WV Realty Inc v. Northern Ins Co NY

Opinions of the United
2003 Decisions States Court of Appeals
for the Third Circuit
6-27-2003
WV Realty Inc v. Northern Ins Co NY
Precedential or Non-Precedential: Precedential
Docket No. 02-2910
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PRECEDENTIAL
Filed June 27, 2003
UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 02-2910
W.V. REALTY INC.;
NEW MONTAGE MANOR, INC.
v.
NORTHERN INSURANCE COMPANY
OF NEW YORK,
Appellant
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE MIDDLE DISTRICT OF PENNSYLVANIA
D.C. Civil No. 00-cv-00525
District Judge: The Honorable A. Richard Caputo
Argued April 10, 2003
Before: BARRY, ROSENN, Circuit Judges and
POLLAK,* District Judge
(Opinion Filed: June 27, 2003)
* The Honorable Louis H. Pollak, Senior District Judge, United States
Court for the Eastern District of Pennsylvania, sitting by designation.
2
Ignatius J. Melito, Esq. (Argued)
Melito & Adolfsen
233 Broadway, 28th Floor
New York, NY 10279
-AND-
William J. Schmidt, Esq.
White & Williams
One Liberty Place, Suite 1800
Philadelphia, PA 19103
Attorneys for Appellant
Michael R. Mey, Esq. (Argued)
Wormuth, Mey & Sulla
318 Penn Avenue
Scranton, PA 18503
-AND-
Jill H. Miller, Esq.
220 Penn Avenue, Suite 301
Scranton, PA 18503
Attorneys for Appellees
OPINION OF THE COURT
BARRY, Circuit Judge:
INTRODUCTION
The roof over a banquet hall collapsed under the weight
of accumulated snow and the insurer was called upon to
pay both building damages and business interruption
losses under the policy. The building damage claim was
resolved fairly expeditiously, but for a variety of reasons —
some good and some bad — attempts to resolve the
business interruption claim dragged on with the insurer’s
conduct with reference to that claim emanating in a
complaint alleging bad faith, pursuant to 42 Pa. Cons. Stat.
§ 8371.
This appeal follows a trial in which the jury found that
the defendant, Northern Insurance Company of New York
(“Northern”), had acted in bad faith and awarded punitive
3
damages. We will remand for a new trial due, first, to the
admission at trial of a discovery violation committed by
Northern which was not probative of its bad faith in
resolving the plaintiffs’ business interruption claim, but
which was unfairly prejudicial in the manner in which it
was presented and because that presentation involved other
bad faith cases against Northern. The admission at trial of
allegations contained in a third-party complaint brought by
Northern against the contractor who built the banquet hall
provides an additional ground for reversal. This evidence
was highly prejudicial, in part because, in closing
argument, plaintiffs’ counsel characterized the allegations
as “fraud upon the Court.” We also find, however, that the
record contains sufficient admissible evidence supporting a
finding of bad faith on the part of Northern; hence, its
motion for judgment as a matter of law was properly denied.1
I.
Plaintiff W.V. Realty, Inc. owned the building at issue in
this case — a 46-room motel, a restaurant and a banquet
facility, located in Moosic, Pennsylvania. Plaintiff New
Montage Manor, Inc. ran the motel, restaurant and catering
business. Northern issued an insurance policy to plaintiffs
which provided coverage for building and property damage
up to $1,360,000 and coverage for business interruption
losses up to $650,000.
In January of 1996, after the roof over the banquet hall
portion of the building collapsed, plaintiffs submitted
claims for both damage to the building and business
interruption losses. The business interruption portion of
the policy covered plaintiffs for (1) net income (net profit or
loss before income taxes) that would have been earned or
incurred were it not for the necessary suspension of
1. Northern’s argument that plaintiffs were not entitled to a jury trial is
rejected without further discussion. See Klinger v. State Farm Mut. Auto.
Ins. Co., 115 F.3d 230, 236 (3d Cir. 1997)(“[T]he punitive damages
remedy in a statutory bad faith action under § 8371 triggers the Seventh
Amendment jury trial right[.]”). Section 8371 does not, however, provide
for the right to a jury trial in state court. Mishoe v. Erie Ins. Co., Nos. 87
& 88 MAP 2001, 2003 WL 21255990, at *7 (Pa. May 30, 2003).
4
operations as a result of the roof collapse, and for (2)
continuing normal operating expenses incurred, including
payroll. These items were covered from the date of loss
through what the policy called the “period of restoration,”
that is, the amount of time that it would reasonably take to
repair the property damage.
Northern determined that the restoration period in this
case was six months.2 Plaintiffs contested Northern’s
determination on two grounds. First, plaintiffs believed that
the period of restoration should be longer given the nature
of the event business. A two-year period, in their view,
would account for the fact that all of the events which had
been scheduled for 1996 and 1997 were cancelled in the
wake of the roof collapse. Even if the banquet hall were
rebuilt by the beginning of 1997 and plaintiffs could begin
to again make reservations, they would not be able to
recover their lost sales because weddings and other events
are booked an average of fourteen months in advance. In
the alternative, plaintiffs argued that they should be
reimbursed for events which were cancelled during the six-
month period of restoration, but which were to occur
outside of it, as well as for events that they were not able
to book during that period because there was no facility
available to show prospective customers.
Soon after the roof collapse, plaintiffs began complaining
to Northern about the financial problems that they were
experiencing. On January 31, 1996, John J. Weichec, the
Northern adjuster assigned to the case, noted in his claim
file that plaintiffs were having cash flow problems because
they had to re-book several weddings at other facilities and
because they were not receiving new deposits. Weichec also
noted that if plaintiffs forwarded documentation pertaining
to the returned deposits for his review and verification, he
would arrange for an advance. Between February and June,
Northern advanced $25,358.31 to plaintiffs to reimburse
them for the returned deposits and other expenses.
2. This six-month “period of restoration” was arrived at by adding the
three months which Northern’s expert determined would be a reasonable
amount of time within which to rebuild the catering hall to the two
months which Northern chose to allot for adjustment and review of the
claim, to an additional thirty days provided for in the policy.
5
On April 3, 1996, plaintiffs wrote to Northern and
explained that their bank would not make a decision
regarding whether to rebuild until it knew the amount of
money plaintiffs would receive for their business
interruption losses. Weichec called Northern’s accountants
to encourage them to finish their evaluation of the claim as
soon as possible. The accountants did so a month later,
concluding that based on a six-month restoration period
and without adopting plaintiffs’ argument that they should
be reimbursed for losses attributable to the six-month
period but falling outside of it, plaintiffs were entitled to
$49,494.88 for their business interruption losses. On May
16, 1996, Weichec wrote to plaintiffs explaining that the
accountant’s report was finished but that he was not
forwarding it to them because plaintiffs had informed him
that they had new information regarding their continuing
expenses.
At the heart of plaintiffs bad faith case is the fact that
Weichec did not immediately provide them with the
undisputed portion of their claim, i.e. the $49,494.88 less
what had already been advanced to them, as soon as the
accountants were finished.3 Northern was admittedly aware
that plaintiffs were experiencing financial difficulties. They
were unable to make the pre-payment required to obtain an
independent estimate of their building loss, their bills
included shut-off notices from some of their utility
companies, and their bank was threatening to foreclose on
their mortgage which, we note, it did in August 1996.
On August 29, 1996, Northern’s accountants, in an
updated report, concluded that plaintiffs were entitled to
$65,322.70 for their business interruption losses over the
relevant six-month period. In the Fall of 1996, Northern
issued two checks for the outstanding balance of
$39,964.39. In January of 1998, plaintiffs submitted an
expert’s report assessing their losses for 1996 and 1997 in
the amount of $695,000.
3. A neutral umpire eventually determined that the $25,358.31 that
Northern advanced to plaintiffs was not, in fact, an element of plaintiffs’
business interruption losses because they constituted extra, as opposed
to continual, expenses under the policy.
6
Because the parties were unable to agree on an
adjustment of plaintiffs’ loss, the appraisal process provided
for in the policy was initiated. Each side selected an
appraiser and the Court of Common Pleas appointed a
neutral umpire, with the direction that “[t]he umpire and
appraisers are directed to proceed with determining the
amount of the Plaintiff ’s losses and claims, in accordance
with the terms and conditions of the insurance policy
issued by the Defendant.” On December 6, 1999, an award
was issued by the neutral umpire, joined by the appraiser
selected by plaintiffs, in which plaintiffs’ losses were
itemized as follows:
Business interruption: $695,706.39
Subject to policy limit of: $650,000.00
Extra expenses for returned deposits: $25,358.31
Building and personal property: $549,840.00
Debris removal: $16,200.00
TOTAL: $1,241,398.30.
The umpire also awarded interest from October 6, 1996 (30
days after the date all necessary information was submitted
to Northern to evaluate the loss) until the date the loss was
paid. On appeal, the Court of Common Pleas affirmed in
part and reversed in part, finding that interest was only
warranted on the amount owed thirty days after the award
was issued. The Superior Court affirmed the Court of
Common Pleas.
In February of 2000, plaintiffs sued Northern for bad
faith in the Court of Common Pleas; the case was
subsequently removed to federal court. The District Court
granted Northern’s motion for summary judgment on
plaintiffs’ bad faith claim with regard to Northern’s payout
on the building damage claim. Thus, the sole issue left for
trial was whether Northern acted in bad faith with regard to
the business interruption claim.
On August 31, 2001, shortly before trial and admittedly
because it would look better for Northern at trial, Northern
finally paid plaintiffs what was owed them under the award.
The jury awarded plaintiffs $650,000 in punitive damages.
After trial, the District Court denied Northern’s motion for
judgment as a matter of law, finding that plaintiffs
7
produced evidence upon which a jury could properly find
that Northern acted in bad faith. The Court also denied
Northern’s motion for a new trial based on, among other
things, plaintiffs’ use at trial of a list of other bad faith
claims and of Northern’s pleading in a subrogation action,
and, in the alternative, for remittitur or a new trial on
damages. The District Court awarded plaintiffs attorneys’
fees totaling $248,260, costs in the amount of $36,424.88,
and interest of $554,946.43. This appeal followed.
II.
We review the District Court’s decision denying a motion
for judgment as a matter of law de novo, and apply the
same standard that the District Court did, namely whether,
viewing the evidence in the light most favorable to the non-
movant and giving it the advantage of every fair and
reasonable inference, there is insufficient evidence from
which a jury reasonably could find liability. Lightning Lube,
Inc. v. Witco Corp., 4 F.3d 1153, 1166 (3d Cir. 1993). The
District Court’s decision to deny Northern’s motion for a
new trial is reviewed for abuse of discretion. See Wilburn v.
Maritrans GP Inc., 139 F.3d 350, 363 (3d Cir. 1998).
Pennsylvania’s bad faith statute provides as follows:
“In an action arising under an insurance policy, if
the court finds that the insurer has acted in bad faith
toward the insured, the court may take all of the
following actions: (1) Award interest on the amount of
the claim from the date the claim was made by the
insured in an amount equal to the prime rate of
interest plus 3%. (2) Award punitive damages against
the insurer. (3) Assess court costs and attorney fees
against the insurer.”
42 Pa.C.S. § 8371. The term “bad faith” is not defined in the
statute, but the Pennsylvania Superior Court has defined it
as “ ‘any frivolous or unfounded refusal to pay proceeds of
a policy.’ ” Terletsky v. Prudential Prop. and Cas. Ins. Co.,
649 A.2d 680, 688 (Pa. Super. 1994) (quoting Black’s Law
Dictionary 139 (6th ed. 1990)). To make out a claim of bad
faith, a plaintiff must show by clear and convincing
evidence that the insurer (1) did not have a reasonable
8
basis for denying benefits under the policy; and (2) knew or
recklessly disregarded its lack of reasonable basis in
denying the claim. Keefe v. Prudential Prop. and Cas. Ins.
Co., 203 F.3d 218, 225 (3d Cir. 2000).
Turning first to Northern’s motion for a new trial, the
judgment of the District Court will be vacated and the case
remanded for the reasons that follow. During discovery,
plaintiffs served a request for the production of documents
which request sought copies of all lawsuits filed against
Northern and two related companies. After a conference
with the District Court, the request was narrowed to “all
lawsuits filed against [Northern and the other two
companies] regarding lawsuits filed against them for bad
faith and claims where co-insurance penalties were applied
to blanket insurance coverage.” Northern responded in
answer thereto that there were none.
After plaintiffs themselves found fifteen bad faith cases
involving Northern, they filed a motion for sanctions. The
District Court found that Northern’s counsel’s failure to
disclose the bad faith cases was inadvertent and excusable
and, thus, substantially justified.4 At the same time, the
Court found that Northern’s conduct in considering the
request was not substantially justified and the bad faith
cases should have been disclosed under a reasonable
reading of the request for the production of documents. The
Court awarded plaintiffs the counsel fees and expenses
incurred in securing the information which Northern had
not provided.
At trial, Lloyd Johnson, in-house counsel for Northern,
was called by plaintiffs and questioned about the original
request for the production of documents, the conference
with the District Court, and the correspondence between
counsel which ensued. Johnson was then questioned about
an affidavit signed by Donna Sofinowski, a claim litigation
4. Northern’s trial counsel explained to the District Court that, due to a
miscommunication, in-house counsel believed he was to produce cases
involving both bad faith claims and co-insurance penalties applied to
blanket coverage. The Court accepted trial counsel’s explanation that
another bad faith case in which he had been personally involved had
slipped his mind.
9
specialist, in which she stated that “[a]fter careful review”
she was unaware of any lawsuits involving “claims for bad
faith and/or claims where co-insurance penalties were
applied to blanket insurance coverage.” Plaintiffs’ counsel
questioned Johnson about the fact that Sofinowski did not
in fact conduct a careful review but instead relied on
Johnson’s representation that there were no such lawsuits.
Plaintiffs’ counsel then asked Johnson whether it was
true that “as a matter of fact, it turned out that there were
hundreds of lawsuits[.]” Defense counsel objected and a
conference was held out of the hearing of the jury. The
District Court overruled the objection, but instructed
plaintiffs’ counsel not to “beat it” — meaning, presumably,
not to beat it to death. Despite this instruction, plaintiffs’
counsel’s next question to Johnson was as follows: “Mr.
Johnson, I asked you as a matter of fact there turned out
to be hundreds of these lawsuits, is that correct?” After
Johnson responded in the affirmative, counsel handed him
what counsel described as “a compilation of those lawsuits”
and asked him to identify it. Defense counsel again
objected, and the Court told plaintiffs’ counsel that he
could only ask Johnson to identify the document but could
not suggest what that document was. But, of course, the
horse was already out of the barn for the jury had been told
that the twenty page spreadsheet which Johnson identified
listed the “hundreds” of bad faith lawsuits against Northern
and the other two companies. While plaintiffs’ counsel did
not move the compilation itself into evidence, the damage
had been done for the jury saw that compilation and
certainly knew what it was.
Plaintiffs’ counsel was also permitted to ask Johnson to
read from the District Court’s opinion granting plaintiffs’
motion for sanctions. Twice — first on direct examination
and then again on redirect — Johnson was told to read the
following excerpt from the opinion aloud to the jury: “I must
note that considering this was a discovery request,
company counsel adopted an overly restricted view of the
request, and it therefore is not without cause to believe
such a restrictive construction was convenient, if not
intentional.” He also was told to read an excerpt in which
the Court stated that it could not find “substantial
10
justification” for Northern’s failure to disclose the bad faith
cases. And the attack on Johnson continued in plaintiffs’
closing argument:
The actions of [Mr. Johnson] were convenient at best
and justified the imposition of a punishment on
Northern Insurance Company for not being honest. I
said Mr. Johnson, lawyers are supposed to be honest
with the Court and counsel. He said, yes. I said the
whole process depends on that honesty, isn’t that
right? And he said yes. And I asked him, that’s not
what the conclusion was about your conduct in this
case?
Finally, the full opinion was admitted into evidence.
The Pennsylvania Superior Court has held that bad faith
is actionable regardless of whether it occurs before, during
or after litigation. O’Donnell v. Allstate Ins. Co., 734 A.2d
901, 906 (Pa. Super. 1999)(“[W]e refuse to hold that an
insurer’s duty to act in good faith ends upon the initiation
of suit by the insured.”). The Superior Court made quite
clear, however, that this did not mean that insureds may
recover under Pennsylvania’s bad faith statute “for
discovery abuses by an insurer or its lawyer in defending a
claim predicated on its alleged prior bad faith handling of
an insurance claim.” Id. at 908 (quoting Slater v. Liberty
Mut. Ins. Co., No. 98-1711, 1999 WL 178367, at *2 n.3
(E.D. Pa. March 30, 1999). This general proposition comes
with the caveat that using litigation in a bad faith effort to
evade a duty owed under a policy would be actionable
under Section 8371.
In those cases in which nothing more than discovery
violations were alleged, courts have declined to find bad
faith. In O’Donnell, the trial court instructed the jury that
they were not to consider conduct of the insurer which
post-dated the institution of suit. Despite its holding that
bad faith which occurs after the institution of suit is
actionable, the Superior Court nevertheless upheld the
jury’s defense verdict. The Court found that there was no
evidence that the allegedly frivolous interrogatories
propounded by the insurer were part of an attempt to
improperly prolong its investigation into the insured’s
11
claim, as opposed to winning the lawsuit which had been
filed against it. Id. at 909. See also Sanders v. State Farm,
47 Pa. D. & C. 4th 129, 145 (Ct. Com. Pl. 2000)(granting
summary judgment in favor of the insurer where the
insured alleged that, in a bad faith action brought by the
insured, the insurer filed multiple and duplicative pleadings
and motions); Slater, 1999 WL 178367 at *1 (denying
insured’s request for leave to amend to add an allegation of
bad faith conduct based on fact that, in suit for insurance
bad faith, insurer withheld material documents, raised
insupportable objections to discovery requests, delayed in
producing discoverable material, failed to produce pertinent
material within the discovery deadline and failed to produce
materials within the time promised by defense counsel). But
see Rottmund v. Continental Assurance Co., 813 F. Supp.
1104, 1109 (E.D. Pa. 1992)(allowing case to go forward
where insured alleged that insurer’s “intentional
misdesignation of a corporate deponent” and “concealment
of the absence of new facts and circumstances which would
justify the defendant’s denial of its own prior allegations
regarding the identity of the murderer of David Artz” could
constitute bad faith).
On the other hand, those cases in which courts have
permitted bad faith claims to go forward based on conduct
which occurred after the insured filed suit all involved
something, beyond a discovery violation, suggesting that
the conduct was intended to evade the insurer’s obligations
under the insurance contract. See, e.g., Cooper v.
Nationwide Mut. Ins. Co., No. 02-2138, 2002 WL 31478874,
at * 4 (E.D. Pa. Nov. 7, 2002)(refusing to dismiss for failure
to state a bad faith claim where insured’s complaint alleged
that the insurer “engaged in obstructive conduct and
induced him to discontinue his state court suit by
misrepresenting its intent to evaluate and settle his
claim[ ]”); General Refractories Co. v. Fireman’s Fund Ins.
Co., No. 01-5810, 2002 WL 376923, at *3 (E.D. Pa. Feb. 28,
2002)(refusing to dismiss for failure to state a claim where
insurer allegedly “made misrepresentations to the court and
filed abusive motions” in insurance coverage litigation
brought by the insured); Krisa v. The Equitable Life
Assurance Soc., 109 F. Supp.2d 316, 321 (M.D. Pa. 2000)
(refusing to dismiss for failure to state a claim where
12
insurer allegedly filed baseless counterclaim against
insured in insurance coverage litigation brought by the
insured).
Plaintiffs have not explained why they believe Northern’s
discovery violation constituted insurance bad faith, or why
that violation falls into the category of using litigation to
evade an obligation under the policy. Plaintiffs do not claim,
for example, that Northern failed to disclose other bad faith
lawsuits in which it had been involved knowing that even
though eventually its failure to disclose them would be
discovered, the progress of the litigation would be delayed
as would the day of reckoning when Northern would be
required to turn over the balance it owed under the neutral
umpire’s award.5
We conclude that the discovery violation in this case fell
into the “pure discovery violation” category as opposed to
the “discovery violation as insurance bad faith” category.
There is simply no evidence that Northern failed to disclose
the bad faith cases in order to avoid paying plaintiffs’
business interruption claim. The discovery violation was,
therefore, not probative of bad faith and was inadmissible
at trial under Federal Rules of Evidence 401 and 402.6 So,
5. The amended complaint includes a claim that Northern committed bad
faith by failing to promptly pay plaintiffs, as well as a claim that
Northern’s failure to pay constituted a breach of the insurance contract.
Evidence that Northern used the discovery process to create delay would
be probative and therefore admissible because it would support both of
these claims.
6. As O’Donnell makes clear, there are some cases in which the insurer’s
conduct during the course of the litigation is both a violation of discovery
rules and a violation of the insurer’s fiduciary duty to the insured. See
O’Donnell, 734 A.2d at 909 (“The court [in Slater] specifically noted that
its holding does not preclude a finding of liability for an insurer’s ‘bad
faith conduct arising in the insurer-insured relationship which happens
to occur during the pendency of an action[.]’ ”). We note that an insurer’s
dishonest conduct during discovery could potentially violate its fiduciary
duty of candor. See, e.g., Black’s Law Dictionary 625 (6th ed.
1990)(defining “fiduciary” inter alia as “a person having duties involving
good faith, trust, special confidence, and candor towards another”). See
also U.S. Fire Ins. Co. v. Royal Ins. Co., 759 F.2d 306, 310 (3d Cir.
1985)(explaining that “the good faith standard requires more than proof
13
too, it follows, was the reading of excerpts from the District
Court’s opinion imposing sanctions for that violation.
But even if we assume that the discovery violation was
committed in connection with an effort on the part of
Northern to avoid its obligations under the policy, the
evidence of that violation would have still been
inadmissible, but now under Rule 403, because its
probative value was substantially outweighed by its unfair
prejudicial effect.
On the one hand, there is the evidence of the discovery
violation which we assume, for purposes of argument, was
probative of an effort to delay payment. Other evidence
admitted at trial established, however, that even after the
Superior Court affirmed the decision of the Court of
Common Pleas, which in turn affirmed the decision of the
neutral umpire, Northern waited over three and a half
months to pay the balance it owed. In the end, by its own
admission, it only paid because trial was looming. The
probative value of the discovery violation was diminished by
the fact that it was not the only evidence that Northern
intentionally delayed payment of the balance it owed.
The unfair prejudicial effect of the discovery violation
arises from the fact that the information that Northern
failed to disclose happened to be other bad faith lawsuits
which had been brought against it. The jury may well have
concluded, in contravention of the strictures of the Rules of
Evidence, that the fact that hundreds of other bad faith
lawsuits had been filed against Northern made it more
likely that it committed bad faith in this lawsuit. Cf. Fed. R.
Evid. 404 (b)(“Evidence of other crimes, wrongs, or acts is
not admissible to prove the character of a person in order
to show action in conformity therewith.”). It seems, at least
to us, that plaintiffs questioned Lloyd Johnson about the
other bad faith lawsuits not so much to demonstrate that
of sincerity; the evaluation of the case by the insurance company must
be honest, intelligent and objective”)(citing Shearer v. Reed, 428 A.2d
635, 638 (Pa. Super. 1981)). Northern’s conduct in this case did not
arise out of the insurer-insured relationship and was not, therefore, a
breach of the fiduciary duty of honesty.
14
Northern committed an intentional discovery violation as to
establish a pattern of bad faith culminating in the “action”
in this case “in conformity therewith.”
There would have been no unfair prejudice had the
District Court permitted evidence of an insurance bad faith
discovery violation to be admitted into evidence without
permitting plaintiffs to disclose to the jury that the
information sought by them and withheld by Northern
happened to be other bad faith cases. As it was, the jury
not only was permitted to learn that the discovery violation
related to other bad faith lawsuits, information that was
irrelevant, but it was permitted to learn that there were
“hundreds” of them. Moreover, the District Court did not
explain to the jury that, in deciding whether Northern acted
in bad faith in this case, it could consider the fact that
Northern committed a discovery violation but not the fact
that there were other bad faith lawsuits against Northern.
It was also error to admit as evidence of bad faith
allegations contained in the amended complaint in a
subrogation action brought by Northern against the
contractor who built the banquet facility. In the amended
complaint, Northern alleged that it had paid plaintiffs an
amount in excess of $1,200,000, and that this amount was
“the fair and reasonable cost for temporary repairs,
permanent building repairs, replacement of damaged
contents, replacement of damaged business property,
business interruption [and] additional expenses.” These
allegations were made despite the fact that at the time the
amended complaint was filed, Northern had paid out
approximately $318,000 to plaintiffs and was refusing to
pay out anything more. At the bad faith trial, several
witnesses were questioned about the subrogation
complaint; plaintiffs’ expert characterized it as “at the best
bad lawyering and at the worst a fraud on the court.” Then,
in summation, plaintiffs’ counsel repeated the phrase
“fraud upon the court” and added that the fraud was
knowing, deliberate and reckless.
The Federal Rules of Civil Procedure permit parties to file
pleadings containing inconsistent factual and legal
allegations. See Indep. Enters. Inc. v. Pittsburgh Water and
Sewer Auth., 103 F.3d 1165, 1175 (3d Cir. 1997). As a
15
general rule, however, “[t]he allegations asserted in an
earlier lawsuit may be introduced by the adversary as
evidence in [a] second action[.]” 5 Wright & Miller § 1283, at
541-542. See also, e.g., Wilson v. Bradlees of New England,
Inc., 250 F.3d 10, 16 (1st Cir. 2001); LWT, Inc. v. Childers,
19 F.3d 539, 542 (10th Cir. 1994). Some courts have made
an exception to the general rule of admissibility for third-
party pleadings. See e.g., Schneider v. Lockheed Aircraft
Corp., 658 F.2d 835, 843 (D.C. Cir. 1981)(citing cases).
We need not decide whether a defendant’s allegations in
a complaint against a third party can be used against the
defendant in the primary action because, even assuming
that they can, the probative value of the evidence here was
minimal and the prejudicial effect great. The probative
value was minimal, first, because the allegations contained
in the subrogation complaint were not, as plaintiffs claim,
evidence that Northern was “seeking to advance its own
interest at the expense of its insured.” Northern’s claim
against the contractor for negligence was contingent on
plaintiffs’ claim against Northern, but plaintiffs’ claim
against Northern would not be affected one way or the
other by Northern’s allegations in the subrogation
complaint. Moreover, Northern’s recovery would be limited
by what it had actually paid out, not by the allegations in
the complaint. In an affidavit submitted to the District
Court, Northern’s subrogation counsel explained that he
amended the complaint, which initially alleged $300,000 in
damages, to allege $1.2 million “to protect Northern’s
interest in recovering all amounts that had already been
paid on this claim and any amounts that might be paid in
the future.” That he was surely entitled to do. Finally, the
question of what was a “fair and reasonable” amount to pay
plaintiffs on their bad faith claim is in part a legal one, and
legal conclusions may not be used as evidentiary
admissions. See Giannone v. U. S. Steel Corp., 238 F.2d
544, 548 (3d Cir. 1956)(“Bearing in mind that legal
conclusions are not admissions . . . we do not find that the
broad language that [the defendant/third-party plaintiff]
used against [the third-party defendant] reasonably capable
of interpretation as factual admissions of faulty
maintenance.”).
16
The evidence of the allegations in the subrogation
complaint was unfairly prejudicial in large part because of
the way in which that evidence was presented to the jury.
The language used by plaintiffs’ expert and by their counsel
— that the allegations constituted “fraud upon the court”
and that the fraud was knowing, deliberate and reckless —
was false and inflammatory.7 The prejudice was enhanced
by the fact that the subrogation complaint was referred to
repeatedly throughout the trial. It was mentioned in
plaintiffs’ opening argument, brought up with several
witnesses and highlighted again in plaintiffs’ closing. The
probative value of the evidence was substantially
outweighed by its prejudicial effect.
We cannot find that the errors committed here were
harmless. See Betterbox Communications Ltd. v. BB Techs.,
Inc., 300 F.3d 325, 329 (3d Cir. 2002)(“In a civil case, an
error is harmless if it is highly probable that it did not
affect the complaining party’s substantial rights.”). Thus, a
new trial will be necessary.8 Although Northern’s motion for
a new trial should have been granted, it was not entitled to
judgment as a matter of law, and in that respect we will
affirm the post-trial order of the District Court. There was
sufficient evidence submitted to the jury on the issue of bad
faith even when the improperly admitted evidence is
stripped away. There was evidence, for example, that
between January 12, 1996 and August of 1996, when
plaintiffs were forced to surrender the property to the bank,
they did not earn any money from their catering business,
7. We note that even if the allegations that the amount of the claim was
$1.2 million and that this amount was fair and reasonable did constitute
“fraud upon the court,” this would not be probative of insurance bad
faith.
8. There were other errors which we note, albeit without further
discussion. Plaintiffs were permitted to question Weichec on a decision
of the Court of Appeals for the Fourth Circuit in a distinguishable case
and ask why, when he became aware of the decision, he did not seek a
legal ruling. Plaintiffs thereafter argued to the jury that this failure was
evidence of bad faith. They were also permitted to question Weichec on
Northern’s offer, after the appraisal award, to settle the entire matter,
including the bad faith claim, and then argue to the jury that the offer
was itself evidence of bad faith.
17
as they had no place to hold events, but continued to incur
bills for its mortgage, utilities, insurance, employees and
taxes. Northern was aware of all of this and aware that
plaintiffs’ utilities were about to be terminated and that the
bank was threatening foreclosure. During this time,
Northern paid nothing for the ongoing business
interruption losses.
Northern argues to us that it reimbursed plaintiffs for,
among other things, the returned deposits and that, while
the appraiser characterized these monies as “extra
expenses,” “[t]he fact that the appraisal process declared
three years later that the payments should be characterized
as extra expense items does not negate the fact that they
were advanced by Wiechec at the time.” Northern also
argues that “[p]laintiffs’ need for sums far in excess of the
remaining undisputed amount of $25,000, rendered the
issue of advances largely academic.”
According to Northern’s own Claims Division Property
Manual, however, “[t]oday, it is doubtful that any insurer
would risk not making an advance on the undisputed
portion of a claim.” Weichec, therefore, arguably violated
Northern’s own policy when, in May of 1996, he did not
forward the undisputed amount due despite knowing that
plaintiffs were in need of funds. At trial, he offered no
explanation for his decision. He testified that no advance
was paid “because we were going to change the valuation,”
but admitted that the valuation was only going to increase.
The jury was, therefore, entitled to find that the delay on
Northern’s part was unjustified and that it constituted bad
faith.
But while there was a basis for a finding of bad faith,
there was no basis for an award of punitive damages even
had there been no trial error. Pennsylvania has adopted
Section 908 of the Restatement (Second) of Torts, which
provides that punitive damages may be “awarded to punish
a defendant for outrageous conduct, which is defined as an
act which, in addition to creating ‘actual damages, also
imports insult or outrage, and is committed with a view to
oppress or is done in contempt of plaintiffs’ rights.’ . . .
Both intent and reckless indifference will constitute a
sufficient mental state.” Klinger v. State Farm Mut. Auto.
18
Ins. Co., 115 F.3d 230, 235 (3d Cir. 1997)(quoting
Delahanty v. First Pa. Bank, N.A., 464 A.2d 1243, 1263 (Pa.
Super. 1983).
This case is distinguishable from a case such as Klinger,
in which we upheld an award of punitive damages because
the insurer made no offer to pay despite the plaintiff ’s
serious injury and the insurer’s clear liability. Here, neither
liability nor the amount due was clear. While Weichec may
not have had a completely open mind with regard to what
plaintiffs believed to be the proper restoration period — and
it was the dispute over the appropriate restoration period
that caused much of the delay — plaintiffs’ interpretation
was a somewhat unorthodox one based on the unique
nature of their business, but no similarly unique terms
were in the standard policy which governed this matter.
While Northern’s decision not to advance plaintiffs the
undisputed portion of their business interruption losses in
May of 1996 is surely some evidence of bad faith, it,
without more, does not support an award of punitive
damages.9
III.
The final judgment of the District Court dated January 7,
2002 will be vacated as will, in all but one respect, the
post-trial order of the District Court dated June 10, 2002.
The matter will be remanded for a new trial.
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
9. If, at the retrial, there is a finding of bad faith, under 42 Pa. Cons.
Stat. § 8371 — the bad faith statute — plaintiffs can receive interest,
court costs and attorneys’ fees as they did following the first trial.