Kransco v. American Empire Surplus Lines Ins. Co.

Decision Date07 May 1997
Docket NumberNo. A070954,A070954
Citation63 Cal.Rptr.2d 532,54 Cal.App.4th 1171
CourtCalifornia Court of Appeals Court of Appeals
PartiesPreviously published at 54 Cal.App.4th 1171 54 Cal.App.4th 1171, 97 Cal. Daily Op. Serv. 3393, 97 Daily Journal D.A.R. 5875 KRANSCO, Plaintiff and Appellant, International Insurance Company et al., Plaintiffs and Respondents, v. AMERICAN EMPIRE SURPLUS LINES INSURANCE COMPANY, Defendant and Appellant.

James F. Thacher, Arthur R. Albrecht, Frank E. Solomon, Thacher, Albrecht & Ratcliff, Stuart Parsons, Kevin P. Crooks, Katherine H. Grebe, Quarles & Brady, for Plaintiff and Appellant Kransco.

Jeffrey T. Bolson, Engstrom, Lipscomb & Lack, for Plaintiffs and Respondents International Ins. Co. and Transco Syndicate No. 1.

Dolores M. Donohoe, Gibbons, Lees & Conley, for Plaintiff and Respondent Agricultural Excess and Surplus Ins. Co.

Bertrand LeBlanc II, Donald T. Ramsey, David M. Rice, Rosemary Springer, Carroll, Burdick & McDonough, J. Ric Gass, Janice A. Rhodes, Kravit, Gass & Weber, for Defendant and Appellant American Empire Surplus Lines Ins. Co.

STRANKMAN, Presiding Justice.

A liability insurer breached its duty of good faith and fair dealing owed its insured manufacturer by unreasonably failing to settle an injured party's action against the insured within policy limits and exposing the insured to a verdict awarding the injured party compensatory and punitive damages far in excess of policy limits. The insurer does not deny its bad faith but argues that the insured's comparative bad faith and comparative negligence as a litigant in the underlying action should reduce its liability.

The trial court initially accepted this argument and asked the jury to determine if the insured itself breached its duty of good faith and fair dealing or failed to exercise ordinary care in handling the underlying action. The jury found that the insured's conduct did contribute to the amount of the excess verdict and set the insured's fault at 90 percent. The trial court later decided that it erred in instructing the jury and entered judgment notwithstanding the verdict in favor of the insured for the full amount of the insured's damages, without reduction for the insured's fault as allocated by the jury. (Code Civ. Proc., § 629.)

The insurer appeals, seeking reinstatement of the allocation of fault and exclusion of certain items of damages. On damages, the insurer principally asserts that the punitive damages component of the underlying judgment is not recoverable because public policy prohibits indemnification of punitive damages, and that a stipulated judgment founded on an excess verdict is not a proper measure of the insured's damages. The insured also appeals, contending that the trial court erred in dismissing its punitive damages claim on a pretrial motion for summary adjudication. We affirm the judgment in its entirety.


In June 1987, 35-year-old Michael Hubert jumped head-first onto his Wisconsin neighbor's backyard water slide toy and broke his neck, instantly rendering him a quadriplegic. Hubert brought suit in Wisconsin against the California manufacturer of the Slip 'N Slide toy, Kransco. Kransco was defended by its Ohio insurer, American Empire Surplus Lines Insurance Company (AES), which had agreed to defend Kransco against bodily injury suits in any state and indemnify it for all sums which Kransco became legally obligated to pay as damages up to $1 million, $900,000 over and above Kransco's $100,000 self-insured retention.

Kransco also had three successive layers of excess insurance above its AES primary insurance coverage: International Insurance Company (International) $2 million limit, excess of $1 million; Agricultural Excess and Surplus Insurance Company (Agricultural) $1 million limit, excess of $3 million; and Transco Syndicate No. 1 Ltd. (Transco) $1 million limit, excess of $4 million. In total, Kransco was insured for $5 million.

Hubert's injury suit against Kransco was tried to a jury in April 1991 and AES provided the defense. Hubert offered to settle his suit against Kransco for $750,000 during the trial, almost a million dollars less than his pretrial demand. AES rejected the offer and unsuccessfully tried to settle the case for $450,000. The jury returned a verdict against Kransco at over $12.3 million: roughly $2.3 million in compensatory damages and $10 million in punitive damages.

Kransco settled with Hubert while post-verdict motions to reduce the award were pending in June 1991. Kransco paid Hubert $7.5 million and agreed to prosecute this bad faith action against AES and to split equally with Hubert any net proceeds from the insurance litigation (after deduction of litigation expenses and reimbursement of the subrogated excess insurers' cash settlement payments). At Hubert's insistence, Kransco stipulated to entry of judgment against it in the full amount of the jury verdict plus interest, roughly $12.5 million total, but Hubert agreed not to execute on the judgment. AES acquiesced to the settlement and contributed its policy limits of $900,000, but objected to the settlement as unreasonable because, AES believed, the verdict was likely to have been judicially reduced or reversed. The excess insurers International and Agricultural contributed their policy limits of $2 million and $1 million, respectively, and Transco contributed $500,000, half its policy limits. Kransco paid the remaining $3.1 million cash settlement amount from its own funds.

Kransco initiated this bad faith insurance litigation in January 1992, alleging that AES breached the covenant of good faith and fair dealing by failing to accept Hubert's offer to settle his claim within AES policy limits despite a substantial risk of a verdict greatly in excess of those limits. Kransco sought recovery of the full amount of the $12.5 million Hubert judgment and millions in punitive damages, but the trial court dismissed the punitive damages claim in a September 1993 summary adjudication. Kransco also claimed that damages were incurred after the Hubert settlement when an unrelated injury action cost over $2 million in settlement and defense which was paid by Kransco and its excess insurer Transco because otherwise available insurance coverage had been exhausted by the Hubert claim mishandled by AES. The three excess insurers were aligned as plaintiffs with Kransco.

The action was tried over five weeks in early 1995. Upon evidence not challenged on appeal, the jury returned a special verdict finding that AES breached its duty of good faith and fair dealing toward Kransco in its handling of Hubert's injury claim. The jury also concluded that the post-verdict settlement with Hubert was not unreasonable. Compensatory damages were assessed at over $14 million, in apparent acceptance of Kransco's argument that it was entitled to recover damages for the $12.5 million Hubert judgment and the defense and settlement costs incurred in the unrelated injury action following the Hubert settlement.

However, the jury also found that Kransco itself had breached its duty of good faith and fair dealing or failed to exercise ordinary care in its handling of Hubert's claim before the verdict, and attributed fault for the Hubert verdict at 90 percent to Kransco and only 10 percent to AES. The jury's special verdict apportioning fault was founded on AES requested instructions directing the jury to consider Kransco's comparative bad faith (anything done by Kransco that injured AES's rights to receive the benefit of its bargain) and comparative negligence (any failure by Kransco to exercise ordinary care in the preparation and trial of the Hubert case). According to AES, Kransco is itself largely to blame for the Hubert verdict because it angered the jury by initially disclaiming knowledge of prior Slip 'N Slide accidents during pretrial discovery in the Wisconsin action.

The trial court reconsidered its acceptance of AES's theory of comparative fault upon Kransco's motion for judgment notwithstanding the verdict (JNOV). (Code Civ. Proc., § 629.) The court found comparative negligence wholly inapplicable to the case and concluded that consideration of comparative bad faith should have been limited to whether Kransco contributed to AES's failure to settle by impairing its assessment of the likelihood of an excess judgment. Under that circumscribed standard, the trial court ruled Kransco entitled to JNOV because there was insufficient evidence of any conduct by Kransco that impaired AES's assessment of the Hubert case. In May 1995, judgment was entered in favor of Kransco for the full amount of damages as calculated by the jury, plus prejudgment interest and costs.

AES appeals, seeking reinstatement of the jury verdict on fault allocation and exclusion of certain items of damages. Kransco also appeals, seeking reversal of the trial court's summary adjudication order dismissing Kransco's punitive damages claim. The excess insurers oppose AES's appeal but have not joined in Kransco's appeal.

A. Insurance Bad Faith and Comparative Fault.
1. AES Breached the Covenant of Good Faith and Fair Dealing by Unreasonably Failing to Settle the Underlying Action.

California has long recognized that "[t]here is an implied covenant of good faith and fair dealing in every contract that neither party will do anything which will injure the right of the other to receive the benefits of the agreement." (Comunale v. Traders & General Ins. Co. (1958) 50 Cal.2d 654, 658, 328 P.2d 198.) This principle applies to insurance policies which are, after all, contracts. (Ibid.) In most contexts, breach of the covenant is compensated with contract remedies alone since the covenant is a contract term. (Foley v. Interactive Data Corp. (1988) 47 Cal.3d 654, 684, 254 Cal.Rptr. 211, 765 P.2d 373.) But an insurer's breach of the covenant in insurance policies is also compensable with broader tort remedies to...

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