Ronald S. Gass
Reinsurance and Insurance Arbitrator and Umpire
Reinsurance and Insurance Dispute Resolution Services Consultant

California Federal District Court Rejects Extension of “Extraordinary” Tort Liability Remedy to Alleged Breach of Reinsurance Contract

In an important new reinsurance decision, a California federal district court ruled that in the absence of any California precedents on point, the state’s Supreme Court would not impose the “extraordinary” remedy of tort liability for an alleged breach of the implied covenant of good and fair dealing in a reinsurance contract. The U.S. District Court for the Central District of California predicted that the state’s highest court would reach this result based on what it perceived to be the essential public policy rationale underlying the Supreme Court’s consistent limitation of tort recovery for a breach of the covenant of good faith and fair dealing to the primary insurance context.

In this case, the reinsured, a joint powers self-insured retention pool consisting of numerous California public agencies, filed a complaint against its reinsurer asserting causes of action for breach of contract and breach of the implied covenant of good faith and fair dealing alleging a tortious breach the reinsurance contract’s implied covenant of good faith and fair dealing. The reinsurer subsequently moved to dismiss the tort claim and related prayer for punitive damages.

The district court observed that tort remedies for breach of the implied covenant of good faith and fair dealing are permitted in the primary insurance context for policy reasons pertaining to the distinctive nature of such contracts and the special relationship between the policyholder and insurer. Primary insurance contracts, according to the court, are generally characterized by elements of adhesion and unequal bargaining power, public interest, and fiduciary responsibility, with the application of tort liability representing a “‘major departure from traditional principles of contract law.’” Thus, California courts have been “loath to ‘extend the exceptional approach taken in those cases to another contract setting.’”

Most of the distinctive public policy considerations associated with primary insurance contracts are not implicated in the reinsured/reinsurer relationship because reinsurance contracts are typically negotiated between sophisticated business entities, the elements of adhesion and unequal bargaining power are generally absent, no fiduciary relationship exists between the parties, and the reinsured is capable of incorporating the risk of non-payment into its reinsurance agreement. Hence, the court ruled that the extension of “extraordinary” tort relief to the breach of a reinsurance contract cannot be justified and predicted that the California Supreme Court would not find the imposition of tort damages to be appropriate: “More is needed to justify such a ‘major departure from traditional principles of contract law.’” Consequently, the court granted the reinsurer’s motion and dismissed the insured’s tort cause of action and related prayer for punitive damages.

California Joint Powers Insurance Authority v. Munich Reinsurance America, Inc., Case No. CV 08-956 DSF (RZx), slip op. (C.D. Cal. April 21, 2008).

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