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Fundamentals of Insurance Law

7/16/2009 9:48:07 AM EST

Federal Court May have Upped the Ante Even More on Consequential Damages for Claims against Insurers for Breach of Contract

By Ted Zwayer

Posted by Ted Zwayer

Earlier this year I discussed the companion cases of Bi-Economy Mkt., Inc. v. Harleysville Ins. Co. of N.Y., 886 N.E.2d 127 (N.Y. 2008), and Panasia Estates, Inc. v. Hudson Ins. Co., 886 N.E.2d 135 (N.Y. 2008), in which the New York Court of Appeals ruled that an insured could seek consequential damages for the breach of a commercial insurance policy by the insurer. Now a federal court has held that an insured can seek consequential damages for an insurer’s breach of a non-commercial insurance policy as well.

The insureds in Woodworth v. Erie Ins. Co., 2009 U.S. Dist. LEXIS 49379 (W.D.N.Y. 2009), purchased a homeowner's insurance policy from the insurer. The policy included coverage of the residence for sudden and accidental physical loss, including loss caused by fire. After their home was destroyed by a natural gas explosion, they filed an action against the insurer for the alleged failure to pay them the entire amount of their loss. The federal district court dismissed a portion of the lawsuit, and the insureds withdrew their bad faith claim seeking punitive damages, which left the remaining breach of contract claim that was based upon the insurer’s alleged failure to pay them the actual cash value of the destroyed home and their additional living expenses under the policy.

The insured’s then moved to amend their complaint to request extra-contractual consequential damages based upon the insurer’s alleged breach of the policy's implied covenant of good faith and fair dealing. The district court phrased the amendment in this fashion:

“Plaintiffs' motion for leave to amend their complaint in order to request an award of consequential damages is based upon Bi-Economy Mkt., Inc. v. Harleysville Ins. Co. of New York, 10 N.Y.3d 187, 192-93, 886 N.E.2d 127, 856 N.Y.S.2d 505 (2008), a decision issued by the New York Court of Appeals in February 2008. In Bi-Economy, the Court held that an insured may recover consequential damages resulting from an insurer's breach of the policy's covenant of good faith and fair dealing provided that such damages were within the reasonable contemplation of the parties at or before the time of contracting as the probable result of a breach. Bi-Economy Mkt., Inc. v. Harleysville Ins. Co. of New York, 10 N.Y.3d at 192-93. Relying upon that decision, plaintiffs now seek to amend their complaint to demand additional living expenses not covered by the policy - specifically, mileage to and from the summer cottage where they have been living since the gas explosion and the lost rental income from that cottage -, as well as emotional distress damages and attorneys' fees.”

The insurer argued in response that Bi-Economy should be applied only to commercial insurance policies.

The district court pointed out that there was nothing in the Bi-Economy decision that implied that it applied strictly to business interruption insurance policies specifically or to commercial insurance policies generally, and in addition that the Panasia Estates, Inc. decision contained language that appeared to apply to all insurance contracts. The district court found that some portions of the proposed amended complaint were not timely and refused to accept them because of prejudice to the insurer, but the district court allowed the amended complaint insofar as it sought damages for consequential damages for extra-contractual living expenses. Because the insureds had initially sought damages for extra-contractual living expenses under a theory that was not governed by the Bi-Economy decision, they were now to be permitted to seek the same damages pursuant to Bi-Economy and Panasia Estates, Inc.

Counsel who practice in this area might also want to read the recent analysis of the Bi-Economy decision in the Harvard Law Review at 122 Harv. L. Rev. 998 (2009). That short review suggests that Bi-Economy should not be construed as a narrow decision limited to business interruption insurance or bad faith claims against insurers, but rather that the decision “should be understood as more broadly chipping away at the traditional contract law limitation on consequential damages.” The article asserts that Bi-Economy reflects a shift away from the “rigid” rule of Hadley v. Baxendale, 9 Exch 341, which restricts consequential damages to only those that were contemplated by the parties. Insurance counsel may want to consider if, as this article suggests, Bi-Economy represents a potential new mechanism to hold insurers accountable for their decisions when dealing with their insureds.

[Editor's Note: Readers with a subscription to lexis.com and the Matthew Bender Insurance Laws Library can quickly and accurately research the law relating to these decisions and consequential damages for breach of insurance policies in The Law of Liability Insurance, at 1-5 The Law of Liability Insurance § 5.05 and 2-5A The Law of Liability Insurance § 5A.26, and in Insurance Bad Faith Litigation at 1-7 Insurance Bad Faith Litigation § 7.03.]

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