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This document is also available as a PDF. Federal Preemption of Extracontractual
Claims Under Flood Insurance Policies
By Lee Craig and Lisa E. Wegrzyn This is one of a series of articles under the by line "Butler Burnette Pappas on Bad Faith" originally published in Mealey's
Litigation Report: Bad Faith , Vol. 12, #16, p.18 (Dec. 15, 1998). Copyright Butler Burnette Pappas 1998. Please also see the Supplement to this article published in January, 1999 following the U.S. Third Circuit Court of Appeals
reversal of its decision on rehearing in Van Holt v. Liberty Mutual Fire Insurance Co. ** ** ** During the past year, numerous areas in the United States have experienced severe and, at
times, unprecedented flooding. Whether the flooding occurred as a result of the active
Atlantic hurricane season or the effect of "El Nino" on national weather patterns, the result
for insurers is the same: an increase in the number of claims under flood insurance policies.
With this comes a corresponding increase in the likelihood of extracontractual or bad faith
claims. This article discusses the right of an insured to sue for extracontractual damages based on
the handling of a claim under the flood insurance program of the National Flood Insurance
Act (the "NFIA"). As will be seen, in many, but not all jurisdictions which have decided the
question, the NFIA preempts state law. For those jurisdictions that have not decided the
question, this article will provide an overview of how preemption principles apply to state
common law claims and statutory remedies, including bad faith and other "extracontractual"
claims, under flood policies. Background of the National Flood Insurance Act The federal system of flood insurance is a bit complicated. In 1968, Congress enacted the
NFIA. (1) The NFIA provides for the issuance of flood insurance policies pursuant to the
National Flood Insurance Program (the "NFIP") (2) . The NFIP is a guaranteed insurance
program administered by the Federal Emergency Management Agency ("FEMA"). (3)
Congress established the NFIP, in part, as "a reasonable method of sharing the risk of flood
losses."(4) It provides flood insurance coverage to all persons, especially persons in high risk
areas who need such protection, at or below actuarial rates.(5) Initially, under the NFIA, private insurance companies formed a pool and contracted with the
Department of Housing and Urban Development to administer the NFIP and issue policies.(6)
Over the years, the program evolved. The Department of Housing and Urban Development
terminated its contractual relationship (7) with the private insurers and FEMA became the
Program Administrator. Eventually, under FEMA's administration of the NFIP, the "Write 1 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm Your Own" ("WYO") Program was created which allowed private insurance companies to
write their own flood insurance policies. (8) These policies are issued by the insurer as the
insurer's own, but the document itself is a standard form approved by FEMA. The insurer
cannot deviate from the approved policy. So, WYO insurance companies issue standard government policies, collect policy premiums,
adjust claims and pay on them.(9) However, WYO insurers keep only the minimum premium
fund necessary to meet claim costs. (10) They hand over the rest to the Flood Insurance
Administration. (11) When an insurance company depletes the premium fund that was "held
back" from the Flood Insurance Administration, the company draws money from FEMA to
cover claims. (12) WYO insurers are responsible for defending suits on claims made under
flood policies.(13) FEMA reimburses the defense costs.(14) Under this system, private insurance companies become "fiscal agents of the United
States."(15) They are not general agents.(16) Although WYO insurers issue the policies, collect
premiums, adjust claims and disburse settlements, FEMA alone bears the risk for the
program. United States Treasury funds ultimately are used to pay claims.(17) And, as stated
above, Treasury funds are used also to reimburse insurers for defense costs.(18) Thus, FEMA
bears the financial responsibility for lawsuits, regardless of whether FEMA or the insurer is
named as the defendant.(19)
Overview of Preemption Federal preemption of state law occurs in one of six ways.(20) 1. Congress passes a statute expressly preempting state law.(21) 2. Congress occupies an entire field leaving no room for state law.(22)
3. Compliance with both federal and state law is impossible.(23)
4. Federal law contains an implicit barrier to regulation by a State.(24)
5. Direct conflict exists between federal and state law.(25) 6. State law obstructs the congressional purpose in passing a federal law. (26)
Few federal statutes preempt state laws applying to insurance companies and insurance
policies.(27) The most prominent example is the Employee Retirement Income Security Act(28)
("ERISA"). ERISA preempts state law by express statutory language. (29) A state law which
"relates to" an employee benefit plan is preempted by ERISA.(30) Courts have interpreted this
preemption broadly to encompass both tort and contract claims for alleged improper claim
handling.(31) ERISA preempts state claims for breach of contract, bad faith, unfair dealing and
intentional infliction of emotional distress.(32)
Preemption of State Law Claims Under the NFIA Unlike ERISA, the NFIA does not contain express preemption language. Nonetheless, most
courts examining the preemption issue have found that the NFIA preempts state common law
and statutory claims based on the following NFIA language:(33) 2 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm [I]nsurance company's and other insurers......may adjust and pay all claims for approved
losses covered by flood insurance in accordance with the provisions of this chapter and,
upon the disallowance by any such company or other insurer of any such claim, or upon
refusal of the claimant to accept the amount allowed upon any such claim, the claimant,
within one year after the date of mailing notice of disallowance or partial disallowance of the
claim, may institute an action on such claim against such company or other insurer in United
States District Court for the district in which the insured property or the major part thereof
shall have been situated, and original exclusive jurisdiction is hereby conferred upon such
court to hear and determine such action without regard to the amount in controversy. Federal courts sitting in Florida,(34) Louisiana,(35) and Mississippi(36) all have found that state
common law and statutory causes of action are barred in disputes arising from policies
issued pursuant to the NFIP. These courts have interpreted the above language to only
authorize suits based on "disputes in coverage, or breach of contract . . . deriving from a
denial of insurance claims." (37) They have relied on the intent of Congress to create a
national unified program for flood insurance. These courts correctly recognize the need for
uniformity of decisions in the application of the law to policies issued pursuant to the
NFIA. (38) The courts note the federal government's extensive participation in the NFIP. (39)
They highlight the government's administrative and financial responsibilities under the
NFIA. (40) Further, they find it significant that Congress failed to include language that
provides for state law claims under the NFIA.(41) Preemption of Actions for Bad Faith A small number of courts have addressed directly the issue of whether the NFIA bars an
action for bad faith. In Stock v. State Farm Insurance Company,(42) the United States District
Court for the Eastern District of Louisiana addressed the issue of whether a claim for bad
faith brought under La. Rev. Stat. § 22:1220 is governed by federal law. The issue was
raised in the context of a motion for remand.(43) The Court denied the motion for remand of
the bad faith claim because the NFIA completely preempted state insurance law, and thus,
federal law controlled all coverage disputes arising out of flood insurance policies. (44)
The Stock Court reasoned that, since Plaintiff first must demonstrate that he is entitled to
coverage before he can be successful in an action for bad faith, the claim for bad faith must
be brought "in connection with" the policy claim.(45) The Court noted that Congress provided
exclusive jurisdiction to the federal courts over actions relating to the adjustment and
payment of flood insurance claims. (46) Accordingly, the Court concluded that federal law
controlled the action for bad faith and the action was within the exclusive jurisdiction of the
federal courts.(47) The Court did not announce the effect of exclusive federal jurisdiction on
the viability of the statutory bad faith claim. Six months after the Stock decision, the United States District Court for the Eastern District
of Louisiana published the opinion in Oppenheim v. Leone. (48) That decision went further
than Stock. It ruled specifically that actions for bad faith under La. Rev. Stat. § 22:1220 are
barred by the NFIA.(49)
In Oppenheim, Plaintiff made a claim under his mother's flood insurance policy for damage to
his house in New Orleans. (50) State Farm denied Plaintiff's claim on the ground that the
damage was not caused by a storm, and therefore, was not covered under the policy. (51) 3 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm After the denial, Plaintiff filed a complaint containing a state law claim for bad faith.(52) State
Farm moved to strike this claim, and for partial summary judgment.(53) State Farm argued that
the flood insurance policy was governed by federal law under the NFIA.(54) Thus, state law
governing insurance policies was preempted by the statute. (55) Plaintiff, on the other hand,
argued that, while the policy was governed by federal law, State Farm's conduct was not.(56)
Plaintiff asserted that, since he was alleging negligent conduct on the part of State Farm's
agent in denying coverage, such conduct was governed by state law including the penalties
of § 22:1220.(57)
The Court granted State Farm's motion finding that the NFIA alone is applicable to questions
of coverage, penalties and attorney's fees. (58) The Court cited the earlier Fifth Circuit
decision in West v. Harris(59) wherein a Plaintiff prevailing in a claim under a flood insurance
policy was not entitled to statutory penalties under state insurance law for denial of
coverage. (60) Based on the Fifth Circuit's interpretation of the NFIA, the Oppenheim Court
concluded that federal law does not recognize a cause of action under § 22:1220. (61)
Preemption of Actions Alleging Fraud by WYO Insurers or their Agents Another cause of action used by insureds to import state law into claims arising from a NFIA
flood policy is alleged fraud. Plaintiffs assert that a fraudulent misrepresentation by the WYO
insurer or its agent misled them about some aspect of coverage. Because such assertions
involve conduct, rather than policy content, the "preemption language" of the NFIA should
not apply. One such case is Stapleton v. State Farm.(62) In Stapleton, the United States District Court
for the Middle District of Florida held that the NFIA preempts state law claims for fraud in the
inducement. In that case, the Plaintiffs alleged that State Farm's agent fraudulently
misrepresented to them that their elevated home would have full coverage for flooding on the
lowest level of the premises.(63) They alleged further that the agent told them this before they
bought the house. (64) They would not have bought it had they known there was no
coverage.(65) A flood damaged the lowest level of the house. (66) State Farm, as provided in the policy,
afforded limited coverage to the damage on that level.(67) Following State Farm's denial of full
coverage, Plaintiffs filed suit for fraud in the inducement and unfair trade practices.(68) State
Farm moved to dismiss, asserting that these state law causes of action were preempted by
the NFIA. (69) After a detailed analysis of the NFIA, the Court agreed and dismissed both
claims.(70)
In ruling on the motion to dismiss, the Court relied on the plain language of the NFIA.(71) The
Court found the NFIA specifically provided for review only of "cases involving disputes in
coverage, or breach of contract causes of action deriving from a denial of insurance
claims." (72) The Act did not provide for state law causes of action arising out of claims
investigations or placement of insurance coverage. (73) The Stapleton Court concluded that
Congress chose narrow language to preempt those state common law and statutory causes
of action.(74) Conversely, in the case of Spence v. Omaha Indemnity Insurance Company(75) the United
States Court of Appeals for the Fifth Circuit distinguished between state law claims alleging
breach of contract and those alleging fraudulent misrepresentation. Plaintiff had made a 4 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm claim for damage to his basement under a flood insurance policy issued by Omaha
Indemnity as a WYO insurer. (76) Omaha Indemnity denied the claim based on a "finished
basement" exclusion. (77) Plaintiff filed suit for breach of contract and fraudulent
misrepresentation. (78) Plaintiff contended that he bought the policy in reliance on
representations made by Omaha Indemnity's agents that the basement would be covered for
flood.(79) In the lawsuit, Omaha Indemnity asserted Plaintiff's claims were time barred. (80) Omaha
Indemnity argued that the one year statute of limitations under the NFIA(81) and its associated
regulations(82) applied rather than the four year limitations period under Texas law for breach
of contract and fraud actions. (83) The trial court denied Omaha Indemnity's motion for
summary judgment. (84) At trial, the jury found Omaha Indemnity liable on both theories. (85)
On appeal, the Fifth Circuit found the breach of contract action time barred, but not the state
law claim for fraud.(86) The Court distinguished between a breach of contract action (which
arises from the partial or complete denial of coverage under a flood policy) and an action for
fraud (which is outside the policy itself and, therefore, attenuated from federal interest). (87)
The Court found it significant that the insurer must issue the policy without alteration and
with the required endorsements. (88) This demonstrates the federal interest in the contract.
Moreover, an action against the insurer under the policy is, in effect, an action against
FEMA.(89) FEMA ultimately is responsible financially for the claim and its defense. In an action for fraud, on the other hand, the WYO-FEMA agreement does not permit the
WYO insurer to receive indemnity from FEMA for its own fraud liability. (90) Further, FEMA
allows WYO insurers almost complete autonomy in the marketing of policies and the
adjustment of claims. (91) Lastly, regulatory language states, "WYO companies shall not be
agents of the federal government." (92) For all those reasons, the federal interest in the
alleged fraud of the WYO insurer is lessened. Preemption of Actions Alleging Unfair Trade Practices As stated above, the United States District Court for the Middle District of Florida has
determined that the NFIA preempts a claim for unfair trade practices under Florida's
Deceptive and Unfair Trade Practices Act (§§ 501.201 - 501.213, Florida Statutes).(93) The
Court based this on "the large administrative role of the federal government" in the NFIP
under the NFIA.(94) The Court relied also on the lack of congressional intent to allow state law
causes of action under the NFIA.(95) The Stapleton court stated, "[n]owhere in the Act is there
any mention of the statutory law of the forum state on any issue."(96)
Preemption of Actions Based on Emotional or Mental Distress Federal law does not provide for recovery of damages based on emotional or mental
distress. (97) Thus, only state common law or statutory law can support such recovery.
Naturally, courts which interpret the NFIA as preempting state law have concluded that
claims for emotional or mental distress are barred.(98) There are two rationales. First, once
state law is preempted, there is no theory for recovery of damages resulting from emotional
or mental distress.(99) Second, as discussed below, damages available under the NFIA are
pecuniary only.(100) Damages and Attorney's Fees under the NFIA 5 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm Generally, if the NFIA preempts state law claims, damages in actions arising out of NFIP
policies must be based on the readily ascertainable value of services and property; that is,
pecuniary damages. (101) The reasoning is that the federal government operates as the
guarantor for all claims and, thus, payment on any claim is made out of Treasury funds.(102)
Allowing recovery for damages that are personal or are punitive would frustrate
congressional intent and defeat the purpose of the NFIA. Increasing the cost of insurance
likely would make it less affordable to persons in high risk areas.(103)
Likewise, the awarding of attorney's fees is prohibited under the NFIA. (104) Some plaintiffs
have tried creatively to obtain attorney's fees in NFIA cases through the Equal Access to
Justice Act.(105) But the courts have rejected this approach because WYO insurers are not
actual agents of the federal government for NFIA purposes.(106) Conclusion A practitioner pursuing or defending claims arising out of a denial of coverage under a flood
policy issued pursuant to the NFIP should not overlook the NFIA preemption issue. The
issue can result in dismissal of state law extracontractual claims including bad faith, fraud
and unfair trade practices. In addition, the Act may limit the prospect of damages that are not
pecuniary, such as punitive damages, attorney's fees and compensation for emotional or
mental distress. ENDNOTES 1. 42 U.S.C. §§ 4001 - 4129. 2. 42 U.S.C. § 4011. 3. See 42 U.S.C. § 4011 and 44 C.F.R. §§ 59.1 - 77.2. 4. 42 U.S.C. § 4001(a)(3). 5. Gowland v. Aetna, 143 F.3d 951, 953 (5th Cir. 1998). 6. See generally Holt v. Liberty Mutual Fire Insurance Company , No. 97-5098, 1998 U.S.
App. LEXIS 29985, *9-10 (3d Cir. November 25, 1998) and Spence v. Omaha Indemnity
Insurance Company , 996 F.2d 793, 794 n. 1 (5th Cir. 1993) (describing the early
organization of the NFIP under the Act). 7. 42 U.S.C. § 4071. 8. 42 U.S.C. § 4081(a) and 44 C.F.R. § 62.23. 9. 42 U.S.C. § 4071. 10. See Holt, *10. 6 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm 11. Id. 12. Id. 13. 44 C.F.R. § 62.23(i)(6) 14. Id. 15. 42 U.S.C. § 4071(a)(1). See also, Gowland, at 953. 16. 44 C.F.R. § 62.23(g). 17. Id. 18. See supra note 13. 19. See supra note 10, at *13. 20. Meyer v. National Farmers Union Property and Casualty Company, 957 F. Supp. 1492,
1498 (D. Wyo. 1997). 21. Id. 22. Id. 23. Id. 24. Id. 25. Id. 26. Id. 27. Statutes preempting state laws applying to insurance companies and/or their policies
include the Employee Retirement Income Security Act, 29 U.S.C. § 1001, et. seq. , the
Federal Employees Health Benefits Act, 5 U.S.C. 8901, et. seq., the Federal Crop Insurance
Act, 7 U.S.C. §§ 1501 - 1521 (split in authority dealing with Multiple Peril Crop Insurance)
and the National Flood Insurance Act, 42 U.S.C. § 4001 et. seq. (split in authority). 28. ERISA governs employee benefit plans and functions to promote the interests of
employees and their beneficiaries. 29 U.S.C. §§ 1003(a), 1002(1). 29. 29 U.S.C. §§ 1144(a). 30. Id. 31. See Mein v. Pool Company, 989 F. Supp. 1337, 1344 (D. Colo. 1998) (discussing the
history of ERISA preemption of state law claims). 7 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm 32. Id. 33. 42 U.S.C. § 4053. 34. See, e.g., Stapleton v. State Farm Fire and Casualty Company, 11 F. Supp. 2d 1344, No.
98-1180-CIV-T-17, 1998 U.S. LEXIS 11756, *8 (M.D. Fla. 1998). 35. See, e.g., Durkin v. State Farm Mutual Insurance Company, 3 F. Supp. 2d 726, 728 (E.
D. La. 1997). 36. See, e.g., Eddins v. Omega Insurance Company, 825 F. Supp. 752 (N.D. Miss. 1993). 37. Stapleton, at *7. 38. See e.g., West v. Harris, 573 F.2d 873, 881 (5th Cir. 1978). 39. See, e.g., Schopen v. State Farm Insurance Co., No. 96-1892 (1), 1996 U.S. Dist. LEXIS
18134, *4 (E.D. La. December 2, 1996). 40. See, e.g., Durkin, at 728. 41. See, e.g., Stapleton, at *7. 42. No. 96-1903 (K)(3), 1996 U.S. Dist. LEXIS 5051 (E.D. La. September 30, 1996). 43. Id. , at *2. The Court did not dismiss the cause of action for bad faith, but rather
re-characterized the claim as a federal one. 44. Id., at *9 -11. 45. Id., at *9 -10. 46. Id., at *11. 47. Id. 48. No. 96-1905 (L), 1997 U.S. Dist. LEXIS 3538 (E.D. La. March 19, 1997). 49. Id., at *3 -4. 50. Id. at *1-2. 51. Id. at *2. 52. Id., at *2 -3. 53. Id. 54. Id. 8 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm 55. Id. 56. Id. at *3. 57. Id. 58. Id. at *2. 59. 573 F.2d 873, 881 (5th Cir. 1978). 60. Oppenheim, at *2-3. 61. Id. at *4. 62. Stapleton, *8. 63. See generally Stapleton v. State Farm Fire and Casualty Company , Court
No.98-1180-CIV-T-17(E) (court file). 64. Id. 65. Id. 66. Id. 67. Id. 68. Id. 69. Stapleton, at *5. 70. Id., at *5, *9. 71. Id., at *7 -8. 72. Id., at *7. 73. Id. 74. Id., at *7 - 8. 75. 996 F.2d 793 (5th Cir. 1993). 76. Id. 77. Id. 78. Id., at 794. 9 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm 79. Id. 80. Id., at 795. 81. 42 U.S.C. § 4072. 82. 44 C.F.R. § 61. 83. Id., at 794 - 795. 84. Id., at 794. 85. Id. 86. Id., at 795 - 796. 87. Id. 88. Id. , at 795 citing 44 C.F.R. § 61.13(a) (providing for standard flood insurance policy
forms) and 44 C.F.R. § 61.13(d) (providing policies to be issued without alteration). 89. Id., at 795. 90. Id., at 796 citing 44 C.F.R. § 62.23(a) (dealing with defense and award reimbursement). 91. Id., citing 44 C.F.R. § 62.23(e) (addressing the marketing and management of policies). 92. Id., citing 44 C.F.R. § 62.23(g). 93. Stapleton, at *9. 94. Id. 95. Id. 96. Id. 97. Schopen, at *4. 98. Id., at *4 -5, see also, Friedman v. South Carolina Insurance Company, 855 F. Supp.
348, 350 (M.D. Fla. 1994). 99. Friedman, at 350. 100. Schopen, at *4 -5. 101. See, e.g., West, 573 F.2d at 883; Eddins, 825 F. Supp. at 754; Stapleton, at *8. 10 of 11 8/7/99 4:22 PM Federal Preemption of Extracontractual Claims Under Flood Insurance Policies http://www.bbplaw.com/publications/9812bf.htm 102. Durkin, 3 F. Supp. 2d 724, 729. 103. Id. 104. Id., See also, Schopen, at *5; Friedman, at 350. 105. The Equal Access to Justice Act, 28 U.S.C. § 2412(d)(1)(a) authorizes an award of
attorney's fees in cases against the government unless the government's position is
"substantially justified." 106. See, e.g., Schopen, at *5. [ Home | Our Practice | Attorneys | Cases | Publications | Events | Clients | Contact | Offices ] 11 of 11 8/7/99 4:22 PM |
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