Farris v. United States Fidelity & Guaranty Co. ( 1978 )

HOLMAN, J.

This is an action for damages claimed to have resulted from defendant’s denial of liability insurance coverage to its insureds. Defendant appeals from that part of the judgment for plaintifs entered on a jury verdict which awarded a recovery for emotional suffering and punitive damages. This case has previously been before this court, but no decision was there made which affects the issues presently in controversy. See Farris v. U. S. Fidelity and Guaranty, 273 Or 628, 542 P2d 1031 (1975).

Plaintiffs, who were partners in a sandwich shop, purchased from defendant a policy of general liability insurance for their business. They were subsequently sued by a business competitor which claimed that plaintiffs had harassed the competitor by engaging in unfair business practices. Plaintiffs tendered the defense of the case to defendant, which denied coverage. At the time of final rejection of coverage, defendant was aware that there was coverage but, nevertheless, chose to deny it. Its claims manager wrote: "* * * lets [sic] bluff it out we can always buy out at a later date.”

After rejection, plaintiffs defended the action themselves and settled the matter prior to trial for $327. In the present case plaintiffs were awarded $2,535 for costs of defense and settlement, $5,000 each for emotional distress, and $10,000 punitive damages. The appeal is from the award for emotional distress and punitive damages only.

The first assignment of error raises the issue whether damages for emotional suffering may be awarded in a case of this kind. Plaintiffs testified they were upset and worried over the financial implications of the cost of defense and the payment of any judgment that might be secured against them. There is no doubt that defendant was guilty of a clear breach of its contract. Plaintiffs contend that defendant is guilty of a tort as well as a breach of contract because it exercised "bad faith” in its decision to deny coverage and to refuse a defense. The generally accepted rule is that emotional distress caused by pecuniary loss resulting from breach of contract is not recoverable. The rule is embodied in Restatement of the Law of Contracts § 341:

"In actions for breach of contract, damages will not be given as compensation for mental suffering, except where the breach was wanton or reckless and caused bodily harm and where it was the wanton or reckless breach of a contract to render a performance of such a character that the defendant had reason to know when the contract was made that the breach would cause mental suffering for reasons other than mere pecuniary loss.” (Emphasis added.)

Accord, McCormick, Damages § 81 at 286 (1935); V Corbin, Contracts § 1076 at 429 (1964 ed); 11 Williston on Contracts § 13.41 at 215 (1968). On the other hand, if the facts justify an action of tort, courts are inclined to allow recovery for emotional distress as part of the damages flowing from a tort cause of action. It therefore becomes important (according to the usual doctrine) whether plaintiffs’ action for damages is one of contract or one of tort.

ORS 746.230, as part of the Insurance Code, enumerates unfair trade practices by insurance companies. It provides, in part:

"(1) No insurer or other person shall commit or perform any of the following unfair claim settlement practices:

«Hi * * * *

"(f) Not attempting, in good faith, to promptly and equitably settle claims in which liability has become reasonably clear.

«Hi Hs * Hi * ”

The above language does not make clear whether the legislature contemplates only claims filed against an insurance company by its insured, as in the case of collision, fire or theft insurance, or whether it also contemplates the settlement of claims filed against its insureds by third parties, as in the case of liability insurance. However, the statute demonstrates that both types of claims are contemplated, as evidenced by the provisions of subsection (2) of the same statute, which states:

"No insurer shall refuse, without just cause, to pay or settle claims arising under coverages provided by its policies with such frequency as to indicate a general business practice in this state, which general business practice is evidenced by:

‡ if: %

"(b) A substantial increase in the number of lawsuits filed against the insurer or its insureds by claimants; * * *

"* * * * * » (Emphasis added.)

The legislature has undertaken, by ORS 731.988, to provide civil penalties for violations of unfair trade practices:

"(1) Any person who violates any provision of the Insurance Code, any lawful rule or final order of the commissioner or any final judgment or decree made by any court upon application of the commissioner, shall forfeit and pay to the General Fund of the State Treasury a civil penalty in an amount determined by the commissioner of not more than $2,000 for each offense, or $10,000 in the aggregate for all such offenses within any three-month period. * * *.

* *

"(2) In addition to the civil penalty set forth in subsection (1) of this section, any person who violates any provision of the Insurance Code, any lawful rule or final order of the commissioner or any final judgment or decree made by any court upon application of the commissioner, may be required to forfeit and pay to the General Fund of the State Treasury a civilpenalty in an amount determined by the commissioner but not to exceed the amount by which such person profited in any transaction which violates any such provision, rule, order, judgment or decree.

"(3) Such civil penalty may be recovered in an action brought thereon in the name of the State of Oregon in any court of appropriate jurisdiction.

"* * * * *.”¹ (Emphasis added.)

It is possible to contend that defendant’s violation of the statute is a tort, and, therefore, plaintiffs are entitled to recovery for emotional distress as well as for their other damages. It is not our understanding that plaintiffs make this contention. It is evident from the statutes that it was the intention of the legislature to prohibit insurance companies from intentionally breaching their contract to settle their insureds’ claims as defendant did here and to inflict certain consequences for so doing. However, such conclusion does not dispose of the question whether damages for emotional suffering were intended to be recoverable by an insured for such a breach. Because the statutes did provide for the payment of damages not usually recoverable in such a situation, it would appear that had the legislature intended to enlarge the damages further, it would have so provided. It was certainly not intended by the legislature that additional pressure to perform the contract be exerted by allowing the recovery of damages for emotional distress, since the statute provides for civil damages recoverable by the state for that purpose. There is nothing to indicate that the legislature intended, when it prohibited certain claims settlement practices in ORS 746.230, that actions for breach of insurance contracts would be transformed, in all of the covered instances, into tort actions with a resulting change in the measure of damages. The statutes express no public policy which would promote damages for emotional distress. Concern about the insured’s peace of mind does not appear to be the gravamen of the statutory policy.

Plaintiffs do contend, however, that the common law of the construction of insurance contracts dictates that defendant was guilty of the kind of "bad faith” conduct which gives rise to tort liability and that damages for emotional distress are, therefore, recoverable along with plaintiffs’ other damages.

The terms "good faith” and "bad faith” have been used by this court and other courts in connection with the duty of an insurer to settle cases within the policy limits when the prayer of the complaint against the insured is greater than the policy limits. It has been pointed out that in such situations conflicts of interest exist when there is a probability that any judgment returned against the insured will be greater than the policy limits. In such cases, the insurer has everything to gain and the insured has everything to lose by gambling on the possibility of a defendant’s verdict. In such situations, because of the conflicts of interest, courts have held the insurer to a duty of "good faith” in investigating the facts and in attempting to settle within the policy limits. The exercise of good faith requires the insurance company to treat the matter as if there were no policy limits and as if any loss would be the sole responsibility of the insurer. Eastham v. Oregon Auto Ins. Co., 273 Or 600, 607, 540 P2d 364 (1975); Kuzmanich v. United Fire and Casualty, 242 Or 529, 532, 410 P2d 812 (1966); Radcliffe v. Franklin Nat. Ins. Co., 208 Or 1, 38, 298 P2d 1002 (1956). Plaintiffs use the language of these cases in asserting their right to damages, including those for emotional distress, arising out of a tort action for failure to exercise good faith in denying coverage.

This court has never decided whether a cause of action for failure to settle within the policy limits is one in contract or one in tort. Radcliffe quotes language which sounds as if it were in tort. See 208 Or at 39. However, in Groce v. Fidelity General Insurance, 252 Or 296, 306, 448 P2d 554 (1969), it is held that as a cause of action in contract, it is assignable by the insured.

Assuming, but not deciding, that a cause of action for failure to settle within the policy limits is one in tort, it is our opinion that the rationale of such an action has no application to the present situation and that the present action is not one in tort. In an action for failure to settle within the policy limits, the insurance company is charged with acting in a fiduciary capacity as an attorney in fact representing the insured’s interest in litigation. The company’s interest comes into conflict with that of the insured’s while representing him; and, arguably, acting in its own interests to the detriment of the insured’s interest while acting in such a fiduciary capacity is a tort. In the present case, defendant did not undertake this fiduciary duty to represent the insured’s interest in the litigation — it refused it. It did not, in the course of representing plaintiffs, violate its fiduciary duty arising out of sole control of the settlement. It never undertook any fiduciary duty by purporting to act in the interests of the insured.²

The distinction set forth above was noted in Santilli v. State Farm, 278 Or 53, 60-63, 562 P2d 965 (1977). It was, however, unnecessary to rule upon the question here posed because we held that the insurance company had just cause for contesting coverage. In Santilli we said:

"Plaintiff also contends that the trial court erred in sustaining defendant’s demurrer to plaintiff’s second cause of action. Plaintiff’s second cause of action alleged that:

"'II.

" The defendant’s refusal to pay the proceeds due plaintiff under the life insurance policy issued to the insured was made in bad faith, was made intentionally, willfully and wantonly without a reasonable investigation by defendant of the facts involved in the claim, and was a willful denial of the plaintiff’s rights under the insurance contract.

" 'III

" 'As a result of defendant’s conduct, the plaintiff has suffered mental distress and anguish to her general damage in the amount of ONE THOUSAND DOLLARS ($1,000.00), and plaintiff is entitled to punitive damages in the sum of TWENTY-FIVE THOUSAND DOLLARS ($25,000.00). * * *.’

"Plaintiff seeks to have this court recognize a cause of action for tortious breach of an insurer’s duty of 'good faith and fair dealing’ when dealing with its insured. This is a distinct tort which has recently emerged in California and has subsequently found favor in some other jurisdictions. See Silberg v. California Life Ins. Co., 11 Cal 3d 452, 113 Cal Rptr 711, 521 P2d 1103 (1974); Gruenberg v. Aetna Insurance Co., 9 Cal 3d 566, 108 Cal Rptr 480, 510 P2d 1032 (1973); Fletcher v. Western National Life Ins., 10 Cal App 3d 376, 89 Cal Rptr 78, 47 ALR3d 286 (1970).

"This tort developed as an outgrowth of the cause of action for an insurer’s bad faith refusal to settle within the coverage limits of a liability insurance policy. See, e.g., Groce v. Fidelity General Insurance, 252 Or 296, 448 P2d 554 (1969); Radcliffe v. Franklin Nat’l Ins. Co., 208 Or 1, 298 P2d 1002 (1956). However, although the two situations are somewhat similar, there is a distinct difference between liability insurance and other types of policies which should not be overlooked.

"When an insured purchases liability insurance, he relinquishes his right to control any litigation brought against him for conduct which is covered under the policy, and he loses his right to negotiate a settlement with the opposing party. Moreover, when the settlement value of a case approaches the policy limits, it becomes increasingly more tempting for the insurer to gamble on the results of litigation, for in refusing to settle under such circumstances, the insurer stands to lose little and gain much. The insured, however, has a strong interest in settlement so as to avoid a judgment in excess of his coverage. Because of this conflict, courts have held insurers to a high duty of good faith and fair dealing when conducting settlement negotiations on behalf of their insured.

"Such considerations are not applicable outside the field of liability insurance. In cases involving the insurer’s duty to pay under policies for theft, fire, health, disability or life insurance, the unique relationship which gives rise to the special duty of liability insurers to attempt to settle within their policy limits does not arise. The insured, or his beneficiary, is not subject to the imposition of excess liability, and his rights and responsibilities are limited to those set forth in his contract.” (Footnotes omitted.) 278 Or at 60-62.

While Santilli was an action upon a life insurance policy and the present action is upon a liability policy, the present action does not involve a failure to settle within the policy limits and the rationale expressed in Santilli is equally applicable. In a footnote to the above quotation we pointed out that some insurance companies have, at times, sought to settle with their insureds for significantly less than that to which they were entitled through deliberate patterns of harassment and delay. This is a case of neither harassment nor delay; it is a plain case of intentional breach of contract. The cases upon which plaintiffs rely and which are cited in the footnote in Santilli are primarily California cases. Some of them are cases like Fletcher v. Western National Life Ins. Co., 10 Cal App 3d 376, 89 Cal Rptr 78, 47 ALR3d 286 (1970), in which the insurance company originally acknowledged responsibility under an accident policy and began to pay. It thereafter started an intentional program of harassment for the purpose of getting its insured in such an upset and emotional state of mind that he would readily settle the company’s remaining liability. It is a typical case of outrageous conduct. However, some of the other cases, while dissimilar in some respects, are sufficiently similar to this case that they are not able to be distinguished. Silberg v. California Life Insurance Co., 11 Cal3d 452, 113 Cal Rptr 711, 521 P2d 1103 (1974); Gruenberg v. Aetna Insurance Company, 9 Cal3d 566, 108 Cal Rptr 480, 510 P2d 1032 (1973). The California courts have not, however, made the distinction pointed out here or in Santilli but have, without recognition that it was the fiduciary position of the insurer which arises when it represents the insured in litigation which gives rise to the good faith language, transposed the language into cases in which insurance companies have not undertaken representation of the insured at all. As a result, they have held an action in tort can lie for the breach of contract. In Gruenberg, supra, the California Supreme Court said:

<<* * * jn those two cases, we considered the duty of the insurer to act in good faith and fairly in handling the claims of third persons against the insured, described as a 'duty to accept reasonable settlements’; in the case before us we consider the duty of an insurer to act in good faith and fairly in handling the claim of an insured, namely a duty not to withhold unreasonably payments due under a policy. These are merely two different aspects of the same duty. That responsibility is not the requirement mandated by the terms of the policy itself— to defend, settle, or pay. It is the obligation, deemed to be imposed by the law, under which the insurer must act fairly and in good faith in discharging its contractual responsibilities. Where in so doing, it fails to deal fairly and in good faith with its insured by refusing, without proper cause, to compensate its insured for a loss covered by the policy, such conduct may give rise to a cause of action in tort for breach of an implied covenant of good faith and fair dealing.” 510 P2d at 1037.

The California court also said:

"It is manifest that a common legal principle underlies all of the foregoing decisions; namely, that in every insurance contract there is an implied covenant of good faith and fair dealing. The duty to so act is imminent in the contract whether the company is attending to the claims of third persons against the insured or the claims of the insured itself. Accordingly, when the insurer unreasonably and in bad faith withholds payment of the claim of its insured, it is subject to liability in tort.” 510 P2d at 1038.

Contrary to the California holdings, for the reasons given in Santilli, we believe defendant’s failure to undertake representation of plaintiffs which required them to represent themselves could only have been a breach of contract, and, in cases of breach, the law is clear that no recovery for mental distress because of threat of pecuniary loss is recoverable.³

Plaintiffs argue that one who enters into a contract of insurance does so to guarantee himself peace of mind in case an action or claim is made against him and, therefore, he should receive reimbursement for that for which he has bargained and not received. They cite language which so states from Fletcher and Crisci v. Security Ins. Co., 66 Cal2d 425, 58 Cal Rptr 13, 426 P2d 173 (1967). The argument does not furnish a logical basis for recovery for emotional distress because many contracts for services, materials or financial assistance, as well as insurance contracts, are similarly made for economic and financial peace of mind. Every manufacturer who contracts in advance for materials which are necessary ingredients for his manufactured article does so for the same reason. Many contracts are made for the purpose of financial protection and assurance. If such a contractual purpose is all that is necessary to entitle one to a recovery for emotional distress resulting from breach of contract, the universal rule above set forth in the excerpt from Restatement of the Law of Contracts would not exist.

Plaintiffs also contend, in effect, that the rule that a party who breaches a contract must pay only normal contract damages should not be applicable because the insurance business is tinged with a public interest similar to that of a public utility, and public policy dictates that full responsibility for the results of failure to perform should be imposed without respect to the rules applicable to other contracting parties. Plaintiffs point out no reasons why such public interest should change the measure of damages which has resulted in the rule against recovery for mental distress brought about by an intentional breach of a contract. Any idea of punishment or warning to others is within the province of punitive damages and has no place in consideration of the propriety of a recovery for emotional distress.

This brings us to defendant’s other assignment of error, which is that the court should not have submitted the issue of punitive damages to the jury. The general rule is that there is no recovery of punitive damages for breach of contract. McCormick, Damages § 81 at 286 (1935) says:

"For any kind of malicious or wanton and oppressive misconduct, actionable as a tort, exemplary damages may be given. Oppressive conduct by carriers and other public service enterprises is a frequent occasion for giving such damages. In actions, however, upon mere private contracts (except the action for breach of promise of marriage), even where the breach is malicious and unjustified, exemplary damages are not allowable.” (Emphasis added.)

More specifically, McCormick says:

"This enumeration of the classes of cases where punitive damages are recoverable has left untouched one important question, May such damages be recovered in actions for breach of contract? We have seen two types of situations where contracts often enter into the transaction upon which the cause of action is based, and where punitive damages are undoubtedly proper, first, the case where one by fraudulent representations has caused another to enter into a contract of purchase and to part with value; second, where one has entered into a contract with a carrier or other public servant and the latter has wantonly breached its duty of service imposed by law. In the former case, the person defrauded may frequently have his choice between suing upon the purely tort basis of an action for fraud and deceit, or he may often sue in contract for breach of warranty, express or implied. If the former theory is chosen, exemplary damages may properly be claimed as in other tort cases where wrong motive is proven, and the fact that a contract was brought about by defendant’s wrong is no reason for denying the usual punitive consequences for deliberate wrong.

"Similarly, as we have seen, the carrier or other public service enterprise who deliberately or wantonly breaches his public undertaking by refusing properly to serve a passenger, shipper, or patron is liable in tort for breach of the public undertaking, and exemplary damages may undoubtedly be assessed in such actions, notwithstanding the fact that the plaintiff could have elected to base his claim upon his contract with the defendant rather than upon the latter’s public duty.” (Footnotes omitted.) McCormick, Damages § 81 at 289-90 (1935).

It is within the province of legislative authority to decide whether an enterprise is of a public service character and the responsibilities and obligations attendant. The legislature recognized the public interest in the enforcement of insurance contracts and undertook to do something about it by enacting ORS 746.230 and 731.988 as part of the Insurance Code. In the absence of any common law civil penalties having been recognized for the conduct in question here, the legislature provided for penalties. In doing so, it did not provide for punitive damages. We, therefore, conclude that because it was writing on a clean slate, the legislature did not intend that punitive damages result because of the public service character of the relationship. It would, therefore, be inappropriate for this court to use further civil penalties for the accomplishments of the same purpose. In the case of Roshak v. Leathers, 277 Or 207, 560 P2d 275 (1977), a majority of this court held that the existence of criminal sanctions is insufficient to prevent the imposition of punitive damages in civil proceedings for the same conduct. However, it was decided that by the enactment of ORS 161.045(3) the legislature demonstrated that it did not intend criminal sanctions to exclude the imposition of civil sanctions by way of punitive damages. The same conclusion cannot be reached here because the penalties provided by ORS 731.988 are specifically made "civil” penalties, thus demonstrating an intention to provide for the exclusive civil penalties to be imposed for the kind of conduct by an insurance company of which defendant was guilty in this instance.

That portion of the judgment for mental distress and punitive damages is reversed.

"ORS 731.004 Short title. ORS chapters 731, 732, 733, 734, 735, 737, 743, 744, 746, 748, 750 and 751 may be cited as the Insurance Code.”

2 The dissenting opinion states that "[s]ince there is no citation of authority for injecting the term 'fiduciary’ into the majority’s analysis, I assume it to be 'cut from the whole cloth.’ ” The dissent then cites three cases which it says stand for the proposition that the insurer is held to the duty imposed upon a "fiduciary” because of the right to control. Two of the cases are those of failure to settle within the policy limits in a situation in which the insurer has undertaken to exercise its contractual right to defend. In all three cases, the insurer was held to the duty of a "fiduciary.” It is, therefore, difficult to see how the dissent arrives at the conclusion that "injecting the term 'fiduciary’ into the majority’s analysis” is " 'cut from the whole cloth.’ ” The classification of an insurer as a "fiduciary” when deciding whether it should settle within the policy limits is so prevalent as not to require citation of authority.

The cases as mentioned above are cited for the proposition that the fiduciary duty comes from the right to control rather than from the exercise of that control. In one of the cases, Gedeon v. State Farm Mutual Automobile Ins. Co., 410 Pa 55, 188 A2d 320, 322 (1963), the court points out that under the typical automobile policy the insurer contracts to perform three distinct obligations. The first is to indemnify against liability for damage caused by the insured to person and property. The opinion then proceeds to point out that the second duty is to defend, and says:

"* * * A refusal without good cause to defend breaches this obligation and gives rise to a cause of action regardless of the good faith of the insurer. See King v. Automobile Underwriters, Inc. [409 Pa 608], 187 A2d 584 (1962). Based on the usual contract rule for determining damages, the recovery for breach of the covenant to defend will ordinarily be the cost of hiring substitute counsel and other costs of the defense. This recovery may be in addition to any other obtained against the insurer.

"Thirdly, by asserting in the policy the right to handle all claims against the insured, including the right to make a binding settlement, the insurer assumes a fiduciary position towards the insured and becomes obligated to act in good faith and with due care in representing the interests of the insured. If the insurer is derelict in this duty, as where it negligently investigates the claim or unreasonably refuses an offer of settlement, it may be liable regardless of the limits of the policy for the entire amount of the judgment secured against the insured. See Cowden v. Aetna Casualty and Surety Company, 389 Pa 459, 134 A2d 223 (1957). Once again there can be a breach of this fiduciary duty without a breach of either the covenant to indemnify or the covenant to defend.” (Emphasis added.)

In one of the other cases, Cowden v. Aetna Casualty and Surety Company, 389 Pa 459, 134 A2d 223, 228 (1957), the court said, quoting Perkoski v. Wilson, 371 Pa 553, 556, 92 A2d 189, 191:

"* * *' When the company voluntarily undertook the defense of [the insured] in pursuance of its privilege under the policy, it assumed a position of trust and confidence which called for an exercise of the utmost good faith, particularly in view of the possible conflict of interest between the insurer and the insured such as later developed.’ * * (Emphasis added.)

Far from standing for the proposition that the fiduciary relationship arises from the right to control, if the cases indicate anything it is that, to the contrary, it arises from the exercise of the defense provided for under the policy and thus from entering upon a fiduciary relationship. To be fair, none of the cases should be cited for either proposition. The courts did not have before them the question which is in issue in the present case and the language, in any event, is equivocal.

3 It may logically be asked what difference it makes whether the action is considered one of contract or of tort. In a case like the present where plaintiffs received no injury or fright resulting in serious physical manifestations, why should it be of moment, when considering whether to allow recovery for the emotional distress, whether a plaintiffs concern about his financial plight arose out of a breach of contract or of a breach of contract which is also a tort? In reality, there probably isn’t any reason for a distinction. Either people should be able to recover for their fear of financial disaster as the result of the other party’s intentional breach of a contract or they should not. Calling an intentional breach of contract a tort has no magical consequences which change anything. Neither is there anything inherent in a contract of insurance which makes the suffering any greater, any less, or any more certain than in numerous other business contracts which are generally breached intentionally and for which no recovery for emotional distress is allowed.