The Arizona Court of Appeals recently upheld a trial court’s reduction of a $55 million punitive damages award to only $620,000 and further reduced the punitive damages to $155,000-a 1:1 ratio to compensatory damages.
The case, Nardelli v. Metro. Group Prop. & Cas. Ins. Co., — Ariz. —, 277 P.3d 789 (App. 2012) (Arizona Reporter citation not yet available), arose from the theft of a recently purchased automobile. In December 2001, the Nardellis purchased a new 2002 Ford Explorer and obtained comprehensive insurance coverage from MetLife. In September 2002, the vehicle was stolen and eventually found abandoned in Mexico with slit seats, cut wires, a torn interior, VIN numbers removed and what turned out to be a ruined engine. A dispute ensued between the insurer and insureds regarding whether the vehicle should have been repaired or totaled. The insurer’s repair estimate increased from an initial estimate of only $815 to $11,000, but the insurer refused to total the vehicle. According to the insureds, the insurer’s claims supervisor eventually told the insureds he was mailing a check for $11,000, the insurer’s obligations would then be met, and the insureds could do whatever they wanted with the check and their vehicle. The insureds turned the check over to the dealership and voluntarily allowed the lender to repossess the vehicle.
The insurer appealed the jury’s decision to award punitive damages and the insureds appealed the trial court’s reduction of punitive damages.
Punitive Damages Liability
The Court of Appeals began its analysis of punitive damages liability in an insurance bad faith case by summarizing Arizona law on this issue. “1To recover punitive damages, the plaintiff must show something more than the conduct necessary to establish the tort of bad faith. [Arizona has] developed a shorthand reference for this ‘something more,’ requiring the plaintiff to prove that defendant’s evil hand was guided by an evil mind. The requisite ‘evil mind’ may be manifested in either of two ways. It may be found where defendant intended to injure the plaintiff [or] where, although not intending to cause injury, defendant consciously pursued a course of conduct knowing that it created a substantial risk of significant harm to others. [P]unitive damages are recoverable in a bad faith tort action when,and only when, the facts establish that defendant’s conduct was aggravated, outrageous, malicious or fraudulent. Indifference to facts or failure to investigate are sufficient to establish the tort of bad faith but may not rise to the level required by the punitive damage rule…. When defendant’s motives are shown to be so improper, or its conduct so oppressive, outrageous or intolerable that such an ‘evil mind’ may be inferred, punitive damages may be awarded. Further, the plaintiff must prove the defendant’s evil mind by clear and convincing evidence. A plaintiff may meet the clear and convincing standard by either direct or circumstantial evidence, and we may infer an ‘evil mind’ from a defendant’s conduct or objectives. [U]nless the defendant is willing to take the stand and admit its ‘evil mind,’ the plaintiff must prove entitlement to punitive damages with circumstantial evidence.”
The Court of Appeals found the following facts presented clear and convincing evidence that the insurer acted with an “evil mind” when it decided to repair rather than total the theft-recovered vehicle: (1) by November 2001, the insurer “instituted an aggressive company-wide profit goal for 2002”; (2) the insurer “assigned the claims department a significant role in achieving that goal”; (3) the insurer “aggressively communicated this goal to the claims department (including the office and employees handling [the insureds’] claims)”; (4) the insurer “tied the benefits of claims offices and individuals to, among other things, the average amount paid on claims”; (5) the insurer’s efforts to reach its profit goal influenced how its employees handled claims; and (6) the insurer did nothing to ensure its focus on meeting its profit goal did not affect how its employees handled, evaluated and assessed claims.”Accordingly, the Court of Appeals upheld the jury’s decision to award punitive damages.
Punitive Damages Constitutionality
Nardelli began its analysis of punitive damages constitutionality by noting, the “Due Process Clause of the United States Constitution imposes a substantive limit on the size of punitive damages awards.” Next, the Court of Appeals cited the three guideposts identified by the United States Supreme Court to consider when determining whether a punitive damages award complies with due process: (1) the degree of reprehensibility of the defendant’s misconduct, (2) the disparity or ratio between the actual or potential harm suffered by the plaintiff and the punitive damages award, and (3) the difference between the punitive damages awarded by the jury and the civil penalties authorized or imposed in comparable cases.
First, regarding reprehensibility, a court should consider: (a) whether the harm caused was physical as opposed to economic, (b) whether the tortious conduct evinced an indifference to or a reckless disregard of the health or safety of others, (c) whether the target of the conduct was financially vulnerable, (d) whether the conduct involved repeated actions or was an isolated incident and (e) whether the harm was the result of intentional malice, trickery, or deceit or mere accident.
In Nardelli, the Court of Appeals reasoned: (a) the harm to the insureds was significant, but largely economic; (b) the insureds presented no evidence that the insurer knowingly or intentionally intended to aggravate one of the insured’s pre-existing mental health conditions; (c) there was no evidence of financial vulnerability; (d) although the Court of Appeals could not state the insurer’s conduct was an isolated incident, there was no evidence that the insurer’s actions were part of a longstanding practice or similar to Hawkins v. Allstate, another Arizona case in which an insurer engaged in an established company policy of automatically taking an arbitrary, predetermined deduction while adjusting the value of a property loss; and (e) the insureds presented evidence that the insurer acted affirmatively rather than accidentally by repeatedly distancing itself from its own claims handling guidelines.Based on these five factors, the Court of Appeals concluded that the insurer’s “misconduct f[ell] within the low to, at most, middle range of the reprehensibility scale.”
Second, regarding the disparity or ratio between compensatory and punitive damages, Nardelli insisted it did “not impose a bright-line ratio between compensatory and punitive damages.” Nonetheless, the Court of Appeals stated, “an award of more than four times the amount of compensatory damages might be close to the line of constitutional impropriety and when compensatory damages are substantial, a lesser ratio, perhaps only equal to compensatory damages, can reach the outermost limit of the due process guarantee.” The Court of Appeals reasoned that, based on the “substantial” compensatory damages award of $155,000, Arizona case law regarding “the appropriate ratios between compensatory and punitive damages,” and the reprehensibility review, “the evidence d[id] not support [either] the roughly 355:1 ratio the jury imposed [or] the 4:1 ratio the superior court imposed.”
Third, regarding comparative penalties, Nardelli noted the Arizona legislature capped civil penalties for unfair claims settlement practices at $50,000 per six-month period and concluded “[t]hese civil penalties alone would not have given [the insurer] notice its practices could result in a $55 million punitive award.” Nardelli, 277 P.3d at 808. Also, although Arizona previously upheld a $3.5 million punitive damages award against an insurer in Hawkins v. Allstate, the Court of Appeals characterized the insurer’s misconduct in Hawkins as intentional and clear, but the insurer’s misconduct in Nardelli as pervasive but stemming from the insurer’s simple failure to control or mitigate the effect of a profit goal on claims employees.
In summary, applying the three guideposts, the Court of Appeals concluded: (1) the reprehensibility of the insurer’s misconduct was low to moderate, (2) the ratio of the punitive damages to the substantial compensatory damages was large, and (3) the applicable civil penalties were far less than the punitive damages award. Thus, “the $55 million in punitive damages awarded by the jury was unconstitutionally excessive [and, a]lthough the superior court reduced the punitive damages to $620,000 (a 4:1 ratio to the compensatory damages), the record [did] not justify awarding punitive damages at a ratio above 1:1 ($155,000).” Accordingly, the Court of Appeals vacated the judgment of punitive damages and directed the superior court to enter judgment awarding the insureds only $155,000 in punitive damages on remand.
The Nardelli case is a significant development in Arizona punitive damages law in at least two respects. First, it appears to reduce insurers’ exposure to large punitive damages awards in bad faith cases, because it moves Arizona closer to a 1:1 ratio between compensatory and punitive damages as the demarcation of constitutionally acceptable punitive damages. Second, it held that an insurer’s failure to control or mitigate the effect of an aggressive, company wide profit goal on the way claims employees adjust claims constitutes bad faith and demonstrates the requisite “evil mind” entitling an insured to punitive damages.
About the Author: Nathan D. Meyer is a Partner at the Phoenix law firm of Jaburg Wilk. One of his specialties is insurance coverage and bad faith. Nate advises and represents his insurance clients in coverage, bad faith, contribution and liability matters.
 Nardelli, 277 P.3d at 801 (citing Thompson v. Better-Bilt Aluminum Prods. Co., 171 Ariz. 550, 556, 832 P.2d 203, 209 (1992) (quoting Rawlings, 151 Ariz. at 161, 726 P.2d at 577).
 Nardelli, 277 P.3d at 801 (citing Rawlings, 151 Ariz. at 162, 726 P.2d at 578.
 Nardelli, 277 P.3d at 801.
 Id. at 801 (italics in original) (citing Rawlings, 151 Ariz. at 578-79, 726 P.2d at 162-63).
 Nardelli, 277 P.3d at 801 (citing Linthicum v. Nationwide Life Ins. Co., 150 Ariz. 326, 332, 723 P.2d 675, 681 (1986).
 Nardelli, 277 P.3d at 801 (citing Hyatt Regency Phoenix Hotel Co. v. Winston & Strawn, 184 Ariz. 120, 132, 907 P.2d 506, 518 (App.1995), Hudgins v. Southwest Airlines, Co., 221 Ariz. 472, 487, 212 P.3d 810, 825 (App.2009).
 Nardelli, 277 P.3d at 801 (italics in original) (citing Hawkins v. Allstate Ins. Co., 152 Ariz. 490, 498, 733 P.2d 1073, 1081 (1987).
 Nardelli, 277 P.3d at 802.
 Id. at 806 (citing Sec. Title Agency, Inc. v. Pope, 219 Ariz. 480, 501, 200 P.3d 977, 998 (App. 2008).
 See Nardelli, 277 P.3d at 806-07 (citing State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408, 418, 123 S.Ct. 1513, 1520 (2003).
 See Nardelli, 277 P.3d at 807.
 152 Ariz. 490, 498, 733 P.2d 1073, 1081 (1987).
 Id. at 807 (citing Hawkins, 152 Ariz. at 502, 733 P.2d at 1085.
 See Nardelli, 277 P.3d at 807-808.
 Id. at 808.
 Id. (citing Pope, 219 Ariz. at 503, 200 P.3d at 1000); State Farm Mut. Auto. Ins. Co. v. Campbell,538 U.S. 408, 425, 123 S.Ct. 1513, 1524 (2002).
 See Nardelli, 277 P.3d at 808.
 152 Ariz. 490, 733 P.2d 1073
 See Nardelli, 277 P.3d at 808 (citing Hawkins, 152 Ariz. 490, 733 P.2d 1073).
 See Nardelli, 277 P.3d at 809.