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April 2010

Amerigraphics Inc. v. Mercury Casualty Company ? Business Income Provision Provides Coverage for Both Net Income and Operating Expenses

Plain Meaning of Business Income Provision Provides Coverage for Both Net Income and Operating Expenses, Without Offset

(March 23, 2010) ___Cal.App.4th___; 10 C.D.O.S. 3633

The California Court of Appeal, Second Appellate District, held a business income provision in an insurance policy provided coverage for lost income and continuing normal business expenses during the period of business suspension, without an offset of two amounts.  The Court of Appeal also held substantial evidence supported an award of punitive damages, but should not exceed compensatory damages by more than a 3.8-to-1 ratio.

Amerigraphics was a printing and graphics design company.  In April 2003, the premises flooded, damaging a printer and a scanner vital to Amerigraphics' business.  The company that sold the equipment to Amerigraphics determined that the printer and scanner had been irreparably damaged.

Amerigraphics reported the loss to its insurer Mercury Casualty Company ("Mercury").  Mercury insured Amerigraphics under a policy that covered damage to property used in the business and tenant improvements, and loss of business income due to business suspension. The Mercury policy defined Business Income as the: (i) Net Income (Net Profit or Loss before income taxes) that would have been earned or incurred if no physical loss or damage had occurred?; and (ii) Continuing normal operating expenses incurred.

According to the trial court, Mercury handled Amerigraphics' claim very poorly. Mercury's conduct included: (1) telling Amerigraphics there was no coverage for business income and tenant improvements, and only looking into the matter when Amerigraphics pointed out the policy provisions; (2) denying coverage for the tenant-improvement claim by stating that its investigation showed no damage even though Mercury did not investigate until after the denial; (3) upon re-opening the tenant-improvement claim, paying a fraction of the amount 693 days after the loss, and only after Amerigraphics wrote a letter to Mercury's president begging for help; (4) wrongfully stating that the printer and scanner had been fixed; and (5) denying business income coverage 522 days after the loss because operating expenses exceeded the projected net income.   

Amerigraphics sued Mercury for breach of contract and bad faith.  Prior to trial, the trial court interpreted the business income provision and held the plain language provided coverage for both elements stated in the definition: net income and continuing normal operating expenses without having to offset one against the other.

The jury found that Mercury had breached the contract and acted in bad faith.  The jury awarded $130,000 in contract damages and $3 million in punitive damages.  The trial court remitted the punitive damages award to $1.7 million.

Mercury appealed.  Reviewing the trial court's interpretation of the business income provision de novo, the Court of Appeal agreed with the trial court that, under the plain language of the policy, the business income provision provided coverage for any lost income and the continuing normal business expenses during the period of business suspension.

In reaching this conclusion, the Court of Appeal rejected Mercury's contention that the word "and" connecting the two sub-parts is the equivalent of the mathematical operator "plus." Under Mercury's interpretation, if the net income during the period before the covered loss was a net loss that was greater than the operating expenses, the insured would be paid nothing under the provision. But because the policy did not use the words "plus," "offset," "subtract," or "minus," the Court of Appeal held the trial court's interpretation was proper and Amerigraphics was entitled to coverage under both sub-parts.  The Court of Appeal noted that even if it assumed the provision was somehow ambiguous, the trial court's interpretation of the provision was consistent with how the insurer believed the insured understood it when the contract was made (i.e., consistent with the insured's objectively reasonable expectations). 

The Court of Appeal also held that the punitive damages award was supported by substantial evidence of malice, oppression or fraud.  In fact, the Court of Appeal stated it had, "little trouble in this case concluding that there was more than substantial evidence to support an award of punitive damages." 

The Court of Appeal then examined de novo whether the $1.7 million award comported with due process under three guideposts: (1) the degree of reprehensibility of the misconduct; (2) the disparity between the actual harm suffered and the punitive damages award; and (3) the difference between the punitive damages awarded and the civil penalties authorized or imposed in comparable cases.

The reprehensibility factor is the most important factor and includes the following considerations: (1) whether the harm caused was physical as opposed to economic; (2) whether the tortious conduct evinced an indifference to or a reckless disregard of the health or safety of others; (3) whether the target of the conduct was financially vulnerable; (4) whether the conduct involved repeated actions or was an isolated incident; and (5) whether the harm was the result of intentional malice, trickery, or deceit, or mere accident.

Applying these factors, the Court of Appeal found the only applicable reprehensible factor was  Amerigraphics's financial vulnerability.  Given that the only reprehensibility factor was purely economic, that the actual harm was $130,000, and that a ratio of 3 or 4 to 1 was the due process norm, the Court concluded the  $1.7 million award was constitutionally excessive.   Instead, the Court found $500,000, or a 3.8 to 1 ratio, was the appropriate amount of punitive damages.  Accordingly, the Court of Appeal reversed the trial court's decision insofar as it awarded punitive damages of $1.7 million. 

This opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. These events would render the opinion unavailable for use as legal authority.

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Christopher R. Wagner