.Rptr.3d __, 2016 WL 3192499 (June 9, 2016). Under California law, attorney fees plaintiff incurred in recovering contract damages are recoverable as an element of compensatory damages for insurer bad faith. Such fees are known in California as Brandt fees after the California Supreme Court’s seminal decision allowing their recovery, Brandt v. Superior Court, 37 Cal.3d 813, 817, 210 Cal.Rptr. 211, 693 P.2d 796 (1985). In Nickerson, the California high court granted review to decide the following question: “Is an award of attorney fees under Brandt v. Superior Court, 37 Cal.3d 813, 210 Cal.Rptr. 211, 693 P.2d 796  (1985), properly included as compensatory damages where the fees are awarded by the jury, but excluded from compensatory damages when they are awarded by the trial court after the jury has rendered its verdict?”

Factual Background

Plaintiff was a disabled veteran who was confined to a wheelchair due to a spinal cord injury. While he and the wheelchair were being lowered from a van, plaintiff fell to the pavement, suffering a broken leg. He was taken by ambulance to the emergency room and then moved to a unit in a Veterans Administration hospital that specialized in treating quadriplegics and paraplegics.

At the time of the accident, plaintiff was insured under a policy that paid plaintiff a daily benefit for medically necessary hospital stays. The insurer paid benefits for plaintiff’s first 19 days in the hospital, but denied benefits for the remaining 90 days plaintiff was in the hospital. The insurer maintained that only the first 19 days qualified as “Necessary Treatment” within the meaning of the policy.

Plaintiff sued the insurer for breach of contract and bad faith. Finding that the policy clause limiting coverage to medically necessary treatment was unclear and inconspicuous and thus unenforceable, the trial court entered a directed verdict for plaintiff in the amount of $31,500 in unpaid benefits on the breach of contract claim. A jury found for plaintiff on the bad faith claim and awarded $35,000 in emotional distress damages and $19 million in punitive damages.

Neither party presented evidence to the jury on plaintiff’s Brandt fees. The parties had stipulated before trial that if plaintiff should prevail on the bad faith claim, the trial court could determine the amount of Brandt fees. Following trial, plaintiff and the insurer stipulated that plaintiff was entitled to $12,500 under Brandt, and the trial court awarded that amount.

Following the jury’s verdict, the trial court conditionally granted a new trial unless the plaintiff accepted a reduction in the punitive award to $350,000—which, at ten times the bad faith damages, was the maximum that the trial court believed would pass constitutional boundaries. In calculating the 10 to 1 ratio, the court included in the compensatory damages denominator only the $ 35,000 in emotional distress damages awarded on the bad faith claim. The court rejected plaintiff’s contention that the denominator also should include the $12,500 in attorney fees plaintiff incurred in recovering contract damages. Plaintiff refused to accept the reduced award and appealed.

The Court of Appeal upheld the trial court’s refuse to include plaintiff’s Brandt fees, despite the Court of Appeal’s holding in Major v. Western Home Insurance Company, 169 Cal. App. 4th 1197, 1224, 87 Cal.Rptr.3d 556 (2009), that “the amount of the jury’s award of Brandt fees … may be properly considered … in determining if the ratio of punitive damages to the tort damages award is excessive.” The court distinguished Major on the ground that the jury in that case had awarded Brandt fees as part of tort damages. When Brandt fees instead “are awarded by the trial court after the jury awards punitive damages,” the court held, the fees are not properly included in the constitutional calculus.

California Supreme Court Opinion

In an opinion authored by Justice Kruger, the California Supreme Court unanimously ruled that Brandt fees should be considered in calculating the ratio of punitive damages to compensatory damages regardless of whether the Brandt fees are awarded by the court or the jury. Accordingly, the supreme court remanded the case to court of appeal, presumably to increase the punitive damages award by 10 times the $12,500 award of Brandt fees or $125,000.

In so ruling, the court emphasized that the issue was not whether Brandt fees qualify as compensatory damages but whether the fact they are awarded by the court, rather than the jury, renders them irrelevant to the constitutional analysis under the United States Supreme Court’s decisions in Campbell and Gore. The insurer had argued that the purpose of the three-part Campbell/Gore test is to permit courts to identify punitive damages awards that are tainted by irrational or arbitrary jury decision-making, and thus only evidence that was presented to the jury properly has a role in that inquiry. The court disagreed, noting that the insurer’s argument misconceives the nature of the constitutional inquiry. In the court’s view, the United States Supreme Court set forth the Campbell/Gore guideposts not to regulate jury descision-making, but to assist appellate courts in determining whether the amount of punitive damages awarded exceeds constitutional limits. If the purpose of inquiry were to ferret out jury bias or prejudice, the court pointed out, the Supreme Court would have instructed appellate courts to invalidate the award altogether rather than reduce the award to constitutional limits. Moreover, the third guidepost—available sanctions for comparable conduct—calls for a broad legal comparison suited to the expertise of appellate courts, not lay juries. Since the Campbell/Gore guideposts were designed to govern post-verdict review of punitive damages awards, rather than the adequacy of the jury’s deliberative process, the court saw no reason why a court should not consider post-verdict compensatory damages in its constitutional calculus.

The court acknowledged that the jury’s ignorance of Brandt fees might have affected the amount of punitive damages awarded, but rejected the insurer’s suggestion that allowing the jury to assess Brandt fees would have lowered the amount of the award. True, giving the jury evidence of plaintiff’s Brandt fees would have allowed the insurer’s counsel to argue that the deterrent effect of Brandt fees obviated the need for a significant punitive damages award. But the jury, the court pointed out, after hearing evidence that plaintiff suffered even more harm than it had previously thought, might well have decided to punish the insurer even more harshly.  In the end, the court refused to allow the insurer to leverage its agreement to let the trial court assess Brandt fees into a truncated application of the Campbell/Gore guideposts.

Implications

The Brandt decision established that attorney fees incurred to compel payment of the benefits are recoverable as an element of the plaintiff’s economic damages, and are thus properly determined by the trier of fact—the jury—unless the parties stipulate otherwise. But in Brandt, the California high court noted that “[a] stipulation for a postjudgment allocation and award by the trial court would normally be preferable since the determination then would be made after completion of the legal services [citation], and proof that otherwise would have been presented to the jury could be simplified because of the court’s expertise in evaluating legal services.”  The Nickerson court’s analysis of the effect of evidence of a plaintiff’s attorney fees on punitive damages awarded highlights some of the tactical decisions trial lawyers face in deciding whether to let the court or the jury assess Brandt fees. An additional concern not mentioned by the Nickerson court is how information about attorney billing records might affect the jury’s perception of the parties and their attorneys.

Another interesting aspect of the Nickerson opinion is the court’s discussion of nearly all the United States Supreme Court cases addressing the constitutionality of punitive damages without once mentioning the admonition repeatedly mentioned in those cases that “few awards exceeding a single–digit ratio between punitive and compensatory damages, to a significant degree, will satisfy due process.”  State Farm Mut. Automobile Ins. Co. v. Campbell, 538 U.S. at 424. The California Supreme Court has staked out its own position on the proper ratio of punitive to compensatory damages that arguably is inconsistent with the United States Supreme Court’s guidance. In Simon v. Sao Paolo U.S. Holding, Inc., 35 Cal.4th 1159 (2005), the California high court upheld a 10 to 1 ratio of punitive to compensatory damages, relying on language in the Campbell opinion stating that ratios greater than single digits might “comport with due process where ‘a particularly egregious act results in only a small amount of economic damage.’” However, the Simon opinion uses language suggesting that ratio of  9 or 10 to 1, rather than the 1 to 1 ratio discussed in Campbell, is the point at which a punitive damages award becomes constitutionally suspect and requires “special justification.” Simon, 35 Cal.4th at 1182. In Nickerson, the California high court singled out the 10 to 1 ratio in Simon as constitutionally permissible and chose not to question the same ratio in the case at hand.  Moreover, the Nickerson opinion omits any discussion of Roby v. McKesson Corp., 47 Cal.4th 686 (2009), in which the California Supreme Court reduced punitive damages to a 1-to-1 ratio where the compensatory award contained a “substantial” non-economic element. The appropriateness of the California Supreme Court’s continued willingness to tolerate ratios as high as 10 to 1 is likely to be a fertile ground for future litigation.

Titles by John DiMugno