TEXAS SUPREME COURT DRAWS THE LINE

LINE ON PUNITIVE DAMAGES, GROSS

NEGLIGENCE AND INSURANCE BAD FAITH

by Gregory F. Burch and Greg Casas

I. INTRODUCTION

On February 2, 1994, the Texas Supreme Court handed down its opinion in Transportation Insurance Company v. Moriel, 1994 WL 27030. This case has been heralded by the insurance industry as the latest and strongest statement yet from the Court in a recent series of opinions curtailing the trend toward liberalized standards in insurance bad faith cases. Important as it is for the insurance industry, though, Moriel also defines crucial new law for any case in which there has been or may be an allegation of gross negligence and in which the plaintiff seeks an award of punitive damages.

II. THE MORIEL CASE

The appeal in Moriel raised three issues. First, in a bad faith case, how should Texas courts apply a definition of gross negligence to determine whether punitive damages are appropriate? Second, what constitutes legally sufficient evidence of gross negligence in an allegation of insurance bad faith to support a punitive damages award? Third, what limits do the Due Process clause of the Fourteenth Amendment to the U.S. Constitution and the Due Course Clause of the Texas Constitution place on an award of punitive damages? The Court never addressed the third issue because it determined that the plaintiff, Juan Moriel, did not present legally sufficient evidence to prove gross negligence and he was, therefore, not entitled to punitive damages. Id. at 1.

Moriel, an employee of Cashway Building Materials, was severely injured when a stack of countertops fell on him. Cashway's workers compensation carrier, Transportation Insurance Company, paid Moriel's hospitalization costs. When complications arose after his release from the hospital, Moriel sought advice from several doctors and received recommendations from each that he take a series of tests in order to determine the extent of his new problem. Transportation Insurance's delay in pre-authorizing payment forced Moriel to reschedule his appointment for the tests. When the test results were returned, Moriel was sent for more counseling and therapy. As with the pre-authorization for the earlier tests, Transportation Insurance significantly delayed payment for these services.

Moriel filed a worker's compensation claim against the compensation carrier, and secured a $30,000.00 award from the Industrial Accident Board. When the compensation carrier appealed to the district court, Moriel counterclaimed, alleging, among other claims, bad faith. Id. at 3. On the bad faith claim, the jury found that the compensation carrier delayed paying the medical bills without a reasonable basis, that it knew or should have known that it had no reasonable basis for delaying payment, and that it acted in reckless and heedless disregard of Moriel's rights. Id. The jury awarded Moriel $1,000.00 in actual damages, excluding mental damages, $100,000.00 in mental anguish damages, and $1,000,000.00 in punitive damages. Id. The Court of Appeals affirmed. 814 S.W.2d 144. On appeal, the Supreme Court addressed the relationship of punitive damages to bad faith claims and gross negligence.

The Court began its analysis of the relationship between punitive damages and bad faith claims with a discussion of the nature of punitive damages. "Punitive damages are levied against a defendant to punish the defendant for outrageous, malicious, or otherwise morally culpable conduct." 1994 WL 27030 at 4. The Court also stated that because punitive damages are analogous to criminal punishments, their imposition requires appropriate substantive and procedural safeguards to minimize the risk of unjust punishment. Id. at 5.

Next, the Court recognized that, in a bad faith insurance dispute, the claim for punitive damages is necessarily linked to the underlying claims for breach of contract and bad faith. According to the Court, a bad faith claim can only exist when a breach of contract is accompanied by an independent tort. Evidence that merely shows a bona fide dispute about the insurer's liability on the contract, and not an independent tort, does not establish bad faith. Similarly, bad faith does not exist when the jury, with the benefit of hindsight, decides that the insurer was simply wrong about the factual basis for its denial of the claim or about the proper construction of the policy. Id. The Court explained that an assured who was attempting to prove bad faith on the part of the insurer must prove that the insurer had no reasonable basis for denying or delaying payment of the claim. Then, the assured must show that the insurer knew or should have known that it had no reasonable basis for its delay or denial. Id. at 6. The bad faith of the insurer justifies an award of compensatory damages and nothing more.

Punitive damages are available to the assured if, and only if, bad faith is accompanied by malicious, intentional, fraudulent, or grossly negligent conduct. Id. at 6. According to the Court, there are two core requirements to determine whether bad faith is accompanied by conduct requiring the imposition of punitive damages. First, the insurance carrier must act on the basis of an "aggravated mental state", such as intent, recklessness, or gross negligence, that involves either purposeful injury to the insured or actual subjective awareness that "serious injury" is highly probable. Id. at 6-7. Second, this intended or probable "serious" injury must be independent and qualitatively different from the underlying breach of contract action and the compensable harms associated with it. Id. at 7.

The Court clearly stated that an insurer's delay or refusal to pay an insured's claim, even when the insurer has no reasonable basis for doing so, is not per se gross negligence. Id. at 10. It is merely bad faith. The focus of whether bad faith involves an independent likelihood of "serious injury" is whether the insurer engages in the sort of outrageous behavior that the law normally seeks to punish. The injury associated with the underlying breach of contract claim does not qualify as a "serious injury." Also, mere inconvenience, annoyance, delay, or mental anguish alone do not satisfy this "serious injury" requirement. The Court does not define "serious injury". Instead, the Court looks to future case law to more adequately define this term. Id.

Having set forth the definitions of bad faith, gross negligence, and the required interaction between the two, the Court applied the new law to the facts of Moriel's case. Id. at 11-12. The Court stated that Transportation Insurance had no actual awareness there was a genuine and unjustifiable likelihood of serious harm to Moriel from the delay of payment of his claims. The Court also stated that Transportation Insurance was unaware of any other harm to Moriel that was independent and qualitatively different from the inconvenience of the unreasonable delay. As a result, the Court reversed the jury's award in favor of Moriel and remanded the case for a new trial, noting that their decision had defined new law.

Because the Court remanded the case for a new trial, it decided to dictate a general set of procedural rules for trial courts to follow when trying cases with claims for punitive damages. Id. at 12. The Court established a bifurcated trial system under which the jury will hear evidence relevant to actual damages, the amount of actual damages, and liability for punitive damages (e.g. whether the defendant exhibited gross negligence) and then deliberate on those issues only. Id. at 15. If the jury determines that punitive damages are mandated, the same jury will then be presented evidence of the defendant's net worth, plus any other evidence relevant only to the amount of punitive damages, and will then deliberate on the proper amount of punitive damages to award considering the totality of the evidence presented at both phases of the trial. Id. However the Court refused to raise the evidentiary standard for a finding of gross negligence from a preponderance of the evidence to clear and convincing evidence. Id. at 17.

Further, the Court established a new procedure for the courts of appeal to follow as they review cases involving an award of punitive damages. The Court now requires the courts of appeal to detail the relevant evidence in their opinions and explain why this evidence supports or does not support punitive damages. Id. at 16. The Court did not mandate, however, that trial courts make specific findings as to whether the award of punitive damages is justified in light of the evidence. The Court stated, however, that such findings would be helpful. Id. at 18.

In an opinion bitterly opposed to the majority (denoted as a "concurring opinion" only because the minority would also have remanded the case), Justices Doggett and Gammage attack the majority for limiting a plaintiff's potential recovery of punitive damages from insurance companies. Id. They allege that the majority had sidestepped the issues on appeal and twisted case law to purposefully eliminate claims for punitive damages by deserving plaintiffs. Justice Doggett accuses the majority of "achieving its social agenda at any cost", Id. at 19, and "rewriting history", Id. at 22. Although the minority opinion makes some slight reference to the need for clearer standards in punitive damage cases, it marks a new level of animosity in the rhetoric that has increasingly divided the two "wings" of the Court in the last few years.

III. INSURANCE BAD FAITH

For insurers, Moriel is the latest in a series of recent cases that have significantly restricted the cause of action for "bad faith" denial of claims or claims-handling practices. The "insurance bad faith" claim arises from the peculiar relationship between an insurer and its insured. Unlike other contractual relations, the insurance relationship is said to entail a duty of "good faith and fair dealing." Arnold v. National County Mut. Fire Ins. Co., 725 S.W.2d 165 (Tex.1987); see English v. Fisher, 660 S.W.2d 521 (Tex. 1983) (no general tort duty of good faith and fair dealing in contractual relations).

Aranda v. Insurance Co. of North America, 748 S.W.2d 210 (Tex. 1988) first set forth the analysis applied to all breach of good faith and fair dealing claims involving insurers. Aranda established a two-part standard. First, the assured must prove that the insurer had no reasonable basis for denying or delaying payment of the benefits or the policy. Id. at 213. Next, the assured must prove that the carrier knew or should have known that there was not a reasonable basis for denying the claim or delaying payment of the claim. Id. A claimant can recover for an insurer's breach of good faith and fair dealing only if both of these prongs are affirmatively proven.

In Lyons v. Millers Casualty Ins. Co., 31 Tex. Sup.Ct. J. 241 (Dec. 8, 1993) and National Union Fire Ins. Co. v. Dominguez, 37 Tex. Sup. Ct. J. 316 (Jan. 5, 1994), the Court clarified the method by which Texas courts should conduct legal sufficiency review of fact-findings of bad faith against an insurer. Lyons, 31 Tex. Sup. Ct. J. at 241. The Court held that for a finding of bad faith to be upheld, the evidence must establish that the insurer had no reasonable basis for denying or delaying payment, and that the insurer knew or should have known it had no reasonable basis. Id. Dominguez clearly establised that the claimant in a bad faith case has the burden of proving a negative proposition, i.e., the absence of a reasonable basis for denying a claim, of which the carrier knew or should have known. Dominguez, 37 Sup. Ct. J. at 318. In Dominguez, the Court did expand upon Lyons and set forth the procedure an appellate court should follow in reviewing evidence of a finding of bad faith on the part of the insurer. According to the Court, a reviewing court can examine the sufficiency of the evidence only after it has determined what potential basis the insurer could have had in denying the claim. Id. at 318. With this basis in mind, the court must then inquire into whether that basis was reasonable. Id. The evidence the court must review during this two step inquiry can only relate to the tort issue of no reasonable basis for denial or delay in payment of the claim, not just to the contract issue of coverage. Id. If, under the standard rules of legal sufficiency review, there is no evidence to support a lack of a reasonable basis for denying coverage, or a lack of knowledge that there was on reasonable basis for denial, the finding of bad faith must be reversed. Id.

In Allstate Insurance Company v. Watson, 1994 WL 6788 (Tex. 1994) the Court refused to allow third-party claimants to proceed against an insurer for unfair claims settlement under section 16, article 21.21 of the Texas Insurance Code for two reasons. First, unfair claims settlement is not included in art 21.21, section 16. Id. at 3. As a result, no cause of action under this article could exist. Second, even if such a claim under 21.21 were possible, insurers could not have the required special relationship of trust with third-party claimants that could give rise to an unfair settlement claim. Id. at 4 (citing Vail v. Texas Farm Bureau Mutual Ins. Co., 754 S.W.2d 129 (Tex. 1988) (the duties imposed under art. 21.21 are consistent with the duties the assured owes to the insured under the common law). The Court stated that if it were to recognize the existence of a special insurer-claimant relationship, the holding would necessarily undermine the relationship of trust the insurer must have with its assured. Id. For these reasons, the Court declined to extend to third-party claimants the right to proceed against insurers for unfair claims settlement practices under art. 21.21, section 16.

IV. GROSS NEGLIGENCE

Although it is addressed in connection with insurance bad faith, the discussion of gross negligence in Moriel will probably be important in any case in which there is an allegation of gross negligence. As the Court said, "[t]o sustain the punitive damages awarded to Moriel in this case, the record must contain legally sufficient evidence of Transportation's gross negligence." Moriel at 11.

The Court began its discussion of gross negligence by reference to prior cases highlighting the distinction between ordinary and gross negligence. Looking at Texas' common law of gross negligence, the Court reached as far back as Missouri Pac. Ry. v. Shuford, 72 Tex. 165, 10 S.W. 408 and Southern Cotton Press and Manufacturers Co. v. Bradley, 52 Tex 587, 600 (1880), where gross negligence was defined as "that entire want of care which would raise a presumption of conscious indifference to consequences." The Court then noted that the legislature had addressed the definition of gross negligence in 1987, modifying the common law definition:

"Gross negligence" means more than momentary thoughtlessness, inadvertence or error of judgment. It means such an entire want of care as to establish that the act or omission was the result of actual conscious indifference to the rights, sanity, or welfare of the person affected.

TEX. CIV. PRAC. & REM. CODE § 41.001(5). The Court finds that this change in definition actually raises a higher standard than existed under the common law, i.e. that it "emphasizes that the evidence must 'establish' the defendant's actual conscious indifference, rather than raise the mere belief that conscious indifference might be attributable to a hypothetical reasonable defendant." Moriel at 7.

The crucial analysis in Moriel is the distinction between the two elements necessary to establish gross negligence, the subjective element of the defendant's mental state and the objective element of the "extreme risk" of "serious injury". Unfortunately, the Court gives little guidance on the first of these points, merely reiterating that a plaintiff must prove that the defendant had "actual awareness of the extreme risk created by his or her conduct." Moriel at 9. The opinion goes on to say that it recognizes "the practical difficulty of producing direct evidence of conscious indifference short of the defendant's admission," and endorsed holdings in previous opinions "that the defendant's subjective mental state can be proven by direct or circumstantial evidence." Id.

The Court offers more tangible guidelines to defendants facing allegations of gross negligence on the second element, the objective fact of "serious injury" or "extreme risk". Most importantly, the Court states that:

[d]etermining whether an act or omission involves extreme risk or peril requires an examination of the events and circumstances from the viewpoint of the defendant at the time the events occurred, without viewing the matter in hindsight. In every negligence or gross negligence case, some injury has allegedly occurred. However, the magnitude of the injury may be entirely disproportionate to the riskiness of the behavior. ... If somebody has suffered grave injury, it may nevertheless be the case that the behavior which caused it, viewed prospectively and without the benefit of hindsight, created no great danger. In such a case, punitive damages are not appropriate.

Id. at 9-10 (emphasis added). Thus, while the Court views the issue of gross negligence (and punitive damages) in a broad social policy context of categories of behavior that society finds especially worthy of punishment, it requires that such broad concepts be tied to the specific defendant's mental state and point of view.

V. PUNITIVE DAMAGES

The Court's pronouncements in Moriel regarding punitive damages are also of broader interest beyond the special instance of insurance bad faith. The Court's discussion of punitive damages begins with reference to two recent U.S. Supreme Court opinions that addressed punitive damages in civil cases, Pacific Mut. Life Ins. Co. v. Haslip, 499 U.S. 1, 111 S.Ct. 1032 (1991) and TXO Prod. Corp. v. Alliance Resources Corp., ___ U.S. ___,113 S.Ct. 2711 (1993). These cases were followed closely because there was some hope that the U.S. Supreme Court would announce federal constitutional due process limitations on the award of punitive damages in civil cases. Although the high court recognized that unlimited discretion in jury awards of punitive damages "may invite extreme results that jar one's constitutional sensibilities," these opinions did not set out any specific due process guidelines. However, they did point to adequate jury instructions properly defining punitive damages, Haslip, 499 U.S. at 20, and trial and appellate court review employing "detailed substantive standards", Id. at 22, as supporting the punitive damage awards in those cases.

In light of those cases, the Texas Supreme Court in Moriel concluded that "Texas procedures for assessing and reviewing punitive damage awards, both at the trial and appellate levels, in some respects may not adequately ensure that such awards 'are not grossly out of proportion to the severity of the offense and have some understandable relationship to compensatory damages.'" Moriel, 1994 WL at 14, citing Haslip, 499 U.S. at 22. Specifically avoiding the constitutional questions raised in Haslip and TXO, the Moriel Court relied on its "authority under the common law" to announce the two specific procedural changes discussed above, i.e. bifurcation of the punitive damage liability issue from the issue of the amount of punitive damages, and requiring Texas courts of appeal to "detail the relevant evidence in [their] opinion[s], explaining why that evidence either supports or does not support the punitive damage award in light of the Kraus factors." Moriel at 14-16.

The Court refers to its opinion in Alamo National Bank v. Kraus, 616 S.W.2d 908 (Tex.1981), which set out a list of "[f]actors to consider in determining whether an award of exemplary damages is reasonable":

(1) the nature of the wrong,

(2) the character of the conduct involved,

(3) the degree of culpability of the wrongdoer,

(4) the situation and sensibilities of the parties concerned, and

(5) the extent to which such conduct offends a public sense of justice and propriety.

Id. at 910.

The Court did reject two ideas which have been suggested as possible curbs on the award of excessive damages, the standard of proof and mandatory trial court review. The Court acknowledges that many states have raised the standard of proof required to support an award of punitive damages to that of "clear and convincing" rather than the normal civil standard of "preponderance of the evidence." Moriel at 16. However, the Court pointed to the fact that the Texas legislature had considered and rejected this idea in the 1987 "tort reform" legislation as a bar to making this change in Texas law. Id. at 16-17. As to requiring a trial court to articulate how the evidence at trial matches up to the Krause factors, supra, the Court again pointed to this practice as gaining growing acceptance in other states and in certain federal cases, Id. at 17, but, pointing to studies indicating the already over-taxed state trial court system, declined to make such findings mandatory. The Court did encourage trial courts to make such findings wherever possible, to facilitate appellate review. Id. at 18.

VI. CONCLUSION

Moriel marks an important milestone in which the Texas Supreme Court has recognized and addressed the concerns that many defendants have expressed regarding the fairness of Texas' practice with regard to allegations of gross negligence and threats of astronomically high punitive damage awards. There is perhaps no better indication of the potential impact of this decision on the "litigation landscape" in Texas than the vehemence of the "concurring" opinion of the liberal minority on the Court. The authors believe Justice Doggett is correct when he predicts that defendants will welcome the case.

In practice, we believe Moriel will allow defendants to raise meritorious defenses that the chilling effect of the threat of unwarranted punitive damage awards has deterred in the past. A discussion of the social policy implications of this effect is beyond the scope of this article. However, we believe that Moriel signals the beginning of a new era in Texas litigation in which defendants can view the courthouse as a much more level playing field.

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Gregory F. Burch is a partner and Greg Casas is an associate in the Houston office, practicing insurance, tort, admiralty and construction litigation.