Facts

On Oct. 3. 1988, Metropolitan Business Management Inc. (MBM) became the beneficiary of the first deed of trust on property at 29244 Greenwater Road in Malibu. The property was owned by Dominic Annino who contracted with MBM and John Khaki (plaintiffs) to provide services related to his properties including management and maintenance. At the time of the recording, Allstate Insurance Co. (Allstate) issued the Landlords Package Policy to Annino which stated that all provisions of the agreement applied to mortgagees of the property. In December 1997, Allstate changed the terms of the policy, eliminating general liability protection to mortgagees, without giving notice to plaintiffs. On May 18, 2001, Eliot and Cyndi Felman sued plaintiffs for fraud and conspiracy alleging that MBM had misrepresented the amount still owing on its deed of trust on the property. Plaintiffs sent the Felman's suit to Allstate, who rejected it. Allstate's protocol was to look to the current policy terms for coverage and not check to see if earlier policy terms applied. Plaintiffs spent $387,153 defending the suit. On Oct. 18, 2005, plaintiffs filed the instant action against Allstate alleging the following: breach of contract, tortuous breach of the implied covenant of good faith and fair dealing, and declaratory relief. On Nov. 23, Allstate removed the case to federal court on the basis of diversity of citizenship. On May 26, 2006, the court granted Allstate's motion for summary judgment. Plaintiffs appealed. On June 11, 2008, the Ninth Circuit reversed and remanded the case for further proceedings. On Jan. 26, 2009, the court denied plaintiffs' motion for summary judgment stating that that it could not conclude that plaintiffs were unequivocally entitled to coverage because factual disputes existed as to which policy applied and whether plaintiffs were covered as "additional insureds" or "mortgagee insureds." On March 16, the court denied Allstate's motion for summary judgment on the same grounds. On July 6, Allstate filed a motion for judgment as a matter of law. On July 9, the jury returned a verdict in favor of plaintiffs. On July 10, the parties submitted the punitive damages phase to the court with plaintiffs requesting $7 million. On Aug. 4, Allstate moved for summary judgment on the merits of the case and on plaintiffs' claims for declaratory relief and punitive damages.

PLAINTIFFS' CONTENTIONS:
Plaintiffs argued that Allstate had a duty to give mortgagee-insureds 10 days notice before canceling or refusing to continue or renew a policy. Plaintiffs further argued that they were mortgagees from the inception of the policy, that Allstate knew they were listed as mortgagee-insureds, that the original policy terms required Allstate to defend claims based on misrepresentation, that all provisions of that policy applied equally to mortgagees, that the policy required Allstate to give plaintiffs 10 days notice, and that Allstate did not provide notice that it was refusing to continue covering misrepresentation and reducing coverage for mortgagees. Plaintiffs argued that, in the event an insurer fails to provide adequate notice of a change in policy, the earlier policy terms control. Finally, plaintiffs argued that punitive damages were warranted because there was ample evidence that Allstate deliberately tried to conceal the new policy terms, adopted an unreasonably narrow interpretation of the policy, failed to timely respond to plaintiffs tender of defense, had a policy of evaluating claims based on current terms while failing to investigate the applicability of past policies, and concealed records which proved that plaintiffs had been insureds since 1995. Regarding punitive damages, plaintiffs argued that damages were appropriate because Allstate's protocol was clearly illegal and that an award of $7 million was necessary to punish and deter Allstate from continuing such an illegal policy.

DEFENDANT'S CONTENTIONS:
Allstate argued that plaintiffs were not a "named insured" or "additional named insured" and thus they were not entitled to notice of the change in policy terms. It claimed that MBM's request to become an "additional insured" was never effectuated and that, in any event, such a request would not have triggered a duty to notify because MBM still would not have been an "additional named insured." Allstate conceded that the "evidence insurance" did list MBM as an insured, but only as a mortgagee. Allstate argued that, as mortgagees, plaintiffs were not entitled to notice. It claimed that a mere change in policy does not trigger the duty to notify mortgagees. Allstate further argued that plaintiffs were not entitled to coverage under the terms, which were applicable at the time of the suit. It argued that mortgagees are only entitled to first-party property coverage and not liability coverage. It claimed that it was not objectively reasonable for a mortgagee to expect liability coverage under a landlord policy. Allstate also argued that plaintiffs were not sued in the capacity under which the policy covered them but in their own capacity as mortgagees and lienholders. Furthermore, it argued, they were not covered because their actions were not in the scope of alleged employment. Allstate argued that the underlying suit arose out of alleged fraud and the policy, in any case, did not cover intentional acts. Regarding the claim of bad faith, Allstate argued that there was a genuine dispute as to coverage and that its conduct was reasonable in part because it consulted legal counsel before coming to the conclusion that plaintiffs were not covered. Allstate also argued that the law did not support the request for $7 million in punitive damages because the compensatory damage award was substantial.

Result

The jury found that Allstate unreasonably withheld policy benefits owed to plaintiffs and that the conduct was malicious, oppressive, or in reckless disregard of plaintiffs' rights. The court denied Allstate's motion for judgment as a matter of law finding that, as mortgagees, plaintiffs were entitled to notice of the policy change. The court found that plaintiffs had provided sufficient evidence for a reasonable jury to find that Allstate had acted in bad faith and that plaintiffs were entitled to declaratory relief and punitive damages. Having found that Allstate had a duty to defend the underlying lawsuit, the court granted plaintiffs' request for declaratory relief. Finally, the court granted plaintiffs' request for punitive damages in the amount of $3 million, finding that an award of $7 million was excessive.