On Appeal from the United States District Court for the Eastern District of Pennsylvania, D.C. Civ. No. 84-1581.
Before: GIBBONS, Chief Judge, BECKER, Circuit Judges and BROWN, District Judge.*fn*
BECKER, J., Circuit Judge.
This appeal, from a judgment entered on a jury verdict in favor of an insured against its excess carrier, raises several questions of Pennsylvania insurance law. The Trustees of the University of Pennsylvania, the corporate owner of the Hospital of the University of Pennsylvania ("HUP"), and the plaintiffs in the district court, won a $4.8 million judgment in compensatory damages against the Lexington Insurance Co., HUP's excess insurer. The jury also awarded punitive damages, attorneys' fees and prejudgment interest. The claim arose from Lexington's refusal to pay its share of a settlement in a suit against HUP by Mrs. Estelle Soppe, who had suffered catastrophic injuries from the administration of a contaminated diagnostic test fluid at the hospital.
Initially, we must consider Lexington's contention that it is absolved from liability because HUP did not give timely notice of the claim and HUP's contention that lack of timely notice does not save Lexington because Lexington was not prejudiced. We conclude: (1) that the question of late notice and prejudice was for the jury; (2) that the district court gave erroneous instructions on the policy's notice requirements; but (3) that the rule of Brakeman v. Potomac Ins. Co., 472 Pa. 66, 371 A.2d 193 (1977), requiring the insurer to prove prejudice as a condition of disclaimer, applies to this case despite the relative sophistication of the insured, hence late notice is not conclusive; and (4) that the faulty instructions were harmless because the jury rejected Lexington's claims of prejudice. We conclude that the jury's verdict was supported by substantial evidence.
We next consider the enforceability of the two-tiered settlement entered into between HUP and Mrs. Soppe. This type of settlement provides for the tort victim to recover a larger amount if the insurer is liable than if the tortfeasor must pay the settlement out of its own pocket. We find that the Pennsylvania would approve the two-tiered settlement involved in this case, so long as the amount the insurer must pay was reasonable and was sincerely believed to be reasonable by the insured. Despite some problematic evidentiary rulings which we also find to constitute harmless error, we conclude that the record supports the jury's determination that the two-tiered settlement was reasonable and entered into in good faith. We therefore sustain the judgment for Lexington's share of the underlying settlement.
We also affirm the awards of prejudgment interest and attorneys fees. With respect to the latter, we reject the argument that, while Pennsylvania permits an award of attorneys fees in an action to establish the insurer's breach of a duty to defend, it would not permit an award to enforce a duty to indemnify. However, we set aside the award of punitive damages, concluding that Pennsylvania would not recognize an action for punitive damages against an insurer even where the insurer refuses in bad faith to compensate its insured.
I. FACTS AND PROCEDURAL HISTORY
On June 9, 1981, Estelle Soppe, HUP's fifty-four year old director of volunteer services, drank a contaminated and highly toxic magnesium sulfate solution while undergoing a simple diagnostic procedure at the hospital. Dr. Bruce Trotman, a staff physician, supervised the test. As a result, Mrs. Soppe lost ninety percent of her small bowel as well as her gall bladder, spleen and one kidney. Having lost the ability to digest food, she is fed by a tube inserted in a vein leading to her heart, a long, laborious and painful process which requires most of her waking day.
At the time of the incident, the hospital's medical malpractice insurance consisted of three tiers. The first tier, as required by Pennsylvania law, 40 Pa. Cons. Stat. Ann. § 1301.701 (a)(1)(i) (Purdon Supp. 1986), was provided by the hospital and consisted of $100,000 coverage for itself and $100,000 for Dr. Trotman. The second tier, provided by the Pennsylvania Medical Professional Liability Catastrophe Loss Fund (the "CAT Fund"), a state agency, consisted of $1 million coverage for each health care provider (i.e., HUP and Dr. Trotman). See 40 Pa. Cons. Stat. Ann. § 1301.701 (Purdon Supp. 1986). The third tier, known as excess or umbrella coverage, was provided by Lexington in the amount of $10 million.
Under Condition 5 of the HUP-Lexington policy, HUP had the obligation to notify Lexington of a potentially covered claim:
Whenever the Insured has information from which the Insured may reasonably conclude that an occurrence covered [by the policy] involved injures or damages which, in the event that the Insured should be held liable, is likely to involve this policy, notice shall be sent to the Company as soon as practicable, provided however, that failure to notify the Company of any occurrence which at the time of its happening did not appear to involve this policy, but which at a later date would appear to give rise to claims hereunder, shall not prejudice such claims.
The policy also provided, however, that Lexington had no right to assume the defense of suits against HUP. Lexington had the right only "to associate with the Insured or the Insured's underlying insurer, or both, in the defense and control of any claim . . . where the claim . . . involves, or appears reasonably likely to involve Lexington."
Notwithstanding Condition 5, HUP did not notify Lexington after Mrs. Soppe's tragic accident, though it did initiate its own investigation. Approximately ten months later, on April 19, 1982, HUP received a request for Mrs. Soppe's medical records from the law firm of Litvin, Blumberg, Matusow & Young ("Litvin"), a firm with a reputation for prowess in medical malpractice cases. Ten months after this request, in February of 1983, Litvin brought a malpractice action on behalf of Mrs. Soppe against the hospital and Dr. Trotman in the Court of Common Pleas of Philadelphia County.
HUP engaged the law firm of Duane, Morris & Heckscher to conduct the defense both for HUP and Dr. Trotman, and the firm proceeded to investigate the case, to file an answer and to conduct discovery. On October 31, 1983, the Court granted Mrs. Soppe's petition for special listing. In early December, 1983, Litvin forwarded to the court and to HUP an evaluation of Mrs. Soppe's injuries which described a damage potential of $5 to $10 million. For apparently unrelated reasons, HUP's malpractice consultants, ARCAP, finally advised HUP to notify its excess insurers in a letter dated December 5, 1983. HUP did so on December 19.
On February 18, 1984, Lexington wired HUP disclaiming coverage on grounds of late notice. Lexington took the position that this late notice had prejudiced it for three reasons: (1) unspecified "gross mishandling" of the investigation and legal defense; (2) a failure of HUP's counsel to explore additional theories of liability that would involve other health care providers or HUP's products liability insurer; and (3) the failure of HUP's counsel to prosecute cross-claims against Dr. Trotman because of a conflict of interest. (360a-361a). At the time of the letter, the Soppe action was scheduled for trial on February 28, 1984, although it was ultimately postponed until April of that year.
In early April, 1984, on the eve of trial, Mrs. Soppe, HUP and Dr. Trotman reached a settlement. Under the terms of the settlement, Mrs. Soppe agreed to accept $2.2 million from HUP's own (self-insurance) coffers and from the CAT Fund. HUP also agreed to pay an additional $4.8 million if it was successful in the suit it had brought against Lexington. Pending that suit, HUP agreed to pay Mrs. Soppe $550,000, for which it would be reimbursed by payment of one third of the proceeds of the suit against Lexington until that $550,000 was satisfied. The settlement also provided that if HUP did not win its suit against Lexington, it would pay Mrs. Soppe an additional $1.6 million over the next two years and would guarantee payment of Mrs. Soppe's lifetime medical expenses, which promised to be enormous.
On April 23, 1984, Mrs. Soppe, HUP and Dr. Trotman presented this settlement to Judge Bernard Goodheart of the Court of Common Pleas of Philadelphia County. Pursuant to the parties' request, Judge Goodheart considered the relative merits of the settlement and expressed his approval. On May 17, 1984, the parties again appeared before Judge Goodheart, this time to permit a Deputy Attorney General of the Commonwealth of Pennsylvania, Lawrence Barth, to present his views that the settlement was in the best interests of HUP. Mr. Barth purported to appear in the exercise of the Attorney General's responsibility of overseer of Pennsylvania charities, although there was no apparent need for his appearance.
On April 2, 1984 (prior to presentation of the settlement to Judge Goodheart), HUP instituted the present suit in the Eastern District of Pennsylvania against Lexington seeking a declaratory judgment, damages in the sum of $4.8 million to satisfy the Soppe settlement, punitive damages and attorneys' fees. After trial, the case was submitted to a jury on special interrogatories. The jury found that HUP's notice was not late according to the requirements of the HUP-Lexington policy. Accordingly, in conformance with its charge, the jury made no finding whether Lexington had been prejudiced by late notice. The jury also found that the settlement in the Soppe case was reasonable and made in good faith, and that Lexington's denial of coverage was in bad faith and so outrageous as to entitle HUP to punitive damages in the amount of $500,000. Following the jury verdict, the district court awarded HUP's attorneys' fees in the amount of $148,938.00 and costs of $17,602.30. The district court denied Lexington's motions for judgment n.o.v. and for a new trial. Lexington filed this timely appeal.
Lexington first claims that the judgment should be overturned because notice of the claims was late under the policy as a matter of law.
The policy provided for HUP to notify Lexington "as soon as practicable" after HUP had information from which it "may reasonable [have] conclude[d]" that injuries or damages were likely to involve the policy. Lexington notes that Mrs. Soppe received all her medical care from HUP after her accident, so that HUP had all the necessary information from which it could determine the magnitude of Mrs. Soppe's injuries as they developed in the period following the accident. Lexington claims that at least from April 19, 1982, when the Litvin firm requested Mrs. Soppe's medical records, suit was obviously inevitable, and that it was clear that any suit was likely to involve Lexington's policy because of the catastrophic nature of Mrs. Soppe's injuries. At the latest, claims Lexington, HUP's obligation to notify was triggered when Mrs. Soppe filed suit in February, 1983.
Despite these indications, HUP waited until December 1983, ten months after Mrs. Soppe had filed suit, before providing notice. Noting that the Pennsylvania Supreme Court has upheld a trial court's directed verdict that eight months following an accident was not "as soon as practicable," Farmers Nat'l Bank of Ephrata v. Employers Liab. Assurance Corp., 414 Pa. 91, 199 A.2d 272, 274 (1964), Lexington argues that notice was late here as a matter of law.
Farmers N at'l Bank and other cases relied on by Lexington concern the amount of time that may pass after circumstances have triggered the duty to notify that may still be "as soon as practicable." The principle question in this case, however, is when the duty was triggered. HUP defend its delay in giving notice on two grounds.
First, HUP claims that its notice was not late because HUP did not know the cause of Mrs. Soppe's injuries and believed them not to be the result of the hospital's activities (in particular, the administration of contaminated magnesium sulfate solution) until it received a report to the contrary from one of its experts in October, 1983. We are not impressed with this argument. The policy does not postpone the duty to notify until the insured has information from which it may believe itself liable but only until the insured has information that a claim may involve the Lexington policy if the insured is liable. Lexington conceded, and we agree, that HUP must have some grounds for believing its liability at issue. But, at the latest, HUP was aware of that potential when Mrs. Soppe filed her suit in February, 1983.
HUP also claims, however, that it was not aware that Mrs. Soppe's claim would implicate the Lexington policy until HUP received Mrs. Soppe's damage evaluation, claiming damages of five to ten million dollars, in early December, 1983. There was testimony in the record that as late as November, 1983 HUP's seasoned and capable trial counsel believed the case would settle for around $1.5 million. In that event Mrs. Soppe's claim would not have implicated Lexington's coverage. If the jury credited this testimony, it had reasonable grounds for believing that the duty to notify did not commence until soon before the actual, December, 1983 notice. As we have intimated, the jury also had grounds for believing that HUP's duty to notify commenced months, even years, before this date. In view of the conflicting testimony, however, we believe the issue of late notice was properly a question for the jury.
Lexington next claims that the district court improperly instructed the jury regarding the meaning of late notice under the policy. The district court's instructions on the meaning of the policy were as follows:
The policy provides that the notice of the potential claim is to be given only when the insured reasonably believes that a claim might involve Lexington's coverage. Not that a claim has been made, but only in the event that it's going to involve Lexington. Thus, it leaves that determination of the potential value to the insured, not to the insurance company.
As I mentioned earlier, Lexington than has the burden of proving by a preponderance of the evidence that the Trustees of the University and its agents had no reasonable basis for their doubt that the claim of Estelle Soppe would reach the insurance provided by the Lexington policy.
Construction of an insurance policy, like construction of any contract, is a matter of law so long as a court may fairly read it without ambiguity. Ram Construction Co., v. American States Ins. Co., 749 F.2d 1049, 1052-53 (3d Cir. 1984); cf. Cooper Lab. v. International Surplus Lines Ins. Co., 802 F.2d 667, 671 (3d Cir. 1986) (distinction between law and fact in contract case is matter of federal law). We believe that the district court's instruction was in error.
Despite the policy's tortured phrasing, it unambiguously sets out an objective standard for the time at which notice was required. The policy required notice whenever the Insured had information from which it might "reasonably conclude" that an occurrence was "likely to involve" the policy. Exactly what this "may reasonably conclude" language required is somewhat unclear. Arguably it required notice if any insured could reasonable have concluded that the occurrence would involve the policy -- although we consider the significance of the term "may" sufficiently ambiguous to preclude such an onerous interpretation. We do believe, however, that the policy required notice at least if the insured, acting on the basis of the knowledge HUP possessed at the time, should have believed that the incident was likely to involve the policy if it had considered the matter reasonably. Thus we hold that the policy imposes an objective standard.
Under this formulation, the jury instruction was in error for two reasons. First, it mentioned the jury that the determination whether to notify was left entirely to HUP when in fact HUP had an obligation to notify Lexington if the information reasonably required it. Second, the instruction told the jury that if HUP had any reasonable basis for doubting that Mrs. Soppe's claim would reach the Lexington coverage, it had no obligation to notify. In fact, HUP had the obligation to notify whenever reasonable judgment, based on the information available to HUP, suggested that the claim was likely to involve Lexington. HUP could have this obligation to notify despite many reasonable doubts that the claim would actually involve Lexington's coverage.
Although the district court quoted the actual language of the policy to the jury, we do not believe that doing so corrected these two errors. The construction of an unambiguous policy is for the court; the district court construed it but did so erroneously. Moreover, the jury possessed abundant evidence from which it could have concluded that notice was late if it had received a proper instruction.
1. Notwithstanding the incorrect jury instruction on late notice, we may not order a new trial unless Lexington demonstrates prejudice from the late notice. In Brakeman v. Potomac Ins. Co., 472 Pa. 66, 371 A.2d 193 (1977), the Pennsylvania Supreme Court held that late notice will only release an insurance company from its obligations under a policy if it can prove actual prejudice. Lexington claims, however, that the rationales provided by the court in Brakeman make its holding inapplicable to the present case.
First, claims Lexington, Brakeman hinged on the automobile insurance context in which it arose. According to Lexington, Brakeman turned on the view that the legal obligation to carry automobile insurance removed the element of free will in normal contractual relationships. Lexington further asserts that the Brakeman court relied on the strong public policy, expressed by Pennsylvania's no-fault insurance law, in favor of compensating victims of automobile accidents. In contrast, Lexington points out that this case involves no automobile claims and a victim who will, at all events, be substantially compensated by a financially responsible defendant, HUP.
Brakeman certainly turned in part on the Pennsylvania Supreme Court's view that most insurance contracts are not negotiated agreements but rather are dictated by the insurance company in all matters but price. 371 A.2d at 196. The Brakeman court also discussed the policy favoring compensation of tort victims. 371 A.2d at 198. Although the court noted the particular strength of these arguments in the automobile context, see id. at n.8., the court discussed both kinds of reasoning in general terms, and its discussion applies outside of the automobile context. Pennsylvania courts have ...