Bad Faith - Third Circuit Holds Insurer Liable For Bad Faith Even Though Insured’s Agent Canceled Policy Prior To Loss
Last week, in Gallatin Fuels, Inc. v. Westchester Fire Insurance Co., Nos. 06-3133, 06-3134 (Aug. 9, 2007), the U.S. Court of Appeals for the Third Circuit held under Pennsylvania law that an insurer acted in bad faith and
was liable for $4.5 million in punitive damages even though the insured’s agent had canceled the insurance policy prior to the loss.
This case involved insurance issued by Westchester Fire Insurance Co. to cover equipment leased by Gallatin Fuels, Inc. to Mon View Mining Corp. for use in Mon View’s mining operation. Gallatin was named as the loss payee.
Because Mon View could not afford the premium, it entered into a finance agreement with Universal Premium Acceptance Corp. (“UPAC”) giving UPAC the power to arrange payment for and/or cancel the policy. When Mon View
stopped making premium payments, UPAC canceled the policy effective March 28, 2002. Gallatin was not notified. On April 8, 2002, Mon View’s mine filled with water and toxic gases and Gallatin, not knowing of the cancellation,
submitted a proof of loss on April 24, 2002. Westchester’s claims adjuster rejected and returned the proof of loss statement on the basis that there was no loss, but did not inform Gallatin that the policy had been cancelled.
On October 25, 2002, Westchester advised Gallatin that the policy had been canceled. Westchester gave Gallatin the option of paying the outstanding premium, but indicated that there were coverage defenses to the claim.
Gallatin ultimately sued Westchester for breach of contract and bad faith in the U.S. District Court for the Western District of Pennsylvania. A jury found in favor of Gallatin on both claims and awarded $1.325 million in compensatory
damages and $20 million in punitive damages (which the district court reduced to $4.5 million).
On appeal, Westchester argued that the district court erred by refusing to hold that the policy was canceled prior to loss. The Third Circuit agreed and vacated the compensatory damages award. Westchester further argued that it could
not be liable for bad faith because it had no duty to provide coverage under the canceled policy. The court disagreed, stating that under Section 8371, a bad faith claim is not contingent on succeeding on the breach of contract claim.
The Third Circuit reasoned that the bad faith claim was based on behavior beyond denying the claim; namely, that Westchester misrepresented policy terms, dragged its feet in investigating the claim, hid information, shifted its basis
for denying the claim, and did not assert policy cancellation until six months after Gallatin made a claim. Based on these circumstances, the court affirmed the bad faith judgment. It stated “we find that this is one of the
exceedingly rare cases in which an insurer can be liable for bad faith even after the insured cancels the policy.”
The Third Circuit also upheld the punitive damages award, finding that the award was based on injury-causing bad faith conduct, not claims-handling violations. The court rejected Westchester’s argument that the $4.5 million
punitive damages award was excessive, holding that although the compensatory damages award was vacated, the $1.1 million attorneys’ fee award to Gallatin (not challenged on appeal) was the proper point of comparison. On that
basis, the court held that the ratio (4.09:1) was not constitutionally excessive.