On certified question from the Fifth Circuit Court of Appeals, the Texas Supreme Court, in Fairfield Insurance Company v. Stephens Martin Paving, LP, 246 S.W.3d 653 (Tex. 2008), addressed whether Texas’ public policy prohibits a “liability insurance provider from indemnifying an award for punitive damages imposed on its insured because of gross negligence.”  The court answered this question in the negative by narrowly holding that exemplary damages are insurable under workers’ compensation and employers’ liability policies.  Rather than clearing the air, the court’s long awaited opinion actually raises more questions about the insurability of punitive damages.

 

In Stephens Martin Paving, an employee died as a result of injuries sustained when the “brooming machine” (riding equipment used in road construction) he was operating rolled over.  Stephens Martin Paving, his employer, carried a workers’ compensation and employers’ liability insurance policy issued by Fairfield Insurance Company.  The employee’s survivors brought suit against Stevens Martin Paving alleging gross negligence, seeking relief outside the workers’ compensation policy.  Meanwhile, Fairfield sued Stephens Martin Paving in federal district court seeking a declaratory judgment that Fairfield did not owe the duty to defend or indemnify the employer in the underlying suit.  The federal district court concluded that the language in the policy covered exemplary damages and that the public policy of Texas did not prohibit insurance coverage for those damages.  The federal court entered judgment declaring Fairfield had the duty to defend Stephens Martin Paving, and indemnify it if it was adjudicated responsible for the damages sought in the underlying suit brought by the employee’s survivors.  Fairfield appealed, and the U.S. Fifth Circuit certified the broad question of the insurability of punitive damages for gross negligence to the Texas Supreme Court.

 

The Texas Supreme Court noted that whether exemplary damages for gross negligence are insurable requires a two-step analysis.  First, the court had to decide whether the plain language of the policy provided coverage for the exemplary damages sought in the underlying suit.  Second, if the Court concluded that the policy did provide coverage in the first instance, the Court had to determine whether the public policy of Texas allowed coverage in the circumstances presented.  However, because the Fifth Circuit’s question was directed only at the public policy of Texas, the Court limited its discussion to the second prong of the analysis and presumed that the policy language covered the exemplary damages sought.

 

Considering whether Texas’s public policy should prohibit coverage for exemplary damages, the Texas Supreme Court first analyzed the context in which the Legislature has spoken on the issue.  Looking to the workers’ compensation statutes and the Texas Department of Insurance’s execution of those statutes, the court determined that the Legislature clearly intended to provide for and to allow additional insurance coverage for an employer’s gross negligence.  Although the Legislature’s expressed intent ended the inquiry at issue, the Texas Supreme Court recognized that the Fifth Circuit framed its certified question as a broad inquiry into Texas public policy concerning coverage for exemplary damages.  Although hesitant to opine on policy language and fact situations not before the court, it did continue to discuss other circumstances where the insuring of punitive damages might violate Texas public policy.  First, the court cited a variety of examples where the Legislature had taken action and explicitly prohibited an insurer from payment of punitive damages.  Second, the court expressed concern that the insurability of punitive damages in some other contexts might violate public policy, even if not expressly prohibited by the Legislature.  For instance, the court noted that coverage for exemplary and punitive damages in the uninsured and underinsured motorist context might be against public policy given that the uninsured motorist would not be punished for his recklessness and that such payment would, in practice, be made by all of the policyholders in the state.  Thus, the Texas Supreme Court recognized the deterrent effect of punishing a party by punitive awards, and expressed concern that transferring these costs to an insurer could defeat their purpose.  Ultimately, the high Court left open many questions about the limits of insuring against such damages.

 

Unanswered Questions

 

Will the Holding of Stephens Martin Paving Be Adopted by Other States? 

 

Whether other states will adopt the narrow holding of Stephens Martin Paving is unclear.  However, it is likely that any state doing so must first analyze its own workers’ compensation provisions and their stated purposes.  In Stephens Martin Paving, the court engaged in a careful review of the applicable policy language and formats, the entire time keeping in mind the state’s workers’ compensation provisions.  This process led the court to conclude that there was a definite intent by the Legislature to allow a party to insure against exemplary damages through employers’ liability policies.  This conclusion was drawn because the claims permitted by the Legislature against an employer participating in the workers’ compensation scheme (as claims outside the exclusive remedy of workers’ compensation) were, by definition, claims for exemplary damages based on gross negligence.  Absent this type of evidence, coverage for punitive damages may not necessarily be read into a policy’s terms in other jurisdictions.  Therefore, every policy must be reviewed on its own terms and in light of the applicable state’s workers’ compensation provisions. 

 

Does Texas Public Policy Prohibit Coverage for Punitive Damages In Other Contexts?

 

As the Texas Supreme Court stated, freedom to contract is a major consideration in resolving disputes over the insurability of punitive damages.  How far this freedom runs, however, is still unclear.  In some insurance agreements, insurers and their policyholders explicitly bargain for and agree to include coverage for punitive damages.  But, in many instances there are no explicit contractual terms demonstrating the specific intent to insure such damages.  Regardless, even if the policy clearly provides coverage for punitive awards, state law or public policy may explicitly or implicitly prohibit coverage for certain types or categories of such awards.

 

For example, even if punitive damages based on vicarious liability are insurable under Stephens Martin Paving, awards based on direct liability may not be.  The court in Stephens Martin Paving clearly took note that the purpose of exemplary damages is to punish the wrongdoer and to deter similar behavior.  This purpose could be frustrated by allowing the penalty to be shifted to a third party through insurance.  An offender who can “pass the buck” for his wrongdoing to an insurer arguably does not directly suffer the loss and therefore might not be sufficiently deterred from repeating his behavior.  For this reason, although sometimes making an exception for vicarious liability, California, Florida, Massachusetts, and New York, to name a few, have strictly prohibited the insuring against punitive damages that are directly assessed against a policyholder.

 

Likewise, even if punitive damages based on gross negligence are insurable, it is still unclear what this means for awards based on other standards such as fraud, malice, or reckless, willful or intentional conduct.  The standard in Stephens Martin Paving was based on gross negligence.  The court did not address whether it would violate public policy to insure an award of punitive damages based on some other standard of conduct.  Further, the meaning of these standards is often undefined and may differ based on a state’s common law and statutory provisions.  For instance, would it be permissible to insure conduct so reckless as to demonstrate a substantial lack of concern for whether an injury would result?  If so, is it also permissible to insure a course of action that shows an actual or deliberate intention to cause harm?  Generally, such conduct is expressly excluded.  But whether or not excluded, it is not an insurable event because it is not fortuitous.  At least where actual intent is at issue, there clearly are open questions as to whether claims for punitive damages would be insurable, including under the Stephens Martin Paving ruling in Texas.

 

Conclusion

 

Although policyholders may contend that Stephens Martin Paving is a broad pronouncement regarding the insurability of punitive damages, a closer look is disappointing.  The Texas Supreme Court reached a careful and narrow determination regarding coverage for punitive awards against employers based on gross negligence claims outside the exclusive remedy of the workers’ compensation scheme.  In future cases, coverage will likely depend on many factors, including whether the insurer and the policyholder explicitly agreed to include punitive awards in the underlying insurance policy.

 

For more information, please contact William W. Pugh (wwpugh@liskow.com) in our Houston office and Harold J. Flanagan (hgflanagan@liskow.com) in our New Orleans office and Kevin J. Connolly (kconnolly@liskow.com) in our Houston office or go to www.liskow.com.