Legal Times

Punitive Damages Award Under Fire in High Court

By Julie Rovner

Legal Times Staff

The Supreme Court next month will hear argument in a case that according to both sides is a textbook example of the effects of punitive damages -- providing either that they are a societal scourge or an important civil deterrent.

From the insurance industry's point of view, the fact that the punitive damages awarded in the case are more than 2,000 times the actual damages demonstrates how such awards have gotten out of hand.

As the plaintiffs see it, the need for large punitive damage awards to deter tortious behavior is graphically illustrated by the fact that the insurance company was found by a jury to have "grossly mistreated" its policy-holders, engaging in "deliberate deceptive practices and fraud" in denying the claim and later trying to cover up its actions.

The punitive damages elements are potentially important enough to have prompted the filing of amicus briefs from at least 15 organizations, including the American Council of Life Insurance, the Health Insurance Association of America, the National Association of Independent Insurers, and the American Insurance Association. The insurance organizations support Aetna's claim that the awarding of $3.5 million in punitive damages for a bad-faith failure to pay a $1,600 claim violates the excessive fines clause of the Eighth Amendment.

An amicus brief has also been filed by the Association of Trial Lawyers of America and the California Trial Lawyers Association in support of the plaintiff's argument that punitive damages are civil in nature, so the Eighth Amendment is not applicable. Further, the brief argues, "Limiting and restricting civil punitive damage awards will only serve to encourage intentional and calculated misconduct."

The Court, however, may never reach the question of punitive damages. First of all, the Court -- which is scheduled to hear oral argument Dec. 4 -- has not yet noted probable jurisdiction in v. Lavoie (No. 84-1601), which is on appeal from the Alabama Supreme Court.

Furthermore, observers and the lawyers directly involved note that the case presents many other issues on which the Court could base a decision.

For example, in addition to the Eighth Amendment argument, Aetna charges in its Supreme Court brief that because the state of Alabama did not officially recognize a tort of bad faith failure to pay an insurance claim until 1981, and because the contract in question was executed in 1967 and performed in 1977, subjecting the company to liability violates the Constitution's contract clause by imposing retroactively "a new, unanticipated and severe obligation on that contract."

In addition, Aetna is charging that the company's right to a fair, unbiased hearing was violated because T. Eric Embry, at the same time he was participating as a justice in the Alabama Supreme Court's decision, was pursuing his own case against another insurance company for bad-faith failure to pay an insurance claim. That suit gave him a "direct, personal interest in the outcome of the case," Aetna argued in its brief.

Aetna's case will be argued before the Court by Theodore B. Olson, a partner with the D.C. office of Gibson, Dunn & Crutcher, who rejoined that firm last year after a four-year stint as the Justice Department's top legal advisor. Olson refused to single out any of the issues in the case as more important than the others. "The key issue for my client is winning this case," he said.

(This is not the only case in which Olson is attempting to break constitutional ground. He recently filed suit in U.S. district court seeking to have price-fixing charges filed by the Federal Trade Commission against his client, Ticor Title Insurance Co., and five other title insurance companies, thrown out. The companies argue that the FTC and other regulatory agencies have no constitutional powers to enforce federal laws because they are not really part of the executive branch.)

In the meantime, attorneys for Margaret and Robert Lavoie, the appellees in the case, charge that the Court lacks jurisdiction because the federal issues were not raised until an application for rehearing in the case -- too late to meet the Court's requirement that federal issues be "timely raised."

"Aetna claims it was surprised by these issues" said Jack N. Goodman of Pierson, Ball & Dowd in D.C., who will be arguing the case for the Lavoies. "The only surprise is that they lost the case."

The case arose from a hospital stay by Margaret Lavoie in February 1977. On orders from her doctor, she was admitted to the Mobile Infirmary Hospital with symptoms including lower back pain, osteoarthritis, and bleeding from the bowel. She was discharged 23 days later and presented with hospital and doctor bills totaling $3,230.

Aetna, which covered Lavoie as a dependent under a policy for employees of the city of Mobile (her husband was a former police officer, retired on disability), paid $1,580 of the bill but refused to pay the balance of $1,650. Its reason for the denial, ultimately rejected by the trial court, was that some of the tests performed while Lavoie was in the hospital were "not usual and customary procedures for the diagnosis given" and that other tests could have been administered on an outpatient basis.

Unable to pay the remainder of the bill, the Lavoies retained an attorney, Tom Harrison of Mobile, Ark., in an effort to get the company to change its mind, but the claim was rejected three more times. At that point, Stein turned the case over to his former classmate, Joseph M. Brown, Jr., whose firm -- Mobile, Ala.'s Cunningham, Bounds, Yance, Crowder & Brown -- specialized in personal injury litigation.

On Sept. 29, 1978, Brown filed suit, seeking the $1,650 and $1 million in punitive damages. Since the company's actions didn't seem to meet the statutory requirements for fraud, Brown "patterned my own little animal" based on the California tort of bad-faith failure to pay an insurance action.

Since Alabama had not recognized that tort, the punitive damages claims were dismissed by the trial court. Brown appealed to the state supreme court, which, in August, 1979, reversed the lower court ruling, saying that it had not foreclosed the possibility of recovery under the bad- faith theory.

Once Brown began taking depositions, he said, he knew he had a strong case. After a trip to Aetna's home office in Hartford, Conn., Brown revised to $5 million his punitive damages claim. "I knew it stunk" before going to Hartford, "but when I got back, it stunk even more," he said. "There was evidence that everyone at Aetna who had any contact with the claim engaged in deliberately deceptive practices against the Lavoies, their lawyer, and the court."

For example, according to Brown, Aetna claims personnel knowingly violated company procedure by failing to solicit the opinion of medical staff before denying the claim, although correspondence to the Lavoies indicated that the claim had been reviewed by the company's medical department. Later, at least three Aetna employees were exposed as having made knowing misrepresentations under oath in an effort to cover up the misconduct.

Brown's case, however, failed to impress the trial court. On the basis of affidavits submitted by Aetna -- which later were shown to contain false statements -- the court granted an Aetna motion for summary judgment. In October 1981, the Alabama Supreme Court again reversed and remanded the case, only hours after handing down a decision officially recognizing the intentional tort of bad faith in first-party insurance actions.

Despite the fact that the case had already withstood two state supreme court challenges, the trial, which finally got under way in November of 1982, didn't generate a lot of interest. "I couldn't even get my partners interested," Brown said. "The Friday before the trial was to begin, one of my partners told me, 'We'll get a judgment, but this ain't no $5 million case.'"

Three days later, after hearing Brown's case and seeing at least one Aetna employee admit to having lied under oath in an earlier deposition, the jury took just 50 minutes to return a verdict awarding the Lavoies the disputed $1,650 and $3.5 million in punitive damages. "The foreman told me they would have been out sooner," Brown said, "but he had a couple of people holding out for the whole five million."

Aetna appealed, and in a per curiam decision handed down last December (later revealed to have been written by Embry), the Alabama Supreme Court found the evidence to be "overwhelming that Aetna acted in bad faith"; that Aetna's partial payment on the claim did not preclude a bad faith finding; that the verdict was not excessive; and that the financial condition of the Lavoies at the time they received the hospital bill (Robert Lavoie testified in court that his total monthly income for February 1977 was $700) was not improperly allowed into evidence.

Aetna filed an application for rehearing with a subsequent brief raising constitutional questions for the first time, but it was not until the February 1985 filing of a motion to disqualify that Aetna first alleged that Embry's participation was improper.

Two Cases Filed

The charge is based on two bad-faith actions Embry filed against insurance companies. One suit, filed in early 1984 against the Maryland Casualty Company over its failure to pay a claim for a lost mink coat, was settled shortly after its filing, when the company agreed to pay the claim.

The other suit was part of a class action complaint against Blue Cross and Blue Shield of Alabama; Embry alleged the company had intentionally delayed the payment of claims arising from an illness from which his wife died in 1983. The class action was settled last April, with a stipulation by Blue Cross that it "recognizes that some problems have occurred in the past and is determined to minimize them in the future." Embry received what he termed, in a recent interview, "a substantial sum" from Blue Cross to settle the case.

Embry retired from the court in September because of a heart ailment and is currently of counsel to Birmingham's Emond & Vines, a firm specializing in personal injury, malpractice, and product liability actions. He continues to deny an impropriety in his participation in the Aetna decision. As for claims that he was biased against insurance companies, he said, "I voted for the insurance company 17 out of 22 times" during his tenure on the court.

Although Lavoies counsel Goodman said he is optimistic that the Supreme Court will simply deny jurisdiction, he also is confident that if the Court reaches the merits, the Alabama court's decision will be upheld.

As for Aetna's contract clause argument, Goodman responded that the Supreme Court has held over the years that the clause applies only to legislative actions, not to judge-made law. And the Eighth Amendment prohibition on excessive fines, Goodman said, has repeatedly been held to apply only in criminal cases. He called Aetna's attempt to broaden the scope of the amendment to cover civil fines "breathtaking."

"Windfalls for Policy-Holders'

Olson, on the issue of punitive damages, said that such awards are "tending to drive people out of the insurance-writing business." In addition, he said, large punitive damage awards like the one against Aetna are "windfalls for the few policy-holders that ultimately came out of the pockets of other policy-holders."

Agreeing that punitive damages awards have grown excessive, Victor E. Schwartz of D.C.'s Crowell & Moring said, "The idea that there's an unlimited amount of money out there has been its apex." Schwartz, a torts expert who has lobbied on behalf of industry for changes in products liability law, said, "The public perception is that the system has turned into a lottery for greed, and that some standards of reasonableness or predictability need to be imposed." Desirable changes, in Schwatz's view, would be to allow civil defendants some of the constitutional protections afforded to criminal defendants, to impose a higher standard than a preponderance of the evidence for cases involving punitive damages, and to let judges set the amount of punitive damages once juries have determined they should be awarded.

But plaintiffs' lawyers say that limiting the amount of punitive damages would represent "an open invitation for abusive practices," as Goodman put it. "If we insulate insurance companies, the result in this case would have been that Aetna would have had to pay $1,600," said Brown. He added that if punitive damages were severely limited, as many insurance companies are suggesting, "if I was an insurance company executive, I'd tell my claims adjuster to deny every claim."

Both Goodman and Brown, however, said that certain caps on punitive damages could be imposed without removing the deterrent effect. Both mentioned a Montana law, cited favorably in one of the amicus briefs supporting Aetna, that limits punitive damages to the greater of $25,000 or 1 percent of the net worth of the defendant. One percent of Aetna's net worth, they pointed out, would be about $40 million.

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