* District Judge of the Northern District of Texas, sitting by

designation. UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

__________________

No. 94-30558

__________________

In the Matter Of: HANNOVER CORPORATION OF

AMERICA, ET AL.,

Debtors,

WILLIAM G. HAYS, JR., Receiver for

Debtor-In-Possession rpi Redwood

Raevine Corporation,

Appellant,

versus

STATE FARM MUTUAL AUTOMOBILE

INSURANCE COMPANY,

Appellee.

______________________________________________

Appeal from the United States District Court for the

Middle District of Louisiana

______________________________________________

(October 4, 1995)

Before JOLLY and BENAVIDES, Circuit Judges, and FITZWAT ER *

, District Judge.

BENAVIDES, Circuit Judge:

The central issue of this appeal is whe ther an insurance

company's refusal to pay a claim on a stolen automobile was

unreaso nable entitling the claimant to statutory penalties and

attorneys' fees under Louisiana law. Concluding that the2

bankruptcy court clearly erred in finding that the insurance

company was reasonable in its refusal to pay the claim, we reverse

and remand for further proceedings.

FACTUAL AND PROCEDURAL BACKGROUND

Appellant William G. Hays, Jr. ("the Receiv er"), is the

Receiver for Debtor-in-Possession, Redwood Raevine Corporation

("Redwood"), wh ich is a part of various bankrupt companies

associated with an individual, Sam Recile. By a July 29, 1992

order of the United States District Court for the Eastern District

of Louisiana, the Rec eiver took possession of Redwood's assets,

including a 1991 Mercedes Benz automobile that is at the center of

this controversy. This order also enjoined Redwood from selling,

disposing of, or encumbering any asset of the company without prior

court approval.

On August 24, 1992, the Receiver reported to the police that

the Mercedes had been stolen from the Redwood complex. The next

day, the Receiver notified the insurer of the car, appellee State

Fa rm Mutual Automobile Insurance Company ("State Farm"), of the

loss. State Farm, however, refused to settle the claim because it

was investiga ting whether or not the Mercedes had actually been

stolen. Apparently, State Farm had been informed that the car had

been sold and exported several days before the reported theft.

On June 25, 1993, the Re ceiver initiated an adversary

proceeding seeking payment of the loss, with interest, costs, and

statutory penalties and attorneys' fees under Louisiana Revised1 Section 22:658 provides:

A. (1) All insurers issuing any type of contract . . .

shall pay the amount of any claim due any insured

within thirty days after receipt of satisfactory proofs

of loss from the insured or any party in interest.

. . . .

B. (1) Failure to make such payment within thirty days

after receipt of such satisfactory written proofs and

demand therefor . . . when such failure is found to be

arbitrary, capricious, or without probable cause, shall

subject the insurer to a penalty, in addition to the

amount of the loss, of ten percent damages on the

amount found to be due from the insurer to the insured,

or one thousand dollars, whichever is greater, payable

to the insured, or to any of said employees, together

with all reasonable attorney fees for the prosecution

and collection of such loss . . . .

La. Rev. Stat. Ann. § 22:658 (West Supp. 1995).

2 Section 22:1220 provides:

A. An insurer . . . owes to his insured a duty of good

faith and fair dealing. The insurer has an affirmative

duty to adjust claims fairly and promptly and to make a

reasonable effort to settle claims with the insured or

the claimant, or both. Any insurer who breaches these

duties shall be liable for any damages sustained as a

result of the breach.

B. Any one of the following acts, if knowingly

committed or performed by an insurer, constitutes a

breach of the insurer's duties imposed in Subsection A:

. . . .

(5) Failing to pay the amount of any claim

due any person insured by the contract within

sixty days after receipt of satisfactory

proof of loss from the claimant when such

failure is arbitrary, capricious, or without

probable cause.

C. In addition to any general or special damages to

which a claimant is entitled for breach of the imposed

duty, the claimant may be awarded penalties assessed

3 Sta tutes 22:658 1 and 22:1220. 2 Following trial, the bankruptcyagainst the insurer in an amount not to exceed two

times the damages sustained or five thousand dollars,

whichever is greater.

La. Rev. Stat. Ann. § 22:1220 (West Supp. 1995).

4 court rendered judgment in favor of the Receiver for $45,000, the

amount of the loss, plus interest and costs. However, the

bankrup tcy court did not award penalties or attorneys' fees

pursuant to sections 22:658 or 22:1220 because it found that State

Farm acted reasonably in condu cting its investigation. The

Receiver appealed to the district court alleging that the

bankruptcy court erred in failing to award the penalties and

attorneys' fe es. The district court affirmed the bankruptcy

court's judgment; this appeal ensued.

ARBITRARY AND CAPRICIOUS ACTION

Under section 22:658, an insurance beneficiary is entitled to

penalties and attorneys' fees if, following satisfactory proof of

loss, the insurer fails to pay a claim within thirty days and the

failure is found to be arbitrary, capricious, or without probable

cause. La. Rev. Stat. Ann. §§ 22:658(A)(1), (B)(1) (West Supp.

1995). Similarly, section 22:1220 imposes a duty of good faith and

fair dealing on an insurer and subjects an insurer to penalties if

the insurer fails to pay a claim within sixty days following

satisfactory proof of loss, and the failure was arbitra ry,

capricious, or without probable cause. La. Rev. Stat. Ann. §§

22:1220(A ), (B)(5), (C). Satisfactory proof of loss occurs when

the insurer has adequate knowledge of the loss. C otton Bros.

Baking Co. v. Industrial Risk Insurers

, 941 F.2d 380, 386 (5th Cir.5

1991), on rehearing

, 951 F.2d 54, cert. denied

, 504 U.S. 941

(1992); Hart v. Allstate Ins. Co. , 437 So.2d 823, 828 (La. 1983).

As this Court recently noted, both statutes are p enal in

nature. R eal Asset Management, Inc. v. Lloyd's of London

, 1995 WL

469807, at *1 (5th Cir. Aug. 24, 1995). Because of the penal

nature, the statutes are strictly c onstrued and should not be

invoked when the insurer has a reasonable basis for denying

coverage. S ee S aavedra v. Murphy Oil U.S.A., Inc.

, 930 F.2d 1104,

1111 (5th Cir. 1991). Therefore, the threshold issue is whether

the insurer acted reasonably in failing to timely pay the claim

once the insurer had adequate knowledge of the loss.

The bankruptcy court explicitly found that State Farm did not

act arbitrarily or capriciously in refusing to pay or settle the

claim because "State Farm had a reasonable suspicion and was making

a reasonable investigation of the matter." The court based this

finding on the testimony of a State Farm claim representative that

there was still a reasonable doubt in his mind as to whet her the

vehicle was actually stolen or whether it was sold. The court

concluded: "While it appears quite clear now as a matter of fact

that the vehicle was not sold, at least was not sold by an

authorized representative of the corporation, there was a

reasonable doubt in the mind of State Farm representatives and they

proceeded with reasonable caution to investigate the matter."

This court reviews findings of fact by the bankruptcy court

under the clearly erroneous standard and decides issues of law de

novo. H aber Oil Co. v. Swinehart (In re Haber Oil Co.)

, 12 F .3d6

426, 434 (5th Cir. 1994); see Chevalier v. Reliance Ins. Co. , 953

F.2d 877, 883 (5th Cir. 1992). A finding of fact is clearly

erroneous when, although there is eviden ce to support it, the

rev iewing court on the entire evidence is left with a firm and

definite conviction that a mistake has been committed. Haber , 12

F.3d at 434.

We believe that the bankruptcy court clearly erred considering

the undisputed facts of this ca se. It is uncontested that the

Receiver was rightfully in possession of the Mercedes in accordance

with the July 1992 court order. This same order precluded Redwood

and its officers, directors, or employee s from disposing of

Redwood's property without court approval. The Receiver presented

uncontroverted testimony that the Mercedes was parked at the

Redwood complex in August 1992, just days prior to the theft.

Further, it is uncontested that car was removed from the Receiver's

possession, without c onsent. These facts lead to the inexorable

conclusion that the Mercedes was stolen from the Receiver.

State Farm, however, contends that its failure to settle the

claim was reaso nable because of the "suspicious circumstances"

surrounding the disappearance of the vehicle. Central to its

theory is the discovery of a purported bill of sale reflecting that

Redwood sold the car on June 20, 1992, one month prior to the

Receiver taking possession of Redwood's assets. State Farm argues

that since there was reason to believe that the car was not part of

the receivership estate, it acted reasonably when it denied

coverage pending resolution of its investigati on. The Receiver7

does not dispute that State Farm was entitled to a reasonable

investigation. However, the Receiver maintains that once State

Farm confirmed the fraudulent nature of the bill of sale, it no

longer had a reasonable basis to disp ute that the car was stolen

from the Rece iver and was required to settle the claim. The

Receiver is correct.

The undisputed evidence reflects that State Farm procured the

alleged bill of sale in April 1993, eight months after the reported

theft. This handwritten document reflects the sale of a gold

Mercedes Benz, with only 104 miles from Redwood to Yasser M.S.

Tokatli with a Saudi Arabian mailing address. The signature of the

seller was Mike T. Butler. The buyer's signature appears to be

John G. Davis, who also signed along with Butler as a witness. The

document is notarized by Georgia Notary Public, Linda C. Davis. In

late April 1993, State Farm deposed the president of Redwood, V.

Rae Phillips. Phillips testified that Redwood bought a taupecolored Merce des Benz that was used for business purposes in

December 1990. At the time of receivership, it had seven to ten

thousand miles on it. Concerning the bill of sale, Phillips

testified that she knew none of the names listed on the document.

Specifically, Phillips had never heard of the alleged seller, Mike

T. Butler, and Butler was not associated with Redwood or any of the

Recile companies. Following this deposition, State Farm clearly

had notice that the bill of sale was not genuine. In August 1993,

the fraudulent nature was confirmed when State Farm learned that

the signature of notary Linda Davis was also a forgery. State Farm8

adjuster Kenneth Mann testified t hat State Farm had no other

evidence, aside from the bill of sale, indicating that the car was

transferred by Redwood prior to the receivership. Despite concrete

evidence as of August 1993 that the b ill of sale was fraudulent,

State Farm continued to refuse payment.

State Farm's sole basis for disputing the Receiver's claim

was that the car was sold prior to the Receiver's possession of it.

The only e vidence of prior sale is the fraudulent bill of sale.

Consequently, it is clear from this record that as of August 1993,

State Farm no longer had any reasonable basis to dispute that the

car was stolen from the Receiver. At that time, State Farm was

under a statutory duty to settle the Receiver's claim. However,

State Farm paid the claim only after trial and adverse judgment was

rendered, some eighteen months after learning of the theft and six

months after definitive proof that the bill of sale was fraudulent.

State Farm relies on Headrick v. Pennsylvania Millers Mutual

Insurance Co. , 245 So.2d 324, 327 (La. 1971), for the proposition

that an insurer is entitled to a reasonable time for investigation

where there are suspicious circum stances surrounding a loss.

Headrick involved an arson defense where the claimant was a suspect

and the investigation was ongoing prior to trial. The situation

here is quite different. By August 1993, with the confirmation of

the fraudulent bill of sale, there was no evidence that Redwood

sold the vehicle prior to receivership. It was likewise clear

that: the Receiver was the rightful possessor of the Mercedes; only

the Receiver could approve sale of the car; and that no approval9

was ever given. At this point State Farm's defense evaporated; its

failure to pay became arbitrary and capricious. S ee Bohn v.

Louisiana Farm Bureau Mutual Ins. Co. , 482 So.2d 843, 857-58 (La.

App. 2d Cir.) (holding insurer acts a rbitrarily and capriciously

for failing to settle cla im o nce investigation clearly suggests

that insurer's defense is no longer available to it), writs denied

,

486 So.2d 750, 752 (La. 1986).

Despite this clear duty, State Farm still maintains that it

acted reasonably because other investigations by the National

I nsurance Crime Bureau and the East Baton Rough Parish Sherif f's

Office had not concluded and that State Farm still does not know

what became of the Mercedes. These arguments, however, are

irrelevant to the validity of the Receiver's claim. Even though

other investigations into the disappearance f ailed to piece

together the ultimate fate of the Mercedes, there was still no

evidence before State Farm that the car was sold prior to the

receivership or that the Receiver had sold the car. In the absence

of such evidence, we hold that State Farm's refusal to settle the

claim was arbitrary and capricious.

APPLICATION OF SECTIONS 22:658 AND 22:1220

Given our holding, it is necessary to remand this cause to the

bankruptcy court for determination of applicable statutory

penalties and att orneys' fees under sections 22:658 and 22:1220.

Because the relationship between these statutes has c reated some

confusion, we briefly offer our guidance.

Section 22:658 subjects an insurer to a penalty of ten percent10

of the amount due the insured or one thousand dollars, whichever is

greater, if the insurer fails to pay a claim within thirty days of

satisfactory proof of loss and the insurer acts arbit rarily,

capriciously, or without probable cause. La. Rev. Stat. Ann. §§

22:658(A)(1), (B)(1) (West Supp. 1995). The bankruptcy court

determined the amount of the covered loss was $45,000; therefore,

the Receiver is entitled to the ten percent penalty of $4,500.

Additionally, section 22:658 provides for reasonable attorneys'

fees for the prosecution and collection of the loss. On remand,

the bankruptcy court shall determine and award these reasonable

fees.

The application of section 22:1220 is more complex.

Initially, State Farm argues that section 22:1220 is inapplicable

because the Receiver did not amend his complaint to include section

22:1220 damages until the eve of trial. State Farm objected to the

section 22:1220 alleg ations during its closing argument, but the

issue was mooted when the trial court found no arbitrary or

capricious action. State Farm argues on appeal that its objection

should therefore be resurrected. This point is meritless. While

the Receiver's initial complaint included only section 22:658, it

also prayed for recovery of penalties and fees as provided by law.

Additionally, the pretrial order specifically identified sections

22:658 and 22:1220 as the issues of law in dispute. Under Federal

Rule of Civil Procedure 54(c), a final judgment shall grant the

relief to which the prevailing party is entitled. Fed. R. Civ. P.

54(c). If the defendant has appeared and begun defending the11

act ion, adherence to a particular legal theory suggested by the

pleadings is subordinated to the court's duty to grant the relief

to which the prevailing party is entitled, whether it has been

demanded or not, provided the failure to demand has not prejudiced

the adversary. 10 Charles A. Wright et al., Federal Practice and

Procedure § 2664 (1983). While the Receiver's initial pleadings

may have raised only section 22:658, it is clear from the pretrial

order that both statutes were at issue. Consequently, the

Receiver's failure to initially plead section 22:1220 damages does

not bar recovery if the statute otherwise applies.

Sections 22:658 and 22:1220 are similar in that each statute

provides for penalty awards when an insurer has arbit rarily,

capriciously, or without probable cause failed to timely settle a

claim. As we noted in Real Asset , the primary difference between

the two statutes is that section 22:1220 provides for an insured or

claimant or both to sue for breach of the duties under the statute,

whereas section 22:658 only allows an insured to sue for breach.

1995 WL 469807, at *1. Because this is an action between an

insured and insurer, both statutes apply. See id.

Section 22:1220 is trigge red when, i nter alia

, an insurer

breaches its duty of good faith and fair dealing by failing to pay

the amount of a claim within sixty days of its receipt of

satisfactory proof of loss when its failure is arbitrary,

capricious or without probable cause. La. Rev. Civ. Stat. Ann. §§

22:1220(A), (B)(5) (West Supp. 1995). Under the statute, a

claimant "may be awarded penalties assessed against the insurer in3 We note that section 22:1220, which applies after a sixtyday delay and provides for greater penalties, states that the

claimant "may be awarded penalties." In contrast, a violation of

section 22:658, applicable after a thirty-day delay and providing

for only a ten percent penalty, "shall subject the insurer to a

penalty."

12 an amount not to exceed two times the damages sustained or five

thousand dollars, whichever is greater." 3 I d. § 22:1220(C). State

Farm contends that under Louisiana law, a claimant must prove

damages sustained as a result of the breach to be entitled to the

penalty. S ee Champagne v. Hartford Casualty Ins. Group

, 607 So.2d

752, 758 (La. App. 1st Cir. 1992); see also Khaled v. Windham

, 657

So.2d 672, 680 (La. App. 1st Cir. 1995). According to State Farm,

the Receiver has no damages as a re sult of the breach, save

attorneys' fees, and therefore is not entitled to relief under the

statute. S ee Champagne

, 607 So.2d at 758-59. The Receiver,

relying on Estate of Robichaux v. Jackson National Life Insurance

Co.

, 821 F. Supp. 429, 431 (E.D. La. 1993), aff'd without opinion

,

20 F.3 d 1169 (5th Cir. 1994), and M idland Risk Insurance Co. v.

State Farm Mutual Auto. Insurance Company

, 643 So.2d 242, 244 (La.

App. 3d Cir. 1994), contends that there is no req uirement of a

showing of damages arising from the breach before pena lties are

applicable.

A careful reading of the most re cent authority reveals that

the Louisiana courts of appeals have resolved much of the apparent

conflict. The Louisiana First Circuit holds that a penalty award

under sec tion 22:1220 requires proof of damages arising from the

breach. S ee Champagne

, 607 So.2d at 758; Khaled

, 657 So.2d at 680.4 See

, e.g.

, Midland Risk , 643 So.2d at 244 ("Thus, we find if

an insurer commits any one of the acts enumerated in Section

1220(B), penalties may be imposed without a showing of

damages.").

13 While there is language in earlier Louisiana Third Circui t cases

that no showing of damages from the breach is necessary, 4 the Third

Circuit now concurs that the double-damages provision applies only

after a showing of damages arising fr om the breach. S ee Hall v.

State Farm Mut. Auto. Ins. Co. , No. 94-867, 1995 WL 323106, at *4

(La. App. 3d Cir. May 31, 1995). However, if no damages are proven

the claimant can still be awarded the maximum $5,000 penalty. Id.

Previous Third Circuit authority is consistent with this position.

See Midland Risk

, 643 So.2d at 244 (affirming a $5,000 penalty

award in the absence of proof of damages); Harris v. Fontenot

, 606

So.2d 72, 73-73 (La. App. 3d Cir. 1992) (affirming a $5,000 penalty

award although damages not proven). Likewise, R obichaux is

consistent with this interpretati on. 821 F. Supp. at 431-32

(awarding $5,000 penalty where plaintiff failed to prove damages as

a result of the breach). Consequently, on remand the bankruptcy

court should consider appellant's claim for penalties under section

22:1220 and determine if the Receiver has damages arising from the

breach making the double-damage provision applicable. If there are

none, only the $5,000 maximum penalty can apply in the event

penalties are awarded under section 22:1220. In any event, the

Receiver shall be at least entitled to the $4,500 penalty and

reasonable attorneys' fees under section 22:658.

CONCLUSION14

The bankruptcy court erred in finding that State Farm did not

act arbitrarily and capriciously in r efusing to settle the

Receiver's claim. Accordingly, the district court's order

affirming that portion of the judgmen t denying appellant's claim

for penalties and attorneys' fees under sections 22:658 and 22:1220

must be REVERSED and the case REMANDED to the district court with

instructions to REMAND to the bankruptcy court for further

proceedings consistent with this opinion.