Saturday, April 26, 2008

Consequential Damages

COMMERCIAL PROPERTY -- BUSINESS INCOME LOSS COVERAGE -- CONSEQUENTIAL DAMAGES

Bi-Economy Market, Inc. v. Harleysville Ins. Co. of NY
10 N.Y.3d 187 (Ct. Apps. decided 2/19/2008)


Extracontractual damages aren't what they used to be.

On February 19, 2008, the New York Court of Appeals decided a pair of first-party property insurance cases that some have since touted as portending expanding vistas of "bad faith" litigation against insurers in New York.

In Bi-Economy Market, Inc. v. Harleysville Ins. Co. of NY, the 5-2 majority reversed the lower courts' dismissal of the insured's claim for consequential damages allegedly due to the insurer's delay in paying policy benefits. Relying on pre-existing but mostly non-insurance case law, the Court of Appeals held that

in light of the nature and purpose of the insurance contract at issue, as well as Bi-Economy's allegations that Harleysville breached its duty to act in good faith, we hold that Bi-Economy's claim for consequential damages including the demise of its business, was reasonably foreseeable and contemplated by the parties, and thus cannot be dismissed on summary judgment.

To the majority, "the very purpose of business interruption coverage would have made Harleysville aware that if it breached its obligations under the contract to investigate in good faith and pay covered claims it would have to respond in damages to Bi-Economy for the loss of its business as a result of the breach." The Court rejected the insurer's argument that the policy's "consequential loss" exclusion applied to negate coverage for the insured's alleged consequential damages.

In his dissent, Judge Smith opined that the majority's ruling effectively and erroneously re-labels punitive damages as consequential damages, and a "bad faith" failure to pay a claim as a "breach of the covenant of good faith and fair dealing." Judge Smith warned:

The majority's bad policy choice is more important than the flaws in its reasoning. This attempt to punish unscrupulous insurers will undoubtedly lead to the punishment of many honest ones. Under today's opinions, juries will decide whether claims should have been paid more promptly, or in larger amounts; whether an insurer who failed to pay a claim did so to put pressure on the insured, or from legitimate motives, or from simple inefficiency; and whether, and to what extent, the insurer's slowness and stinginess had consequences harmful to the insured. All these very difficult, often nearly unanswerable, questions will be put to jurors who will usually know little of the realities of either the insured's or the insurer's business. The jurors will no doubt do their best, but it is not hard to predict where their sympathies will lie.

The result of the uncertainty and error that the majority's opinions will generate can only be an increase in insurance premiums. That is the real "consequential damage" flowing from today's holdings.

In the companion case of Panasia Estates, Inc. v. Hudson Ins. Co., the same 5-2 majority affirmed the lower courts' denial of the insurer's motion for partial summary judgment dismissing the plaintiff's claims for consequential damages. Relying on its decision in the Bi-Economy Market case, the majority noted that "consequential damages resulting from a breach of the covenant of good faith and fair dealing may be asserted in an insurance contract context, so long as the damages were 'within the contemplation of the parties as the probable result of a breach at the time of or prior to contracting[.]'" Unlike in the Bi-Economy Market case, however, the Panasia Estates water damage claim was denied in its entirety due to the asserted applicability of one or more policy exclusions. In remanding the case back to Supreme Court, however, the Court of Appeals observed that the lower courts "failed to consider whether the specific damages sought by Panasia were foreseeable damages as the result of Hudson's breach", suggesting that there was not enough information in the record before the Court of Appeals to determine whether the consequential damages Panasia was alleging to have suffered were within the contemplation of the parties when the particular insurance policy at issue incepted.

Some commentators, including this one, believe that the Bi-Economy ruling allowing claims for consequential damages to proceed to triers-of-fact must be limited to insurance claims under commercial property policies that afford business interruption or business income loss coverage. However, Judge Smith's dissent in Bi-Economy pointed out that the Panasia Estates case involved no business interruption coverage.

Numerous signals in Bi-Economy -- including the majority's explicit reference to "the very purpose of business interruption coverage" -- would seem to indicate that its holding will support consequential damage claims only under commercial property insurance policies that afford business interruption or business income loss coverage. In his opinion for the majority, Judge Piggot explained that in "determin[ing] whether consequential damages were reasonably contemplated by the parties [and thus recoverable in a subsequent breach of contract action], courts must look to 'the nature, purpose and particular circumstances of the contract known by the parties[.]'" Having recognized that the nature and purpose of business interruption coverage in a commercial property insurance policy contemplates and is to protect against the loss of business, it is somewhat understandable that the majority concluded that Bi-Economy's claim for the "complete demise of its business" was within the contemplation of the parties at the time the insurance policy incepted.

It remains to be seen whether the Bi-Economy Market and Panasia Estates rulings will be extended to losses and claims arising under other than commercial property insurance policies. In my office we have already seen insureds' counsel seek to assert consequential damage claims in: (1) a late notice declaratory judgment action; (2) no-fault benefits recovery suits; and (3) a homeowners' policy first-party breach of contract suit. If and when we obtain or learn of written decisions addressing the scope of Bi-Economy Market and Panasia Estates, we will re-publish them here.

Meanwhile, to avoid the potential sting of consequential damages -- which by their nature are extracontractual -- in all first-party losses insurers should:

  1. ask and document whether and, if so, the insured is taking steps to mitigate the loss and return as quickly as possible to pre-loss status;
  2. use advance payment on condition of reservation of rights forms in offering and making advance payments; and
  3. pay what you believe you owe, as soon as you determine such amount is owed, and regardless of whether there is yet an agreement or settlement on numbers in place with the insured.

Coverage Counsel has learned that Harleysville has filed a motion to reargue this case to the Court of Appeals. It won't be until late May or early June that we'll know the outcome of that motion.

2 comments:

Heidi said...

At the end of your article, you list things insurers should do to avoid the consequential damages allegations. I believe most companies were doing this before the Harleysville case. I realize that in this case, this was a covered loss and the insurer believes it to be covered. My concern, what if the insurer believes the loss is not covered? What if coverage is questionable, and it takes 3-4 months of investigation to determine coverage? Will we be forced to tack on 3-4 months of additional loss of income or loss of rents coverage as "consequential damages"?
What if the insurer denies the loss, is sued by the insured and a jury finds that the loss is covered then? In the meantime, because the insurer denied the loss, the insured went out of business? Just something I have been thinking about.

Roy A. Mura said...

Good questions, Heidi. Hudson Insurance Company thought Panasia Estates loss was not covered and denied the claim, yet found itself subsequently confronted with a consequential damages claim.

A premise of the Bi-Economy ruling seems to be that the insured alleged "bad faith claims handling" by Harleysville. Unfortunately, as Judge Smith pointed out in his dissent, what previously had been a fairly bright line in New York of what must be alleged to assert a "bad faith" claim against insurers for punitive damages has now been significantly blurred, if not erased, with these decisions. Two factors, however, give me hope that the Bi-Economy ruling is and will be limited in its future application:

(1) the New York case decisions upon which the majority relied are not "bad faith" cases -- they are merely breach of contract cases; and

(2) the majority's opinion endorses the pre-existing rule that "to determine whether consequential damages were reasonably contemplated by the parties, courts must look to 'the nature, purpose and particular circumstances of the contract known by the parties... as well as 'what liability the [insurer] defendant fairly may be supposed to have assumed consciously, or to have warranted the [insured] plaintiff reasonably to suppose that it assumed, when the contract was made'". A commercial property policy that affords BI coverage arguable contemplates the loss or demise of the insured's business. Personal lines policies, such as homeowners or auto policies, do not.

That being said, the majority's opinion contains this troubling statement: "When an insured in such a situation suffers additional damages as a result of an insurer's excessive delay or improper denial, the insurance company should stand liable for these damages." Is an "improper denial" merely one that subsequently is litigated and upset? We all know that judges and juries don't always get it right, and erroneously reject perfectly sound and legitimate coverage denials.

To me, the core test must, therefore, be the foreseeability of the alleged consequential damages, rather than on the insurer's conduct in not paying or denying the policy proceeds. If the alleged consequential damages cannot be said to have been within the contemplation of the parties at the time of the policy's inception -- given the policy's "nature, purpose and particular circumstances" -- the consequential damages claim should be amenable to summary judgment. Under the Bi-Economy ruling, however, it is unlikely that defense counsel will any longer be able to make successful CPLR 3211 motions to dismiss such claims for facial insufficiency.

So what's an insurer to do in a claim situation in which it has not yet determined coverage? Ask and document what negative impact a loss has had and will likely have on an insured even during the period of time it takes the insurer to make that determination. Other than that -- and continuing to act in good faith, of course -- there's little an insurer will proactively be able to do to prevent a claim for consequential damages from being made against it following a coverage denial. In the scenario you described, the extra 3-4 months of ALE or LOR coverage that may be "tacked on" will not be consequential damages, but contractual damages awarded in the event your coverage denial is rejected. Insurers always risk -- and stand potentially liable to pay -- contractual damages under their policies. It's the extracontractual, consequential damages award that now seems more viable with the Court of Appeals' rulings in Bi-Economy Market and Panasia Estates.

Although Bi-Economy is now two and a half months old, no case I have been able to find has cited to it yet. I've created an alert in LexisNexis for any such citation and will report any citing cases on this blawg.

An ounce of prevention is worth a pound of cure. The glass is half full.