Contractor recovered judgment against Argonaut for: $24,781 for breach of insurance contract, $229,209 for insurance bad faith, $424,100 for fraud and $14 million in punitive damages based on fraud.

Contractor claimed coverage under a worker's compensation policy that was issued under an employee leasing program. Under such programs, a contractor selects some of its workers to become employees of the lessor while retaining direct employment of its white collar workers. The lessor becomes the employer of the work crews; handles payroll, safety, tax, benefits and worker's compensation insurance; and then leases the work crews back to the contractor. A leasing company may have thousands of employees working for several hundred contractors and thereby can get favorable rates for worker's compensation insurance. Over a four-year period, lessor paid Argonaut more than $10 million in premiums, and Argonaut paid claims totaling $6.4 million. Under the worker's compensation policy, lessor was the named insured.

In order to obtain a building permit, a contractor must show that it has worker's compensation insurance. Health and Safety Code §19825 (a), Labor Code §3800. The leasing contract specified that lessor would provide contractor with certificates of insurance. These were routinely issued by Argonaut's agent, Gallagher, on a standardized Accord certificate. The standard form was confusing to contractors and municipalities unaccustomed to employee leasing arrangements because the contractor seeking the permit was not listed as the "insured." As a result, Argonaut decided to substitute the name of the contractor on the certificate and to insert language that only employees of lessor working on the jobsite "are insured" [sic]. Argonaut and lessor intended that Argonaut was insuring only lessor and not the client contractors.

Contractor, a cabinet and woodworking business, was under contract with lessor from 1995 until the lessor filed for bankruptcy in 1998. More than one year into the contract, contractor asked for a certificate of insurance, and lessor provided it. The certificate described the contractor as the "insured"; said it was issued for information only; said it conferred no rights upon the certificate holder; and stated that only employees of lessor performing work within the nature and scope of their construction employment "are insured under evidence of coverage provided." Contractor testified that when he reviewed the certificate he understood that contractor was the insured since contractor's name was in the "insured" box.

Leasing companies run a risk that a contractor will pay a worker in cash and then, if the worker is injured, seek worker's compensation coverage under lessor's policy. Therefore, the contract provided that no worker would be a lessor employee until the worker completed and signed the pages of a hiring packet and lessor gave written approval for that person to be hired.

The contract also provided that lessor would have an onsite supervisor and would be responsible for management and supervision of the workers. But, these contract provisions never were implemented. Contractor actually handled hiring, training and supervision. In practice, contractor submitted the application packet when the worker was first paid, and lessor always paid wages from the first day of employment regardless of the lack of a timely employment application and without pre-approval.

Contractor employed a worker, gave him a brief training session in woodcutting and put him on the job. Worker later that day severed four fingers while operating a pneumatic whirlwind saw. Supervisor then completed the employment packet, signed worker's name to it and faxed it to lessor together with an injury report. An investigator for lessor interviewed worker in the hospital and found that worker had not signed the application and had never heard of lessor but thought he was an employee of contractor. Lessor informed Argonaut that worker was not an employee and should be denied coverage. Argonaut denied the claim.

Worker contested the denial of the claim, filed for benefits against the Uninsured Employers Fund and sued contractor for tort damages alleging that contractor had failed to secure worker's compensation coverage.

After 18 months of litigation, Argonaut settled with worker for $110,000 and paid medical liens of $130,000; worker dismissed its claims against the Uninsured Employers Fund and against contractor. This litigation followed.

The trial court granted a new trial unless contractor accepted a remittitur of fraud damages to $404,270 compensatory and $5.5 million punitive. Contractor accepted. The judgment was affirmed in part. But, the fraud and punitive damages award was reversed unless contractor consented to a remittitur of the fraud damages to $258,570 and of the punitive damages to $1 million. Diamond Woodworks, Inc. v. Argonaut Insurance Co., 109 Cal.App.4th 1020, 135 Cal.Rptr.2d 736, 2003 DJDAR 6480 (2003).

Breach of contract. The contract required lessor to provide worker's compensation insurance. Uncontradicted evidence showed that lessor invariably employed the workers employed by client contractors from the day they started on the job regardless of paperwork. When the conduct of parties is clearly contrary to the provisions of the contract, a modification setting aside the written provisions is implied. Garrison v. Edward Brown & Sons, 25 Cal.2d 473 (1944). The modification is supported by consideration since contractor performed training and supervision duties on behalf of lessor. Because worker was an employee of lessor, he was entitled to worker's compensation benefits under the Argonaut policy.

Contractor's rights under the policy. Although not a named insured, contractor was a third party beneficiary under the Argonaut insurance contract. Lessor purchased the Argonaut policy for the very purpose of fulfilling its promise to contractor to obtain worker's compensation insurance. This secured for contractor the protection of Labor Code §3602 (d), which applies to employee leasing arrangements. Shell v. Schmidt, 126 Cal.App.2d 279 (1954). The sole purpose of the certificate of insurance was to prove contractor's compliance with Labor Code §3602 (d). Therefore, contractor had a right to have Argonaut promptly pay benefits to the injured worker.

Bad faith. Argonaut acknowledged its failure to investigate the worker's claim was a breach of the implied covenant of good faith and fair dealing. As a third party beneficiary, contractor was entitled to assert a bad faith claim.

Fraud. Argonaut made a promise without any intention of performing it. Civil Code §1710 (4). Lessor in its modified contract made promises that it did not intend to fulfill, including a promise that new hires would be lessor's employees from Day One. The jury properly inferred that lessor intended to deny insurance coverage to a worker hired before paperwork was completed. Lessor acted as Argonaut's agent. Argonaut gave lessor authority to bind insurance in a letter from its underwriting manager to the CEO of lessor.

Compensatory fraud damages. The verdict included $124,000 in fees paid by contractor to lessor, but there was no substantial evidence indicating contractor paid something for nothing. Lessor paid wages. Thus, affirmance was subject to remittitur calculated with reference to that amount.

Punitive damages. Punitive damages for fraud are allowed when it is proven by clear and convincing evidence that the defendant is guilty of oppression, fraud or malice. Civil Code §3294 (a). Argonaut immediately and consistently refused to provide coverage, showing an absolute unwillingness even to attempt performance. But, the award must be further remitted as required by State Farm Mutual Automobile Insurance Co. v. Campbell, ___ U.S. ___, 123 S.Ct. 1513, 155 L.Ed.2d 585 (2003). The U.S. Supreme Court has held that awards of punitive damages must be reasonable and proportionate to the wrong committed and that any irrational and arbitrary award of punitive damage violates the due process clause of the 14th Amendment.

Guideposts referred to by the Supreme Court indicate that an award of punitive damages should be at or near the amount of compensatory damages. The court must evaluate the reprehensibility and the ratio of punitive to compensatory damages and compare the punitive damages with civil or criminal penalties that could be imposed for comparable misconduct.

Here, the harm to contractor was economic, not physical. But, Argonaut's indifference to the health and safety of the maimed worker directly impacted contractor. Argonaut's conduct was sufficiently reprehensible to support an award of punitive damages. But, anything exceeding a ratio of 4 to 1 would not comport with due process under Campbell. The wealth of a defendant cannot justify an otherwise unconstitutional punitive damage award. The $5.5 million in punitive damages (more than 21 times greater than compensatory) are remitted. Nevertheless, a jury did determine that Argonaut's conduct was fraudulent and reprehensible. Accordingly, the Court of Appeal held the ratio should approximate the outer limit and, therefore, remanded for new trial on the punitive damages issue unless the contractor consented to a reduction in punitive damages to $1 million.

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