Even where an insurance company eventually pays a claim, the policyholder still may be able to bring an action for first-party bad faith, that is, a claim that the insurer has breached its obligation to provide coverage benefits. See generally Marc S. Mayerson, “First Party” Insurance Bad Faith: Mooring Procedure to Substance, 38 Tort Trial & Ins. Prac. J. 861 (2003) (available at http://www.spriggs.com/news/pdfs/MSM-31.pdf). If the policyholder is forced to bring suit against its insurer, Campbell raises the question of what is included in counting the “amount of harm to the plaintiff and . . . the general damages recovered.” Specifically, are the policyholder’s attorneys’ fees in the coverage case, which is an element of its damages, properly included in determining the amount that can be multiplied in a punitive-damages assessment?

Two cases have addressed this question, with differing results. As will be seen, one crucial difference – though concededly not fleshed out in the two decisions – is the difference between third-party bad-faith claims (a failure to settle claim that typically is assigned to the underlying tort plaintiff) and a first-party bad-faith claim (where the policyholder seeks recovery due to the carrier’s failure to perform unreasonably and without proper cause).

On remand from the US Supreme Court, the Utah Supreme Court in Campbell v. State Farm, 2004 UT 34, found that attorneys’ fees should not be included in the calculus. The Utah justices said, without real analysis, that they were “convince[d]” they were not “at liberty” to include the attorneys’ fees as part of the compensatory damages for these purposes, though the fees were to be included in the award of “special damages as part of our punitive damages award.” ( 48).

The Campbell court further reasoned that to include the attorneys’ fees would necessitate analyzing the conduct of the litigation as separate acts of bad faith. Finally, the court was troubled by the procedural complexities introduced by including attorneys’ fees because under Utah practice fees are usually awarded in a separate proceeding by the judge as opposed to being awarded by the jury in the damages assessment.

The Utah court’s reasoning is not altogether satisfying. The Utah court has developed a sophisticated and refined contract-damages analysis in the first-party context in which the court recognizes that the policyholder’s cost of pursuing coverage, i.e., its attorneys’ fees in the coverage case, are properly included as an element of recoverable consequential damages flowing from the carrier’s denial of coverage. See Machan v. Unum Life Ins. Co., 2005 UT 37 (June 17, 2005), available at http://www.utcourts.gov/opinions/supopin/Machan061705.htm; Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985). It also does not seem to flow from the court’s analysis that it would need to analyze the reprehensibility of the carrier’s litigation tactics in order to properly assess punitive damages on top of the attorneys’ fees recovery. Of course, there is authority for the proposition that the carrier’s post-denial conduct, including its coverage litigation tactics, are themselves actionable under bad-faith principles, e.g., McIlravy v. N. River Ins. Co., 653 N.W.2d 323 (Iowa 2002); Ingalls v. Paul Revere Life Ins. Group., 561 N.W.2d 273, 280 (N.D. 1997); Southerland v. Argonaut Ins. Co. 794 P.2d 1102, 1106 (Colo. Ct. App. 1990); Spadafore v. blue Shield, 486 N.E.2d 1201, 1203-04 (Ohio Ct. App. 1985). (There’s contrary law as well.)

But if one focuses on the idea that Campbell is a third-party bad-faith claim assigned to the plaintiff the Court’s notion is clearer: the insurer does not owe direct duties to the tort victim (or its duties are more attenuated than those owed its policyholder in resolving the policyholder’s claim for coverage), such that it is more sensible to require a showing of independent harm in order to then include that in the punitive damages calculus. An insurance company owes its insured an abiding duty of good faith, even when it is litigating with its policyholder; thus litigation tactics may be independently actionable in the first-party context, but it is also true that once a carrier denies the claim wrongly, then the policyholder’s only recourse is to bring litigation, so its attorneys’ fees more naturally can be seen as an element of its compensatory damages.

The first-party relationship was the context for the recent decision of the United States Court of Appeals for the Third Circuit in Willow Inn, Inc. v. Public Service Mut. Ins. Co., http://www.ca3.uscourts.gov/opinarch/032837p.pdf (3d Cir. Nov. 16, 2004). In Willow Inn, the Third Circuit held that attorneys’ fees in the bad-faith case were to be included in determining the constitutional propriety of the punitive-damages award. (Note this is slightly different from the question whether the costs of establishing bad faith are a recoverable element of bad-faith damages, which the California Supreme Court, for example, has refused to award as part of the remedy in bad-faith cases, see Brandt v. Superior Court, 37 Cal.3d 813 (1985).)

The Willow Inn court addressed a claim where the insurer dragged its feet in paying the insured’s claim but eventually paid the bulk of the claim. One element the carrier refused sub silentio was the claim for $2000 to defray the insured’s cost of preparing a proof of loss, an express benefit under the insurance policy. The insured brought suit for bad faith and to recover the $2000 (since the insured’s principal claim eventually had been paid by the insurer). The court awarded approximately $135,000 in attorneys’’ fees, plus the $2000. The question on appeal was whether an additional $150,000 punitive-damages award was appropriate, with the narrow question being whether the single-digit multiplier embraced in State Farm v. Campbell applied as against the $2000 contract recovery, as the insurer contended, or whether the attorneys’ fees could be included in assessing whether the amount of punitive damages was disproportionate and unconstitutional.
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The Third Circuit held that the attorneys’ fees incurred in proving bad faith were properly included in determining the punitive-damages:compensatory-damages ratio. Implicitly, the court found that the attorney’s fees were an element of the compensatory damages for bad faith and that the denominator was not limited to the breach-of-contract common-law recovery ($2000). Compare Commissioner v. Banks __ U.S. __ (2005) (http://caselaw.lp.findlaw.com/scripts/getcase.pl?court=US&vol=000&invol=03-892) (contingency fee paid to attorney is taxable to client). By not splitting off the breach-of-contract damages from the awarded attorneys’ fees in the punitive-damages ratio analysis, the Third Circuit easily concluded that the ~1:1 ratio passed constitutional muster.

As suggested at the outset, the principal viable distinction between the Utah decision and the Third Circuit’s decision is the nature of the claim at issue. The Campbell decision on remand was a third-party bad faith claim, that is, a claim that the insurer unreasonably failed to settle the underlying litigation against the insured, and the attorneys’ fees were incurred not by the insured but rather by its assignee who pursued the failure-to-settle claim. In contrast, Willow Inn involved attorneys’ fees stemming from the course of action by the insurer in denying the insured’s claim, paying slowly and after making it jump through procedural hoops, and finally in defending against the insured’s coverage litigation (the insurer’s rationale for that conduct is never explained). All the while, the insurer had an obligation to act in good faith and treat its insured fairly in Willow Inn, a duty it failed to discharge and which caused its insured to incur the attorneys’ fees. On that basis, including those fees in assessing whether the $150,000 punitive damages comported with due process surely seems eminently reasonable.