American International Specialty Lines Insurance Co. v. Res-Care Inc., 2002 U.S. Dist. LEXIS 4507 (5th Cir. June 2, 2008), was an action by American International to recover the non-covered portion of a $9 million settlement it paid pursuant to a non-waiver agreement with Res-Care, its insured.    2002 U.S. Dist. LEXIS 4507 

The district court determined that $5 million of the settlement was attributable to punitive damages and that insurance for those damages was not covered. The Fifth Circuit affirmed. An umbrella policy specifically excluded punitive damages. A $1 million primary policy was silent on that issue and, given the lack of arguments in the district court on the issue, deemed to provide coverage. But, in the circumstances here, the Fifth Circuit concluded that insurance coverage for the punitive damages would be contrary to public policy. (Other issues in the case are not discussed here.)

Res-Care operated Appleridge, a group home for mentally disabled individuals. Tania Wright had cerebral palsy and mental disabilities. On the evening of April 12, 1998, she fell in a hallway and defecated on the floor. Vickie Kennerly poured a mixture of undiluted bleach and another cleaning compound on the floor and left Wright lying there for at least an hour and possibly several hours. Wright told others that Kennerly had poured bleach on her and “set me on fire.” Eventually, Kennerly dragged Wright into a bathroom and cleaned up the floor, but did not wash the bleach off of Wright. She left Appleridge at the end of her shift. Others found Wright in the bathroom and put her to bed in clean clothes, but did not attempt to wash the bleach off. Though Wright had extensive chemical burns, she received little medical care in the following days. She was not taken to the facility’s doctor until 17 hours after the incident. He diagnosed only superficial burns and prescribed pain medication and recommended whirlpool treatments, which were not provided. Wright received no pain medication until almost 24 hours after the incident.

Late in the afternoon, a nurse examined Wright and was shocked at her burns. But the nurses who were aware of the burns did not follow up because Wright had already seen a doctor.

Wright’s skin began peeling off in patches and she began drinking a lot of water, indicating dehydration from the chemical burns. In the early morning of April 15, she fell out of bed and was unresponsive. In the emergency room, she was diagnosed with extensive chemical burns, covering over 40% of her body. She died the next morning of complications from the burns. Her family sued for wrongful death.

In determining whether coverage for punitive damages was barred by public policy, the Fifth Circuit was guided by Fairfield Insurance Co. v. Stephens Martin Paving, LP, 246 S.W.3d 653, 2008 Tex. LEXIS 123 (Tex. 2008), which held that such coverage was permissible in the workers’ compensation context. If the policy covers punitive damages (as this one was deemed to do), the next question is whether the legislature has made an explicit policy decision on permissibility of such coverage. (Fairfield Insurance found insurance permitted in the workers compensation context.) Texas statutes generally prohibit insurance by “health care providers” against punitive damages, with some exceptions for hospitals, nursing homes, and assisted living facilities. But Appleridge was not within the definition of “health care provider,” so those statutes did not apply.

Thus, the court was forced to engage in a more general public policy analysis.

That analysis requires balancing the policy favoring freedom of contract against the extent to which enforcement of the agreement would frustrate other public policies. “The ‘primary purpose of exemplary damages is to punish and deter’” (quoting Fairfield). Recent Texas statutes have emphasized punishment, and “’[p]unishment imposed through exemplary damages is to be directed at the wrongdoer’” (quoting Fairfield). But insurance may be allowed where a corporation or business is held vicariously liable for conduct of its employees, without any culpable involvement by management.

While Res-Care argued that Wright’s case was precisely a case of vicarious liability for employee misconduct, the Fifth Circuit noted that Fairfield had recognized that there might be “extreme circumstances” where “extreme and avoidable conduct” might warrant different treatment. Otherwise, existence of insurance coverage could “’completely eviscerate the punitive purpose behind awarding exemplary damages’” and “could defeat not only an explicit legislative policy, but also the court’s traditional role in deterring conscious indifference’” (quoting Fairfield). Here, the claims against Res-Care included “failing to ensure a safe environment, to properly hire and train its employees, and to ensure that Wright received proper medical care.” Moreover, reports from the State of Texas showed that Res-Care’s other facilities were also poorly operated, “establishing a course of conduct warranting exemplary damages.” A report on Wright’s case recommended that Appleridge be closed. In sum, the court concluded that

the circumstances of Wright’s injury and death, occurring while living in a facility with documented systemic problems of care, were so extreme that the purposes of punishment and deterrence of conscious indifference outweigh the normally strong public policy in permitting the right to contract between insurer and insured. This case demonstrates the kind of “avoidable conduct causing injury” where public policy is best served by requiring the insured to bear the costs of punitive damages.

Res-Care is a significant development in the ongoing struggle over the permissibility of insurance for punitive damages in Texas.

William T. Barker Sonnenschein Nath & Rosenthal, LLP