In insurance fraud cases involving actual or alleged destruction of evidence by the insured, an issue often arises regarding whether an adverse inference instruction is appropriate, and, if so, what form it should take. The Second Circuit recently approved a “light” form of adverse inference instruction that allowed the jury to make an adverse inference about the allegedly destroyed evidence, depending on what facts it found, without requiring the insurer to satisfy a heightened standard of proof in order to obtain such an instruction. The Second Circuit also held that the insurer was required to assert a counterclaim in order to recover payments made prior to discovery of the alleged fraud.
In Mali v. Fed. Ins. Co., 2013 U.S. App. LEXIS 11874 (2d Cir. June 13, 2013), plaintiffs appealed following a jury verdict in favor of their insurer, Federal Insurance Company, in connection with Federal’s denial of plaintiffs’ claim for a barn that was destroyed by a fire. The jury found that plaintiffs had forfeited coverage by submitting fraudulent claims relating to the value of the barn and its contents. Specifically, the plaintiffs had submitted a sketch of the layout of the barn which included fourteen rooms, including a second floor with four rooms and a bathroom, as well copper gutters, pine hardwood floors, and four refrigerators. After Federal questioned the validity of the sketches and declined to make any further payments, plaintiffs filed suit.
During the course of discovery, Federal demanded that plaintiffs produce photographs of the interior of the barn, and in particular, the second floor. Plaintiffs responded that they had no photographs of the second floor. However, at trial the plaintiffs called their antiques appraiser to testify regarding the value of certain items, and in the course of her testimony she stated that she was shown photographs depicting both the items and the interior of the barn, including a photograph of the second floor. Plaintiffs disputed this statement, and testified that they had provided the appraiser with photographs of the items, but not of the barn or the second floor.
After the parties rested, Federal moved for an adverse inference jury instruction as a “sanction” for the Plaintiff’s discovery misconduct. The district court declined to instruct the jury that the evidence “tended to show” that the plaintiffs withheld evidence, but did provide a “light” form of adverse inference instruction, as follows:
In this case, evidence has been received which the Defendant contends shows that a photograph exists or existed of the upstairs of what had been referred to as the barn house, but no such photograph has been produced. If you find that the Defendant has proven by a preponderance of the evidence, one, that this photograph exists or existed, two, that the photograph was in the exclusive possession of the Plaintiffs, and, three, that the non-production of the photograph has not been satisfactorily explained, then you may infer, though you are not required to do so, that if the photograph had been produced in court, it would have been unfavorable to the Plaintiffs. You may give any such inference, whatever force or effect as you think is appropriate under all the facts and circumstances.
On appeal, plaintiffs claimed that it was error for the district court to give the instruction because “the court imposed a sanction without first making the findings necessary to justify the sanction.” The Second Circuit disagreed, ruling that the instruction given by the court was not a sanction, but rather an explanation of inferences the jury was free to draw depending on its findings.
The Second Circuit differentiated the type of instruction given from those adverse inference instructions that are expressly based on a party’s destruction or withholding of evidence. Were the court to have instructed that evidence was in fact destroyed or withheld, and that the jury could draw an adverse inference from its absence, the Court agreed that the district court would have needed to make a finding that the plaintiff’s in fact showed their appraiser a picture of the second floor, and then failed to produce it in discovery. See Residential Funding Corp. v. DeGeorge Financial Corp, 306 F.3d 99, 107 (2d Cir. 2002). Here, though, the Second Circuit found that it was “fundamentally different” to simply explain to the jury “as an example of the reasoning process known in law as circumstantial evidence” that a jury’s finding of certain facts may (but need not) support a further finding that other facts are true. The Second Circuit ruled that such an instruction is not “punishment” or a “sanction,” since the court did not direct the jury to accept any fact as true, and therefore it did not require any factual findings.
Federal also argued that it was entitled to (1) attorney fees and (2) restitution of the payments made to the plaintiffs following the jury’s specific finding that plaintiffs had submitted fraudulent claims. While keeping the door open to the recovery of both categories of expenses, the Second Circuit declined to award them in this case.
As to the claim for attorney fees, the Second Circuit noted that the “American rule” dictates that, absent a statute providing otherwise, the parties to litigation pay their own attorney fees regardless of the outcome. The court did recognize that there was a “narrow exception” to this rule for cases that have been prosecuted in bad faith, but that in order to make such an award, the district court must find by “clear evidence” that (1) the offending party’s claims were “entirely without color,” and (2) the offending party’s claims were made in “bad faith.” Here, the Second Circuit ruled that the district court had made no such findings and therefore Federal was not entitled to attorney fees.
The court similarly rejected Federal’s post-trial motion for equitable relief to recover payments it had made to the plaintiffs prior to declining the claim for fraud. The Second Circuit ruled that such recovery was available as a remedy, but ruled that such the claim must have been brought by way of counterclaim. See Fed. R. Civ. P. 13(a).
This case is particularly helpful to insurers seeking an adverse inference instruction because it concludes that the heightened standard sometimes applied in order to obtain such an instruction does not apply to a lighter form of adverse inference instruction. The case also demonstrates the importance of asserting a counterclaim if the insurer intends to seek recoupment of amounts paid.