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New York ups the Ante by Allowing Consequential Damages against Insurers Who Breach Insurance Policies

We all remember that first lesson on breach of contract damages. Our first day in Contracts, our own version of Professor Kingsfield of The Paper Chase, glowering up at a classroom of 1Ls and picking on the meekest of us to explain those infamous words of Baron Sir Edward Hall Alderson in that most hallowed of cases, Hadley v. Baxendale, 9 Exch 341:
“We think the proper rule in such a case as the present is this. Where two parties have made a contract which one of them has broken, the damages which the other party ought to receive in respect of such breach of contract should be such as may fairly and reasonably be considered as either arising naturally, i.e., according to the usual course of things, from such breach of contract itself, or such as may reasonably be supposed to have been in the contemplation of both parties at the time they made the contract as the probable result of the breach of it.”
The concept that one who breaches a contract should be liable for those consequential damages that were foreseeable has been a central part of our contract jurisprudence at least since the decision of the Court of Exchequer in England in 1854. This rule, though, has not been the rule for the breach of insurance contract provisions in New York. In New York, the remedy for a breach of an insurance contract by an insurer, absent proof of bad faith, has been limited to the payment of the policy proceeds. In a pair of 2008 decisions, though, the New York Court of Appeals changed that rule and held that an insured could plead and recover consequential damages if the insurer breached its duty of good faith and fair dealing and the consequential damages were foreseeable and quantifiable.
In the first case, Bi-Economy Mkt., Inc. v. Harleysville Ins. Co. of N.Y., 886 N.E.2d 127 (N.Y. 2008), the insured was a family-owned wholesale and retail meat market in Rochester, N.Y. After the business was destroyed by a fire, the insured sought to collect under a deluxe business owner's policy that was issued by the insurer. The policy included business interruption insurance for one year, but the insurer only offered to pay for seven months of lost business income. As a result, the insured was unable to reopen the business and subsequently brought a breach of contract action against the insurer, in which it sought consequential damages. The trial court granted summary judgment to the insurer on the basis that New York law and the policy itself precluded consequential damages, and an appellate court affirmed.
The New York Court of Appeals reversed the grant of summary judgment to the insurer, holding that the insurer should have been aware that any breach of its obligations to investigate in good faith and pay covered claims promptly would result in payment of damages to the insured for the loss of its business as a result of the breach. The court stated, “Thus, the very purpose of business interruption coverage would have made Harleysville aware that if it breached its obligations under the contract to investigate in good faith and pay covered claims it would have to respond in damages to Bi-Economy for the loss of its business as a result of the breach…. When an insured in such a situation suffers additional damages as a result of an insurer's excessive delay or improper denial, the insurance company should stand liable for these damages. This is not to punish the insurer, but to give the insured its bargained-for benefit.”
Thus, the claim for consequential damages was reasonably foreseeable and contemplated by the parties. “Therefore, in light of the nature and purpose of the insurance contract at issue, as well as Bi-Economy's allegations that Harleysville breached its duty to act in good faith, we hold that Bi-Economy's claim for consequential damages including the demise of its business, was reasonably foreseeable and contemplated by the parties, and thus cannot be dismissed on summary judgment.”
The New York Court of Appeals followed its decision in Bi-Economy with its companion decision in Panasia Estates, Inc. v. Hudson Ins. Co., 886 N.E.2d 135 (N.Y. 2008). In this decision, the court permitted an insured to plead and seek consequential damages for the insurer’s breach of its duty to investigate, bargain for, and settle claims in good faith under a builders risk policy. The roof of the insured’s building was opened during a renovation, and rain entered the building. The insurer failed to immediately investigate the claims and later denied the claim on the basis that the water damage had been the result of wear and tear instead of the result of a peril that was covered under the policy. The trial court and the intermediate appellate court denied the insurer’s motion to dismiss the insured’s claim for consequential damages, and the New York Court of Appeals affirmed.
These twin decisions provide insureds and plaintiffs’ counsel with an additional tool for attacking denial of coverage decisions by insurers in New York. While most jurisdictions permit insureds to seek punitive damages for bad faith denial of claims, the burden of proof in bad faith litigation is high. Courts in other jurisdictions may find the rationale of the New York Court of Appeals to be persuasive and permit insureds to seek consequential damages when punitive damages cannot be proven. Counsel for insurers who do not practice in New York should examine the Bi-Economy and Panasia decisions to determine if they might be followed in jurisdictions where their clients conduct business.

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.