Courts: Consequential Damages Claims Permitted Against Insurers
Bi‐Economy Market Inc., v. Harleysville Ins. Co., 10 N.Y.3d 187, 856 N.Y.S.2d 505, 886 N.E.2d 127 (2008)

In October 2002, the insured, Bi‐Economy Market, a family‐wholesale retail meat market, experienced a major fire resulting in complete loss of food inventory and heavy structural damage to the building and related equipment. At the time of the fire, the insured had a “Deluxe Business Owner’s” policy with the defendant, Harleysville Insurance Co. The policy included replacement cost coverage on the building, as well as on the business property, also known as “contents” loss coverage. In addition, the policy afforded coverage for lost business income for up to one year from the date of the occurrence giving rise to the claim.

 

The defendant disputed the amount of the claim submitted by the plaintiff; an alternative dispute resolution ultimately awarded the plaintiff $407,181.00. Subsequently, the plaintiff filed a suit against the defendant seeking consequential damages for “the complete demise of its business operation in an amount to be proved at trial.” The plaintiff claimed that the insurer’s delayed payment for the building and contents damage, and the failure to timely pay the full amount of their lost income claim, resulted in the collapse of the business, and that the collapse of the business was a foreseeable consequence of the defendant’s breach of contract actions.

The Court agreed, finding that basic contract law allows the “non‐breaching party to recover general damages which are the natural and probable consequence of the breach.”1 Further, 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 defendant fairly may be supposed to have assumed consciously, or to have warranted the plaintiff reasonably to suppose that it assumed, when the contract was made.’”2 The Court stated that the purpose of business interruption insurance is to provide the insured with financial support to sustain its business in the event that disaster occurs; thus, the defendant should have been able to reasonably foresee that a breach of its duty to act in good faith in accordance with the insurance contract could result in the collapse of plaintiff’s business.

The dissent countered, arguing that the majority’s award of “consequential damages” is actually an award of punitive damages in disguise. New York courts have consistently held that punitive damages are not available to a plaintiff for a breach of insurance contract claim, and that such damage awards cannot be labeled consequential damages simply to circumvent the rule. The dissent likewise reasoned that permitting punitive damages awards disguised as “consequential damages,” in the name of protecting the insured would ultimately cost society too much. “Insurers will fear that juries will view even legitimate claim denials unsympathetically, and that insurers will thus be exposed to damages without any predictable limit.” Naturally, if faced with such a situation, lead insurers would be forced to increase their premiums.

The majority responded to the dissent’s objections by distinguishing the damages it awarded to Bi‐Economy from punitive damages. Punitive damages are designed to punish the wrongdoer by making them an example to others, and are not directly quantifiable, both elements that are not present in this case. Consequential damages, are defined as those “designed to compensate a party for the reasonably foreseeable damages [that] ‘must be proximately caused by the breach’ and must be proven by the party seeking them.” Here, the purpose of the insurance contract was clearly to support the insured’s business operation in the event disaster occurred. The insurer’s failure to perform under the contract directly prevented the insured from sustaining its business operation following the actual occurrence of a disaster. Therefore, in this situation, only awarding the amount of the policy, the majority pointed out, would not place the insured in the position it would have been in had the contract been performed. Awarding damages for the collapse of the insured’s business, the foreseeable and proximate result of the insurer’s failure to perform under the contract, was intended only to place the insured in the position it would have been in had the defendant performed. In light of its reasoning, the Court reversed the order of the Appellate Division that upheld the motion for partial summary judgment with costs and denied defendants’ motion to amend their answer to raise the defense of contractual exclusion for consequential damages.

1 The Court cites Kenford Co. v. County of Erie, 73 N.Y.2d 312, 319 (1989)
2 Kenford, 73 N.Y.2d at 319, quoting Globe Ref. Co. v. Landa Cotton Oil Co., 190 U.S. 540, 544 (1903)


Subrogation Spotlight Part Two: “To Sue or Not to Sue?”


In our first installment, we discussed squaring away the insured and uninsured claims so that a single lawyer may represent the interests of both the insured and the insurer without conflict. Having now safely navigated past these potential ethical obstacles, we now face a decision as to how we may best pursue the claim. Should we proceed immediately to litigation or attempt an amicable resolution at the settlement/claim stage? After all, settlement will likely be little more than a “commercial decision” between insurers, and we’re all one big happy aviation insurance family. So why not just drop a claim letter in the mail and set out on a course of negotiation and resolution?


Not so fast! In light of recent case law on the subject – some of which the undersigned has candidly been victim to – one asserting a subrogation claim may find himself on the receiving end of a declaratory judgment action. My subjective views on the subject later, but for now let’s look at some practical considerations for the would‐be
subrogee. Most importantly, is there an underlying contract setting out certain rights and obligations between the parties? Let’s return to our scenario from Part One:

 

As you may recall, IN OUR TIME AIRLINES, also known as IOT AIRLINES, operates a fleet of twin turboprops. In November of 2007, one of its aircraft suffered a prop strike requiring a replacement blade. Rather than purchase one from the OEM, IOT Airlines purchased a replacement blade from C‐Speed Propellers. On December 25, 2007, while in the course of run‐up, the replacement blade fractured. No one was injured, but the aircraft was taken out of service; the engines suffered vibration damage and cracked mounts. The entire engine had to be removed, inspected, and overhauled. The cost of repair: US$500,000. Investigation of the propeller reveals that it was manufactured with an unapproved and substandard aluminum alloy clearly outside of the FAA Parts Manufacture Approval (PMA) authority for C‐Speed. IOT Airlines is insured by Swift Fleet Insurance Co., specializing in aviation insurance.


In the hopes of early and efficient resolution, IOT’s lawyer, with the consent of the insurer, prepares a comprehensive claim letter to C‐Speed. The letter sets out the basis for the claim, legal theories of recovery (including strict product liability), damages claimed, and a settlement demand of US$500,000. The letter concludes: “We hope you will give this claim your immediate attention. We believe it is in our mutual interest to settle this without resorting to legal proceedings, and we will negotiate in good faith toward this end.”

 

Not surprisingly, when IOT purchased its propeller from C‐Speed, the contract contained various warranty terms. Among these terms (paraphrased except where quoted) are:

1. A requirement that any claim arising from the contract be brought in the state of Michigan;
2. A statement that “this contract shall be interpreted pursuant to the laws of the state of Michigan;”
3. A limited six month warranty or 1,500 flight hour warranty, the sole remedy being the provision of a replacement
blade; and
4. An express disclaimer that the above warranty is “exclusive of all, and in lieu of all, remedies in tort including
negligence and strict liability and in lieu of all warranties express and implied, including any implied warranties of
merchantability and fitness for a particular purpose.”


Clearly, C‐Speed will look to the contractual limited warranties and defenses in defending any claim or settlement. The more pertinent question to the claimant/subrogee is whether these contractual terms can justify C‐Speed’s, the defendant, initiation of its own [declaratory judgment] action to assert these defenses. In some jurisdictions, the above contractual terms may be a sufficient basis for a court to sustain declaratory judgment jurisdiction in a claim by CSpeed to “declare” your tort claims precluded by the contract. This is a bizarre and inverted situation. Consider the following:

 

1. The party seeking to avoid litigation and reach an out‐of‐court settlement finds himself dragged into court courtesy of the declaratory judgment (“DJ”) action;
2. The party initiating the claim is the true defendant – the party the subrogated insurer seeks to hold liable for the loss;
3. This true defendant (nominal plaintiff) has usurped the choice of forum from the true plaintiff, the party that is traditionally considered the master of the forum;
4. The party who would otherwise seek to avoid litigation by reaching out informally to settle finds himself maneuvered into court;
5. Applicable rules of civil procedure may require the subrogated plaintiff (now the DJ defendant) to assert its original subrogation claim as a “compulsory counterclaim” to the subrogation claim – completing the usurpation of forum. See FRCP13(a).


Put all this together and we now have a system that seems to discourage the informal resolution of claims because the party seeking to avoid litigation risks being sued in an unfavorable forum as a consequence of having dared to write a claim letter. Having been forewarned or once‐bitten, in the future, the true plaintiff will now likely initiate his own action directly and forego the claim letter and efforts towards informal settlement. The race to the courthouse is on!

 

When is an Affirmative Defense not an Affirmative Defense?


There are legions of cases to support the proposition that a DJ action is not properly used to assert an affirmative defense to a tort claim. See, e.g. Dow Jones Co. v. Harrods, Ltd., 237 F. Supp.2d 394 (S.D.N.Y 2002) (Dow Jones I), aff’d, 346 F.3d 357 (2d Cir. 2003) (Dow Jones II).

 

A rush to file first in anticipation of litigation in another tribunal, thereby enabling a potential defendant to choose the forum and governing law by which to adjudicate the dispute, and otherwise to interfere with orfrustrate the other party's pursuit of claims elsewhere, is one of the equitable considerations a court may weigh in ruling on a request for declaratory relief.


Dow Jones I, 237 F. Supp.2d at 440 (footnote omitted), aff’d, Dow Jones II, 346 F.2d at 359‐60.


In addition, in a typical subrogation case, the damages are fixed. Unlike an insurance coverage case, in which the insurer and insured need their legal positions fixed to prevent continued damages or prejudice, this is not so in a postrepair subrogation case.

 

The [DJA] was meant to settle legal rights ‘without awaiting a violation of rights or a disturbance of relationships’ Beacon Const. Co. Inc. v. Matco elec. Co., Inc., 521 F.3d 392, 397 (2d Cir. 1975). It was not meant, however, to prevent the cost of litigating where such violations or disturbances have already occurred.

 

See, e.g., Crown Cork & Seal Co. v. Borden, Inc., 779 F. Supp. 33, 36 (E.D. Pa. 1991).


Another line of cases supports the proposition that a Declaratory Judgment Action is an appropriate procedure for interpretation of a contract. See, e.g., Nucor Corp. v. Aceros Y Maquilos de Occidente, S.A. de C.V., 28 F.3d 572, 579 (7th Cir. 1994); Schechter v. Banque Commerciale Privee, Not reported in F.Supp, 1991 WL 105217, *13‐14 (S.D.N.Y. 1991); Broadview Chem. Corp. v. Lucite Corp., 417 F.2d 998, 1000 (2d Cir.1969). And of course, any insurer is familiar with the role of the declaratory judgment action in interpreting insurance policies and declaring the parties rights here under. See, e.g. Farrell Lines Inc. v. Columbus Cello‐Poly Corp. 32 F.Supp.2d 118 (S.D.N.Y., 1997); Continental Casualty Company v. Coastal Savings Bank, 977 F.2d 734, 738 (2d Cir.1992); ACandS, Inc. v. Aetna Cas. and Sur. Co. 666
F.2d 819, 823 (3d Cir.1981).


A dissertation on the scope and intent of the declaratory judgment action is beyond the limits of this column. Insurers and counsel would be well advised to carefully evaluate the risks before formally asserting a claim that will be defended, even in part, by reference to contractual warranties and disclaimers. They may find themselves defending a declaratory judgment action in an unfriendly court.

 

I will simply add, on a purely subjective editorial note, that there are several factors a court will examine in determining whether to retain jurisdiction over a declaratory judgment action. In the context of our hypothetical, I would argue that these factors favor declining the case and letting the claim proceed outside of the court system until the true plaintiff decides otherwise. See Dow Jones & Co. Inc. v. Harrods Ltd., 346 F.3d 357 (2d Cir.2003); The New York Times v. Gonzales, 459 F.3d 160, 167, 2006 WL 2130645, (2d Cir.2006). Nonetheless, even if these factors balance, the strong policy favoring settling out of court should tip the balance in favor of declining jurisdiction over the DJ action. See. e.g., ABKCO Music, Inc. v. Harrisongs Music, Ltd., 722 F.2d 988, 997 (2d Cir. 1983); Eli’s Chicago Finest, Inc. v. The Cheesecake
Factory, Inc.
, 23 F.Supp.2d 906, 909 (N.D. Ill. 1998); see Essex Group, Inc. v. Cobra Wire & Cable, Inc., 100 F.Supp.2d 912, 915 (N.D. Ind. 2000) (quoting Eli’s Chicago, 23 F.Supp2d at 909). Otherwise, every would‐be tort plaintiff asserting a claim to which there are contractual defenses would do so with the sword of Damocles dangling above them. They may have no choice but to initiate a legal claim rather than risk defending one. Hopefully, courts will reverse the trend of this improvident grant of declaratory jurisdiction.

 

Next Time, Put It on Vibrate!

 

In 2005, seventy‐five defendants waiting for their time in court found themselves the recipients of the wrath of a judge presiding over the Domestic Violence Part of the
Niagara Falls City Court., New York The episode began with a cell phone rining in Judge Restaino’s courtroom and no one willing to admit to owning the offending phone. Judge Restaino began to summon individuals to the bench to ask directly whether it was in fact their cell phone. Upon each denial, the Judge proceeded to commit each individual to custody and set bail at $1500. Forty‐six of the seventy‐five defendants were actually taken to booking and of those forty‐six, the unfortunate fourteen who could not immediately post bail were subsequently bussed to the county jail. Though all were ultimately released by the end of the day, many found themselves unable to leave the county jail because they were refused transport back to Niagara Falls.

 

Judge Restaino cited personal stress as the cause of his outburst in 2005 and states that he has been in counseling ever since. Ultimately, on Wednesday, November 27, 2008, the Commission on Judicial Conduct, in a 9‐1 decision, recommended Judge Restaino’s removal from the bench, stating that “In causing 46 individuals to be deprived of their liberty out of pique and frustration, respondent abandoned his role as a reasonable, fair jurist and instead became a petty tyrant, abusing his judicial power and placing himself above the law he was shown to administer.” Raoul Felder, the sole dissenter, cited compassion and Restaino’s otherwise unblemished career as his reasons for dissenting.