Federal Kemper Insurance Co. v. Hornback

711 S.W.2d 844, 1986 Ky. LEXIS 278

• Court: Kentucky Supreme Court
• Decided: June 12, 1986
• Status: Published

Opinions

STEPHENSON, Justice.

The trial court entered judgment against Federal Kemper Insurance Company, imposing punitive damages for bad faith refusal to settle a fire loss with its policyholder. The Court of Appeals affirmed. We granted discretionary review and reverse.

The Hornbacks’ fire insurance policy with Federal Kemper was raised from $6,000 to $30,000. Thirty-five days later, the house burned. The evidence clearly showed that the fire was set. As stated by the Court of Appeals, there was little evidence that the Hornbacks set the fire. However, there was clearly a jury issue presented which was resolved by the jury in favor of the Hornbacks. There was a verdict on the terms of the policy and a vérdict for punitive damages.

Federal Kemper appealed only the judgment for punitive damages.

We reverse the decision of the Court of Appeals but, in so doing, do not fault either the trial court or the Court of Appeals panel.

The case was tried and affirmed on appeal according to Feathers v. State Farm Fire & Casualty Company, Ky.App., 667 S.W.2d 693 (1983).

Feathers involved the fire loss of a house and contents. The insurance company refused to pay on the proof of loss on the ground that it contained misrepresentations. The court opined that the homeowner’s fire policy is unique and that if the allegations of the complaint are true, the breach of contract is so great as to constitute tortious conduct. Feathers then held:

... Nevertheless, once the policyholder has substantially complied with the terms and conditions required by the policy, and there is no substantial or credible evidence that the policyholder directly or indirectly set fire to his property for personal gain, then at that point, the insurance company becomes akin to a fiduciary as to the sums that may be owed under the policy. So the proceeds of the policy may not be withheld unless there is a substantial breach of the contract by the policyholder. Whether or not State Farm was justified in withholding and denying the payment of the losses will be resolved by trial. We simply say that if State Farm was not justified in its actions, then its conduct was tor-tious against the policyholder for which consequential and punitive damages may be presented to the fact finder.

Feathers arrived at this conclusion by recognizing the traditional principle of law in this Commonwealth that one may not recover consequential or punitive damages for breach of contract, citing a line of cases beginning with Cumberland Telephone and Telegraph Co. v. Cartwright Creek Telephone Company, 108 S.W. 875 (1908), and ending with General Accident Fire & Life Assurance Corp. v. Judd, Ky., 400 S.W.2d 685 (1966).

Feathers then went on to state that for the purpose of establishing a definite principle of law, these and similar authorities are flawed for the reason that they contain such modifiers as ordinarily. Cumberland stated unequivocally that punitive damages are not recoverable for a mere breach of contract. Judd gratuitously added ordinarily when it relied upon and cited Cumberland. We do not regard Judd as in any way diminishing the rule denying punitive damages in contract cases.

Feathers established a new tort action in this Commonwealth by reasoning that the insurance company became a fiduciary by breach of a covenant to act in good faith.

This new tort is apparently based on Gruenberg v. Aetna Ins. Co., 9 Cal.3d 566, 108 Cal.Rptr. 480, 510 P.2d 1032 (1973).

In that opinion, it is stated that California recognizes a cause of action in tort against the insurance company for breach of an implied covenant of good faith and fair dealing. This case drew an analogy of the fiduciary relationship created in third-party cases involving automobile accidents, whether there was good faith on the part of the insurer to settle within policy limits so as to protect the insured against a judgment in excess of the policy limits. The opinion allows recovery for mental distress, not punitive damages. We do not draw such an analogy in this Commonwealth so as to convert an action for breach of contract into a tort action.

The only fiduciary relationship we recognize attaching to insurance policies is the excess-of-the-policy-limits cases where good faith is required on the part of the insurance company. Manchester Ins. & Indem. Co. v. Grundy, Ky., 531 S.W.2d 493 (1975), and similar cases cited therein, recognize these principles. This principle of law is contract and not tort and has no application to insurance contracts generally. Above all, there is no suggestion that punitive damages would follow breach.

The theory expressed in Grundy is that of protection of the policyholder against a larger judgment than the policy limits. There is no protection of the policyholder involved in Feathers. The insurance company has an obligation to pay money according to the terms of the contract. Failure or refusal to pay will give rise to a suit for breach of contract.

We are of the opinion that Feathers is not, and should not be, the rule in this Commonwealth and, to the extent that we are able, overrule it. Sanctions for a frivolous defense, as provided for by our rules, are deemed sufficient to deter insurance companies from refusing to pay according to the terms of the contract without cause.

The decision of the Court of Appeals is reversed with directions that the claim for punitive damages be dismissed.

GANT, VANCE, and WHITE, JJ., concur. VANCE, J., files a separate concurring opinion. LEIBSON, J., dissents and files a separate dissenting opinion in which STEPHENS, C.J., and WINTERSHEIMER, J., join.