Court Asked to Limit Damages for ‘Bad Faith’

WASHINGTON â€”  When Margaret Lavoie and her husband first went to court in Mobile, Ala., in 1978, they were merely trying to recover $1,650.22 they said the Aetna Insurance Co. still owed them on a $3,028.25 claim they had submitted to cover her hospital bills.

Six years later, after the Alabama Supreme Court ruled on the case, the couple stood to collect a cool $3.5 million in punitive damages for the company’s “bad faith� failure to pay the claim--along with $1 million in interest and a $350,000 penalty for Aetna’s unsuccessful appeal to the court.

The company, staggered by the prospect of paying 3,000 times more than the Lavoies had sought, has appealed this unusual case to the U.S. Supreme Court. At issue are:

--The legality of virtually unlimited punitive-damage awards, which are becoming increasingly common throughout the nation.

--The validity of the automatic 10% penalty that Alabama adds to monetary judgments against defendants who appeal such awards and lose.

--The ethical conduct of the Alabama Supreme Court justice who wrote the majority opinion in the 5-4 decision against Aetna, when, unknown to the company, the judge himself had filed two similar bad-faith lawsuits against other insurance companies.

The U.S. Supreme Court’s decision figures to have broad impact beyond the dispute between Aetna and the Lavoies. In recent years, the number of enormous punitive-damage awards has increased markedly around the nation. In California since 1983, juries have awarded such damages in more than 200 cases, returning verdicts totaling $450 million.

According to the Assn. of California Insurance Companies, much of the increase in punitive-damage awards can be attributed to the expansion of the “bad faith� doctrine--a right, recognized by a growing number of states, to sue insurance companies that unfairly refuse to pay a claim and collect punitive damages from them.

Consumer Costs Driven Up

The trend has caused widespread concern within the insurance industry that the size and unpredictability of such awards will cause administrative havoc and drive up costs to consumers.

On the other side, lawyers who bring such cases defend big awards as justifiable punishment and a highly effective deterrent when large, financially powerful companies wrongly deny policyholders’ legitimate claims. The attorneys representing the Lavoies accused Aetna of the “gross misconduct� of knowingly deceiving the couple in denying their claim four times.

The $1,650.22 in dispute included charges for inpatient diagnostic tests and hospital room and board, items the Lavoies said were necessary to determine whether she suffered from an abdominal or intracranial disease. The company said that the tests were not the ones customarily given in such instances, and that they could have been given on an outpatient basis.

In their lawsuit, the Lavoies said that Aetna failed to have its own medical staff review the case before it denied the claim, and ignored evidence that would have upheld the claim.

The case went to trial in 1982. After just 50 minutes of deliberation, the jury ruled for the Lavoies, awarding the couple $3.5 million in punitive damages.

‘Overwhelming’ Evidence

Last December, the Alabama Supreme Court upheld the award, finding “overwhelming� evidence of bad faith on the part of Aetna. The majority opinion, unsigned but later disclosed to have been written by Justice T. Eric Embry, concluded that the Lavoies had shown that “the dark shadows of fraud and conspiracy enveloped each and every aspect of Aetna’s actions.�

The court added 10% to the $3.5-million verdict under a state law that penalizes unsuccessful appeals of such cases. With interest, Aetna faced a judgment approaching $5 million.

It was not until later, the company said, that it learned that Embry had previously filed two of his own bad-faith actions, in which he was seeking punitive damages against two other insurance companies. He had sued one company for refusing to pay a claim for the theft of his late wife’s mink coat. And he had filed a class action, on behalf of himself and other Alabama state employees, against a health insurance carrier for alleged failure to pay medical claims promptly.

The first action was settled before the state Supreme Court ruled in the Aetna case, when the insurer agreed to pay Embry’s theft claim. Some time after the Aetna decision, Embry’s class action was dismissed and he received what he now calls a “nice sum� from a settlement with the company.

The judge, now retired from the court and practicing law in Birmingham, flatly denies that there was any impropriety.

“My conscience is clear--it doesn’t bother me at all,� he said. “The insurance companies are desperate to fight these bad-faith actions. They’ll resort to anything.�

Aetna, citing what appeared to be the justice’s conflict of interest in its case, later asked the court to set aside its ruling. The court, without dissent, denied the request.

Aetna then appealed to the U.S. Supreme Court (Aetna vs. Lavoie, 84-1601). The justices agreed last June to review Aetna’s appeal during their current term, and a decision is expected by next spring.

Constitutional Defense

The company contends that the huge damage award violates Eighth Amendment prohibitions against “excessive fines�--a provision historically aimed at protecting defendants in criminal cases. Such a disproportionate penalty serves no purpose except to provide a windfall to winning plaintiffs, the company argues.

The American Insurance Assn., one of several insurance groups backing Aetna, observes that many large punitive-damage awards far exceed any known criminal case fines. In the first half of 1985, juries in five California cases awarded $242 million in punitive damages, subject to reduction by the courts. The association is urging the court to provide new guidelines or set limits on such awards.

Aetna says that Alabama’s 10% penalty on unsuccessful appeals unfairly discourages losing defendants from exercising their right to appeal, and makes no distinction between frivolous or delaying actions and serious ones.

The Lavoies’ attorneys say that punitive-damage awards have long been recognized as a valid civil penalty, and that the $3.5-million award against Aetna was not excessive in view of Aetna’s “egregious misconduct.� The automatic 10% penalty is a legitimate way of deterring dilatory appeals that deprive plaintiffs like the Lavoies of prompt receipt of their award, the lawyers add.

As for Aetna’s contention that Embry should have removed himself from the case, the insurance company maintains that he had a “direct, pecuniary interest� in the outcome of the Aetna case because upholding the multimillion-dollar damage award enhanced the potential for recovery in his own case.

Conflict Called ‘Severe’

“I have never seen a case where the appearance of a conflict of interest is as severe as it is here,� said Larry L. Simms of Washington, an attorney for Aetna. “ . . . The system of justice can’t tolerate that kind of situation, no matter what was going on in his own mind.�

Attorneys for the Lavoies, defending Embry’s role in the case, say that his decision did not change Alabama law and that, contrary to Aetna’s claims, he had no direct interest in the outcome because his own lawsuits involved different claims and different issues.

In bringing suit against the health insurance company, Embry “wasn’t really seeking money, but was seeking reform of the system,� said Jack N. Goodman of Washington, an attorney representing the Lavoies. “His opinion in the Aetna case was limited to the circumstances in that case. It is very difficult to see how it could have affected his own case.�